BUSINESS STRATEGY

MODULE 1

CHAPTER 1 | WHAT IS BUSINESS STRATEGY

A business strategy is defined as a company’s dynamic plan to gain and sustain competitive advantage
in the marketplace. Strategies are more likely to be successful when the plan explicitly takes into account
four factors:

1.​ Where to compete, or the attractiveness of a

market or customer segment in the targeted
markets
2.​ How to offer unique value relative to the
competition in the targeted markets
3.​ What resources or capabilities are necessary to
deliver that unique value
4.​ How to sustain a competitive advantage once it
has been achieved.

The goal of the strategic plan is to create competitive

advantage and it must be able to respond to new
information that comes as customers, competitors, and
technologies change.

Competitive advantage requires that a firm consistently

outperform its rivals in generating above average profits
(i.e., returns in excess of what an investor expects from
other investments with a similar amount of risk).

Markets | Leaders must choose the industries a company competes in and the specific customer
segments or needs it will address within those industries.

For example, before the Ipod, Apple competed only in the computer industry. Its product markets included
desktop and laptop computers. Launching iPod and iTunes took Apple into the music industry. Later,
when Apple launched the iPhone, it entered the cell phone business. Apple targets the high end customer
segments within its industries. Its customers want the latest in technology, see themselves as innovations,
appreciate design and elegance, and are not price sensitive.

It is also important to select geographic markets to serve. Apple competes on a worldwide basis, which
allows it to spread heavy research and development costs across its many geographic markets.

Unique Value | Companies typically try to achieve a competitive advantage by choosing between one of
two generic strategies for offering unique value: low cost or differentiation.

Companies such as Walmart, Ryanair, Taco Bell, and Kia attract customers by being cost leaders, offering
products or services that are priced lower than competitor offerings.

Key sources of cost advantage include economies of scale, lower cost inputs, or proprietary production
know-how.

A firm that chooses a differentiation strategy focuses on offering features, quality, convenience, or
image that customers cannot get from competitors.

1
For instance, Starbucks wins though differentiation by offering multiple blends of high quality coffee in
convenient locations.

Resources and Capabilities | Delivering unique value requires developing resources and capabilities
that will allow the company to perform activities better than competitors.

Resources refer to assets that the firm accumulates over time, such as plants, equipment, land, brands,
patents, cash, and people.

Capabilities refer to processes (or recipes) the firm develops to coordinate human activity to achieve
specific goals.

Strategists also have learned that it is helpful to align the firm’s structure (organization design), staffing
(people), skills (capabilities/processes), systems (e.g., information and reward systems), and shared
values and style (its culture) with its strategy for offering unique value.

Sustaining Advantage | By being the first to offer music downloads through its easy to use iTunes
software, Apple encouraged its customers to store their entire music libraries on iTunes. Designing iTunes
so that it wouldn’t easily download songs to other music players helped Apple to prevent competing MP3
players from taking market share from Ipod. These actions helped Apple capture and sustain the value it
created.

What Information and Analysis Guides Strategy Formulation?

The earliest steps in the strategic management process involve analyses and choices that later result in
the formulation and implementation of a company’s strategy. These choices are made within the context
of the company’s mission, and only after an analysis of the external and internal environment.

Mission

A company’s mission outlines the company’s primary purpose and often specifies the business or
businesses in which the firm intends to compete- or the customers it intends to serve. Most business firms
start with a mission, even if it isn’t formally stated. For instance, Starbucks started with a mission to bring
high quality coffee to the masses in the United States.

As companies grow and develop formal mission statements, these statements often define the core value
that a firm espouses, and are often written to inspire employees to behave in particular ways. Even after it
has been formalized, however, a company’s mission is still open to interpretation.

External Analysis

External analysis should enlighten managers about the competitive forces that influence the profitability of
particular markets and industries, as well as opportunities and threats.

This involves an analysis of customers or potential customers, notably an analysis of their needs and
price sensitivity. In particular, the strategist can make better decisions about how to offer unique value
by considering a group of customers who all have similar needs (i.e., segmentation analysis).

2
Internal analysis

Internal analysis involves an analysis of the company’s set of resources and capabilities that can be
deployed- or should be developed- to deliver unique value to customers. This is where resource allocation
becomes an important dimension of strategy. After a company decides how it hopes to offer unique value,
it must allocate the resources necessary to build those resources or capabilities.

How are strategies formulated?

Formulating a strategy involves selecting which actions the company will take to gain and sustain
competitive advantage. A company will also need to formulate, and then implement, strategy at three
different levels of the organization: corporate, business unit, and functional.

Corporate strategy refers to decisions that are made by senior corporate executives about where to
compete in terms of industries and markets.

Business unit strategy is made at the level of the strategic business unit- standalone business units in a
company that typically have their own profit and loss responsibility.

Finally, within each business unit are different functions such as product development, operations,
information technology, sales and marketing, and customer service. A functional strategy should align
with the overall business unit strategies to effectively implement the business unit strategy.

Strategy vehicles for achieving strategic objectives

A firm may choose to grow by diversifying, adding to its products or opening a new line of business.

Acquisition is a strategy vehicle used for growth and diversification or to acquire key resources.

Sometimes companies decide to access new resources and capabilities through a strategic alliance- an
exclusive relationship with another firm- rather than through acquisition.

Vertical integration, or the make-buy decision, is also a vehicle for achieving objectives. For example,
when Apple decided to move into retailing by establishing Apple Stores, the company made a decision to
“make” stores that sold their own products, rather than simply “buy” the retailing services of stores run by
other companies, such as Best Buy or Walmart.

Finally, companies may use international expansion as a vehicle to achieve economies of scale, access
key resources, or learn new skills (i.e. competitive advantage).

Strategy implementation

Strategy implementation is the translation of a chosen strategy into organizational action so as to

effectively implement the activities required to achieve strategic goals and objectives. Effective
implementation typically requires the following:

●​ The functional strategies within the company- R&D, operations, sales and marketing, HR
management- are well aligned with delivering the unique value identified in the overall strategy.
●​ The organization’s structure, systems, staff, skills, style, and culture are designed to facilitate the
execution of the strategy.

3
Who is responsible for business strategy?

Strategic leaders are typically the leaders of an organization who develop strategy through the strategic
management process. These leaders are responsible for not only formulating strategy, but also for
explaining the strategy in a way that employees will understand- and in a way that will motivate
employees to execute it.

Deliberate strategies are implemented as a result of a careful analysis of markets, customers,

competitors, and a firm’s resources and capabilities.

Emergent strategy refers to a plan or a pattern of action that develops and emerges over time in an
organization despite a mission or goals.

Successful companies typically have strategies that are partly deliberate, due to effective strategic
planning processes, and partly emergent, due to willingness to respond to changes in the external
environment and to ideas that come from within the organization (e.g. this lead to the introduction of the
iPod).

Who benefits from a good business strategy?

