Please answer the following prompt(s) in your initial post (you will not be able to see the posts of your classmates until you make your initial post).  Discussion board posts are individual-level assignments.  Please do not discuss with your group members or anyone else within/outside of your section.     

(a) Identify one concept that was not clear to you from chapters 1 through 6.  Elaborate why the concept was not clear in 50-100 words (i.e., minimum 50 words and maximum 100 words).

(b) Identify one concept from chapters 1 through 6 that you are most likely to use in your career.  Elaborate how you will use it in your career in 50-100 words (i.e., minimum 50 words and maximum 100 words).

 

Chapter 1: What is Strategy?

LO 1-1 Explain the role of strategy in a firm’s quest for competitive advantage.

LO 1-2 Define competitive advantage, sustainable competitive advantage, competitive disadvantage, and competitive parity.

LO 1-3 Describe the roles of vision, mission and values in a firm’s strategy.

LO 1-4 Evaluate the strategic implications of product-oriented and customer-oriented vision statements.

LO 1-5 Justify why anchoring a firm in ethical core values is essential for long-term success.

LO 1-6 Explain the AFI strategy framework.

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Strategy and Competitive Advantage

Strategy: Goal-directed actions a firm takes
Gaining and sustaining competitive advantage
Superior performance relative to competitors in your industry
Company X
Company Y
Return on Invested Capital (ROIC)
Average
Industry Average ROIC %
Consulting 20
Newspaper -5

Competitive advantage
Competitive disadvantage

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Competitive Advantage and Economic Value Created
Exhibit 5.7
Jump to Appendix 7 long image description

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Baker, Sama Baker Sulaiman (BSBS) –

Differentiation Strategy:
Achieving Competitive Advantage
Exhibit 6.3
SOURCE: Adapted from M.E. Porter (1980), Competitive Strategy. Techniques for Analyzing Industries and Competitors (New York: Free Press).
Jump to Appendix 4 long image description

©McGraw-Hill Education.
Under a differentiation strategy, firms that successfully differentiate their products enjoy a competitive advantage. Firm A’s product is seen as a generic commodity with no unique brand value. Firm B has the same cost structure as Firm A but creates more economic value, and thus has a competitive advantage over both Firm A and Firm C because (V − C)B > (V − C)C > (V − C)A. Although, Firm C has higher costs than Firm A and B, it still generates a significantly higher economic value than Firm A.
4

Baker, Sama Baker Sulaiman (BSBS) – Why people paying less for firm B?
Cost Leadership Strategy:
Achieving Competitive Advantage
Exhibit 6.4

Jump to Appendix 5 long image description

©McGraw-Hill Education.
Under a cost-leadership strategy, firms that can keep their cost at the lowest point in the industry while offering acceptable value are able to gain a competitive advantage. Firm A has not managed to take advantage of possible cost savings, and thus experiences a competitive disadvantage. The offering from Firm B has the same perceived value as Firm A but through more effective cost containment creates more economic value (over both Firm A and Firm C because (V − C)B > (V − C)C > (V − C)A. The offering from Firm C has a lower perceived value than that of Firm A or B and has the same reduced product cost as with Firm B; as a result, Firm C still generates higher economic value than Firm A.
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Baker, Sama Baker Sulaiman (BSBS) –

Unique Strategic Positioning
Conscious trade-offs: [DIFFERENTIATION] or [COST LEADERSHIP]
What to do and what not to do
Successful strategy requires combining a set of activities for a unique position in an industry
Competitive advantage has to come from:
Performing different activities or
Performing the same activities differently than rivals

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What Strategy Is Not
Grandiose statements
Example: “We will be No. #1”
A failure to face a competitive challenge
Example: Blockbuster didn’t address Netflix, Redbox, Amazon Prime, and Hulu
Operational effectiveness, competitive benchmarking, or tactical tools
Examples: “pricing strategy,” “operations strategy,” “brand strategy”

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Element of Strategy: A-F-I Framework

?

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Effective Vision
Captures an organization’s aspiration
Identifies what it ultimately wants to accomplish
Forward-looking and Inspiring: Motivates employees to aim for a target
Employees tend to feel part of something bigger than themselves.
Helps employees find meaning in their work
Allows employees to experience a greater sense of purpose

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Two Types of Vision Statements

Product-Oriented
Customer-oriented
Defines a business in terms of a good or service provided
Defines a business in terms of providing solutions to customer needs
To be the most efficient carrier in the railroad business
To make the world more open and connected
Myopic view of the competitive landscape
Less flexible
Focuses employees on problem solving for the customer
Customer needs may change
The means of meeting those needs may change also
We are building a new history in which our customers and our individual team members realize transformational growth (Vision statement for Central Maine and Quebec Railway)

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Vision Statement and Competitive Advantage

Vision Statement
Competitive advantage
The vision is customer-oriented
Internal stakeholders help define the vision
Organizational structures align with the vision statement

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Mission and Values

Mission
Values
Defines how the vision is accomplished
Principles to guide behavior of employees at all levels
The products and services it will provide
Ethical standards and norms
The markets in which it will compete
Helps employees understand the company culture
Deal with complexity and resolve conflict
Top management commitment to values or lip service
GMU’s core values? IDEA
Need strategic commitments/actions:
– Costly
– Long-term oriented
– Difficult to reverse.

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Learning Objectives

LO 2-1 Explain the role of strategic leaders and what they do.

LO 2-2 Outline how you can become a strategic leader.

LO 2-3 Describe the roles of corporate, business, and functional managers in strategy formulation and implementation.

LO 2-4 Evaluate top-down strategic planning, scenario planning, and strategy as planned emergence.

LO 2-5 Assess the relationship between stakeholder strategy and sustainable competitive advantage.

LO 2-6 Conduct a stakeholder impact analysis.

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What Do Strategic Leaders Do?
Exhibit 2.1
– Pursuing an organization’s goals
– Directing the activities of others
– Successful use of power and influence

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CEOs spend most of their time “interacting—talking, cajoling, soothing, selling, listening, and nodding—with a wide array of parties inside and outside the organization.” Surprisingly given the advances in information technology, CEOs today spend most of their time in face-to-face meetings. They consider face-to-face meetings most effective in getting their message across and obtaining the information they need.
2

Why Study Top Management: Upper Echelon’s Theory

Values of the top management team
Organizational outcomes
(strategic choices and performance)
Age
Education
Experience

©McGraw-Hill Education.

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Level-5 Leadership Pyramid
Based on the bestseller Good to Great by Jim Collins
Explored over 1,000 good companies to find 11 great ones (stock returns seven times the average market over a prolonged period)

Progression: Each level builds upon the previous one: Prior levels must be mastered before moving on

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In the bestseller Good to Great, Jim Collins explored over 1,000 good companies to find 11 great ones. Collins found consistent patterns of leadership among the top companies, as pictured in the Level-5 leadership pyramid. Collins found that all the companies he identified as great were led by Level-5 executives. So if you are interested in becoming an ethical and strategic leader, the leadership pyramid suggests the areas of growth required.
4

Exhibit 2.3 Strategy Formulation and Implementation Across Levels
Jump to Appendix 3 long image description

SBU: Stand-alone division with a profit-and-loss responsibility
Accounting, Finance, Marketing, R &D, HR, Manufacturing, etc.
Creating synergies across SBUs
Decide whether to enter or exit industries and markets
Set strategic objectives and monitor performance
Allocate scare resources among SBUs

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1st of 3 Process Approaches: Top-down Strategic Planning
Top management attempts to program future through detailed analysis, five-year plans, correlated budgets, and performance monitoring
Rational, data-driven strategy process
Potential shortcomings:
May not adapt well to change
Formulation separate from implementation
Information flows top-down (one-way)
The leaders’ future vision can be wrong

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2nd of 3 Process Approaches: Scenario Planning
Top management envisions optimistic and pessimistic “what if” scenarios and derives strategic responses
New laws, demographic shifts, changing economic conditions, technological advances, etc.
Black swan (high impact highly improbable) events

Create multiple detailed and executable strategic plans.
What resources and capabilities do we need to compete successfully in each scenario?
What strategic initiatives should we put in place to respond to each scenario?
How can we shape our expected future environment?
Exh 2.5

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3rd of 3 Approaches: Strategy as Planned Emergence
Unplanned but still evaluated and coordinated by mgmt.
Relies on personal experience, deep domain expertise, and front-line employee insights

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Exhibit 2.6. This figure illustrates how parts of a firm’s intended strategy are likely to fall by the wayside because of unpredictable events and turn into unrealized strategy.
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Strategy Highlight 2.2: Frappuccino
Diana – Starbucks manager in California
Received requests for iced beverage
Tried the beverage, and liked it
Requested Starbucks HQ offer the drink
Request denied
She did it anyway
Sales skyrocketed
Was eventually adopted by Starbucks Execs
This is now the Starbucks Frappuccino: At one point, was 20% of Starbucks revenues

©McGraw-Hill Education.

