COST ADVANTAGE AND DIFFERENTIATION ADVANTAGE
Jan 01, 2016
STRATEGIC POSITIONING SHOULD IMPROVE PROFITABILITY
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Where managers of a company situate that company relative to it’s rivals along important competitive dimensions
To reduce the effects of rivalry and thereby improve profitability
A FIRM’S CHOICE OF POSITION DEPENDS ON TWO FACTORS
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Firm’s resources and capabilities1
Industry structure2
A FIRM CAN GAIN ADVANTAGE OVER RIVALS IN TWO WAYS
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No advantage overrivals
Advantage over rivals
Low-cost
Differentiation
Description
Produce an essentially equivalent product at a lower cost
Produce a differentiated product and charge suffici-ently higher prices to more than off-set the added costs of differentiation
THE STRATEGIC POSITIONING MODEL
5Adapted from poster, M.1980. Competitive strategy, 1980.
Low-cost Differentiation
Strategic advantage
Strategictarget
Narrow(i.e., particular segment only)
Broad(i.e., industry wide)
Broaddifferentiation
Focused costleadership
Focuseddifferentiation
Broad low-costleadership
LOW-COST LEADERSHIP AND DIFFERENTIATION OFFER GREATER MARKET SHARE AND/OR PROFITS
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Examples
Benefits
Low-cost leadership Differentiation
• Pacific Cycle
• Gallo Wines
• Wal-Mart
• Southwest Airlines
• Home Depot
• Trek Bicycles
• Coca-Cola and Pepsi
• Mercedez Benz
• Honda, Yamaha, and Suzuki motorcycles
• Stouffers (frozen foods)
• Capture market share by offering lower-price or
• Earn higher by maintaining price parity
• Capture market share by
offering higher quality at same price or
• Earn higher margins by raising prices over competitors
STRATEGIC POSITIONING EXAMPLES
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Low-cost Differentiation
Strategic advantage
Strategictarget
Narrow
Broad• Trek Bicycles
• Coca-cola
• Jet Blue• Montague
• Mercedes Benz (in US)
• Wal-Mart
• Gallo Wines
LOW-COST AND DIFFERENTIATION CAN GENERATE HIGH MARGINS
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Hyundai Elantra
Honda Civic
Chevy Cavalier
Product cost Producer’s margin Buyer’s cost*
Hyundai has a cost advantage
Honda has a differentiation advantage
Price
Price
Price
* Including maintenance and other intangibles
RESULTS OF DIFFERENTIATED, LOW-COST, AND INTEGRATED POSITIONS
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Successful differentiated competitor
Successful low-cost competitor
Industry average competitor
Competitor with both advantages (integrated)
Price
Cost
Industry average cost
Industry average price
KEY DRIVERS OF COST ADVANTAGE
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• Economies of scale
• Learning
• Product technology
• Product design
• Location advantages for sourcing inputs
DISECONOMIES OF SCALE – SIZE DOES NOT ENSURE ECONOMIES OF SCALE
Learning
Economiesof scope
Productiontechnology
Productdesign
Location
Economiesof scale
• Economies of scale exist during a period of time if the average total cost for a unit of production is lower at higher levels of output
• You must review cost to assess whether economies of scale exist:
–Fixed costs remain the same for different levels of production
–Variable costs are the costs of variable inputs (such as raw materials and labor) and vary directly with output
–Marginal cost is the cost of the last unit of production
–Total cost is the sum of all production costs and always increases as output goes up
–Average cost is the mean cost of total production during a given period (say, a year)
DISECONOMIES OF SCALE – SIZE DOES NOT ENSURE ECONOMIES OF SCALE
Learning
Economiesof scope
Productiontechnology
Productdesign
Location
Some sourcesof economies
• R&D spend
• Advertising spend
• Specialization of specific production processes
• Superior inventory management
• Purchasing power
Some sourcesof diseconomies
• Bureaucracy
• High labor costs
• Inefficient operations
Economiesof scale
MINIMUM EFFICIENT SCALE (MES)
Learning
Economiesof scope
Productiontechnology
Productdesign
Location
Average cost
Scale of operations
Diseconomies of scale
Economiesof scale
Economiesof scale
Minimum efficient scale: The minimum scale needed to achieve
maximum cost savings (i.e., minimum costs)
LEARNING CURVE AS A SOURCE OF COST ADVANTAGE
Economiesof scale
Learning
Economiesof scope
Productiontechnology
Productdesign
Location
Costs decrease …
as the scale of operation increases during any given period of time
Economiesof scale
with the cumulative level of production since the production of the first unit
Learning curve
How Learning Differs from Scale
LEARNING CURVE (continued)
Economiesof scale
Economiesof scope
Productiontechnology
Productdesign
Location
Step 1: Measure
Step 2: CalibrateNo. of bikes produced
Hours spent on last bike
1
2
4
8
16
32
64
128
30.00 actual
27.00 actual
24.30 actual
21.87 est.