Organization have four primary stakeholder groups:

1.​ Capital market stakeholder (shareholders, banks, etc.)

2.​ Product market stakeholders (customers, suppliers)
3.​ Organizational stakeholders (employees)
4.​ Community stakeholders (communities, gov’t bodies, community activists)

Some people believe that shareholders (owners of the company) are the most important. Others argue
that customers, governments, or communities should be the primary beneficiaries of business activity. In
the US, shareholders typically receive highest priority, but each stakeholder group can influence the
strategic decisions that are made by a company.

4
CHAPTER 2 | ANALYSIS OF THE EXTERNAL ENVIRONMENT : OPPORTUNITIES AND THREATS

One of the key threats a strategist must understand and cope with is competition. Often, however,
managers define competition too narrowly as if it occurred only among today’s direct competitors.

For instance, Nokie was so focused on Microsoft as its key competitor in the 3G operating system
industry, and Motorola and Ericsson as its cellphone competitors, that it failed to effectively prepare for
Apple’s entry into the industry.

Even though industries might appear to differ significantly, the principles that determine the underlying
drivers of profitability are often the same.

Determining the right landscape : Defining a firm’s industry

The first strategic decision that most firms must make is to select the industry, and markets, in which it will
compete.

The landscape is typically defined by: (1) the industry (or industries) in which a firm competes, and (2) the
product and geographic markets within that industry that the firm targets.

For example, Nokia competes primarily in the cellular telephone manufacturing and operating system
industries. Within the cellular telephone manufacturing industry, Nokia targets multiple product markets by
selling a range of handsets, from high end smartphones to inexpensive basic phones. The company also
targets multiple geographic markets, focusing mainly on Europe and developing economies in the Middle
East and Africa.

Furthermore, it seems obvious that Microsoft competes in the computer software industry. However, it
may be less obvious that those aren’t their only industries. In addition to operating systems, Microsoft also
makes the XBox gaming system, so it competes in the gaming console industry as well as the PC
operating system industry.

Firms must choose which markets to compete in, with many large firms choosing to compete in several at
the same time.

If managers do not properly define and understand their industry, they may be vulnerable to unseen
competitors. For example, Nokia defined itself primarily as a mobile handset manufacturer. As a result,
managers failed to see computer hardware companies like Apple and web search companies like Google
becoming potential competitors- or potential partners.

Truly understanding an industry often begins by taking a customer oriented view.

Rather than identifying the industry based on the product or services they produce (such as phones),
firms should think carefully about the job that products do for customers. What does a product fill?

Understanding customer needs can be very helpful in defining the boundaries of an industry.

Five forces that shape average profitability within industries

Rivalry, buyer power, supplies power, threat of new entrants, and threat of substitute products. The
strength of each of these five forces varies widely from industry to industry.

5
FORCE 1 | RIVALRY

Each move by a firm provokes countermoves among competitors, resulting in a constantly shifting
competitive landscape populated by winners and losers. Firms’ moves and countermoves can take many
forms, including sales and promotions, better quality or service, a wider variety of products, or lower
prices.

The following seven factors are critical to understanding the intensity of rivalry in an industry:

1.​ The number and relative size of competitors

The more competitors there are in an industry, the more likely that one or more of them will take action to
gain profits at the expense of others. The large number of firms responding to one another tend to create
intense rivalry (i.e. fragmented industry). The same is true of the relative sizes of competitors. If firms are
approximately the same size, they tend to be able to respond, or retaliate, strongly to moves by rival
firms.

Industries that are concentrated have far fewer competitors and tend to be dominated by a few large
firms. In these industries, rivalry is typically much less intense. Smaller competitors do not have the
capability to respond to actions taken by large firms, and the few large competitors are more aware of
each other and less likely to risk actions that may result in price wars.

2.​ Relatively standardized products

When products are standardized, or commodity-like, buyers are less loyal to a particular brand and it is
easier to convince them to switch brands. Firms that sell standardized products often have to compete by
offering sales, rebates, or lowering prices.

3.​ Low switching costs for buyers

Switching costs for buyers are related to the degree of product standardization. For instance, switching
from an iPod to another MP3 player might require music lovers to move all of their music files from iTunes
to a different music software. In contrast, most of us can change our brand of gum or candy bar without
any switching costs.

4.​ Slow growth in demand for products or services

When demand is increasing rapidly, most firms can grow without taking existing customers from
competitors. When growth slows, they may try to increase their sales volume by attracting customers from
their competitors through sales promotions, price discounts, or other tactics.

5.​ High levels of unused production capacity

Unused production capacity is expensive. Firms typically try to produce at or near their full production
capacity so that they can spread the fixed cost. However, when more is produced than is demanded in
the market, firms often have to drop their price or risk having unsold products (e.g., automobile industry).

6.​ High fixed costs, highly perishable products, high storage costs

Airlines, for instance, operate with high fixed costs. If it appears that a scheduled flight is going to have
few passengers, an airline may be tempted to discount steeply in order to fill as many seats as possible.
The variable costs of an additional passenger is very little, so selling a seat for less would not cost the

6
airline money, but leaving it empty would mean the airline has fewer passengers over whom to spread its
fixed costs.

E.g., as food nears the date when produce will spoil, grocery chains often steeply discount it rather than
lose the sale completely.

Products with high storage costs exhibit the same characteristics. If firms have an oversupply and are
forced to store the product, they may discount the price to avoid storage costs.

7.​ High exit barriers

In some industries, companies don’t exist even when they aren’t making a lot of money. Most often, they
stay because they have made investment in specialized equipment that can’t be used in any other
industry.

Also, emotional ties to employees or a business can also lead to less than rational decisions by top
management to stay in business.

FORCE 2 | THREAT OF ENTRY

One of the important tasks for strategists is to identify firms that might enter their industries.

New entrants pose a double hazard. First, they are typically anxious to gain market share. Unless the
industry is growing quickly, that market share must come at the expense of existing firms. Second, new
entrants bring new production capacity, which tends to drive prices down unless demand is growing faster
than the increase in supply.

New entrants mean greater rivalry, so existing firms often try to discourage new entrants by building
barriers to entry. Incumbent firms often signal new entrants that they are likely to retaliate by slashing
prices, increasing advertising, or other competitive moves that help the established firms hold onto their
market share. If the threats of retaliation are perceived as credible, potential entrants might decide to stay
away.

-​ Economies of scale, experience, or learning

These types of economies occur when the cost per unit of production decreases as a firm produces more.
In essence, lower costs allow the firm to either lower its price, perhaps in retaliation for a new firm
entering the market, or to maintain its price while earning more profits than competitors.

When these economies exist, new firms will be at a cost disadvantage. However, if conditions change so
that cost saving from these economies become smaller, the barrier diminishes.