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Internal and External Stakeholders in an Exchange Relationship with the Firm
Exhibit 2.8

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If any stakeholder withholds participation in the firm’s exchange relationships, it can negatively affect firm performance. The aerospace company Boeing, for example, has a long history of acrimonious labor relations, leading to walk-outs and strikes. This in turn has not only delayed production of airplanes but also raised costs. Borrowers who purchased subprime mortgages are stakeholders (in this case, customers) of financial institutions. When they defaulted in large numbers, they threatened the survival of these financial institutions and, ultimately, of the entire financial system.
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Stakeholder Impact Analysis
Exhibit 2.9
Power, Legitimacy, and Urgency
Three stakeholder attributes:

©McGraw-Hill Education.
Examples:
Boeing opened a new airplane factory in South Carolina to move production away from its traditional plant near Seattle, Washington. South Carolina is one of 28 states in the United States that falls under the right-to-work law in which employees in unionized workplaces are allowed to work without being required to join the union. In contrast to its work force in Washington state, the South Carolina plant is nonunionized, which should lead to fewer work interruptions due to strikes and Boeing hopes to higher productivity and improvements along other performance dimensions (like on-time delivery of new airplanes). In 2014, Boeing announced that its new 787 Dreamliner jet would be exclusively built in its nonunionized South Carolina factory.
Many companies incentivize top executives by paying part of their overall compensation with stock options. They also turn employees into shareholders through employee stock ownership plans (ESOPs). These plans allow employees to purchase stock at a discounted rate or use company stock as an investment vehicle for retirement savings. For example, Alphabet, Coca-Cola, Facebook, Microsoft, Southwest Airlines, Starbucks, Walmart, and Whole Foods all offer ESOPs
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The Pyramid of Corporate Social Responsibility

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Philanthropic responsibilities are often subsumed under the idea of corporate citizenship, reflecting the notion of voluntarily giving back to society. Over the years, Microsoft’s corporate philanthropy program has donated more than $3 billion in cash and software to people who can’t afford computer technology.
According to the CSR perspective, managers need to realize that society grants shareholders the right and privilege to create a publicly traded stock company. Therefore, the firm owes something to society. Moreover, CSR provides managers with a conceptual model that more completely describes a society’s expectations and can guide strategic decision making more effectively. For an insightful but critical treatment of this topic, see the 2003 Canadian documentary film The Corporation.
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Learning Objectives

LO 3-1 Generate a PESTEL analysis to evaluate the impact of external factors on the firm.

LO 3-2 Differentiate the roles of firm effects and industry effects in determining firm performance.

LO 3-3 Apply Porter’s five competitive forces to explain the profit potential of different industries.

LO 3-4 Explain how competitive industry structure shapes rivalry among competitors.

LO 3-5 Describe the strategic role of complements in creating positive-sum co-opetition.

LO 3-6 Explain the five choices required for market entry.

LO 3-7 Appraise the role of industry dynamics and industry convergence in shaping the firm’s external environment.

LO 3-8 Generate a strategic group model to reveal performance differences between clusters of firms in the same industry.

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The Firm Within Its External Environment
Exhibit 3.1
General Environment (managers have little direct influence)
General Environment
Task Environment

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This image represents each of these environmental layers in detail, moving from a firm’s general environment to its task environment.
2

Drivers of Superior Firm Performance
Exhibit 3.2
INDUSTRY EFFECTS: For example, barriers to entry
FIRM EFFECTS: Managerial actions
OTHER EFFECTS:
Business Cycle
Unexplained variance

©McGraw-Hill Education.
Although a firm’s industry is not quite as important as the firm’s strategy within its industry, they jointly determine roughly 75 percent of overall firm performance. The remaining 25 percent relates partly to business cycles and other effects.
3

Political Factors
Processes & actions of government bodies
Can be shaped through:
Lobbying
Public Relations
Contributions
Litigation
Political and legal forces are closely related.

©McGraw-Hill Education.
For example, hotel chains and resort owners have challenged Airbnb in courts and lobbied local governments, some of which passed regulations to limit or prohibit short-term rentals. Local residents in New York, San Francisco, Berlin, Paris, and many other cities are also pressuring local governments to enact more aggressive rules banning short-term rentals because they argue that companies such as Airbnb contribute to a shortage of affordable housing by turning entire apartment complexes into hotels or transforming quiet family neighborhoods into all-night, every-night party hot spots. 
4

Economic Factors
Largely macro-economic
Economy-wide phenomena
Examples include:
Growth rates
Levels of employment
Interest rates
Price stability
Currency exchange rates

©McGraw-Hill Education.
Occasionally, boom periods can overheat and lead to speculative asset bubbles. In the early 2000s, the United States experienced an asset bubble in real estate.4 Easy credit, made possible by the availability of subprime mortgages and other financial innovations, fueled an unprecedented demand in housing. Real estate, rather than stocks, became the investment vehicle of choice for many Americans, propelled by the common belief that house prices could only go up. When the housing bubble burst, the deep economic recession of 2008–2009 began, impacting in some way nearly all businesses in the United States and worldwide.
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Sociocultural Factors
Society’s cultures, norms, and values
Are constantly in flux
Differ across groups
Demographic trends
Population characteristics
Age, gender, family size, ethnicity, sexual orientation, religion, and socioeconomic class

©McGraw-Hill Education.
In recent years, for example, a growing number of U.S. consumers have become more health-conscious about what they eat. This trend led to a boom for businesses such as Chipotle, Subway, and Whole Foods. At the same time, traditional fast-food companies McDonald’s and Burger King, along with grocery chains such as Albertsons and Kroger, have all had to scramble to provide healthier choices in their product offerings.
The most recent U.S. census revealed that 55 million Americans (16.4 percent of the total population) are Hispanic. It is now the largest ethnic group in the United States and growing fast. On average, Hispanics are also younger and their incomes are climbing quickly. This trend is not lost on companies trying to benefit from this opportunity. For example, MundoFox and ESPN Deportes (specializing in soccer) have joined Univision and NBC’s Telemundo in the Spanish-language television market. In the United States, Univision is now the fifth most popular network overall, just behind the four major English-language networks (ABC, NBC, CBS, and Fox). Likewise, advertisers are pouring dollars into the Spanish-language networks to promote their products and services.
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Technological Factors
Application of knowledge
New processes and products
Innovations in process technology:
Lean manufacturing and Six Sigma quality
Innovations in product technology:
Smartphones and wearable devices

©McGraw-Hill Education.
As discussed in the Chapter Case, Airbnb launched a radical process innovation of offering and renting rooms based on a business model leveraging the sharing economy. If one thing seems certain, technological progress is relentless and seems to be picking up speed.
Strategy Highlight 3.1 details how BlackBerry fell victim by not paying sufficient attention to the PESTEL factors.
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Ecological Factors
Broad environmental issues:
Natural environment
Global warming
Sustainable economic growth
Can provide business opportunities
Tesla cars have zero emissions

