Maryam Ahmed​ ​ ​ ​ Managerial Policy​ ​ ​ ​ ​ 25994

Managerial Policies

The AFI Strategy Framework

Part 1: Analysis

●​ What is Strategy?
●​ Strategic Leadership
●​ Managing the Strategy Process
●​ External analysis: industry structure, competitive forces, and strategic groups.
●​ Internal analysis: resources, capabilities and core competencies
●​ Shared value and competitive advantage

Part 2: Formulation

●​ Business Strategy: DIfferentiation, COst Leadership, and Blue Ocean

●​ Business Strategy: Innovation, Entrepreneurship and Platforms
●​ Corporate strategy: vertical integration and diversification
●​ Corporate strategy: strategic alliances, mergers and acquisition
●​ Global strategy: competition around the world.

Part 3: Implementation

●​ Organizational Design: Structure, Culture, and Control.

●​ Corporate Governance, Business Ethics, and Business Models.

What is Strategy?
Strategic management is the integrative management field that combines analysis, formulation, and
implementation in the quest for competitive advantage.

Mastery of Strategic Management enables us to see the organization in its entirety.

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What strategy is: Gaining And Sustaining COmpetitive Advantage

Strategy is a set of integrated actions a firm takes to gain and sustain superior performance relative to
competitors. The output of strategic management processes is a strategy. To achieve superior
performance, companies compete for resources.

A good strategy can achieve superior performance and sustainable competitive advantage relative to its
competitors. A good strategy consists of

1.​ Diagnosing/Analyzing the external and internal environments to identify competitive challenges.
2.​ Making a guiding policy to address the competitive challenge by formulating a strategy. It can
have corporate, business, and functional strategies
3.​ Implementation of the guiding policy through coherent actions.

What is Competitive Advantage?

Competitive advantage: Superior performance relative to competitors in the same industry or the industry
average. It is always relative and is assessed by benchmarking either the performance of competitors or
industry average.

Sustainable CA is when a firm outperforms its competitors for a prolonged period. If a firm
underperforms it is said to have a competitive disadvantage. Competitive parity is when rivals are
performing at a similar level.

Two Strategies form the basis for competitive advantage:

●​ DIfferentiation: unique product at similar cost

●​ Cost Leadership: Similar product at lower cost

Benefits from CA is higher profitability and increased market share. Successful companies try to fill a gap
in the market. For numerous other entrepreneurs, creating shareholder value and making money is the
consequence of being purpose-driven.

A good strategy delivers superior value while managing the creation costs and it is achieved through
strategic positioning. Firms stake out a unique position that allows firms to provide affordable value.
(Walmart and Nordstrom case).
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Having a clear strategic profile and serving a specific market segment is of importance. It is important for
firms to know who to cater and who not to cater as resources are limited. This can help firms win in the
same industry (not zero-sum). Firms need to stake out a unique and profitable segment.

Operational effectiveness, marketing skills, and other functional expertise can strengthen a unique
strategic position. However, they do not substitute for competitive strategy. If all firms are catering to the
same segments then lesser profits for everyone.

Red Queen effect: A situation in which everyone runs faster but there are no changes in relative strategic
positions. It results in a zero sum situation where little to no value is created for customers.

Strategy is not:.

●​ Grandiose Statements
●​ A Failure to Face a Competitive Challenge
●​ Operational Effectiveness, Competitive Benchmarking, and Other Tactical Tool

Stakeholder Strategy and Competitive Advantage

Value Creation

Occurs when companies with a good strategy are able to provide products or services to consumers at a
price point that they can afford while keeping their costs in check, thus making a profit at the same time.
Both parties benefit from this trade as each captures a part of the value created and society benefits. Value
creation lays the foundation for societal benefits. CA firms reinvest the profits and grow.

The goals of a good strategy are to create value and to capture some of it. All organizations are embedded
in a network of exchange relationships, for which a stakeholder strategy is made.

Stakeholder Strategy

Stakeholders are organizations, groups, and individuals that can affect or be affected by a firm’s actions.
They have a vested claim or interest(various contributions) in the firm’s performance and continued
survival. A firm can have internal and external stakeholders.
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●​ If any stakeholder withholds participation in the firm’s exchange relationships, it can negatively
affect firm performance
●​ Putting shareholder interest above all else risks the company's economic performance and even
threatens its very survival.

Effective stakeholder management exemplifies the firm’s performance, increasing its CA which ensures
continued survival.

Stakeholder impact Analysis

The challenge in stakeholder strategy is to ethically balance the conflicting needs of various stakeholders
while ensuring shareholders achieve their desired ROI. There are three stakeholder attributes:■

●​ Power is when stakeholders can get the firm to do something that it otherwise wont
●​ Legitimate is when stakeholder claim is legally valid or otherwise appropriate
●​ Urgent is when a stakeholder requires a company’s immediate attention and response.
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1.​ IDENTIFY STAKEHOLDERS: “Who are our stakeholders?” Stakeholders that currently or
potentially can have a material effect on the company are the most powerful internal and external
stakeholders. It can be shareholders or customers, suppliers. If their needs are not met, it will
affect materially affect the firm
2.​ IDENTIFY STAKEHOLDERS’ INTERESTS: “What are our stakeholders’ interests and claims?”
Categorise the stakeholders into urgency, power and legitimate groups.
3.​ IDENTIFY OPPORTUNITIES AND THREATS: “What opportunities and threats do our
stakeholders present?” In the best-case scenario, strategic leaders transform such threats into
opportunities.
4.​ IDENTIFY SOCIAL RESPONSIBILITIES: “What economic, legal, ethical, and philanthropic
responsibilities do we have to our stakeholders?” CSR provides strategic leaders with a conceptual
model that helps them identify society’s expectations and guides strategic decision making.
a.​ Economic Responsibilities: a business enterprise is an economic institution. Stakeholders
can expect different things from a company. To meet all these expectations, firms must
obey the law and act ethically to gain and sustain CA
b.​ Legal Responsibilities: These embody a society’s notions of right and wrong. They also
establish the rules of the game.
c.​ Ethical Responsibilities: Legal responsibilities define only the minimum acceptable
standards. The law cannot address all possible business situations therefore the firm should
go beyond its legal responsibilities to reflect the full scope of stakeholders’ expectations,
norms, and values.
d.​ Philanthropic Responsibilities: These are often subsumed under the idea that companies
should voluntarily give back to society.
5.​ ADDRESS STAKEHOLDER CONCERNS: “What should we do to effectively address the
stakeholder concerns?” Firms need to decide the appropriate actions for the firm, given all of the
preceding factors. Thinking about power, legitimacy, and urgency helps firms prioritize different
stakeholders.
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Implications for Strategic Leaders

Strategy is the art and science of success and failure. The difference between success and failure lies in an
organization’s strategy.

●​ Strategic leaders know that competition exists and find how to deal with it.
●​ They are mindful of the organization’s internal and external stakeholders
●​ THey realize that the principles of strategic management can be applied universally to all
organizations.
●​ They make decisions under conditions of uncertainty and complexity. They must monitor and
evaluate the progress toward key strategic objectives and make adjustments by fine-tuning.

Strategic Leadership: Managing the Strategy Process

Strategic Leadership

Strategic leadership: Executives’ use of power and influence to direct the activities of others when
pursuing an organization’s goals. If these executives achieve CA, they show strategic leadership. Strategic
leaders can draw on position power and informal power.

WHAT DO STRATEGIC LEADERS DO?

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CEOs consider face-to-face meetings most effective because it enables CEOs to pick up on rich nonverbal
cues, such as facial expressions, body language, and mood. Strategic leaders also argue that being in the
office fosters collaboration and idea generation, noting that employees working from home are less
productive. Employees prefer WFH

ARE STRATEGIC LEADERS BORN OR MADE? (INNATE OR LEARNED)

Upper-echelons theory: A conceptual framework that views organizational outcomes as reflections of the
values of the members of the top management team as they interpret situations through their unique
perspectives, shaped by their personal circumstances, values, and experiences. It says Strategic leadership
results from innate abilities and learning.

Level-5 leadership pyramid: A conceptual framework of leadership progression with five distinct,
sequential levels. The individual can move to the next leadership level only after mastering the current
level.
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THE STRATEGY PROCESS ACROSS LEVELS: CORPORATE, BUSINESS, AND FUNCTIONAL

LEADERS

According to the upper-echelons theory, strategic leaders determine a firm’s ability to sustain a CA
through their strategies. The strategy process consists of: Strategy formulation concerns the choice of
strategy in terms of where and how to compete and Strategy implementation involves the organization,
coordination, and integration of how work gets done.