-​ Other cost advantages not related to scale

1.​ Patents or proprietary technology (e.g., in pharmaceutical industry)

2.​ Better locations
3.​ Economies of scope
4.​ Preferential access to resources or access to distribution networks

-​ Capital requirements

Anything that requires the start up costs will reduce the pool of possible entrants. For instance, the
computer semiconductor chip industry, dominated by Intel, makes a very complex product.

7
New entrants would need to spend years of R&D before they had a viable product and could make their
first sale. The high capital requirements needed for long periods of R&D limit the number of entrants to
those with enough financial or other resources to enter.

-​ Network effects

When network effects are in operation, the greater the number of people using products from a given firm,
the greater the demand grows for that firm’s product.

For instance, a new entrant wanting to compete with Facebook is at a distinct disadvantage, because
most of their potential customers are more likely to be on Facebook, making it less likely that they will be
willing to switch to a new social media site.

-​ Government policy restrictions

For instance, governments often raise the costs of entry by requiring bonding, licenses, insurance, or
environmental studies before a firm can enter an industry.

Also, when competing across international borders, additional regulations, such as trade restrictions and
local content requirements, may be applied to try to limit foreign competition. In some industries, such
hairstyling, the requirement might be fairly minimal, but in others, such as oil refining, they can become so
onerous that most new firms cannot overcome the barrier.

FORCE 3 | THREAT OF SUBSTITUTES

A substitute is a product that is fundamentally different yet serves the same basic function or purpose as
another product. It involves determining the boundaries of an industry, and then scanning other industries
to find products that might serve the same basic functions.

If the product has the same basic characteristics and is made using the same general set of inputs, it
would be considered part of rivalry, rather than a substitute. For instance, competitor brands serving the
same basic need, such as Apple’s iPhones and Samsung’s smartphone running Google’s Android
operating system are rivals, not substitutes.

In general, substitutes put downward pressure on the price that firms in an industry can charge. The
factors that determine the intensity of a threat of substitutes include the awareness and availability of
substitutes and their price and performance compared to an industry’s products.

-​ Awareness and availability

Sometimes customers aren’t readily aware that substitutes exist. The threat increases when substitute
products are well known. Likewise, if the substitute product is just as easy for customers to obtain as the
industry’s products are, it is more of a threat.

-​ Price and performance

If substitutes are cheaper than products from another industry, the threat is higher. Likewise, if the
performance of substitutes is similar or better, the threat is higher. For instance, many newspapers have
seen steep declines in circulation as Internet news has gained in quality.

8
FORCE 4 | BUYER POWER AND PRICE SENSITIVITY

Determinants of bargaining power:

●​ Relative size and concentration of customers : if there are few buyers but many sellers, then the
sellers compete more strongly for buyer business, vice versa.
●​ Customers buy standardized products
●​ Customers have good information
●​ Customers threaten to integrate backward

Buyer price sensitivity | In general, when buyers are more sensitive, they are more likely to exert pressure
on suppliers to keep prices low. Buyers exert pressure not just through price negotiation but also through
more comparison shopping and a greater willingness to switch suppliers, for reasons like:

●​ Financial crisis : if many of an industry’s buyers are in the same situation, there is a cap on what
suppliers can charge
●​ Customers buy in large volumes
●​ Product/service is a significant portion of buyer’s costs : if the product is only a small part of their
cost structure, buyers are less likely to bother negotiating or comparison shopping.

FORCE 5 | SUPPLIER POWER

Determinants of bargaining power:

●​ Relative size and concentration of suppliers relative to industry participants

●​ High degree of differentiation of product and services / switching costs
●​ Suppliers threaten to integrate downward: a good example of this is Google and its decision to
forward integration into the smartphone industry by manufacturing its own phones.

In summary

The five forces help explain why industry profitability is what it is- and why it might be changing. Attractive
(profitable) industries are those where firms have created power over buyers and suppliers, created
barriers to entry to reduce the threat of new entrants, and minimized the threat of substitutes while
keeping rivalry to a minimum. Even inefficient, relatively poorly run companies can earn superior profits
under such conditions.

One thing to keep in mind is that the five forces are subject to change. Each of the five forces can be
altered by actions taken by firms inside or outside the industry.

New thinking about the five forces and industry attractiveness

To use a popular idiom : “Beauty is in the eye of the beholder”. Or, in other words, unattractive markets
according to traditional industry analysis may be quite attractive to the right kind of entrant.

Where successful companies choose to compete doesn’t depend so much on the historical profitability or
structural attractiveness of the market. Rather, it is fundamentally tied to what unique value they can offer,
what capabilities they have, and whether they can prevent imitation.

For industries that are not attractive from a five forces perspective, successful entry requires offering a
unique value proposition with unique resources and capabilities.

9
On the flip side, it is also important to understand that attractive markets from a five forces perspective
are typically unattractive for new entrants. In general, it is easier for new entrants to make money in
unattractive industries than attractive ones.

In general, companies should compete at the “job to be done” level (if one understands the functional,
emotional and social needs of the customer segment, the task of offering unique value becomes much
easier.

Tesla started in the automobile industry by targeting wealthy individuals who loved fast cars but also had
a desire to be green. Customers purchased a Testa not just because it solved a functional need
(transportation, speed) but also an emotional need (“I want a green world”) and a social need (“I want to
be part of the Tesla community and want others to know about my social consciousness”). Now Tesla has
added in-home battery charging stations and roof mounted solar panels for homes. So from a historical
perspective, Tesla is now in the roofing segment of the home construction industry as well as being in the
automobile industry. One could say that Tesla is in the energy industry at a very high level- which is true.
But it has expanded into roof tiles and battery-charging stations to do a particular job of a very specific
segment of customers: provide a convenient one stop shop for clean energy at home and on the road for
individuals who want a green world.

How the general environment shapes firm and industry profitability

The five forces are subject to change and may be affected, even radically, if elements of the general
environment change. The relative importance of each of the g.e. factors differ from industry to industry. In
the fast food industry, for instance, social forces, such as a shift toward healthier eating, are likely to
significantly alter the threat of substitutes, but technological change doesn’t play a large role.

10
COMPLEMENTARY PRODUCTS OR SERVICES

Complementary products or services are those that can be used in tandem with those in another industry.
For example, video gaming hardware and software, or smartphone operating systems and apps, are
complementary sets of products.

When two complements are used together, they are worth more that they are used apart.

For instance, the number of entrants in the App industry is actually increasing the barriers to entry in the
smartphone operating system industry. It would be difficult for a new mobile operating system to come on
the scene and compete with Apple or Android. Even Microsoft has experienced challenges entering the
mobile operating system business even though it had a head start over Apple and Google.

Determinants of the relative bargaining power of complements:

●​ Relative concentration : higher concentration implies higher bargaining power
●​ Customer switching costs versus competitors and complements (e.g. doctors vs pharmaceutical
companies, doctors have a higher switching cost)
●​ Relative complements/competitor switching costs
●​ Asymmetric integration threats
●​ Rate of growth of the market:
○​ Growing market: relatively generalized bargaining power
○​ Mature / Declining market: the ones that have the highest bargaining power take
advantage of it

The value net framework:

The presence of complementors was having an impact

on all other agents / dynamics in the industry (e.g.
rivalry, profitability, concentration).