©McGraw-Hill Education.
Negative examples come readily to mind, as many business organizations have contributed to the pollution of air, water, and land, as well as depletion of the world’s natural resources. BP’s infamous oil spill in the Gulf of Mexico destroyed fauna and flora along the U.S. shoreline from Texas to Florida. This disaster led to a decrease in fish and wildlife populations, triggered a decline in the fishery and tourism industries, and threatened the livelihood of thousands of people. It also cost BP more than $40 billion and one-half of its market value (see Strategy Highlight 2.2).
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Legal Factors
Official outcomes of political processes:
Laws
Mandates
Regulations
Court decisions
Many industries have been deregulated:
Airlines, telecom, energy, and trucking

©McGraw-Hill Education.
Consider how several European countries and the European Union (EU) apply political and legal pressure on U.S. tech companies. European targets include Apple, Amazon, Facebook, Google, and Microsoft—the five largest U.S. tech companies—but also startups such as Uber, the taxi-hailing mobile app. Europe’s policy makers seek to retain control over important industries ranging from transportation to the internet to ensure that profits earned in Europe by Silicon Valley firms are taxed locally. The EU parliament even proposed legislation to break up “digital monopolies” such as Google. This proposal would require Google to offer search services independently as a standalone company from its other online services.
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Porter’s Five Forces Model
Exhibit 3.3
Competition viewed broadly to not only include direct competitors but potential new entrants, substitutes, suppliers, and buyers
Industry’s long-term profit potential determined by the above five factors
Demand higher price
Demand lower price
Brings new capacity
Better price-performance trade-off
Airline industry
You & me, Travel website
Aircraft manufacturer, pilots, mechanics
Train, Video-conferencing

©McGraw-Hill Education.
Porter derived two key insights that form the basis of his seminal five forces model:
1. Rather than defining competition narrowly as the firm’s closest competitors to explain and predict a firm’s performance, competition must be viewed more broadly, to also encompass the other forces in an industry: buyers, suppliers, potential new entry of other firms, and the threat of substitutes.
2. The profit potential of an industry is neither random nor entirely determined by industry-specific factors. Rather, it is a function of the five forces that shape competition: threat of entry, power of suppliers, power of buyers, threat of substitutes, and rivalry among existing firms.
As a rule of thumb, the stronger the five forces, the lower the industry’s profit potential—making the industry less attractive for competitors. The reverse is also true: the weaker the five forces, the greater the industry’s profit potential—making the industry more attractive.
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Threat of Entry is high when:
Minimum efficient scale low
Network effects not present
Capital requirements low
Incumbents do not possess SIZE-INDEPENDENT advantages such as brand loyalty, proprietary technology, access to [raw materials, distribution channels, geographical location], cumulative learning and experience effects, etc.
Customer switching costs low
Restrictive government regulations non-existent
Incumbents will not or cannot retaliate

©McGraw-Hill Education.
The threat of entry is high when:
✓The minimum efficient scale to compete in an industry is low.
✓Network effects are not present.
✓Customer switching costs are low.
✓Capital requirements are low.
✓Incumbents do not possess:
Brand loyalty.
Proprietary technology.
Preferential access to raw materials.
Preferential access to distribution channels.
Favorable geographic locations.
Cumulative learning and experience effects.
✓Restrictive government regulations do not exist.
✓New entrants expect that incumbents will not or cannot retaliate.
To benefit from economies of scale, Tesla is introducing new models, helping it move away from small-scale and costly production of niche vehicles to larger production runs of cars with a stronger mass-market appeal.
Network effects: For example, Facebook, with over 1.2 billion active users worldwide, enjoys tremendous network effects, making it difficult for more recent entrants such as Google Plus to compete effectively.
Switching costs – For example, a firm that has used enterprise resource planning (ERP) software from SAP for many years will incur significant switching costs when implementing a new ERP system from Oracle
Capital requirements: Tesla Motors made a sizable capital investment of roughly $150 million when it purchased the Fremont, California, manufacturing plant from Toyota and upgraded it with a highly automated production process, using robots to produce cars of the highest quality at large scale.
Advantages independent of size – Tesla’s lithium-ion batteries are not only the most expensive and critical parts of an all-electric vehicle, but they are also in short supply. Tesla’s new battery “gigafactory” will afford it independence from the few worldwide suppliers, such as Panasonic of Japan, and also likely bestow an absolute cost advantage.
Government policy – India did not allow foreign retailers such as Walmart or IKEA to own stores and compete with domestic companies in order to protect the country’s millions of small vendors and wholesalers. China frequently requires foreign companies to enter joint ventures with domestic ones and to share technology.
Threat of retaliation – For example, in the southeastern United States, TV cable company Comcast has entered the market for residential and commercial telephone services and internet connectivity (as an ISP, internet service provider), emerging as a direct competitor for AT&T. Comcast also acquired NBC Universal, combining delivery and content. AT&T responded to Comcast’s threat by introducing U-verse, a product combining high-speed internet access with cable TV and telephone service, all provided over its fast fiber-optic network.
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Threat of Substitutes is high when:
Substitutes have better price-performance trade-off
Buyer’s switching cost is low
Substitutes typically come from outside the given industry (video-conferencing for airline industry)

©McGraw-Hill Education.
The threat of substitutes is high when:
✓The substitute offers an attractive price-performance trade-off.
✓The buyer’s cost of switching to the substitute is low.
Examples: many software products are substitutes to professional services, at least at the lower end. Tax preparation software such as Intuit’s TurboTax is a substitute for professional services offered by H&R Block and others. LegalZoom, an online legal documentation service, is a threat to professional law firms. Other examples of substitutes are energy drinks versus coffee, videoconferencing versus business travel, e-mail versus express mail, gasoline versus biofuel, and wireless telephone services versus Voice over Internet Protocol (VoIP), offered by Skype or Vonage.
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Bargaining Power of Suppliers Is High When:
1) Concentrated (or limited) supplier industry
2) Suppliers not dependent on industry for majority revenue

3) Incumbent firms face supplier switching costs
Supplier Industry
Industry X buys 90%
Industry Y buys remaining 10%
Supplier X
Supplier Y
Incumbent firm
4) Suppliers offer differentiated products
5) There are no supplier substitutes
6) Suppliers can forward-integrate into the industry

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Bargaining Power of Buyers Is High When:
1) There are a few buyers & each buyer purchases large quantities
2) The industry’s products are standardized or undifferentiated commodities
3) Buyers face low or no switching costs
4) Buyers can backwardly integrate into the industry

©McGraw-Hill Education.

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Rivalry Among Competitors
Intensity of rivalry determined by (covered next):
Industry competitive structure
Industry growth
Strategic commitments
Exit barriers

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1) Exhibit 3.4 Industry Competitive Structures

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2) Industry Growth
Affects intensity of rivalry among competitors
During periods of high growth:
Consumer demand rises
Price competition among firms decreases
They focus on capturing new customers
They are not focused on taking profitability away from each other
During periods of negative growth:
Rivalry is fierce
Rivals can only gain at the expense of one another

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3) Strategic Commitments
Affects intensity of rivalry among competitors
Firm actions that are:
Costly
Long-term oriented
Difficult to reverse
Example: Airline industry
Hub and spoke model requires significant upfront fixed costs and investments

©McGraw-Hill Education.

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4) Exit Barriers
Affects intensity of rivalry among competitors
Obstacles that determine how easily a firm can leave that industry
Examples:
Contractual obligations
Emotional attachments

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A Sixth Force: Complements and Co-Opetition
Complementary product adds value when used with the original product
Increases demand for the original product
Should complements be included as the sixth force?

©McGraw-Hill Education.
For example, in the smartphone industry, Google complements Samsung. The Korean high-tech company’s smartphones are more valuable when they come with Google’s Android system installed. At the same time, Google and Samsung are increasingly becoming competitors. With Google’s acquisition of Motorola Mobility, the online search company launched its own line of smartphones and Chromebooks.
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Industry Dynamics
Five forces model only a snapshot in time
Industries aren’t stable over time
Consolidation: Mergers and acquisitions consolidate an industry
Convergence: Unrelated industries satisfy the same need
Repeat analysis over time
How are the drivers of individual forces going to change in the future

©McGraw-Hill Education.