●​ Corporate strategy: where to compete in industry, markets, and geography. Responsible for setting
strategic objectives and allocating scarce resources. The objective of corporate-level strategy is to
increase the overall company value to make it higher than the sum of the individual business units’
value.
●​ Business strategy: how to compete. Three generic business strategies are available: cost
leadership, differentiation, and value innovation. Within the guidelines from corporate
headquarters, they formulate an appropriate generic business strategy—cost leadership,
differentiation, or value innovation—to gain competitive advantage.
●​ Functional strategy: how to implement a chosen business strategy. Functional-level strategies
focus on improving a firm’s value creation and cost structure in support of the business-level
strategy.

Vision, Mission, and Values

The first step in the strategic management process is to define:

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●​ Vision. What is our purpose? What do we want to accomplish ultimately?
●​ Mission. How do we accomplish our goals?
●​ Values. What commitments do we make, and what safeguards do we put in place, to act legally
and ethically as we pursue our vision and mission?

After definition, formulation and implementation begins. This is an iterative process.

PURPOSE-DRIVEN VISION

Vision: A statement that captures an organization’s purpose and aspiration. It spells out what the
organization ultimately wants to accomplish. Then leaders build core competencies to make the vision
into a reality.

Core competencies are a result from the interplay of resources and capabilities, These are built by
defining a strategic intent (A stretch goal that pervades the entire organization with a sense of purpose).
THis too is an iterative process.

Matching a firm’s vision to its given level of internal resources and capabilities creates a static fit with the
external environment. However, this approach focuses on maintaining the current situation (status quo),
limits an organization’s results, and curtails an organization’s ability to achieve stretch goals. As a result,
the organization is not able to accomplish a higher purpose such as making the world a better place by, for
instance, addressing climate change and social injustices. In contrast, a clear strategic intent motivates and
accelerates organizational learning across all levels to create and build the core competencies needed to
make the vision a reality, even when the stretch goals seem initially out of reach. Seemingly impossible
goals derived from a purpose-driven vision motivate employees and foster innovation. Exhibit 2.4
summarizes the interplay between a purpose-driven vision, strategic intent, and core competencies. As
noted earlier, a firm’s purpose-driven vision is expressed as a forward-looking and inspiring statement that
provides meaning for employees in pursuit of the organization’s ultimate goals.

sBut can for-profit firms inspire and motivate as effectively as nonprofits do? The answer is yes. A truly
meaningful and inspiring purpose-driven vision—whether for a nonprofit firm or a for-profit firm—makes
employees feel that they are part of something bigger, which can be highly motivating. When employees
are motivated, firm financial performance tends to follow, but the success runs deeper than just higher
profits.

VISION STATEMENTS AND COMPETITIVE ADVANTAGE.

Do vision statements help firms gain and sustain competitive advantage? It depends. The effectiveness of
vision statements differs by type.
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PRODUCT-ORIENTED VISION STATEMENTS.

A product-oriented vision defines a business in terms of a good or service provided. It forces managers to
take a more myopic view of the competitive landscape (e.g., “We are in the typewriter business”). They
tend to be less flexible and thus more likely to fail. The lack of an inspiring needs-based vision can cause
the long-range problem of failing to adapt to a changing environment

CUSTOMER-ORIENTED VISION STATEMENTS

It defines a business in terms of providing solutions to customer needs—for example, “We provide
solutions to professional communication needs.” They can more easily adapt to changing environments as
they identify a critical need but do not explain how to meet that need. Why? Customer needs may change.

MOVING FROM PRODUCT-ORIENTED TO CUSTOMER-ORIENTED VISION STATEMENTS

In some cases, product-oriented vision statements do not interfere with the firm’s success in achieving
superior performance and competitive advantage.

MISSION

Building on the vision, firms create a mission, which describes what an organization actually does, the
products and services it plans to provide, and the markets in which it will compete. People sometimes
wrongly use the terms vision and mission interchangeably

●​ A vision defines what an organization wants to be, and what it wants to accomplish ultimately
●​ A mission describes what an organization does and how it proposes to accomplish its vision.

VALUES

An organization’s values are important in the strategy process.

Core Value Statement: Statement of principles to guide an organization as it works to achieve its vision
and fulfill its mission, for both internal conduct and external interactions; it often includes explicit ethical
considerations. Extralegal standards.

Organizational Core Values: Ethical standards and norms that govern the behavior of individuals within a
firm or organization. Strong ethical values and norms have two important functions:

1.​ Underlie the vision statement and provide stability to the strategy, laying the groundwork for
long-term success.
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2.​ Serve as guardrails to keep the company on track.

Organizational core values must be lived with integrity, especially by the top management team as it
trickles down.

The Strategic Management Process

TOP-DOWN STRATEGIC PLANNING

Top-down strategic planning: A rational, data-driven strategy process through which top management
attempts to program future success. All decision-making responsibilities are concentrated in the office of
the CEO.

Top-down strategic planning rests on the assumption that we can predict the future from the past. Works
well when the environment is stable, but it has some major shortcomings.

●​ The formulation of strategy is separate from implementation.

●​ Information flows one way only: from the top down.
●​ Unforeseen events can make even the most scientifically developed and formalized plans obsolete.

SCENARIO PLANNING
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Scenario planning: Strategy planning activity in which top management envisions different what-if
scenarios to anticipate plausible futures in order to derive strategic responses. Scenario planning starts
with a top-down approach to the strategy process. Typical scenario planning considers both optimistic and
pessimistic futures and is timely. Managers then formulate plans if the envisioned optimistic or
pessimistic scenarios begin to appear.

The goal is to create a number of detailed and executable strategic plans making it more flexible and more
effective than the more static strategic planning approach with one master plan.

Black swan events: Incidents that describe highly improbable but high-impact events. Strategic leaders
need to consider how black swan events might affect their strategic planning.

STRATEGY AS PLANNED EMERGENCE: TOP DOWN AND BOTTOM UP

Strategy as planned emergence: Strategy process in which organizational structure and systems allow
bottomup strategic initiatives to emerge and be evaluated and coordinated by top management. Strategic
initiatives can bubble up from deep within the organization through autonomous actions, serendipity, and
resource allocation process.
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Strategic Decision Making

STRATEGIC INFLECTION POINTS

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Strategic dissonance Occurs when a firm’s static fit no longer matches competitive realities. t when a
firm’s current strategy no longer provides the expected outcomes

Strategic inflection point: A turning point in determining the future of company; the moment when the
fundamentals of a business and its industry are about to chang

Two Distinct Modes of Decision Making

Theory of bounded rationality: When individuals face decisions, their rationality is confined by cognitive
limitations and the time available to make a decision. Thus, individuals tend to “satisfy” rather than to
optimize.

Cognitive limitations: Constraints such as time or the brain’s inability to process large amounts of data
that prevent us from appropriately processing and evaluating each piece of information we encounter

Along with cognitive limitations, humans are prone to cognitive biases

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●​ Illusion of control: A cognitive bias that highlights people’s tendency to overestimate their ability
to control events.
●​ Escalating commitment: A cognitive bias in which an individual or a group faces increasingly
negative feedback regarding the likely outcome from a decision, but nevertheless continues to
invest resources and time in that decision, often exceeding the earlier commitments.
●​ Confirmation bias: A cognitive bias in which individuals tend to search for and interpret
information in a way that supports their prior beliefs. Regardless of facts and data presented,
individuals will stick with their prior hypothesis
●​ Reason by analogy: A cognitive bias in which individuals use simple analogies to make sense out
of complex problems.
●​ Representativeness: A cognitive bias in which conclusions are based on small samples, or even
from one memorable case or anecdote
●​ Groupthink: A situation in which opinions coalesce around a leader without individuals critically
evaluating and challenging that leader’s opinions and assumptions.

HOW TO IMPROVE STRATEGIC DECISION MAKING

●​ Devil’s advocacy: Technique that can help to improve strategic decision making; a key element is
that of a separate team or individual carefully scrutinizing a proposed course of action by
questioning and critiquing underlying assumptions and highlighting potential downsides.
●​ Dialectic inquiry: Technique that can help to improve strategic decision making; key element is
that two teams each generate a detailed but alternate plan of action (thesis and anti-thesis). The
goal, if feasible, is to achieve a synthesis between the two plans.

Implications for Strategic Leaders

●​ Strategic leaders use position, informal power, and influence to direct the activities of others when
implementing the organization’s strategy.
●​ To gain and sustain a competitive advantage, they need to put an effective strategic management
process in place. An important first step in crafting an effective strategic management process is to
articulate an inspiring and purpose-driven vision and mission backed up by ethical core values.
●​ All employees should feel invested in and inspired by the firm’s purpose and vision.. Belief in a
company’s vision and mission motivates its employees.
●​ They need to design a process that supports strategy formulation and implementation.