PESTEL Analysis

POLITICAL & LEGAL FACTORS

Political, legal, and regulatory forces are those that arise from the use of government. When new laws are
passed, they may alter the shape of an industry and influence the strategic actions that firms might take.

In the US, following the Great Recession, the Federal Reserve required banks to keep larger amounts of
cash on hand to cover potential mortgage related losses. One consequence of this regulation was less
lending to small businesses, erecting entry barriers in many industries and changing the nature of rivalry
in industries with many small firms

11
ECONOMIC FACTORS

The state of an economy can affect a region or nation and, subsequently, the ability of the average firm in
an industry to be profitable

Economic growth | Economic expansion tends to improve customer balance sheets, lower price
sensitivity, and increase the growth rate in an industry, as customers purchase more, easing rivalry. The
reverse is also true.

Interest rates | This affects particularly expensive items like housing, cars, and even education, which
often require customers to take out loans to purchase. When interest rates are low, industry growth rates
increase and rivalry decreases.

Firms sometimes engage in price wars as a strategy for gaining market share when rates are high, rather
than investing in R&D and new product development.

Currency exchange rates | Exchange rates can have a large impact on the prices that customers pay for
products from firms in other countries, directly affecting profitability for those firms.

For instance, from mid 2010 to mid 2011, the Swiss franc appreciated 65% against the US dollar, making
Swiss products 65% more costly in the US, even though the cost of production hadn’t changed at all.

Inflation | Inflation tends to decrease overall economic growth, increasing rivalry and possibly buyer and
supplier power and the threat of substitutes. When firms can’t predict what price they will be able to get
for a particular product, investments in new product development become riskier.

SOCIO CULTURAL FACTORS ( & DEMOGRAPHIC FORCES )

Social forces refer to society’s cultural values and norms, or attitudes. For instance, changing cultural
norms about health have resulted in laws against sodas being sold in schools and lawsuits against fast
food retailers such as McDonald’s for marketing “unhealthy” food to children.

However, social forces can create opportunities if a firm happens to be among the first to act on changes
in values and attitudes. For instance, Facebook helped to change social norms about connecting to
friends and family.

Firms that compete in a global industry must understand differences among consumers in each country
they serve. For example, the collectivist orientation of many people in China results in considering open
sharing a norm, which ultimately allows a greater acceptance of product knockoffs and software pirating
than many people are comfortable with in countries that tend to have individualist orientations.

Education level, population growth and composition, lifestyle, family size and structures are also among
the characteristics of these factors that affect industries.

The average age of the population within a nation can also have a tremendous effect on some industries.
In Japan, for instance, more than 20% of the population is over age 65. The robotics industry has already
felt this shift. Japanese companies like Honda have invested tens of millions of dollars in robots for home
use, including walk assist robots that help seniors with weakened muscles remain ambulatory when they
would otherwise need to use a wheelchair.

12
TECHNOLOGICAL FORCES

Technological changes can include new products, new processes or new materials. Early adopters are
often able to gain market share and earn higher profit margins than those who are late to adopt. At the
same time it can also lower barriers to entry.

ECOLOGICAL / NATURAL ENVIRONMENT

Many firms have responded by implementing green initiatives. Although some of these may be for public
relations purposes, only many firms have established serious goals.

CHAPTER 3 | INTERNAL ANALYSIS : STRENGTHS, WEAKNESSES, AND COMPETITIVE

ADVANTAGE

The value chain

Porter’s value chain not only provides a framework to describe the activities a company performs, it also
can help identify which activities represent the firm’s competitive strength and weaknesses (but provides
no guidance about strength relative to competitors).

The resource based view

Resources are what a firm employs to create value and competitive advantage. Capabilities represent
how firms do things- the processes they use. Priorities explain why firms allocate critical resources to
achieve key objectives.

Resources: the “what”

Four types of resources enable both the core operational and important support/administrate activities in
the value chain.

Capabilities: the “how”

Capabilities are processes that the firm has developed to coordinate human activity in order to achieve
specific goals.

A firm’s advantage becomes stronger if it develops dynamic capabilities (take time to develop and
require significant learning).

For instance, Procter & Gamble has many brand resources, such as Crest, Tide, Pampers, Pantene. But
it also had been through the process of creating a new brand many times. Through repetition, P&G has
refined its capability to create new brands to the point that it now has dynamic capability that can help it
expand its existing brand resources with new additions.

Dynamic capabilities can help firms modify and evolve processes to keep pace with environment changes
such as new competitors, shifting demographics, or emerging technologies, and also enable firms to
incorporate learning into their processes.

Furthermore, they entail complex connections and coordination among different internal units within the
firm. For example, finding the optimal site for a restaurant requires input from marketing about
demographic information and target customer segments; the corporate counsel about sales contracts and
local regulations; and real estate professionals skilled at identifying, negotiating, and closing on
properties.

13
Also, at Pixar, values favoring creative collaborations led to a design priority: interaction. Building a
workspace that promoted these interactions maintains and enhances Pixar’s rich capabilities for
innovation in both technical design and storytelling.

Priorities: the “why”

Priorities are driven by a company’s underlying values. Values lead to priorities that help executives,
managers, and employees make decisions. Priorities drive the creation of resources and capabilities in
two ways. First, priorities guide resource allocation processes such as capital investment, human capital
acquisition and training, and brand development. Second, priorities maintain those allocations over time
when things get tough.

The VRIO model of sustainability

VALUE

Value denotes worth for customers. Products or services have value when they create direct pleasure,
satisfaction, or when they create indirect opportunities for users to experience pleasure and satisfaction.

For instance, low price itself may produce some direct pleasure for users, but its benefits are mostly
indirect, because purchasing products and services at a low cost usually leaves users with more money
to spend on other things that provide them pleasure or satisfaction.

Similarly, resources that help a firm bring differentiated products and services to the market create value
for customers, other than creating economic value for the firm- profit.

RARITY

McDonald’s tries to find unique locations for its restaurants, such as being the only restaurant at a
freeway exit, or the closest to the on-ramp, or its presence as the sole dining option inside many Walmart
stores.

Rare or unique resources create competitive advantage through a basic principle of economics- scarcity.

INIMITABILITY

Inimitability is the extent to which competitors cannot easily reproduce a product by employing equal, or
equivalent, sources of value in their own products and services. Several factors drive inimitability:

●​ Path dependence

Path dependence means that the process through which a resource or capabiliyìty came into being may
make it difficult for competitors to imitate. Path dependence heps to block imitation when resources or
capabilities follow a sequential development path- for example, when previous investments enable later
ones, or when significant learning underlies the resource or capability.