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Exhibit 3.7 Strategic Groups and Mobility Barriers in U.S. Domestic Airline Industry
2) Choose two key dimensions: Not highly correlated
3) Graph the firms in the strategic group; firm market share indicated by the bubble size.
Group of firms pursuing similar strategies in an industry
Mobility Barriers
Rivalry strongest between firms in the same strategic group
External environment and five forces affect strategic groups differently
Some strategic groups more profitable
1) Identify important strategic dimensions

©McGraw-Hill Education.

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Entry Choices
Exhibit 3.6
Source: Based on and adapted from Zachary M.A., Gianiodis P.T., Tyge Payne G., and G.D. Markman (2014), Entry timing: enduring lessons and future directions, Journal of Management, 41: 1409; and Bryce D.J. and J.H. Dyer (2007), Strategies to crack well-guarded markets, Harvard Business Review, May: 84-92.
Jump to Appendix 6 long image description

©McGraw-Hill Education.
This represents an integrative model that can guide the entry choices firms make. Rather than considering firm entry as a discrete event (i.e., simple yes or no decision), or a discrete event composed of five parts, this model suggests that the entry choices firms make constitute a strategic process unfolding over time.
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Learning Objectives

LO 4-1 Differentiate among a firm’s core competencies, resources, capabilities, and activities.

LO 4-2 Compare and contrast tangible and intangible resources.

LO 4-3 Evaluate the two critical assumptions behind the resource-based view.

LO 4-4 Apply the VRIO framework to assess the competitive implications of a firm’s resources.

LO 4-5 Evaluate different conditions that allow a firm to sustain a competitive advantage.

LO 4-6 Outline how dynamic capabilities can enable a firm to sustain a competitive advantage.

LO 4-7 Apply a value chain analysis to understand which of the firm’s activities in the process of transforming inputs into outputs generate differentiation and which drive costs.

LO 4-8 Identify competitive advantage as residing in a network of distinct activities.

LO 4-9 Conduct a SWOT analysis to generate insights from external and internal analysis and derive strategic implications.

©McGraw-Hill Education.

Why care about BUS 498?
What makes a firm most respected in the future?
(Results of a CEO survey as cited in Hitt, Ireland, and Hoskisson, 2006)
Strong and well-thought out strategy
Maximizing customer loyalty and satisfaction
Business leadership
Quality products and services
Strong and consistent profits

©McGraw-Hill Education.
2
The material contained in this slide is not available in your text. But this material will be on the exam.

Why care about BUS 498?
What do recruiters look for in graduating MBAs?
TWSJ Sept 22 2004
Percentage of recruiters who said each attribute is “very important.”
89% Communication and interpersonal skills
87% Ability to work well within a team
85% Personal ethics and integrity
84% Analytical and problem-solving skills
74% Success with past hires
73% Leadership potential
72% Fit with the corporate culture
68% Strategic thinking
64% Likelihood of recruiting “stars”
54% Well-rounded
50% Willingness of the school’s students to relocate

©McGraw-Hill Education.
3
The material contained in this slide is not available in your text. But this material will be on the exam.

Where Does Competitive Advantage Come From?
Exhibit 4.3
Exhibit 4.3
Any assets that a firm can draw on
Organizational/managerial skills to orchestrate diverse resources
Unique strengths embedded deep within a firm
Distinct and fine-grained business processes
Create, deploy, modify, reconfigure, upgrade, leverage
IKEA: Designing modern functional home furnishings at low cost

©McGraw-Hill Education.
Resources: Any assets that a firm can draw on when formulating and implementing a strategy. Examples: cash, buildings, machinery, or intellectual property.
Capabilities: Organizational and managerial skills necessary to orchestrate a diverse set of resources and deploy them strategically. They find their expression in a company’s structure, routines, and culture.
Activities: Distinct and fine-grained business processes that enable firms to add incremental value by transforming inputs into goods and services. Examples include: order taking, the physical delivery of products, or invoicing customers.
Take Honda as an example of a company with a clearly defined core competency. Its life began with a small two-cycle motorbike engine. Through continuous learning over several decades, and often from lessons learned from failure, Honda built the core competency to design and manufacture small but powerful and highly reliable engines for which it now is famous. This core competency results from superior engineering know-how and skills carefully nurtured and honed over several decades. Honda’s business model is to find a place to put its engines. Today, Honda engines can be found everywhere: in cars, SUVs, vans, trucks, motorcycles, ATVs, boats, generators, snow blowers, lawn mowers and other yard equipment, and even small airplanes. Due to their superior performance, Honda engines have been the most popular in the Indy Racing League (IRL) since 2006. Not coincidentally, this was also the first year in its long history that the Indy 500 was run without a single engine problem.
Key point: core competencies that are not continuously nourished will eventually lose their ability to yield a competitive advantage. And second, in analyzing a company’s success in the market, it can be too easy to focus on the more visible elements or facets of core competencies such as superior products or services. While these are the outward manifestation of core competencies, what is even more important is to understand the invisible part of core competencies.
Examples of Core Competencies
IKEA: Designing modern functional home furnishings at low cost
Beats Electronics: Marketing: perception of coolness
Facebook: IT capabilities to provide reliable social network services globally on a large scale.
Netflix: Creating proprietary algorithms-based on individual customer preferences.

4

What is the Resource Based View (RBV)?
A model that sees certain types of resources (VRIO) as key to superior firm performance
Resource Heterogeneity:
A firm is a unique bundle of resources and capabilities
These bundles differ across firms
Resource Immobility:
Resources don’t move easily from firm to firm
Resources are difficult to replicate
Resource differences can last for a long time

Critical Assumptions

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Note that the resource-based view of the firm uses the term resource much more broadly than previously defined. In the resource-based view of the firm, a resource includes any assets as well as any capabilities and competencies that a firm can draw upon when formulating and implementing strategy.
Resource Heterogeneity: For example, Southwest Airlines (SWA) and Alaska Airlines both compete in the same strategic group (low-cost, point-to-point airlines). But they draw on different resource bundles. SWA’s employee productivity tends to be higher than that of Alaska Airlines, because the two companies differ along human and organizational resources. At SWA, job descriptions are informal and employees pitch in to “get the job done.” Pilots may help load luggage to ensure an on-time departure; flight attendants clean airplanes to help turn them around at the gate within 15 minutes from arrival to departure. This allows SWA to keep its planes flying for longer and lowers its cost structure, savings that SWA passes on to passengers in lower ticket prices.
Resource Immobility: Continental and Delta both attempted to copy SWA, with Continental Lite and Song airline offerings, respectively. Neither airline, however, was able to successfully imitate the resource bundles and firm capabilities that make SWA unique.

5

Exh: 4.4 Tangible and Intangible Resources

Jump to Appendix 3 long image description
Competitive advantage more likely from intangible resources.