External Analysis: Industry Structure, Competitive

Forces, and Strategic Groups

The PESTEL Framework

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PESTEL model: A framework that categorizes and analyzes an important set of external factors
(political, economic, sociocultural, technological, ecological, and legal) that might impinge upon a firm.
These factors can create both opportunities and threats for the firm. A firm’s external environment
consists of all factors outside the firm that can affect its ability to gain and sustain a competitive
advantage. One common approach to understanding how external factors influence a firm is to consider
the source or proximity of these factors.

POLITICAL FACTORS

Political factors result from the pressure that various groups such as government bodies, NGOs, and social
movements can exert to influence the decisions and behavior of firms. Applying political pressure can
make legal decisions. Firms can also apply pressure through non market activities

Nonmarket strategy: Strategic leaders’ activities outside the market to influence a firm’s general
environment through such activities as lobbying, public relations, contributions, and litigation that will
lead to favorable outcomes for the firm.

ECONOMIC FACTORS

Economic factors in a firm’s external environment are largely macroeconomic. Strategic leaders need to
consider how the following five macroeconomic factors can affect firm strategy:

●​ Growth rates: The overall economic growth rate measures the change in the value of goods and
services produced by a nation’s economy. We look at real growth rate (without inflation) which
tell whether the business activity is expanding or contracting
●​ Employment Level: Growth rates directly affect the employment level. In boom times,
unemployment tends to be low, and skilled human capital becomes scarce and more expensive
●​ Interest Rates: The amount that creditors earn for lending their money and the amount that debtors
pay to use that money, adjusted for inflation. Keeping interest rates low spurs investments by
businesses and spending by consumers.
●​ Price Stability: It is rare because economic growth is dynamic and needs to be matched with
adequate monetary supply. It is not desirable to keep inflation at 0%. Strategic leaders therefore
know that they need to address changing price levels over time. There can be inflation and
deflation in a country and it is not of a single good or product but the entire price level.
●​ Currency Exchange Rates: The currency exchange rate determines how many dollars one must
pay for a unit of foreign currency. critical for any company trading internationally,

SOCIOCULTURAL FACTORS
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Sociocultural factors capture a society’s cultures, norms, and values. Because sociocultural factors are
constantly in flux and differ across groups.

Demographic trends are critical sociocultural factors. These trends capture population characteristics
related to age, gender, family size, ethnicity, sexual orientation, religion, and socioeconomic class.

TECHNOLOGICAL FACTORS

Technological factors capture the application of knowledge to create new processes and products.
Significant innovations in process technology include lean manufacturing, Six Sigma quality, genetic
engineering, AI, and quantum computing. The internet of things reduces energy consumption and can
notify users that a system requires maintenance long before it breaks down.

ECOLOGICAL FACTORS

Ecological factors concern broad environmental issues such as the natural environment, climate change,
and sustainable economic growth. Organizations and the natural environment coexist in an interdependent
relationship. Strategic leaders can no longer separate the natural and the business worlds; they are
inextricably linked.

Externalities occur when the production or consumption of goods and services imposes costs on or
provides benefits to others, but the prices of the goods and services do not capture these costs and
benefits. They can be negative and positive.

LEGAL FACTORS

Legal factors capture the official outcomes of political processes as manifested in laws, mandates,
regulations, and court decisions, all of which can directly impact a firm’s profit potential. Regulatory
changes tend to affect entire industries.

The PESTEL model provides a way to scan, monitor, and evaluate the critical external factors and trends
that might influence firm performance. Such factors create both opportunities and threats and it influences
firm performance.

However, the PESTEL framework is a static model, taking a snapshot of many moving parts at a given
point in time. This shortcoming implies that the dynamics behind different forces in a firm’s external
environment are harder to capture. Nonetheless, a PESTEL analysis can help strategic leaders recognize
external factors and turn threats into opportunities.
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Industry Structure and The Firm Strategy: The FIve Forces Model

Firm performance is determined primarily by two factors:

●​ Industry effects Firm performance attributed to the structure of the industry in which the firm
competes. The structure of an industry is determined by elements common to all industries, such
as entry and exit barriers, number and size of companies, and types of products and services
offered, and this structure determines the profit potential.
●​ Firm effects Firm performance attributed to the actions strategic leaders take.

An industry is a group of incumbent firms with more or less the same set of suppliers and buyers. The
PESTEL framework evaluates the external environment to identify opportunities and threats, industry
analysis provides for identifying an industry’s profit potential and identifying implications for one firm’s
strategic position within an industry.

A firm’s strategic position is based on creating value for customers while containing the cost. Competitive
advantage flows to the firm that creates as large a gap as possible between the value of its product or
service and the cost required to produce it.

Five forces model: A framework that identifies five forces that determine the profit potential of an
industry and shape a firm’s competitive strategy.

Key Insights

1.​ Competition is viewed more broadly in the five forces model. Rather than defining competition
narrowly as the firm’s closest competitors, they are also buyers, suppliers, the potential new entry
of other firms, and the threat of substitutes. It shows how to deal with competition.
2.​ Industry profit potential is a function of the five competitive forces: The five forces model enables
strategic leaders to understand the firm’s industry environment and shape firm strategy.
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THE THREAT OF ENTRY

The threat of entry describes the risk of potential competitors entering the industry. It makes an industry
less attractive as:

●​ It reduces the industry’s overall profit potential

●​ It increases spending by incumbent firms.

However, entry barriers (Obstacles that discourage or prevent entry into an industry) reduce this. Several
types of entry barriers:

●​ Economies of scale: cost advantages that accrue to firms with larger output because they can
spread fixed costs over more units, employ technology more efficiently, benefit from a more
specialized division of labor, and demand better terms from their suppliers. If the required scale to
reach the lowest possible production cost is high, the threat of entry is decreased.
●​ Network effects: The positive impacts that one user of a product or service has on other users of
that product or service. The value of the product increases for each user.
●​ Customer switching costs: Switching costs are the costs that a customer incurs when changing to
the products, services, and/or brands offered by a different vendor. . The higher the switching
costs, the lower the threat of entry. High customer switching costs not only deter entry but also
reduce customer churn among existing firms in the industry, thereby also contributing to lower
competitive rivalry.
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●​ Capital requirements: Capital requirements are the “entry ticket price” into a new industry. The
higher the capital requirements to enter an industry, the lower the threat of entry. However, if an
industry is attractive enough, efficient capital markets are likely to provide the necessary funding
to enter an industry.
●​ Advantages independent:
○​ Brand Loyalty: This captures a consumer’s emotional attachment and feelings toward a
specific brand. It translates into repeat purchases of the brand’s products and services.
○​ Proprietary Technology: Any process, method, device, or system that firms use to solve
problems when providing products and services. It deters new entries because they are
often developed through years of experience in a particular industry.
○​ Preferential Access: Preferential access to raw materials, critical components, and
distribution channels can bestow absolute cost advantages.
○​ Favorable Locations provide advantages that other locales cannot match easily. These
benefits include proximity to the company’s main markets, access to skilled and lower-cost
workers, world-class universities, favorable tax and other incentives.
○​ Cumulative Learning and Experience. Finally, incumbent firms often benefit from
cumulative learning and experience effects over long periods. Attempting to obtain such
deep design, engineering, and manufacturing knowledge within a shorter time frame is
often costly, if not impossible, due to time compression diseconomies.
●​ Government policy: Government policies frequently restrict or prevent new entrants. To protect
millions of small vendors and wholesalers. With new entry comes increased competition that
frequently results in lower prices, better quality, more innovation, and more choices for
consumers. Therefore, the threat of entry is high when restrictive government policies do not exist
or when industries are deregulated.
●​ Credible threat of retaliation: A credible threat of retaliation by incumbent firms often deters entry
and initiates a price war if it occurs. Other retaliatory weapons include increased product and
service innovation, advertising, sales promotions, and litigation.

THE POWER OF SUPPLIERS

Suppliers with strong bargaining power can exert pressure on an industry’s profit potential.

1.​ Powerful suppliers can raise the cost of production by demanding higher prices for their inputs or
by reducing the quality of input factors or service level delivered.
2.​ Powerful suppliers threaten firms because they reduce the industry’s profit potential by capturing
part of the economic value created.