19.68 est.
17.71 est.
15.92 est.
14.34 est.
Step 3: Project
Learning
10.00
15.00
20.00
25.00
30.00
35.00
0 24 48 72 96 120
144
168
192
216
240
264
288
312
336
Hou
rs
Number of Bikes Produced
East Side Bikes Learning Curve Hours per
bike
ECONOMIES OF SCOPE AS A SOURCE OF COST ADVANTAGE
Economiesof scale
Learning
Economiesof scope
Productiontechnology
Productdesign
Location
If a firm produces two or more products and can share resources among two or more of these (e.g., share manufacturing machines) – thereby lowering the costs of each product – it benefits from economies of scope
PRODUCTION TECHNOLOGY AS A SOURCE OF COST ADVANTAGE
Economiesof scale
Learning
Economiesof scope
Productiontechnology
Productdesign
Location
Often, a new entrant who wants to compete against industry incumbents with significant scale and experience advantages, tries to match or beat incumbents’ costs by introducing a production technology that is subject to different economics (e.g., Jet Blue, Nucor Steel)
PRODUCTION DESIGN AS A SOURCE OF COST ADVANTAGE
Economiesof scale
Learning
Economiesof scope
Productiontechnology
Productdesign
Location
Product design can sometimes be altered to lower a firm’s production costs (e.g., Canon vs. Xerox)
LOCATION AS A SOURCE OF COST ADVANTAGE
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Economiesof scale
Learning
Economiesof scope
Productiontechnology
Productdesign
Location
Sometimes firms try to attain lower production costs by locating their operations in cheaper labor markets (e.g., Pacific Cycle manufactures in China and Taiwan to achieve lower costs than Trek who manufactures in the US)
KEY DRIVERS OF DIFFERENTIATION ADVANTAGES
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• Premium brand image
• Customization
• Unique styling
• Speed
• More convenient access
• Unusually high-quality
To drive up customer’s willingness to pay and generate demand sufficient to
(1) Recoup added costs and
(2) Generate enough profits to make strategy worthwhile
Key Drivers Purpose
DRIVERS AND THREATS TO DIFFERENTIATION AND LOW-COST ADVANTAGE
Low-cost
Differentiation
• Economies of scale
• Learning
• Economies of scope
• Superior technology
• Product design
• Location
Drivers Threats
• New technology
• Too low-quality
• Social, political, and economic risks of outsourcing
• Premium brand image
• Customization
• Unique styling
• Speed
• Convenient access
• Unusually high-quality
• Failure to increase buyer’s willingness to pay higher prices
• Under estimating cost of differentiation
• Over fulfillment of buyer’s needs
• Lower cost imitation
VALUE-CHAIN ACTIVITIES: OVERALL COST LEADERSHIP
McGraw-Hill/IrwinStrategic Management, 3/e Copyright © 2007 The McGraw-Hill Companies, Inc. All rights reserved.
Exhibit 5.3 Value-Chain Activities: Examples of Overall Cost LeadershipSource: Adapted with the permission of The Free Press, a division of Simon & Schuster, Inc., from Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985 by Michael E. Porter.
TESTING THE QUALITY OF A STRATEGY
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Key Evaluation Criteria Sub-questions
1. Does your strategy exploit your key resources?
• With your particular mix of resources, does this strategy give you an advantageous position relative to your competitors?
• Can you pursue this strategy more economically than competitors?• Do you have the capital and managerial talent to do all you envision? • Are you spread too thin?
2. Does your strategy fit with current industry conditions?
• Is there healthy profit potential where you're headed? • Are you aligned with the key success factors of your industry?
3. Will your differentiators be sustainable? • Will competitors have difficulty imitating you? • If imitation cannot be foreclosed, does your strategy include a ceaseless
regimen of innovation and opportunity creation to keep distance between you and the competition?
4. Are the elements of your strategy consistent and aligned with your strategic position?
• Have you made choices of arenas, vehicles, differentiators, and staging, and economic logic?
• Do they all fit and mutually reinforce each other?
6. Can your strategy be implemented? • Will your stakeholders allow you to pursue this strategy? • Do you have the proper complement of implementation levers in place?• Is the management team able and willing to lead the required changes?