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Example: Google’s headquarters provides examples of both tangible and intangible resources. The Googleplex is a piece of land with a futuristic building, and thus a tangible resource. The location of the company in the heart of Silicon Valley is an intangible resource that provides access to a valuable network of contacts and gives the company several benefits. It allows Google to tap into a large and computer-savvy work force and access graduates and knowledge spillovers from a large number of universities, which adds to Google’s technical and managerial capabilities.9 Another benefit stems from Silicon Valley’s designation as having the largest concentration of venture capital in the United States. This proximity benefits Google because venture capitalists tend to prefer local investments to ensure closer monitoring. Google received initial funding from the well-known venture capital firms Kleiner Perkins Caufield & Byers and Sequoia Capital, both located in Silicon Valley.
6

Exhibit 4.5 The VRIO Decision Tree
Increase economic value creation
(V – C).
Only one or a few firms possess it
Unable to develop/buy the resource at a reasonable price.
Firm has effective organizational structure and coordinating systems.
Direct imitation or substitution

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According to this model, a firm can gain and sustain a competitive advantage only when it has resources that satisfy all of the VRIO criteria. If the answer is “yes” four times to the attributes listed in the decision tree, only then is the resource in question a core competency that underpins a firm’s sustainable competitive advantage.
Example: Beats Electronics’ ability to design and market premium headphones that bestow a certain air of coolness upon wearers is a valuable resource. The profit margins for Beats designer headphones are astronomical: The production cost for its headphones is estimated to be no more than $15, while they retail for $150 to $450, with some special editions over $1,000. Thus, Beats’ competency in designing and marketing premium headphones is a valuable resource in the VRIO framework.
Beats Electronics’ ability and reach in product placement and celebrity endorsements that build its coolness factor are certainly rare. No other brand in the world, not even Apple or Nike, has such a large number of celebrities from music, movies, and sports using its product in public. Thus, this resource is not only valuable but also rare.
Beats’ core competency in establishing a brand that communicates coolness is built upon the intuition and feel for music and cultural trends of Dr. Dre, one of music’s savviest marketing minds. Although the sound quality of Beats headphones is good enough, they mainly sell as a fashion accessory for their coolness factor and brand image. Because its creator Dr. Dre relies on gut instinct in making decisions rather than market research, this resource is costly to imitate. Even if a firm wanted to copy Beats’ core competency—how would it go about it? The music and trend-making talent as well as the social capital of Dr. Dre and Jimmy Iovine, two of the best-connected people in the music industry, might be impossible to replicate.

7

Isolating Mechanisms
Barriers to imitation
Prevents rivals from competing away firm advantage
Better expectations of future resource value
Path dependence
Causal ambiguity
Social complexity
Intellectual property (IP) protection

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BETTER EXPECTATIONS OF FUTURE RESOURCE VALUE. Sometimes firms can acquire resources at a low cost, which lays the foundation for a competitive advantage later when expectations about the future of the resource turn out to be more accurate. Example: obtain real estate / land at a low cost.
PATH DEPENDENCE. Path dependence describes a process in which the options one faces in a current situation are limited by decisions made in the past. Arthur, W.B. (1989), “Competing technologies, increasing returns, and lock-in by historical events,” Example; 80% of U.S. carpets are made in Dalton, GA.
CAUSAL AMBIGUITY. Causal ambiguity describes a situation in which the cause and effect of a phenomenon are not readily apparent. Example: it is difficult to determine the exact root cause of Apple’s success
SOCIAL COMPLEXITY. Social complexity describes situations in which different social and business systems interact. Example: the culture of Zappo’s leads to their excellence in customer service.
INTELLECTUAL PROPERTY PROTECTION. Intellectual property (IP) protection is a critical intangible resource that can also help sustain a competitive advance. Examples: patents, designs, copyrights, trademarks, trade secrets.
8

Dynamic Capabilities
A firm’s ability to:
Adapt resources, capabilities, core competencies over time
Create, deploy, modify, reconfigure, upgrade, leverage
In a changing external environment (PESTEL: technological change, deregulation, globalization, demographic shifts)
The goal:
Create a strategic fit with the firm’s new environment
Gain and sustain competitive advantage in a changing env.
Avoid core rigidity (former core competency turned into a liability due to environment change)

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Apple’s dynamic capabilities allowed it to redefine the markets for mobile devices and computing, in particular in music, smartphones, and media content. For the portable music market through its iPod and iTunes store, Apple generated environmental change to which Sony and others had to respond. With its iPhone, Apple redefined the market for smartphones, again creating environmental change to which competitors such as Samsung, BlackBerry, Google (with its Motorola Mobility unit), or Microsoft (with its Nokia unit) must respond. Apple’s introduction of the iPad redefined the media and tablet computing market, forcing competitors such as Amazon and Microsoft to respond. With the introduction of the Apple Watch it is attempting to shape the market for computer wearables in its favor.
A lack of strategic fit with a changing environment created at least two problems for Procter & Gamble in recent years (see Strategy Highlight 4.2). First, following the deep recession of 2008–2009, U.S. consumers moved away from higher-priced brands, such as those offered by P&G, to lower-cost alternatives. Moreover, P&G’s direct rivals in branded goods, such as Colgate-Palmolive, Kimberly-Clark, and Unilever, were faster in cutting costs and prices in response to more frugal customers.
P&G also fumbled recent launches of reformulated products such as Tide Pods (detergent sealed in single-use pouches) and the Pantene line of shampoos and conditioners. The decline in U.S. demand hit P&G especially hard because the domestic market delivers about one-third of sales, but almost two-thirds of profits for the company. Second, by focusing on the U.S. market, P&G not only missed out on the booming growth years that the emerging economies experienced during the 2000s, but it also left these markets to its rivals. As a consequence, Colgate-Palmolive, Kimberly-Clark, and Unilever all outperformed P&G in recent years.
9

Exhibit 4.7 A Generic Value Chain (Internal)
Internal activities a firm engages in when transforming inputs into outputs
add value/cost indirectly
add value/cost directly
Transform inputs into outputs horizontally along the internal value chain.
Necessary to sustain primary activities

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Retail chain American Eagle Outfitters, for example, needs to identify suitable store locations, either build or rent stores, purchase goods and supplies, manage distribution and store inventories, operate stores both in the brick-and-mortar world and online, hire and motivate a sales force, create payment and IT systems or partner with vendors, engage in promotions, and ensure after-sales services including returns.
A maker of semiconductor chips such as Intel, on the other hand, needs to engage in R&D, design and engineer semiconductor chips and their production processes, purchase silicon and other ingredients, set up and staff chip fabrication plants, control quality and throughput, engage in marketing and sales, and provide after-sales customer support.
10

Strategic Activity Systems
A network of interconnected activities
Socially complex and causally ambiguous
Enhance likelihood of sustained competitive advantage
Characteristics:
Elements can be easily observed
How activities are managed is not easily observed
Difficult to imitate
Activity systems must evolve as external environment changes
Add new activities
Remove activities that are no longer relevant
Upgrade activities that have become stale

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The Vanguard Group’s Activity System – 1997
Exhibit 4.8
Source: Adapted from N. Siggelkow (2002), “Evolution toward fit,” Administrative Science Quarterly 47: 146.
Jump to Appendix 7 long image description

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In 1997, The Vanguard Group had less than $500 million of assets under management. It pursued its mission of being the highest-value provider of investment products and services through its unique set of interconnected activities. The six larger ovals depict Vanguard’s strategic core activities: strict cost control, direct distribution, low expenses with savings passed on to clients, offering of a broad array of mutual funds, efficient investment management approach, and straightforward client communication and education. These six strategic themes were supported by clusters of tightly linked activities (smaller circles), further reinforcing the strategic activity network.
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The Vanguard Group’s Activity System – 2017
Exhibit 4.9
Source: Adapted from N. Siggelkow (2002), “Evolution toward fit,” Administrative Science Quarterly 47: 146.
Jump to Appendix 8 long image description

©McGraw-Hill Education.
The system evolved over time as Vanguard’s management added a new core activity—customer segmentation—to the six core activities already in place in 1997 (still valid in 2017). Vanguard’s managers put in place the customer-segmentation core activity, along with two new support activities, to address a new customer need that could not be met with its older configuration. Its 1997 activity system did not allow Vanguard to continue to provide quality service targeted at different customer segments at the lowest possible cost. The 2017 activity-system configuration allows Vanguard to customize its service offerings: It now separates its more traditional customers, who invest for the long term, from more active investors, who trade more often but are attracted to Vanguard funds by the firm’s high performance and low cost.
13

SWOT Matrix 3 x 3 (1)
Opportunities
–
–
– Threats
–
–
–
Strengths
–
–
– How can the firm use internal strengths to take advantage of external opportunities?
How can the firm use internal strengths to reduce the likelihood and impact of external threats?
Weaknesses
–
–
– How can the firm overcome internal weaknesses that prevent the firm from taking advantage of external opportunities? How can the firm overcome internal weaknesses that will make external threats a reality?