To compete effectively, companies generally need various inputs and services. The relative bargaining
power of suppliers is high when:

●​ The supplier’s industry is more concentrated than the industry it sells to

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●​ Suppliers do not depend heavily on the industry for much of their revenues
●​ Incumbent firms face high switching costs when changing suppliers
●​ Suppliers offer products that are differentiated
●​ There are no readily available substitutes for the suppliers’ products or services.
●​ Suppliers can credibly threaten to forward-integrate into the industry

THE POWER OF BUYERS

Buyers’ bargaining power is the flip side of suppliers’ bargaining power. Buyers are customers, and their
power relates to the pressure they can put on the producers’ margins by demanding a lower price or higher
product quality. Strong buyers can therefore reduce industry profit potential and a firm’s profitability.

Factors that increase buyer power

●​ There are only a few buyers, and each buyer purchases large quantities
●​ The focal industry’s products are standardized or undifferentiated commodities.
●​ Buyers face low or no switching costs.
●​ Buyers can credibly threaten to integrate into the industry backwardly

Buyers are price sensitive when:

●​ The purchase represents a significant fraction of the buyer’s cost structure or procurement budget
●​ They earn low profits or are strapped for cash.
●​ The quality or cost of their products and services is not affected much by their inputs’ quality or
cost.

THE THREAT OF SUBSTITUTES

Substitutes are the threat that products or services available from outside the given industry will come
close to meeting the needs of current customers. A high threat reduces industry profit potential by limiting
the price that the industry’s competitors can charge for their products and services. The threat is high

●​ The substitute offers an attractive price/performance trade-off: when they offer a low-cost
alternative that provides a similar or equivalent product or service performance
●​ The buyers’ cost of switching to the substitute is low

RIVALRY AMONG EXISTING COMPETITORS

Rivalry among existing competitors describes the intensity with which companies in the same industry
jockey for market share and profitability. This rivalry can range from genteel to cutthroat. The other four
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forces all exert pressure on this rivalry, The stronger the forces, the stronger the expected competitive
intensity.

The intensity of rivalry among existing competitors is determined mainly by the following factors:

●​ Competitive industry structure: Elements and features common to all industries, including the
number and size of competitors, the firms’ degree of pricing power, the type of product or service
offered, and the height of entry barriers.

●​ Industry growth: Industry growth directly affects the intensity of rivalry among competitors.
During periods of high growth, there is positive-sum competition, rivals are focused on capturing
a larger piece of an increasing pie rather than taking market share and profitability away from one
another. Rivalry among competitors is fierce in zero sum and negative sum situations.
●​ Strategic commitments: Decisions that are costly, have a long-term impact, and are difficult to
reverse. Contrast with tactical decisions, which are short-term and can be easily reversed. If firms
make strategic commitments to compete in an industry, rivalry among competitors is likely to
become more intense
●​ Exit barriers: The rivalry among existing competitors is also a function of an industry’s exit
barriers, the obstacles that interfere with a firm’s ability to leave an industry. They can be caused
by economic and social factors.
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A SIXTH FORCE: THE STRATEGIC ROLE OF COMPLEMENTS

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A complement is a product, service, or competency that adds value to the original product offering when
the two are used in tandem. Complements increase demand for the primary product, thereby enhancing
the profit potential for the industry and the firm. A company that provides a good or service that leads
customers to value your firm’s offering more when the two are combined is a complementor.

Co-opetition: Cooperation by competitors to achieve a strategic objective.

Changes over Time: Entry choices and industry dynamics

Entry choices

Industry Dynamics

The five forces is a static model and cannot determine the changing speed of the industry. Therefore it
should be repeated at different points in time. Sometimes

●​ Become Fragmented: This fragmentation generally happens when there are external shocks to an
industry such as deregulation, new legislation, technological innovation, or globalization.
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●​ Industry convergence: the process whereby formerly unrelated industries begin to satisfy the same
customer need and is brought on by technological advances which can lead to the emergence of
entirely new industries.

Strategic group: The set of companies that pursue a similar strategy within a specific industry.

Strategic group model: A framework that explains differences in firm performance within the same
industry.

The distinct differences across strategic groups reflect the business strategies that firms pursue. Firms in
the same strategic group tend to follow a similar strategy. Therefore, companies in the same strategic
group are direct competitors. The rivalry among firms within the same strategic group is generally more
intense than the rivalry among strategic groups: Intragroup rivalry exceeds inter-group rivalry.

THe Strategic group model gives us the following insights:

●​ Competitive rivalry is strongest between firms in the same strategic group

●​ The external environment affects strategic groups differently
●​ The five competitive forces affect strategic groups differently.
●​ Some strategic groups are more profitable than others.

Mobility barriers: Industry-specific factors that separate one strategic group from another.

Strategic groups are dynamic. Firms can carve out a more robust strategic profile along crucial
dimensions, resulting in new strategic (sub)groups. Membership in different strategic (sub)groups has
distinct competitive implications.

Implication for Strategic Leader:

●​ Define the relevant industry

●​ Identify the key players in each of the five forces and attempt to group them into different
categories
●​ Determine the underlying drivers of each force
●​ Assess the overall industry structure
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Internal Analysis: Resources, Capabilities, and Core

Competencies

From External to Internal

The purpose is to explain why firms within the same industry perform differently. Differences often stem
from internal factors—resources, capabilities, and core competencies.

Even when firms face similar external opportunities and threats, performance varies due to firm-specific
effects Internal analysis helps identify strengths and weaknesses that influence competitive advantage.

Effective strategy combines external analysis with internal analysis. Managers should leverage strengths
to exploit opportunities and minimize weaknesses and threats..

Strategic fit: Occurs when an organization matches its internal resources and capabilities to the external
environment, exploiting external opportunities while mitigating external threats and internal weaknesses.

Core Competencies

Core competencies: Unique strengths, embedded deep within a firm, that are critical to gaining and
sustaining competitive advantage. They are expressed through a firm’s structures, processes, and routines.

CA often results from a firm’s core competencies rather than visible products or services. They are the
foundation for creating higher customer value or lower costs compared to rivals. Firms compete not just
on what they sell but on the capabilities that support those offerings.​
Enables premium pricing and customer loyalty.

LEVERAGING CORE COMPETENCIES REQUIRES FOCUS ON WHAT TO DO AND WHAT NOT

TO DO

Strategy is as much about deciding to do things differently as it is about deciding what not to do. Avoiding
activities that dilute focus helps the firm leverage its core competency. Competition is not only about
products and services but also about developing, nurturing, honing, and leveraging core competencies.
Before expanding, firms should perfect and replicate their core competency model.

RESOURCES AND CAPABILITIES

Because core competencies are critical to gaining and sustaining a competitive advantage, it is essential to
understand how they are created. Firms develop core competencies through the interplay of:
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●​ Resources are any assets a firm can draw on when crafting and executing a strategy. Resources can
be tangible or intangible. Resources reinforce core competencies by providing the necessary
foundation for creating value.
●​ Capabilities are the organizational and managerial skills needed to orchestrate a diverse set of
resources and deploy them strategically. They are intangible and expressed in a company’s
structure, routines, and culture.

Firms must look beyond visible success (products and services) to understand the underlying resources
and capabilities that sustain it. Superior firm performance generates profits that can be reinvested into the
firm (retained earnings) to further upgrade resources and capabilities, helping maintain strategic fit within
a dynamic environment.
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The Resource-Based View (RBV)

The RBV sees resources as key to superior firm performance and helps identify core competencies
systematically.

TYPES OF RESOURCES

According to the RBV, resources fall into two broad categories: Tangible resources and Intangible
resources

Competitive advantage more often arises from intangible resources, which are socially complex, built
over time, and difficult to imitate

RESOURCE HETEROGENEITY AND RESOURCE IMMOBILITY

The RBV is based on two key assumptions that explain differences in firm performance:

●​ Resource Heterogeneity: Firms differ in the bundles of resources, capabilities, and competencies
they possess. Even within the same industry or strategic group, resource bundles are unique.
●​ Resource Immobility: Resources are “sticky” and do not move easily between firms. Differences
in resources can persist over time and are difficult to replicate.

Together, resource heterogeneity and resource immobility explain why performance differences among
firms can persist for long periods—a contrast to perfect competition, where all firms have equal access to
resources and capabilities.

The VRIO Framework

VRIO framework A theoretical framework that explains and predicts firm-level competitive advantage.
For a resource to be the basis of a sustainable competitive advantage, it must satisfy four attributes:

●​ Valuable: A resource is valuable if it helps a firm exploit an external opportunity or offset an

external threat.
●​ Rare: A resource is rare if the number of firms that possess it is less than the number of firms it
would require to reach a state of perfect competition.
●​ Costly to Imitate: . A resource is costly to imitate if firms that do not possess the resource are
unable to develop or buy the resource at a comparable cost.
○​ Direct Imitation: Occurs when rivals try to copy a valuable, rare resource.
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○​ Substitution: Competitors develop strategic equivalents to satisfy the same customer need.
●​ Organized to Capture Value: The characteristic of having in place an effective organizational
structure, processes, and systems to fully exploit the competitive potential of the firm’s resources,
capabilities, and competencies.