●​ Tacit knowledge

Many valuable skills and processes, such as Walt Disney’s knack of choosing good stories or Steve Job’s
ability to spot a great design in a product, can’t be learned easily, if they can be learned at all. These skills
are difficult, maybe even impossible, to learn, teach, or coach, because they are based on tacit
knowledge. Tacit knowledge is sticky, or immobile, and difficult to imitate by competitors.

14
 ●​ Causal ambiguity

Causality refers to the notion that one thing causes another: A leads to B. However, correlation does not
equal causation, and just because A and B appear together does not mean that A causes B.

For example, General Motors tried to imitate Toyota’s production methods- the Toyota Production System-
to produce cars at the same cost and quality. But even after its engineers spent weeks and months
watching Toyota build cars in a joint venture plant, GM still wasn’t able to achieve equal productivity, the
cause of Toyota’s productivity was not easy to determine because it was spread throughout the
organization, including hiring and training systems, the layout of its plants, and fundamental priorities, and
culture of the company.

●​ Complexity

Resources, capabilities, and priorities become difficult for competitors to imitate when they span the
organization or contain many interrelated elements and exhibit substantial complexity.

●​ Time compression diseconomies

Diseconomies happen when an action increases, rather than decreases, cost and inefficiency.

If a project requires a $20 million investment per year for the next two years, time compression
diseconomies mean that you can’t get the same results by spending $40 million in one year. Resources
that come from natural or physical processes cannot be rushed. Similarly, resources that come from
differences in individual or organizational abilities to learn require adequate time for lessons to be
deciphered and processed.

●​ Network effect and first mover advantages

Much of the reason eBay is so successful has to do with the network effects, which economists call
positive network externalities.

Network effects represent a specific form of a first mover advantage. For example, eBay has been able to
lock up the best sellers and most active buyers for its site because it was the first mover in the market.
Being the second to enter is difficult, as eBay learned in Japan, where it exited the market because
Yahoo!’s auction site had captured the first mover advantage.

In addition to customers, they can also lock up other resources such as locations, patents, or scarce raw
material inputs. They can also establish long term contracts with customers and set industry standards
that favor their products.

ORGANIZED TO EXPLOIT

E.g.: before 1970, the NFL Players Association (NFLPA) had been a weak collection of player
representatives. During the 1970s, however, the NFLPA emerged as a tre, well organized union, capable
of engaging owners in meaningful contract negotiations backed up by credible threats of striked and legal
action. The contracts that the NFLPA negotiated for its members have garnered an increasing percentage
of the NFL’s growing revenue. The NFLPA’s stronger organization enhanced its legal standing and
administrative abilities, allowing players to capture the value from their rare and inimitable resources.

15
Assessing competitive advantage with VRIO

Firms that can’t create value don’t

survive (i.e. competitive failure).
Many companies, especially new
start-ups, introduce valuable
products that are also unique and
rare and enjoy a period of
competitive advantage.

The combination of value and

uniqueness creates a short run
competitive advantage in time for a
firm.

Over time, however, competitors can imitate these resources and create competitive parity in the
industry. Parity means that a company survives but has no real competitive advantage over rivals.

To create competitive advantage in the long run, a firm must create barriers to imitation. However, durable
advantages dissipate over time, and moving from durable to sustainable potential advantage into an
actual one requires an organizational structure and design that captures the value from resources and
capabilities.

Companies that realize sustained competitive advantage combine the legal elements, such as contract or
intellectual property rights; administrative elements, including organizational structure; and cultural
elements, such as norms regarding rewards and what constitutes equity, that allow them to capture high
profits that come from their valuable, rare, and inimitable resources, capabilities or priorities.

The competitive advantage pyramid: a tool for assessing competitive advantage

16
 ●​ Archival data: written or numeric information can be found in the library
or on the Internet
●​ Interviews: these can rage from personal question to impersonal
surveys
●​ Observation: own experiences, such as visits or use of products or
services are also valuable

The competitive advantage pyramid provides a way to quickly document and understand a company’s
sources of competitive advantage, and it allows one to make some judgment about how durable and
sustainable that advantage might be.

For each strength, weakness, resource, capability, value, or priority you identify, include the source from
which you drew your data. If your data all come from a single source such as a website or a Bloomberg
Businessweek, Fortune, or Wall Street Journal article, then your pyramid will be weaker than if the
information is drawn from multiple sources. Tapping other data sources, such as doing an interview or
scheduling a plant visit will pay great dividends in creating a more complete profile of a company.

CHAPTER 4 | COST ADVANTAGE

Economies of scale

Economies of scale arise from four principal sources:

1.​ Ability to spread fixed costs of production

2.​ Ability to spread non production costs:
-​ Large volumes enable companies to spread the cost of R&D, advertising and G&A
expenses

17
 3.​ Specialization of machines and equipment
4.​ Specialization of tasks and people (i.e. task employee specialization)

At some point, however, the costs

per unit no longer decrease with
increases in volume. The point Q1 is
called the minimum efficient scale.
It is the optimal quantity for a
company to produce.

If a company continues to increase its volume beyond the minimum efficient scale, the cost per unit
actually starts to increase, due to diseconomies of scale. In large organizations, diseconomies of scale
can happen because large plants become very complex to manage.

Moreover, while large firms typically have an advantage in economic upturns, they are sometimes at a
disadvantage during a downturn because they have more difficulty spreading fixed costs when demand
declines.

Some firms with heavy fixed costs have moved to reduce the risks of large fixed costs by shifting more of
their cost structure from fixed costs to variable cost. One way they do this is by outsourcing more of their
activities. For example, rather than invest in information technology personnel or equipment, they may
outsource these services at a low cost provider.

The key point to remember is that size and scale do not always guarantee a cost advantage.

Economies of scope

Economies of scope differ from economies of scale in that the company does not reduce costs by
increasing the volume of a specific activity but by expanding the scope of its operations to related
activities, so that some costs can be shared.

Economies of scope exist when the cost of conducting two business activities within the same company is
less than the cost of those same two businesses operated separately.

The learning curve

It is a tool that managers can use to determine the contribution of human learning on the part of
employees to reduction in costs per unit.

18
Learning curve advantages are also relevant in service industries such as accounting and also personal
services such as hair styling.

The experience curve

This curve shows how costs per unit change with increase in cumulative volume produced. It does a
better job of capturing the effects of economies of scale than a learning curve does, because it includes
all costs and not just labor.

The law of experience : production costs usually decline by 10% to 30% with each doubling of
cumulative output.

Also, learning and experience curve slopes tend to be steeper in the early stages of production because
learning occurs more rapidly in the early stages of production.

Most strategists today acknowledge that there is a correlation between market share and profitability and
appreciate that greater market share will lead to lower costs per unit. However, in most cases the cause
of both market share and profitability is some common underlying factor, such as a lower cost method of
production or an innovative product that allows a firm to grow.