External analysis: Covered in Chapter 3
Internal analysis: Covered in Chapter 4

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14

SWOT Matrix 3 x 3 (2)
Use the SWOT matrix to develop alternatives.
Note the specific combination of internal and external factors associated with each alternative
Evaluate the pros and cons of each strategic alternative.
Select one or more alternatives to implement.
Carefully explain decision rationale.
Including why other strategic alternatives were rejected

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15

My Strategy Exercise
What Is My Competitive Advantage?
What are your strengths and weaknesses?
What are you doing to ensure your capabilities are dynamic?
Skill upgrades, behavior modifications, etc.
Are some of your strengths valuable, rare, and costly to imitate?
How could you persuade your boss that you could be a vital source of sustainable competitive advantage?

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16

Learning Objectives

LO 5-1 Conduct a firm profitability analysis using accounting data to assess and evaluate competitive advantage.

LO 5-2 Apply shareholder value creation to assess and evaluate competitive advantage.

LO 5-3 Explain economic value creation and different sources of competitive advantage.

LO 5-4 Apply a balanced scorecard to assess and evaluate competitive advantage. (please skip this section for the exam; no slides included here either)

LO 5-5 Apply a triple bottom line to assess and evaluate competitive advantage. (please skip this section for the exam; no slides included here either)

LO 5-6 Use the why, what, who, and how of business models framework to put strategy into action.

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1

An Overview of Frameworks Discussed
To measure and assess firm performance:
Accounting profitability
Shareholder value creation
Economic value creation
Integrative frameworks, combining quantitative data with qualitative assessments:
The balanced scorecard
The triple bottom line

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2

Accounting Profitability
Accurately assesses firm performance
Compares firm performance to competitors / industry average
Available through:
Standardized accounting metrics (GAAP, FASB)
Form 10-K statements
Profitability ratios
Return on invested capital (ROIC), return on equity (ROE), return on assets (ROA), and return on revenue (ROR)

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One of the most commonly used metrics in assessing firm financial performance is return on invested capital (ROIC), where ROIC = (Net profits/Invested capital). ROIC is a popular metric because it is a good proxy for firm profitability. In particular, the ratio measures how effectively a company uses its total invested capital, which consists of two components: (1) shareholders’ equity through the selling of shares to the public, and (2) interest-bearing debt through borrowing from financial institutions and bond holders.
To explore further drivers of this difference, we break down return on revenue into three additional financial ratios:
Cost of goods sold (COGS) / Revenue.
Research & development (R&D) expense / Revenue.
Selling, general, & administrative (SG&A) expense / Revenue.
3

Exhibit 5.1 Comparing Apple and Microsoft:
Drivers of Firm Performance
How much of the firm’s sales is converted into profits
How effectively capital is being used to generate revenue

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4

Limitations of Accounting Data
Historical and backward-looking
Does not consider off–balance sheet items:
Pension obligations
Leasing obligations
Focuses mainly on tangible assets
May not be the most important
Consider: innovation, quality, customer experience

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5

The Declining Importance of Book Value in a Firm’s Stock Market Valuation
Exhibit 5.2
Source: Analysis and depiction of data from Compustat, 1980–2015
Jump to Appendix 3 long image description

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In 1980, about 80 percent of a firm’s stock market valuation was based on its book value with 20 percent based on the market’s expectations concerning the firm’s future performance. This almost reversed by 2000 (at the height of the internet bubble), when firm valuations were based only 15 percent on assets captured by accounting data. The important take-away is that intangibles not captured in firms’ accounting data have become much more important to a firm’s competitive advantage. By 2015, about 75 percent of a firm’s market valuation was determined by its intangibles.
6

Shareholder Value Creation – Definitions
Shareholders
Own shares of stock, are legal owners
Risk Capital
Money provided for an equity share
Total Return to Shareholders
Stock price appreciation + dividends
Market Capitalization
Dollar value of total shares outstanding
Number of outstanding shares x share price

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All public companies in the United States are required to report total return to shareholders annually in the statements they file with the Securities and Exchange Commission (SEC). In addition, companies must also provide benchmarks, usually one comparison to the industry average and another to a broader market index that is relevant for more diversified firm.
Investors also adjust their expectations over time. Since the business in the slow-growth industry surprised them by delivering higher than expected growth, they adjust their expectations upward. The next year, they expect this firm to again deliver 4 percent growth. On the other hand, if the industry average is 10 percent a year in the high-tech business, the firm that delivered 8 percent growth will again be expected to deliver at least the industry average growth rate; otherwise, its stock will be further discounted.
7

Stock Market Valuations of Apple and Microsoft, 1990–2017
Exhibit 5.3
Source: Depiction of publicly available data
Jump to Appendix 4 long image description

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8

Limitations of Shareholder Value Creation
Stock prices can be volatile
Difficult to assess firm performance
Macroeconomic factors affect stock prices
Economic growth or contraction
Unemployment, interest and exchange rates
Stock prices can reflect the mood of investors
Investors can be irrational

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9

Competitive Advantage and
Economic Value Created [V-C]
Exhibit 5.7
Jump to Appendix 7 long image description
(Also called Producer Surplus)

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Competitive advantage can be based on: economic value creation because of superior product differentiation, or a relative cost advantage over rivals.
Value denotes the dollar amount (V) a consumer attaches to a good or service. Value captures a consumer’s willingness to pay and is determined by the perceived benefits a good or service provides to the buyer. The cost (C) to produce the good or service matters little to the consumer, but it matters a great deal to the producer (supplier) of the good or service since it has a direct bearing on the profit margin.
10

Firm B’s Competitive Advantage
Same cost as firm A but firm B creates more economic value.
Firm B’s advantage is based on superior differentiation.
Exhibit 5.4
Jump to Appendix 5 long image description

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Only Firm A and Firm B are competing in the market for laptops. Assuming that both Firm A and Firm B have the same total unit cost of producing the particular laptop models under consideration ($400) and the market at large has preferences similar to yours, then Firm B will have a competitive advantage. This is because Firm B creates more economic value than Firm A (by $200), but has the same total cost.
The amount of total perceived consumer benefits equals the maximum willingness to pay, or the reservation price. This amount is then split into economic value creation and the firm’s total unit cost. Firm A and Firm B have identical total unit cost, $400 per laptop. However, Firm B’s laptop (e.g., Apple’s MacBook Pro) is perceived to provide more utility than Firm A’s laptop (e.g., Dell’s generic laptop), which implies that Firm B creates more economic value ($1,200 – $400 = $800) than Firm A ($1,000 – $400 = $600). Taken together, Firm B has a competitive advantage over Firm A because Firm B creates more economic value. This is because Firm B’s offering has greater total perceived consumer benefits than Firm A’s, while the firms have the same total cost. In short, Firm B’s advantage is based on superior differentiation leading to higher perceived value. Further, the competitive advantage can be quantified: It is $200 (or, $1,200 – $1,000) per laptop sold for Firm B over Firm A.
11

Firm C’s Competitive Advantage
Exhibit 5.5
Same total perceived consumer benefits as firm D, but firm C creates more economic value.
Jump to Appendix 6 long image description

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In this image, two different laptop makers each offer a model that has the same perceived consumer benefits ($1,200). Firm C, however, creates greater economic value ($900, or $1,200 – $300) than that of Firm D ($600, or $1,200 – $600). This is because Firm C’s total unit cost ($300) is lower than Firm D’s ($600). Firm C has a relative cost advantage over Firm D, while both products provide identical total perceived consumer benefits ($1,200). In this example, Firm C could be Lenovo with lower cost structure than Firm D, which could be HP, but both firms offer the same value. As this image shows, Firm C has a competitive advantage over Firm D because it has lower costs. Firm C’s competitive advantage over Firm D is in the amount of $300 for each laptop sold. Here, the source of the competitive advantage is a relative cost advantage over its rival.
12

Opportunity Costs and Limitations of
Economic Value Creation
Opportunity costs
The value of the best forgone alternative
Limitations of Economic Value Creation
Valuing a consumer good isn’t easy
The value of a good changes in the eyes of consumers
Income, preferences, time, etc.