ISOLATING MECHANISMS: HOW TO SUSTAIN A COMPETITIVE ADVANTAGE

The VRIO is not everlasting. Over time, rivals attempt to imitate or substitute valuable resources and
capabilities. Firms rely on isolating mechanisms

isolating mechanisms Barriers to imitation that prevent rivals from competing away the advantage a firm
may enjoy. A moat to protect CA. They correspond to being costly to imitate.

Key isolating mechanisms include:

●​ Better Expectations of Future Resource Value: A firm can gain a competitive edge if it more
accurately anticipates the future value of resources than its rivals. By acquiring undervalued assets
today that will appreciate tomorrow, a firm captures value others overlook. If a firm can
consistently forecast resource value better than competitors, it transforms a one-time lucky bet into
a sustainable competitive advantage.
●​ Path Dependence: A situation in which the options one faces in the current situation are limited by
decisions made in the past. Once certain investments, routines, or geographic clusters form, they
are difficult to replicate or replace. Strategic decisions, once made, are not easily reversed.
Capabilities and reputations take time to build and cannot be bought or rushed, reinforcing the
power of path dependence.
●​ Causal Ambiguity: A situation in which the cause and effect of a phenomenon are not readily
apparent. If even firm insiders cannot pinpoint why they outperform rivals, outsiders will find
imitation nearly impossible.
●​ Social Complexity: A situation in which different social and business systems interact with one
another. These relationships—built on trust, teamwork, and shared norms—cannot be easily
codified or copied. The interconnectedness of systems and relationships multiplies exponentially
as an organization grows, making imitation virtually impossible.
●​ IP Protection: A critical intangible resource that can provide a strong, temporary isolating
mechanism, and thus help to sustain a competitive advantage. The five main forms are:
○​ Patents – protect inventions and processes
○​ Designs – protect product appearance
○​ Copyrights – protect artistic and written works
○​ Trademarks – protect brands and logos
○​ Trade secrets – protect confidential know-how
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The Dynamic Capabilities Perspective

CORE RIGIDITIES

A former core competency that turned into a liability because the firm failed to hone, refine, and upgrade
the competency as the environment changed. A firm’s external environment is rarely stable, and in many
industries, the pace of change is intense. Firms that fail to adapt their core competencies to a changing
environment lose their competitive advantage and may go out of business. This ability to renew and align
competencies with environmental changes lies at the heart of the dynamic capabilities perspective.

Dynamic capabilities: A firm’s ability to create, deploy, modify, reconfigure, upgrade, or leverage its
resources in its quest for competitive advantage. The fit between internal strengths and the external
environment must be dynamic, not static. THEY not only help firms adapt to change but also create
market change, shaping industry evolution.

RESOURCE STOCKS AND RESOURCE FLOWS

Resource stocks: The firm’s current level of intangible resources

Resource flows: The level of investments made to build or maintain these intangible resources.

The Bathtub Metaphor:​

Imagine a bathtub filled with water:

●​ The amount of water represents a firm’s resource stocks.

●​ The faucets represent investment flows—decisions that build intangible assets such as innovation,
R&D, or marketing capabilities.
●​ Each investment has an opportunity cost—money spent on one area (e.g., R&D) cannot be spent
on another (e.g., marketing).
●​ Leaks represent the loss of resources—through employee turnover, forgetting capabilities, or
outdated knowledge.
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Strategic leaders must decide:

●​ Which investments to make, when, and how much

●​ How to maintain and grow intangible resources while preventing leaks through turnover or
neglect.

The Firm Value Gain and Strategic Activity Systems

Firm Value Chain

There are two types of value chains: industry value chains and firm value chains.

●​ Industry value chains are vertical and show how raw materials are transformed into finished goods
and services through distinct stages(industries or groups of industries)
●​ Firm value chains are horizontal, showing internal activities within a single firm, from basic
research to after-sales support and customer service. These horizontal firm value chains intersect
with vertical industry value chains at various stages.

DISTINCT ACTIVITIES

A firm’s core competencies are expressed through its activities—specific, coordinated actions that create
value at each step of the chain. Activities differ from broad functional areas; for instance, “marketing” is a
function, but “running digital ad campaigns” is a distinct activity. Each activity contributes to the firm’s
high perceived value, supporting a cost-plus-margin pricing strategy.
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GENERETIC FIRM VALUE CHAIN

A typical value chain illustrates the transformation of inputs into outputs through distinct stages. When
the value added by these activities exceeds their total cost, the firm earns a profit margin. Different
businesses configure their value chains uniquely:

PRIMARY AND SUPPORT ACTIVITIES

The value chain divides a firm’s activities into primary and support categories:

●​ Primary Activities (directly add value): Supply chain management, Operations, Distribution,
Marketing and sales, After-sales service
●​ Support Activities (indirectly add value): Research and development (R&D), Information systems,
Human resources, Accounting and finance, Firm infrastructure

To gain a competitive advantage, each activity must either add value or reduce cost. These activities form
the basic units of a firm’s strategic position—whether as a low-cost leader or a differentiator.

The resource-based view identifies the resources and capabilities behind core competencies, while the
value chain perspective shows how those competencies translate into superior performance through
distinct activities.
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STRATETIC ACTIVITY SYSTEMS

Strategic activity system: The conceptualization of a firm as a network of interconnected activities to form
the basis of competitive advantage. Such systems are often socially complex and causally ambiguous,
making them difficult for competitors to replicate. Even if a rival can copy individual activities, imitating
the entire system is nearly impossible.

RESPONDING TO CHANGING ENVIRONMENTS

Strategic activity systems must evolve over time to maintain relevance. Failure to adapt leads to
competitive disadvantage as the environment and rivals’ capabilities change. Strategic leaders should
therefore:

●​ Add new value-creating activities,

●​ Remove outdated ones, and
●​ Upgrade those that have become inefficient.

These changes reshape the firm’s entire activity network and require adjustments to resources and
capabilities.

Implications for Strategic Leaders

The ultimate goal is to leverage internal strengths to capitalize on external opportunities while mitigating
internal weaknesses and defending against external threats. When internal and external analyses are
successfully aligned, a firm achieves what is called a strategic fit.

SWOT

●​ Internal Strengths (S) and Weaknesses (W) relate to a firm’s resources, capabilities, and
competencies. Whether a resource is a strength or weakness can be determined using the VRIO
framework.
○​ A resource is a weakness if it is not valuable, meaning it doesn’t help the firm exploit an
opportunity or neutralize a threat.
○​ A resource is a strength (and potentially a core competency) if it is valuable, rare, costly to
imitate, and if the firm is organized to capture the value it creates.
●​ External Opportunities (O) and Threats (T) arise from the general environment, captured by
PESTEL analysis and Porter’s Five Forces.
○​ An attractive industry, identified through Five Forces, represents an external opportunity
○​ Conversely, changes like stricter regulation or shifting customer preferences may represent
external threats.

The SWOT Matrix and Strategic Alternatives

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The process of developing strategic alternatives typically involves four steps:

1.​ Strengths–Opportunities (S–O): These are offensive strategies, such as expanding into a new
market by leveraging brand reputation.
2.​ Weaknesses–Threats (W–T): These are defensive strategies, like restructuring to reduce
vulnerability in a declining market.
3.​ Strengths–Threats (S–T): Use internal strengths to minimize the impact of external threats..
4.​ Weaknesses–Opportunities (W–O): Address internal weaknesses to take advantage of external
opportunities.

After developing these strategic alternatives, leaders evaluate the pros and cons of each option, choose the
most promising strategies, and provide a clear rationale for their decisions—including why certain
alternatives were rejected.

A key challenge is that a factor can be both a strength and a weakness, or an opportunity and a threat,
depending on perspective. Thus, leaders must base it on rigorous internal and external analyses

Shared Value and Competitive Advantage

From CSR to CSV

ESG criteria: A set of standards beyond mere financial results on which companies are evaluated.
Environmental, social, and governance (ESG) goals.

To understand how firms balance financial and societal goals, we examine shareholder capitalism and its
evolution toward stakeholder capitalism and creating shared value (CSV).

SHAREHOLDER CAPITALISM

Shareholder capitalism: A traditional, economic system in which the investors who own shares in a public
company are the providers of risk capital and therefore the company’s legal owners.