How strategists use the scale and experience to make decisions

Growth / Investment strategy

Experience curves tend to be steeper in fast growing industries. A scale or experience curve slope in a
particular industry that is quite steep (a slope less than 85% is quite steep, meaning that with each
doubling of volume, costs drop by 15% or more) indicates that first movers in a fast growing market will
secure a widening cost advantage.

Firms in an industry with a steep curve have an imperative to grow as fast, or faster, than their rivals, so
they do not end up at a cost disadvantage.

Pricing strategy

A company can use the curve to anticipate future costs at different levels of volume. If higher unit volumes
produce lower costs per unit, the company may want to price its product or service aggressively low, so
that it can gain enough market share to reach those higher volumes and make more money.

For example, Hyundai has been described as a company that is pricing very aggressively to gain market
share in order to lower its future costs per unit. The strategy seems to be working, as evidenced by the
fact that shares have tripled in the US in the last 10 years. Of course, if all firms in an industry attempt to
price for market share gains without a sustainable cost advantage, the strategy may not work for anyone.

Costs management strategy

It is possible to plot scale or experience curves for a company and for its competitors, allowing company
leaders to assess how well each company is managing its costs.

E.g., for many years, General Motors produced more cars than any other automaker in the world. An
industry wide analysis of several companies’ costs per unit showed that while GM produced the most
units, it did not have the lowest cost per unit. Toyota, Honda, and Hyundai all had lower costs per unit.

19
Acquisition strategy

A scale curve can be useful to predict cost synergies, which is why acquiring firms must pay a premium to
the shareholders of the target firm.

Proprietary knowledge

Patents are often important sources of proprietary intellectual property.

E.g., Toyota has long been known to have lower production costs than its US competitors in the auto
industry- GM, Ford, and Chrysler- because it has pioneered flexible production techniques (TPS), while
US firms have always relied on mass production techniques. These techniques are not protected by
patent but by trade secrets.

The architect of the Toyota Production System was an engineer, Taiichi Ohno, who realized that Toyota
simply didn’t have the volume of production required to compete with US automakers on the basis of
economies of scale. So, Ohno invented a set of processes that allowed Toyota the flexibility to make three
to four different car models with the same plant. US automakers, in comparison, could typically only make
one or two different car models within the same plant.

A key principle of the TPS is “just in time” delivery of components, both from outside suppliers and from
different manufacturing stations within the plant. Delivering components close to the time they will be
used keeps inventories at plants low and minimizes waste.

Studies have shown that the TPS comprises roughly 30 key processes, including its just in time delivery.
Although US firms have tried to imitate many of the practices of TPS, they have been relatively
unsuccessful at understanding the full proprietary system and how it works. As a result, Toyota has been
able to maintain a cost advantage and quality advantage over many competitors.

Lower input costs : there are four primary ways that companies can achieve cost cost advantage
through lower cost inputs:

1.​ Bargaining power over suppliers

There are two main sources of bargaining power: buying a lot from the supplier and using successful
negotiating tactics.

Suppliers are known to drop prices by 5 to 10% with a doubling of purchased volume. At high volumes,
suppliers experience economies of scale and the law of experience, so they can lower their prices.

E.g., Walmart is well known for its purchasing strategy and tough negotiating tactics. Walmart spreads its
purchases across numerous suppliers, so that no one supplier has a dominant market share in any
particular product category. The company’s willingness to drop a supplier if another supplier comes in with
a lower price is widely known. These practices let suppliers know that they are expandable, which creates
an incentive for suppliers to always give Walmart their lowest prices.

2.​ Cooperation with suppliers

Toyota is known for working cooperatively with suppliers to get lower cost and higher quality inputs.
Rather than spread purchases across multiple suppliers, Toyota has a two vendor policy: it typically works
with only 2 partner suppliers of a particular input. By working with a smaller number of suppliers, Toyota is
able to devote resources to make sure it coordinates very effectively with these particular suppliers.

20
Toyota will even send its own engineers to help suppliers implement more efficient manufacturing
processes to lower their costs. As a result of their close, highly cooperative relationship with Toyota, many
suppliers will build their manufacturing plants close to Toyota’s automobile assembly plants, thereby
lowering the costs of transportation, logistics, and face to face communications.

3.​ Location advantages

The price of inputs can vary significantly between locations because of differences in wage rates,
exchange rates, or raw material or energy costs.

4.​ Preferred access to inputs

In some instances, a company may have a cost advantage because it has preferred access to particular
inputs. For example, drilling oil in Saudi Arabia requires only the simplest drilling technologies, because
drilling is less complicated in the desert and oil is more frequently found relatively close to the surface. For
this reason, Saudi Arabian oil companies, like Saudi Aramco, can access oil more cheaply than most oil
companies in the world can. Not surprisingly, Saudi Aramco is reportedly the most profitable oil company
in the world.

In similar fashion, the diamond company De Beers has historically had preferred access to diamonds
because De Beers owns and controls the output of a large percentage of the world’s diamond mines.

Companies gain a cost advantage only through preferred access to inputs when those inputs are raw
materials (such as oil or diamonds) that are rare and difficult to imitate.

Different business model

There are two basic ways to create a new business model: to eliminate activities or steps in the value
chain or to perform different activities altogether.

-​ Eliminating steps in the value chain

One reason Ryanair has a cost advantage over other airlines in Europe is because it does not offer any
in-flight meals, pillows, blankets, or even airsick bags.

Similarly, Panasonic has long had a cost advantage over competitor Sony, because it opts to spend only
half as much as Sony spends for R&D each year. Rather than lead in product development, Panasonic
follows, largely by imitating Sony’s technologies. Panasonic also spends less than Sony does on
advertising, because it does not lead in launching new product designs. Eliminating some R&D and
advertising allows Panasonic to have lower costs, and lower prices, for comparable products.

-​ Performing completely new activities

Book retailer Barnes & Noble sells books through large superstores. In 1995, [Link] began to sell
books in a completely different way- over the Internet. It was much cheaper for Amazon to build a few
large warehouses, take orders online, and ship books directly to the customers’ homes than to do the
things Barnes & Nobles was doing: building superstores, hiring employees to staff the stores, and buying
and storing inventory.

21
CHAPTER 5 | DIFFERENTIATION ADVANTAGE

When customers go to purchase a product (or a service) to get a job done, they tend to consider two
factors:

1.​ The way a product is differentiated from other products to perform the job they want done
2.​ The price of the product

Product differentiation is a strategy whereby companies attempt to gain competitive advantage by

offering value that is not available to other products or services or that other products don’t do as well.
This value may come in the form of different product features, product quality or reliability, convenience,
or brand image.

Product differentiation is always a matter of customer perception.

When the perceived value of the product increases in the mind of the customer, it also increases the
customer’s willingness to pay a higher price. Thus, companies that invest resources to create unique
features in their products often charge a premium price (investments in resources increase the cost of
their offering).