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Example of Opportunity Costs of an Entrepreneur: (1) forgone wages if employed elsewhere; (2) the cost of capital invested in the business vs. the stock market vs. U.S. Treasury bonds.
13

Why, What, Who, and How of Business Models Exhibit 5.10
Details a firm’s competitive tactics and initiatives
Explains how the firm:
Intends to make money
Conducts its business
With buyers, suppliers, and partners

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How companies do business can sometimes be as important, if not more so, to gaining and sustaining competitive advantage as what they do. Indeed, a slight majority (54 percent) of senior executives responded to a recent survey stating that they consider business model innovation to be more important than process or product innovation.
14

Popular Business Models
Razor-razorblade: pay for replacements
Subscription: pay for access
Pay as you go: pay for what you consume
Freemium: pay for extra features / add-ons
Wholesale: products sold at a discount
Agency: products sold on commission
Bundling: more than one product sold at a discount

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Razor-razorblade: was invented by Gillette, which gave away its razors and sold the replacement cartridges for relatively high prices. The razor–razor-blade model is found in many business applications today. For example, HP charges little for its laser printers but imposes high prices for its replacement toner cartridges.
Subscription: Microsoft uses a subscription-based model for its new Office 365 suite of application software. Other industries that use this model presently are cable television, cellular service providers, satellite radio, internet service providers, and health clubs. Netflix also uses a subscription model.
Pay as you go: most widely used by utilities providing power and water and cell phone service plans, but it is gaining momentum in other areas such as rental cars and cloud computing such Microsoft’s Azure.
Freemium: examples include Spirit Airlines (in the United States), Ryanair (in Europe), or AirAsia, which provide minimal flight services but allow customers to pay for additional services and upgrades à la carte, often at a premium.
Wholesale: book publishers sell books to retailers at a fixed price (usually 50 percent below the recommended retail price). Retailers, however, were free to set their own price on any book and profit from the difference between their selling price and the cost to buy the book from the publisher (or wholesaler).
Agency: long used in the entertainment industry, where agents place artists or artistic properties and then take their commission. More recently we see this approach at work in a number of online sales venues, as in Apple’s pricing of book products or its app sales.
Bundling: In the Microsoft Office Suite, a user might value Word more than Excel and vice versa. Instead of selling both products for $120 each, Microsoft bundles them in a suite and sells them combined at a discount, say $150.

15

Dynamic Nature of Business Models
Business Models:
Can be combined
Can evolve
Can be disrupted
Businesses must respond to disruption & adapt
Legal conflicts can arise

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Examples:
Business models can be combined: AT&T uses both razor-razorblade & subscription models
Business models can evolve: Freemium is an evolution of razor-razorblade
Business models can be disrupted: Amazon disrupted wholesale models of publishers
Businesses must respond to disruption & adapt: Many book publishers worked with Apple on an agency approach, in which the publishers would set the price for Apple and receive 70 percent of the revenue, while Apple received 30 percent. Publishers inked their deals with Apple, but how could they get Amazon to play ball? For leverage, publishers withheld new releases from Amazon. This forced Amazon to raise prices on newly released e-books in line with the agency model to around $14.95
Legal conflicts can arise: In 2012 the Department of Justice determined that Apple and major publishers had conspired to raise prices of e-books. A year later, Apple was found guilty of colluding with several major book publishers to fix prices on e-books and had to change its agency model.

16

Learning Objectives

LO 6-1 Define business-level strategy and describe how it determines a firm’s strategic position.

LO 6-2 Examine the relationship between value drivers and differentiation strategy.

LO 6-3 Examine the relationship between cost drivers and the cost-leadership strategy.

LO 6-4 Assess the benefits and risks of differentiation and cost-leadership strategies vis-à-vis the five forces that shape competition.

LO 6-5 Evaluate value and cost drivers that may allow a firm to pursue a blue ocean strategy.

LO 6-6 Assess the risks of a blue ocean strategy, and explain why it is difficult to succeed at value innovation.

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Generic Business Strategies: Strategic Position and Competitive Scope
Exhibit 6.2

Jump to Appendix 3 long image description
In a specific product market
Tension: Value creation and pressure to keep cost in check
Who: which customer segments?
What: customer needs will we satisfy?
Why: do we want to satisfy them?
How: will we satisfy our customers’ needs?

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These two business strategies are called generic strategies because they can be used by any organization—manufacturing or service, large or small, for-profit or nonprofit, public or private, domestic or foreign—in the quest for competitive advantage, independent of industry context. Differentiation and cost leadership require distinct strategic positions, and in turn increase a firm’s chances to gain and sustain a competitive advantage.
The automobile industry provides an example of the scope of competition. Alfred P. Sloan, longtime president and CEO of GM, defined the carmaker’s mission as providing a car for every purse and purpose. GM was one of the first to implement a multidivisional structure in order to separate the brands into strategic business units, allowing each brand to create its unique strategic position (with its own profit and loss responsibility) within the broad automotive market. For example, GM’s product lineup ranges from the low-cost-positioned Chevy brand to the differentiated Cadillac brand. In this case, Chevy is pursuing a broad cost-leadership strategy, while Cadillac is pursuing a broad differentiation strategy. The two different business strategies are integrated at the corporate level at GM.
JetBlue attempts to combine a focused cost-leadership position with a focused differentiation position. Although initially successful, JetBlue has been consistently outperformed for several years by airlines that do not attempt to straddle different strategic positions, but rather have a clear strategic profile as either a differentiator or a low-cost leader. For example, Southwest Airlines competes clearly as a broad cost leader (and would be placed squarely in the upper-left quadrant. The legacy carriers—Delta, American, and United—all compete as broad differentiators (and would be placed in the upper-right quadrant. Regionally, we find smaller airlines that are ultra low cost, such as Allegiant Air, Frontier Airlines, or Spirit Airlines, with a very clear strategic position. These smaller airlines would be placed in the lower-left quadrant because they are pursuing a focused cost-leadership strategy.

2

Exhibit 6.3 Achieving Competitive Advantage with a Differentiation Strategy
Competitive advantage achieved when economic value created (V – C) is greater than competitors
– Product features
– Customer service
– Complements

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Under a differentiation strategy, firms that successfully differentiate their products enjoy a competitive advantage. Firm A’s product is seen as a generic commodity with no unique brand value. Firm B has the same cost structure as Firm A but creates more economic value, and thus has a competitive advantage over both Firm A and Firm C because (V − C)B > (V − C)C > (V − C)A. Although, Firm C has higher costs than Firm A and B, it still generates a significantly higher economic value than Firm A.
Several competitors in the bottled-water industry provide a prime example of pursuing a successful differentiation strategy. As more and more consumers shift from carbonated soft drinks to healthier choices, the industry for bottled water is booming—growing about 10 percent per year. In the United States, the per person consumption of bottled water surpassed that of carbonated soft drinks for the first time in 2016. Such a fast-growing industry provides ample opportunity for differentiation. In particular, the industry is split into two broad segments depending on the sales price. Bottled water with a sticker price of $1.30 or less per 32 ounces (close to one liter) is considered low-end, while those with a higher price tag are seen as luxury items. For example, PepsiCo’s Aquafina and Coca-Cola’s Dasani are considered low-end products, selling purified tap water at low prices, often in bulk at big-box retailers such as Walmart. On the premium end, PepsiCo introduced Lifewtr with a splashy ad during Super Bowl LI (2017), while Jennifer Aniston markets Smartwater, Coca-Cola’s premium water.
Example of customer service: Zappo’s offers free shipping both ways, they do not outsource customer service, and they don’t use pre-determined scripts for service. Trader Joe’s stores stock local products as requested by the community.
Example of complements: smartphones and cellular services. A smartphone without a service plan is much less useful than one with a data plan. Traditionally, the providers of phones such as Apple, Samsung, and others did not provide wireless services. AT&T and Verizon are by far the two largest service providers in United States, jointly holding some 70 percent of market share. To enhance the attractiveness of their phone and service bundles, phone makers and service providers frequently sign exclusive deals. When first released, for instance, service for the iPhone was exclusively offered by AT&T. Thus, if you wanted an iPhone, you had to sign up for a two-year service contract with AT&T. 