This position was Milton Friedman’s and it rests on three assumptions:

1.​ Free markets are perfectly efficient: Friedman described how thousands of people worldwide
unknowingly cooperate to make a single pencil, all coordinated by the “invisible hand” of the
price system. Competitive markets allocate resources efficiently and promote cooperation without
central planning.
2.​ Individual freedom should be society’s highest goal: Corporations, as “legal persons,” enjoy rights
similar to individuals, such as the ability to sign contracts or pay taxes. However, excessive
corporate freedom can lead to negative externalities, problems governments try to mitigate
through regulation.
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3.​ Managers are agents of shareholders: In public firms, managers act on behalf of shareholders,
whose goal is to maximize returns. Spending company resources on ESG goals that shareholders
do not agree with creates a principal-agent problem.

THE PUBLIC STOCK COMPANY

The public stock company is a key institution in capitalist economies, responsible for creating goods,
services, employment, and innovation. It rests on an implicit contract with society—companies receive
the privilege of incorporation in exchange for contributing positively to social welfare.

Four main features make the public stock company a powerful vehicle for economic progress:

1.​ Limited liability for investors, encouraging broader participation and entrepreneurial risk-taking.
2.​ Transferability of ownership through stock markets, allowing liquidity and diversification.
3.​ Legal personality, granting firms continuity beyond their founders’ lives.
4.​ Separation of ownership and management, allowing professional managers to run firms on behalf
of shareholders.

As a result, many scholars and leaders now argue for redefining corporate purpose toward stakeholder
capitalism and shared value creation.

STAKEHOLDER CAPITALISM AND SHARED VALUE

The concept of the firm has evolved from focusing solely on profits, to embracing CSR and now toward
creating shared value.

Major challenges facing modern capitalism:

1.​ Climate Change. A “tragedy of the commons (A problem that arises when individuals, companies,
or nations pursue their own self-interest without considering the wellbeing of society or the global
community)”
2.​ Economic Inequality. Extreme disparities in wealth
3.​ Beleaguered Institutions. Declining trust in governments, health systems, and even democracies
due to crises such as the Covid-19 pandemic and political polarization.

To address these issues, CSV was proposed which is a Framework proposing that strategic leaders
maintain a dual focus on shareholder value creation and value creation for society. CSV aims to link firm
performance with societal progress. Companies gain competitive advantage not by ignoring social issues
but by solving them.

Porter’s shared value framework emphasizes three key strategies:

1.​ Expanding the customer base to include underserved populations (“the base of the pyramid”).
2.​ Redefining the value chain by partnering with nontraditional organizations such as NGOs
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3.​ Building new regional clusters that drive innovation and growth

FROM CORPORATE SOCIAL RESPONSIBILITY (CSR) TO CREATING SHARED VALUE (CSV)

Difference between CSR and CSV

●​ CSR operates on the idea that firms that “do well” financially should also “do good” through
philanthropy or ethical initiatives. CSR tends to be reactive and externally motivated, often added
later as a response to public pressure or regulation.
●​ CSV, by contrast, embeds societal value creation directly into a firm’s competitive strategy. It is
proactive, purpose-driven, and core to business operations.

In short, while CSR is about “giving back,” CSV is about “doing better” aligning profit-making with
solving social problems.

Competitive Strategy

A competitive advantage exists when one firm outperforms another. It seems simple to compare two firms
and identify the better performer as the one with the advantage, but this approach has limitations. It does
not explain how or why a firm achieves its advantage, how we can measure it, or how it works in the
context of an entire industry and an ever-changing external environment.

●​ What exactly is a competitive advantage?

●​ How do we know when a firm has achieved it?
●​ How can it be measured?
●​ How do we understand it in relation to the whole industry?
●​ What strategic implications can managers draw from this understanding?

ACCOUNTING METRICS

Accounting data help assess this advantage by measuring a firm’s financial performance using
standardized figures from income statements and balance sheets. To evaluate competitive advantage,
strategic leaders must be able to:

●​ Accurately assess their firm’s performance.

●​ Compare and benchmark that performance against competitors in the same industry or the industry
average. There is data for standardized, objective comparisons between firms.

Common Profitability Ratios Used:

●​ ROIC (Return on Invested Capital): Measures how effectively capital is used to generate profits.
●​ ROE (Return on Equity): Indicates profitability relative to shareholders’ equity.
●​ ROA (Return on Assets): Assesses how efficiently assets are used to produce earnings.
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●​ ROR (Return on Revenue): Evaluates how much profit is generated from sales

LIMITATIONS OF ACCOUNTING DATA

●​ Backward-Looking: Accounting data are historical; they reflect past decisions, not future
potential. Data are published after delays, making them outdated for real-time strategic
decision-making. Relying solely on them is like “driving while looking in the rearview mirror.”
●​ Exclude Off–Balance-Sheet Items: Some obligations or assets are not reflected in balance sheets,
such as: Pension obligations or Operating leases. Strategists must adjust data to make fair
comparisons between firms with different capital structures.
●​ Ignore Intangible Assets: Traditional accounting focuses mainly on tangible assets, even though
intangibles now drive most firm [Link] are often core competencies that create competitive
advantage but do not appear on the balance sheet.
●​ Amortization Issues: Intangible assets are difficult to value or depreciate accurately.​
Their worth may either: Drop to zero quickly (due to obsolescence), or Increase exponentially.

SHAREHOLDER VALUE CREATION

Shareholders are individuals or organizations that own one or more shares of stock in a public company.
They are the legal owners of public firms and provide risk capital—money invested in exchange for
equity. Risk capital cannot be recovered if the firm goes bankrupt.

The key metric is Total Return to Shareholders (TRS), which includes: Stock price appreciation, and
Dividends received over a specific period.

TRS is external and forward-looking, unlike accounting data, which are internal and backward-looking. It
reflects how the stock market views the firm’s past performance, current state, and future growth
expectations. Since investors emphasize future potential, this explains why intangibles (like innovation
and brand equity) are increasingly vital for valuation.

Efficient-Market Hypothesis: The idea that all available information about a firm’s past, current state, and
expected future performance is embedded in the market price of the firm’s stock. Comparing stock prices
or market capitalization across rivals offers a useful way to assess competitive advantage over the long
term.

Market Capitalization: Represents the total dollar market value of a company’s outstanding shares.
(Market cap = Number of outstanding shares × Share price)

A central debate concerns how net profits should be used:

●​ Shareholder view: Profits belong to shareholders and should be returned via dividends or stock
buybacks.
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●​ Employee/stakeholder view: Profits should be reinvested to improve wages, benefits, and
organizational development.

BENCHMARK METRICS

Benchmarks are Comparison with the industry average, and Comparison with a broader market index for
diversified firms. Because competitive advantage is relative, these benchmarks help determine if a firm is
outperforming rivals.

GROWTH-RATE PREDICTIONS

Effective growth strategies boost a firm’s profitability and stock price. Investors expect continuous
growth, and stock prices rise only if actual growth exceeds expectations. Investor expectations adjust over
time:

STOCK MARKET VALUATIONS

Long-term stock market valuation trends (Share Price × Number of Shares) are a valuable indicator of
competitive advantage.

LIMITATIONS OF SHAREHOLDER VALUE CREATION

●​ High Volatility: Stock prices fluctuate significantly in the short term. Therefore, long-term trends
provide more accurate measures of competitive advantage.
●​ Macroeconomic Influences: External factors affect stock prices. This makes it difficult to isolate
the impact of firm strategy from economic conditions.
●​ Investor Psychology: Market sentiment can be irrational, leading to over- or under-valuations.

ECONOMIC VALUE CREATION

The relationship between economic value creation and competitive advantage forms the foundation for
developing a firm’s cost leadership or differentiation strategy. A firm has a competitive advantage when it
creates more economic value than its rivals.

Economic value created = Buyer’s willingness to pay – Firm’s total cost to produce.

Creator economic value is created from total perceived consumer benefits.

Value, Price, and Cost (V–P–C Framework)

To calculate competitive advantage, three key variables are needed:

1.​ Value (V): The dollar amount (V) a consumer attaches to a good or service; the consumer’s
maximum willingness to pay; also called reservation price.
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2.​ Price (P): The actual market price charged.
3.​ Cost (C): Firm’s total unit cost of production.

Consumers care about value, not cost. Producers focus on cost, as it determines profitability.

Producer surplus: Another term for profit, the difference between price charged (P) and the cost to
produce (C)

Consumer surplus: Difference between the value a consumer attaches to a good or service (V) and what
he or she paid for it (P)

Trade happens because both sides benefit: Consumers enjoy surplus and Producers earn profit. The
distribution of value created may be unequal, but both still gain.