Sources of product differentiation

Different product/service features

1.​ Does a better job on existing features

Some companies differentiate their products by focusing on one particular feature and doing a better
functional job than other products by providing value on that particular feature.

E.g., Dyson vacuums have gained market share by claiming the Cyclone technology in their vacuums
provides better “sucking” capability.

Some companies succeed by doing a better job of providing service to customers. Of course, every
company must provide service to customers, but some just figure out ways to exceed customer
expectations.

22
 2.​ Does more jobs

E.g., Facebook did a job that the other social networking sites did not do when it gave users the ability to
alert their friends about their “relationship status”, a particularly important piece of information for
teenagers and college students.

3.​ Does a unique job

E.g., Disney theme parks are the only places you can go to see Mickey Mouse or ride the Pirates of the
Caribbean to see Captain Jack Sparrow.

Products that are designed to be customizable by customers do a unique job because they can be
created expressly to meet one particular customer’s unique need.

E.g., Nike allows customers to design their own athletic shoes by selecting from a variety of design, color,
and print options.

Quality or reliability

A product differentiated based on quality or reliability offers essentially the same features and functionality
of other products, but lasts longer. For customers who don’t like the hassle of products breaking down,
this can be an important differentiator.

Historically, Honda and Toyota have succeeded, and differentiated their products, based on superior
reliability. Their vehicles have typically been at the top of various quality ratings because they have the
fewest defects. Customers don’t necessarily purchase Honda or Toyota vehicles because of superior
styling, more comfortable seats, or more power. They buy them because they are reliable and don’t often
break down.

Convenience

The product itself might actually be identical to other products on the market, but the seller has figured out
a way to make it easier for customers to buy.

E.g., Starbucks does attempt to differentiate its coffee through branding and by offering different blends
and taste. But perhaps just as important, the company makes its coffees very easy to find.

Convenience is also one of the reasons why Coke and Pepsi are so successful. By investing in enormous
vending machine networks, they ensure that when you are thirsty, there is likely to be a Coke or Pepsi
nearby.

Convenience also includes making a product easier to purchase. [Link] was the pioneer of one
click purchase on the Internet, differentiating its services and contributing to its ability to outsell other
Internet retailers. It essentially provides a one stop shop for customers looking to buy products online.

A special case of convenience involves the size of the network or ecosystem of the firm offering a product
or a service. Some products or services are more convenient to use because there is a large network of
other users (e.g., Facebook, eBay in the US, and Yahoo! in Japan).

Brand image

Brand image is typically developed through marketing, via advertisement, promotion, and other marketing
activities.

23
Interestingly, numerous studies have shown that the more people are exposed to something, be it a
brand, a company, or products, the more they come to trust it (i.e., the mere exposure effect, or in social
psychology, the familiarity principle).

Beyond mere exposure, companies also attempt to actively associate their products with positive qualities
in the minds of customers. Sometimes, the job we hire a product to do is to help us feel part of an elite
group or club. For example, this is why many people hire a brand such as LV, Versace or Rolex even
when functionally equivalent products can be purchased at a much lower price.

How to find sources of product differentiation

Customer segmentation

Companies are more successful when they can offer the exact value that each customer is looking for.
However, the cost of designing a specific product for each customer is usually prohibitively high. The next
best solution is to group customers based on similar needs and then create products that meet the needs
of a particular group (i.e., customer segmentation).

Along with defining customer segments, a company must choose which segments are actually in its target
market. Strategy involves making trade offs, and companies often have to make decisions about where to
deploy scarce resources to get their best return.

When companies do not effectively segment customers into similar need based groups, then they are
likely to run into one of two problems. The first problem is that they may add features, and costs, to their
products that some groups of customers don’t really want and don’t want to pay for. The second problem
is that they may not add features that certain groups care about and would be willing to pay for, potentially
losing market share to rival firms that do offer those features.

Markets are usually segmented in one of three ways:

1.​ Product attributes

By assessing the relative importance that customers put on different attributes, and grouping customers
based on what they want in those attributes, it may be possible to design products to meet the needs of
that customer segment.

E.g., Honda tends to design motorcycles that appeal to customers who want reliable, easy to handle
transportation vehicles. Harley Davidson designs rugged motorcycles that are loud, showy, and highly
customizable.

2.​ Demographic / Customer attributes

Popular ways to segment the consumer market include by age, socioeconomic status (e.g. income),
education, profession, and ethnic group.

A typical way to segment the business market is based on size of companies, as measured in revenues,
assets, or employees. Large companies are often perceived to have needs that differ considerably from
those of small companies.

Segmenting based on demographics has the advantage that it is relatively easy to do, once you have
data to place customers into different demographic categories. The disadvantage is that not all individuals
(or companies) within a particular demographic category share the same needs and wants.

24
 3.​ Job to be done

Every job has a functional, social, and an emotional dimension. The relative importance of these
dimensions varies from job to job.

E.g., “I need to feel like I belong to an elite, exclusive group” is a job for which luxury brand products such
as Gucci and Versace are hired. In this case, the functional dimension of the job isn’t nearly as important
as its social and emotional dimensions.

When companies in an industry segment customers in a particular way, there may be an opportunity for a
company to segment the market in a different way, thereby identifying groups of customers whose needs
are not met by the typical method of segmentation. This might allow a company to offer a different value
proposition, thereby creating a competitive advantage with a particular group of customers.

Mapping the consumption chain

This involves identifying all the steps

through which customers pass from
when they first become aware of a
need for a product to the time when
they finally have to dispose of it or
discontinue using it.

25
 -​ How do consumers become aware of their need for a product or service?

A company may be able to differentiate its product if it can find a unique way to make consumers aware
of a need.

For example, Oral-B discovered a way to capitalize on a widespread habit (i.e., using a toothbrush for too
long, until its bristles become word and no longer effective at cleaning teeth) by inventing a way for the
toothbrush to communicate to the customer that it needs to be replaced. Oral B introduced a patented
blue dye in the center of its toothbrushes. The dye gradually fades as the brush is used. When the dye
completely disappears, it signals the user that the brush is no longer effective and needs to be replaced.
Thus, customers are made aware of a need that previously had gone unrecognized.

-​ How do consumers find your offering?

Companies can differentiate their offering if they can make the search process easier for customers by
making it less complicated, more convenient, or less expensive.

Many companies help consumers find their product by paying to be at the top of a Google search.

Other ways to make a product easier to find include making it available when other are not, as companies
that have 24 hour telephone order lines do, or offering it in places where competitors do not offer theirs.
E.g., some credit card companies set up booths on college campuses to put credit cards within easy
reach of college students.

-​ How do consumers make their final selections?

It is critical to ensure that consumers are aware of features that differentiate a product. Some companies
assist in product selection by providing customers with side by side comparisons of their products with
those of competitors.