Economic Value Creation and Firm Financial Performance

●​ Revenues depend on: Value created for consumers, and Price charged × Quantity sold.
●​ Profit formula: TR - TC = TP

LIMITATIONS OF ECONOMIC VALUE CREATION

●​ Valuing consumer perceptions is difficult: Estimating V requires observing revealed preferences

(actual buying behavior).
●​ Consumer value changes dynamically with income, preferences and time.
●​ Complexity for diversified firms: Easier for single-product firms

Hence, to gain a holistic performance view, managers combine it with frameworks like the Balanced
Scorecard and Triple Bottom Line
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THE BALANCED SCORECARD

Just as pilots depend on several instruments to monitor altitude, airspeed, and fuel for safe flight, strategic
leaders must rely on multiple performance measures to evaluate a firm’s success.

The balanced scorecard is a Strategy implementation tool that harnesses multiple internal and external
performance metrics in order to balance financial and strategic goals.

FOUR KEY QUESTIONS OF THE BALANCED SCORECARD

1. How do customers view us? (Customer Perspective)

●​ Reflects how customers perceive the company’s products and services, directly influencing
revenues and profits.
●​ A favorable perception increases customers’ willingness to pay (reservation price), enhancing
competitive advantage
●​ Managers monitor speed, quality, service, and cost to improve customer satisfaction.

2. How do we create value? (Internal Processes and Innovation Perspective)

●​ Challenges managers to focus on innovation, learning, and business processes that drive future
competitiveness.
●​ Typical metrics include:
○​ Percentage of revenue from new products.
○​ External collaboration metrics.
●​ The emphasis is on building organizational learning, collaboration, and innovation capability.

3. What core competencies do we need? (Internal Capability Perspective)

●​ Encourages leaders to identify and nurture the core competencies essential to long-term success.
●​ These competencies should be supported by strong internal processes.

4. How do shareholders view us? (Financial Perspective)

●​ Focuses on financial performance from the shareholders’ point of view.

●​ Common measures include:
○​ Cash flow
○​ Operating income
○​ Return on invested capital (ROIC)
○​ Return on equity (ROE)
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○​ Total returns to shareholders
●​ This perspective connects the firm’s strategic initiatives with shareholder value creation and future
expectations of growth.

ADVANTAGES OF THE BALANCED SCORECARD

●​ Communicates and links the strategic vision to responsible parties within the organization.
●​ Translates vision into measurable operational goals.
●​ Designs and aligns business processes with strategic priorities.
●​ Implements feedback and learning systems that allow strategic goals to be updated and improved.
●​ Balances short-term and long-term objectives, helping managers evaluate both current
performance and future potential.
●​ Provides a concise performance report comparing actual outcomes to target values.
●​ Encourages a broader view of success, beyond financial metrics, incorporating customer
satisfaction, internal efficiency, and innovation.

DISADVANTAGES OF THE BALANCED SCORECARD

●​ It is a tool for strategy implementation, not for strategy formulation.

●​ It offers limited guidance on which specific metrics to choose—these depend on context.
●​ The framework’s success depends on managerial skill in:
○​ Developing a sound underlying strategy, and
○​ Translating that strategy into measurable objectives.
●​ It can track and compare performance to targets, but it does not explain how to correct deviations
or improve poor results.
●​ Failure to achieve competitive advantage often reflects weak strategic execution, not flaws in the
tool itself.
●​ Effective use of the balanced scorecard requires discipline, strategic clarity, and continuous
adaptation.

THE TRIPLE BOTTOM LINE

the concept of the triple bottom line (TBL), which emphasizes that true business success depends on
achieving positive outcomes across three dimensions — economic, social, and ecological. Collectively,
these dimensions are often referred to as the three Ps: profits, people, and planet.

THE THREE DIMENSIONS OF THE TRIPLE BOTTOM LINE

1.​ Profits (Economic Dimension): Represents the financial viability of the firm. A business must be
profitable to survive and sustain its operations. Profitability provides the foundation for long-term
investment and growth.
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2.​ People (Social Dimension): Focuses on the well-being of employees, customers, suppliers, and
communities. Includes initiatives like healthier products, fair labor practices, and employee
development.
3.​ Planet (Ecological Dimension): Examines the firm’s relationship with the natural environment.
Involves efforts toward reducing pollution, improving energy efficiency, using renewable
resources, and promoting recycling. Addresses how the company

Implications for Strategic Leaders

●​ No best strategy exists—only better ones (better in comparison with others).

●​ The goal of strategic management is to integrate and align each business function and activity to
obtain superior performance at the business unit and corporate level
●​ Both quantitative and qualitative performance dimensions matter in judging the effectiveness of a
firm’s strategy

Business Strategy: Differentiation, Cost Leadership

and Blue Ocean

Business Level Strategy: How to Compete for Advantage

Business-level strategy refers to the goal-directed actions managers take to achieve competitive advantage
when competing in a single product market. It may focus on one product or a group of similar products
that share the same distribution channel. It answers “How should we compete?”

Strategic Leaders Must Answer Four Key Questions:

●​ Who are the customer segments we will serve?

●​ What customer needs, wishes, and desires will we satisfy?
●​ Why do we want to satisfy these particular needs?
●​ How will we satisfy them effectively?

Determinants of Competitive Advantage: Competitive advantage arises from two interdependent sources:
industry and Firm.
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Interdependence Between Industry and Firm Effects: Industry and firm effects influence each other. Both
together determine a firm’s strategic position in the market.

Strategic Position: Defined by a firm’s relative value creation and cost structure compared to competitors.
The firm’s value-cost position ultimately determines its competitive advantage and profitability.

STRATEGIC POSITION

Competitive advantage arises from the difference between perceived value (V) created for consumers and
the total cost (C) incurred by the firm. The greater the economic value created (V – C), the greater the
firm’s potential for achieving and sustaining a competitive advantage.

Managers have two primary levers to compete effectively:

●​ Value (V): How much utility or benefit customers perceive in the product.
●​ Cost (C): The total expenses the firm incurs to create that value.

Defining Strategic Position: A firm’s business-level strategy determines its strategic position, or its profile
based on value creation and cost, within a specific product market. The goal is to stake out a unique and
valuable position that satisfies customer needs while maintaining the largest possible gap between value
and cost.

Trade-Offs in Strategic Positioning:

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●​ Higher value creation usually requires higher costs.
●​ Executives must therefore make strategic trade-offs between a cost position and a value position.
●​ The challenge is to balance the tension between value creation and cost control to maintain
economic value creation and profit margins.

GENERIC BUSINESS STRATEGIES

Why They’re Called “Generic”:

These strategies can be applied by any organization Each strategy represents a distinct strategic position,
increasing the firm’s chance of achieving and sustaining competitive advantage.

Trade-Offs Between Value and Cost:

●​ Since value creation and cost tend to be positively correlated, firms face important trade-offs.
●​ A successful business strategy either:
○​ Performs similar activities differently from rivals, or
○​ Performs different activities that lead to higher value creation or lower cost.

Scope of competition The size of the market in which a firm chooses to compete

THE STRATEGY MATRIX

The two main dimensions of business-level strategy are:

●​ Strategic Position: Differentiation vs. Cost Leadership

●​ Scope of Competition: Broad vs. Narrow

Four Resulting Strategic Types:

●​ Broad Differentiation Strategy: Aims to create higher value for customers than competitors.
Achieved by delivering unique features or superior quality while maintaining similar or slightly
higher costs. Enables the firm to charge premium prices.
●​ Broad Cost-Leadership Strategy: Seeks to deliver similar value as competitors but at a lower cost.
Allows the firm to offer lower prices and attract price-sensitive customers.
●​ Focused Differentiation Strategy: Same as the differentiation strategy except with a narrow focus
on a niche market.
●​ Focused Cost-Leadership Strategy: Same as the cost-leadership strategy except with a narrow
focus on a niche market.
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Stuck in the middle: Strategic position that is not clearly defined as low cost or differentiation; results
from attempts to straddle different strategic positions and leads to inferior performance results.

Differentiation Strategy: Understanding Value Drivers

Generic business strategy that seeks to create higher value for customers than the value that competitors
create, while containing costs. Add unique features that increase the perceived value of goods or services
in consumers’ minds. Consumers are willing to pay a higher price (premium) when they perceive greater
value.

Focus of competition:

●​ Unique product features

●​ Superior services
●​ New product launches
●​ Strong marketing and promotion
●​ Not price competition

Achieving Competitive Advantage

A firm achieves advantage when economic value created (V − C) is greater than competitors’.

For example:, Firm A produces generic commodity and Firm B and C use differentiation. If firm B offers
a higher value than FIrm A with the same cost then it maintains cost parity and achieve competitive
advantage. If FIrm C offers higher value, but at higher cost. If it has a larger (V − C) than Firm A, hen it
achieved competitive advantage. However if Firm B and FIm C both offer same value but Firm B has
lower cost then Firm B has competitive advantage.