Alternatively,a company can select the one feature that customers might care about and trumpet how
their product beats others on that particular feature.

Anything that can be done to make the product selection process more comfortable, less irritating, or
more convenient has the potential to be a differentiator.

-​ How do customers order and purchase your product or service?

[Link] has made the process of purchasing a product online easier by storing all of your relevant
personal and credit information and allowing you to use their one click purchase option. Similarly,
Starbucks has created a “Starbucks Card” that is essentially a credit or debit card that allows you to
quickly swipe your way to a coffee. In addition to buying the coffee faster, customers who use a Starbucks
Card also accumulate points that can be applied to future purchases at Starbucks.

-​ How is your product or service delivered and/or installed?

Transporting and assembling products are stumbling blocks for customers, so these services can be a
source of differentiation.

If a product requires assembly or installation, companies may differentiate themselves by making it easier
to install.

26
 -​ How is your product stored?

When it is expensive, inconvenient, or even dangerous for customers to have a product simply sitting
around, a company has the potential to differentiate the product by providing better or easier storage
options.

E.g., NordicTrack, a maker of workout equipment including cross country ski machines and treadmills,
has designed many of its workout machines to easily fold up and slide under a bed or into a closet ​
(i.e., easy to store machines).

-​ What do customers need help with when they use your product?

E.g., each year during Thanksgiving in the US, millions of home chefs cook a turkey. Many of these
people are making it for the first time and have questions about the process. Butterball (and some other
turkey providers) install a pop up button on the turkey that springs outward when the turkey is done. Its
help line and pop up signals help differentiate Butterball as the best turkey choice for inexperienced
cooks.

-​ What if customers aren’t satisfied and need a return or exchange?

Handling problems well when the product doesn’t work out for a customer can be as important as meeting
the need that motivated the initial purchase.

Nordstrom is an excellent example of a company that has focused on succeeding through superior
service including after sale service.

Customers may be unhappy with a particular product that they return, but they are not unhappy with the
store if it does everything possible to make sure that the return is easy to do.

-​ How is your product repaired, services, or disposed of?

Repair experiences- both good and bad- can influence a lifetime of subsequent purchases. Thus,
companies can find opportunities to differentiate by ensuring that products are quickly and easily repaired
when they fail to work properly.

E.g., RC Willey, a successful seller of mattresses and appliances, will haul away your old mattress or
oven for free when you buy a new one. By disposing of obsolete or broken appliances, mattresses, and
furniture for customers when they purchase a product, RC Willer meets a customer need that may be
unrelated to the new product, but still differentiates the product because it comes with a service that
makes the customer’s life easier.

Building the resources and capabilities to differentiate

E.g.: How Starbucks built the resources to differentiate

One capability that proved essential in order for Starbucks to differentiate itself with high quality coffee
and multiple blends was the ability to roast and blend coffee beans. Most coffee shops in the US did not
roast their own coffee beans and therefore couldn’t match the quality of coffee that SB offered. They also
learned- through analysis and trial and error- to identify the optimal locations within a city in order to make
each shop as conveniently accessible to as many customers as possible. To prevent imitation of its coffee
shops, SB built stores as quickly as possible so that would-be imitators would find that the best locations
for similar coffee shops within a city were already taken.

27
New thinking: achieving low cost and differentiation

Porter stressed that “achieving cost leadership and differentiation are usually inconsistent, because
differentiation is usually costly”. Studies have shown, however, that business units that successfully
combine both low cost and differentiation advantage have the highest ROI.

E.g., Intel was able to successfully differentiate its microprocessors through superior processing speed
and with its “Intel Inside” and “Pentium” branding. This allowed Intel to develop a dominant position in the
marketplace which allowed it to generate larger volumes than competitors, thereby resulting in lower
costs per unit because of a steep experience curve (ultimately leading to higher ROI).

The same could be said for Apple’s iPod. The iPod came to dominate the market due to superior features
which subsequently led to large production volumes and low cost per unit.

How are companies able to compete on both price and differentiation simultaneously? The basic
arguments is that by offering a combination of low price and differentiation the company is able to attract
so many customers that they are able to lower their cost (and price) per customer (through economies of
scale and scope) and generate enough profits to invest in new differentiated offerings that bring in even
more customers. This leads to a virtuous cycle of creating new layers of unique value.

If successful, the company simultaneously offers low price and a differentiated product- a combination of
unique value that is extremely difficult for any competitor to match. There is simply no reason for a
customer to switch to a competitor offering. If Uber offers both lower price and more convenience, why
would anyone want to use a taxi? This explains why taxis have lost more than 80% share in some
markets like San Francisco.

Assessing differentiation performance

Companies that do an exceptional job of providing unique value to customers get their customers to
promote the products to others. In effect, they turn their customers into salespeople. Naturally, this has a
positive effect on a company’s growth.

28
 FROM INDUSTRIES TO ECOSYSTEMS

An ecosystem is a locally independent collaborative arrangement of multiple firms, other organizations

(e.g. public agencies), and/or customers that co-create value outside of single organizational boundaries
based on multilateral interactions.

Ecosystems comprise sets of actors with varying degrees of multilateral, non generic
complementarities (i.e., need to co-specialize) that are not fully hierarchically controlled.

James Moore, a researcher in the field of social and economic systems, explained how Walmart built up a
vivid business ecosystem consisting of a sophisticated distribution network and community members, with
increasing success in terms of sales growth and store numbers. He also described how each business
ecosystem followed a “lifecycle of evolutionary stages”, thereby including biological ideas of birth, growth,
and death into ecosystem thinking in management.

Other researchers have claimed that organizations could not formulate strategies on their own but
dependent on the health of the surrounding ecosystem: firms need to orchestrate a multitude of
collaborators- sometimes even competitors at the same time- in order to create value.

29
 What ecosystems are not

Why do ecosystems emerge?

How then can firms address this problem that seems to overstretch their own resources? It is through new
organizational models that span firm and industry boundaries. It is by accessing resources and
capabilities firms do not own themselves but rather pool with their collaborators. And it is by distributing
part of the risk to partners and by decomposing complex solutions into manageable components.

As organizations build products and services, they assemble and link value generating activities. These
organizations incur costs arising from aligning, monitoring, or negotiating these activities.

Organizations exist to reduce these costs and inefficiencies by internalizing the necessary resources and
capabilities under one umbrella. The alternative would be buying all these activities on the market. Simply
imagine the overwhelming complexity an organization would face if it had to manage a large crowd of
unconnected freelancers, for example, some to initiate a marketing campaign and others to operate the
logistics.

30
 How ecosystems transform traditional industries

Traditional music value chain​ ​ ​ ​ ​ New music industry value network

31
 Roles and actors in the ecosystem

How healthy is your ecosystem?

-​ Robustness: to the survival rate of

firms (the higher it is, the more robust the
ecosystem is)
-​ Niche creation: cutting yourself a
specific role within the ecosystem

32