Balancing Value and Cost

●​ Increasing value often leads to higher costs (e.g., R&D, premium materials, skilled labor).
●​ If costs rise faster than perceived value then the value gap shrinks and advantage erodes.​

Alternative Pricing Approach

While differentiation often involves premium pricing, firms can also offer greater perceived value at
similar prices, gaining market share. It then gains economies of scale and economies of scope.
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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

Key Value Drivers

Value drivers only enhance competitive advantage when the increase in value (ΔV) exceeds the increase
in cost (ΔC): Condition: ΔV > ΔC → strengthens strategic position.

1.​ Product Features: Primary lever for differentiation. Adding unique attributes transforms a
commodity into a distinctive product with premium pricing power. Requires strong R&D
capabilities and innovation.
2.​ Customer Service: Superior service increases perceived value and fosters customer loyalty. It can
result in a strong brand reputation.
3.​ Complements: Products/services that add value when consumed together. They enhance the
attractiveness of the core offering.

Cost-Leadership Strategy: Understanding Cost Drivers

The cost-leadership strategy aims to reduce a firm’s overall costs below those of competitors while still
offering products or services that provide acceptable value to customers. The main idea is not to provide
the best or most unique product, but to provide a product that meets basic customer expectations at the
lowest possible price.

To achieve this, firms focus on optimizing every step in the value chain, such as manufacturing,
operations, logistics, and supply management, so they can produce and deliver efficiently.

A firm that successfully implements this strategy achieves competitive advantage when the economic
value created (V − C) is greater than that of its competitors. In this context:

●​ Firm A represents a company with a vulnerable cost structure that is not particularly low or
efficient.
●​ Firm B reduces costs below Firm A’s level while maintaining the same level of value creation
(differentiation parity). This allows Firm B to achieve greater economic value creation by
maintaining low costs while offering acceptable quality.
●​ Firm C, on the other hand, might not achieve differentiation parity—it provides slightly less
value—but because its costs are even lower, it still enjoys a competitive advantage over Firm A.

Essentially, both Firm B and Firm C outperform Firm A, but Firm B performs best overall because it
combines low cost with comparable value.
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A cost leader can either:

1.​ Charge similar prices as competitors but earn higher profit margins, or
2.​ Charge lower prices to increase sales volume and market share.

However, success in cost leadership does not mean completely ignoring quality. Firms must still provide
products that meet a basic level of customer expectation “adequate value.”

To sustain a cost advantage, strategic leaders must manage several key cost drivers:

1.​ Cost of input factors – Firms gain advantage when they access cheaper raw materials, labor,
capital, or technology.
2.​ Economies of scale – As firms produce more, the cost per unit decreases because fixed costs are
spread over a larger output. Large-scale operations also allow the use of specialized equipment and
processes. But there’s a limit: beyond a certain scale, firms face diseconomies of scale—rising
costs due to complexity, bureaucracy, or coordination challenges.
3.​ Learning-curve effects – As a company gains experience, workers and processes become more
efficient, reducing costs over time. This “learning by doing” effect is seen in industries like aircraft
manufacturing and tech. Repeated practice and process refinement lead to lower costs.
4.​ Experience-curve effects – When a firm not only learns from experience but also introduces
process innovations, it can jump to a new, steeper learning curve with even lower costs.

Business-Level Strategy and the Five Forces: Benefits and Risks

Business-level strategies allow firms to establish strong strategic positions that increase their chances of
gaining and sustaining a competitive advantage.

Differentiation Strategy: Benefits and Risks

A differentiation strategy seeks to create higher perceived value with less costs. Its products hold a unique
market position, allowing it to command premium prices and reduce competitive pressures.

Benefits of Differentiation Strategy:

●​ Reduced rivalry: A firm with a unique offering faces less direct price-based competition. Rivals
must invest heavily in improving features and brand reputation to compete.
●​ Reduced threat of entry: Strong brands, unique features, and intangible assets (like reputation and
customer loyalty) are difficult and costly to imitate, deterring new entrants.
●​ Protection from powerful suppliers: When a firm’s value creation exceeds the price charged, it can
pass input cost increases to customers without losing demand.
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●​ Reduced buyer power: Loyal customers are less price-sensitive and less likely to demand price
cuts.
●​ Reduced threat of substitutes: Unique attributes create customer attachment, reducing the appeal
of alternative products.

Risks of Differentiation Strategy:

●​ Commoditization: When once-unique products become standard, competition shifts to price.

●​ Over-differentiation: Adding costly features that do not increase perceived value can hurt
profitability. For example, improving display resolution beyond what the human eye can detect
adds cost without value.
●​ High costs of uniqueness: If the expenses of maintaining differentiation exceed customers’
willingness to pay, the strategy becomes unsustainable.

Cost-Leadership Strategy: Benefits and Risks

A cost-leadership strategy focuses on achieving the lowest cost structure with acceptable value. Cost
leaders increase efficiency, achieve economies of scale, and tightly control costs.

Benefits of Cost-Leadership Strategy:

●​ Protection from rivalry: In a price war, the cost leader survives longer because it can remain
profitable at lower prices.
●​ Reduced threat of entry: Economies of scale and large market share make entry difficult for
smaller firms.
●​ Protection from suppliers: Cost leaders can absorb input price increases by accepting lower
margins.
●​ Protection from buyers: The firm can lower prices to meet buyer demands while remaining
profitable.
●​ Defense against substitutes: A cost leader can drop prices to retain value relative to new
substitutes.

Risks of Cost-Leadership Strategy:

●​ Erosion of margins by new entrants: New firms with superior technology or expertise can undercut
existing cost leaders
●​ Technological disruption: Innovations can introduce substitutes that redefine industry cost
structures.
●​ Supplier and buyer pressure: Powerful suppliers or buyers might squeeze margins further,
threatening profitability.
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●​ Value threshold risk: If cost reduction sacrifices product quality or service beyond what customers
find acceptable, demand will drop.
●​ Shift in competition focus: If customers begin valuing non-price attributes (like design or
experience), the cost leader’s advantage diminishes.

The success of each depends on context and relies on two factors:

●​ How well the strategy leverages the firm’s internal strengths while mitigating its weaknesses
●​ How well the strategy helps the firm exploit external opportunities while avoiding external threats
●​ There is no single correct business strategy for a specific industry. The best strategy is one that
attempts to maximize economic value creation and is effectively implemented.
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Blue Ocean Strategy: Combining Differentiation and Cost Leadership

Blue oceans: Untapped market space that is ripe for the creation of additional demand and the resulting
opportunities for highly profitable growth.

Red oceans The known market space of existing industries, where the rivalry among existing firms is
cutthroat because the market space is crowded and competition is a zero-sum game.

Red Oceans vs. Blue Oceans

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●​ Red Oceans are the existing market spaces where competition is intense.
○​ Companies fight over the same customers.
○​ Products become commodities.
○​ Price wars erode profits.
○​ The market is “bloody” with rivalry—hence, “red.”
●​ Blue Oceans are new, uncontested markets.
○​ Firms create new demand instead of fighting for existing customers.
○​ Competition becomes irrelevant.
○​ Profitable growth opportunities emerge.

A Blue Ocean Strategy successfully combines low cost and differentiation through what’s called value
innovation—achieving both lower costs and higher perceived value simultaneously.

Value Innovation: The Heart of the Strategy

To create a blue ocean, managers must achieve value innovation, meaning they innovate in a way that:

●​ Increases perceived value for consumers, and

●​ Reduces costs for the company.

Instead of trying to “beat” competitors, firms redefine the rules of competition by changing what
customers value and how products are delivered.

Value innovation is achieved through the Eliminate–Reduce–Raise–Create Framework:

1.​ Eliminate: Which factors does the industry take for granted that should be eliminated?
2.​ Reduce: Which factors should be reduced well below the industry standard?
3.​ Raise: Which factors should be raised well above the industry standard?
4.​ Create: Which factors should be created that the industry has never offered?

The Danger: “Stuck in the Middle”

A Blue Ocean Strategy is difficult to execute because it requires balancing two opposite forces—low cost
and differentiation. If a company fails to reconcile these trade-offs, it ends up “stuck in the
middle”—having neither the cost advantage of a cost leader nor the unique value of a differentiator. Being
stuck in the middle means unclear positioning, inefficient operations, and inferior performance.

The Strategy Canvas

A strategy canvas visually maps how firms perform across different competitive factors in an industry.
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●​ A consistent, focused curve (like Delta’s or Southwest’s) shows a clear strategy.
●​ A zigzagging curve (like JetBlue’s) reveals inconsistency and strategic confusion.