3

Exhibit 6.4 Achieving Competitive Advantage
with a Cost Leadership Strategy

– (1) Cost of input factors (raw material, capital, labor)
– (2) Economies of scale
– (3) Learning-curve effects
– (4) Experience-curve effects

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As an example, GM and Korean car manufacturer Kia offer some models that compete directly with one another, yet Kia’s cars tend to be produced at lower cost, while providing a similar value proposition.
Under a cost-leadership strategy, firms that can keep their cost at the lowest point in the industry while offering acceptable value are able to gain a competitive advantage. Firm A has not managed to take advantage of possible cost savings, and thus experiences a competitive disadvantage. The offering from Firm B has the same perceived value as Firm A but through more effective cost containment creates more economic value (over both Firm A and Firm C because (V − C)B > (V − C)C > (V − C)A. The offering from Firm C has a lower perceived value than that of Firm A or B and has the same reduced product cost as with Firm B; as a result, Firm C still generates higher economic value than Firm A.
Cost of input: In the market for international long-distance travel, the greatest competitive threat facing U.S. legacy carriers—American, Delta, and United—comes from three fast-growing airlines located in the Persian Gulf states—Emirates, Etihad, and Qatar. These airlines achieve a competitive advantage over their U.S. counterparts thanks to lower-cost inputs—raw materials (access to cheaper fuel), capital (interest-free government loans), labor—and fewer regulations (for example, regarding nighttime takeoffs and landings, or in adding new runways and building luxury airports with swimming pools, among other amenities).
Economies of Scale: Reaping economies of scale and learning is critical for the airframe-manufacturing industry in order to ensure cost-competitiveness. The market for commercial airplanes is often not large enough to allow more than one competitor to reach sufficient scale to drive down unit cost. Boeing chose not to compete with Airbus in the market for superjumbo jets; rather, it decided to focus on a smaller, fuel-efficient airplane (the 787 Dreamliner, priced at roughly $250 million) that allows for long-distance, point-to-point connections. By 2017, it had built over 530 Dreamliners with more than 1,200 orders for the new airplane. Boeing can expect to reap significant economies of scale and learning, which will lower per-unit cost. At the same time, Airbus had delivered 210 A-380 superjumbos (sticker price: $430 million) with more than 100 orders on its books. If both companies would have chosen to compete head-on in each market segment, the resulting per-unit cost for each airplane would have been much higher because neither could have achieved significant economies of scale (overall their market share split is roughly 50–50).
Learning curve effects: Learning drives down cost, because it takes less time to produce the same output. Professionals learn how to be more efficient with cumulative experience, for example: writing computer code, developing new medicines and building submarines.

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1) Uneven unionization (Roth, TWSJ, 03/25/09, B1)
FedEx UPS
Formed as an airline in the 1970s
Railway Act Formed as a trucking company
National Labor Relations Act

Company-wide employee votes required for labor representation
Location-by-location basis unionization permitted

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Exhibit 6.5 Economies of Scale
Decreases in per unit costs as output increases
Diseconomies of Scale:
Firm too big
Coordination complexities
Inflexible and slow

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Firms with greater market share might be in a position to reap economies of scale, decreases in cost per unit as output increases. This relationship between unit cost and output is depicted in the first (left-hand) part of this image. Cost per unit falls as output increases up to point Q1. A firm whose output is closer to Q1 has a cost advantage over other firms with less output. In this sense, bigger is better.
The output range between Q1 and Q2 in the figure is considered the minimum efficient scale (MES) to be cost-competitive. Between Q1 and Q2, the returns to scale are constant. It is the output range needed to bring the cost per unit down as much as possible, allowing a firm to stake out the lowest-cost position achievable through economies of scale.
Benefits to scale cannot go on indefinitely, though. Bigger is not always better; in fact, sometimes bigger is worse. Beyond Q2, firms experience diseconomies of scale—increases in cost as output increases. As firms get too big, the complexity of managing and coordinating the production process raises the cost, negating any benefits to scale.
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(2) Economies of Scale Drivers
(a) Spread fixed costs over a larger output
(b) Employ specialized systems and equipment
(c) Take advantage of certain physical properties (cube-square rule)

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Spread fixed costs over a larger output example: Microsoft spent $25 billion on R&D for Windows 7 before a single copy was sold
Employ specialized systems and equipment example: Demand for Tesla’s Model S sedan allowed it to employ cutting-edge robotics
Take advantage of certain physical properties example: Big box stores can stock more merchandise and handle inventory efficiently
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(2c) Cube-Square Rule: “Big Box” Retailers’ Advantage
Dimension increases from 2 to 3
6-8
Surface area increases from 24 to 54 (by 125%)
Volume increases from 8 to 27 (by 238%)

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(3) Learning Curve Effects
We learn how to be more efficient with experience
First noted during aircraft manufacturing in the 1930s: When production doubled, per-unit cost dropped by a predictable and constant rate (approximately 20%)
The more complex the underlying process the more learning effect we can expect with experience
How this may apply to you at School?

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Gaining Competitive Advantage Through Learning Curve and Experience Curve Effects
Exhibit 6.7

Jump to Appendix 7 long image description
(4) Experience curve: When technology is changed while output is constant (e.g., new production process)

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Firm A produces eight aircraft and reaches a per-unit cost of $73 million per aircraft. Firm B produces 128 aircraft using the same technology as Firm A (because both firms are on the same [90 percent] learning curve), but given a much larger cumulative output, its per unit-cost falls to only $48 million. Thus, Firm B has a clear competitive advantage over Firm A, assuming similar or identical quality in output. Firm C realizes a positive impact of change due to technology and process innovation.
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Benefits & Risks of Competitive Positioning
Competitive Force Differentiation Benefits Differentiation Risks Cost Leadership Benefits Cost Leadership Risks
Threat of Entry Protection against entry due to intangible resources such as a reputation for innovation, quality, or customer service Erosion of margins
Replacement Protection against entry due to economies of scale Erosion of margins
Replacement
Power of Suppliers Protection against increase in input prices, which can be passed on to customers Erosion of margins Protection against increase in input prices, which can be absorbed Erosion of margins
Power of Buyers Protection against decrease in sales prices, because well-differentiated products or services are not perfect imitations Erosion of margins Protection against decrease in sales prices, which can be absorbed Erosion of margins
Threat of Substitutes Protection against substitute products due to differential appeal Replacement, especially when faced with innovation Protection against substitute products through further lowering of prices Replacement, especially when faced with innovation
Rivalry Among Existing Competitors Protection against competitors if product or service has enough differential appeal to command premium price Focus of competition shifts to price
Increasing differentiation of product features that do not create value but raise costs
Increasing differentiation to raise costs above acceptable threshold Protection against price wars because lowest-cost firm will win Focus of competition shifts to non-price attributes
Lowering costs to drive value creation below acceptable threshold

There is no single correct business strategy for a specific industry. The deciding factor is that the chosen business strategy provides a strong position that attempts to maximize economic value creation and is effectively implemented.

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Reference section 6.4 for additional details.

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Exhibit 6.9 Blue Ocean Strategy: Value Innovation
Simultaneously pursue differentiation (V ↑) and low cost (C ↓)
Blue ocean metaphor:
Untapped market space
Creation of additional demand Highly profitable growth
Trader Joe’s: Offers high value at much lower costs than Whole Foods
Toyota: Delivers higher quality cars at lower cost

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Lowering a firm’s costs is primarily achieved by eliminating and reducing the taken-for-granted factors that the firm’s rivals in their industry compete on.
Perceived buyer value is increased by raising existing key success factors and by creating new elements that the industry has not offered previously.
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Achieving Successful Value Innovation
Lowering costs (Ikea)
Eliminate: Which of the factors that the industry takes for granted should be eliminated? (No salespeople and after sales service)
Reduce: Which of the factors should be reduced well below the industry’s standard? (Warranties)
Increasing perceived consumer benefits (Ikea)
Raise: Which of the factors should be raised well above the industry’s standard? (Thousands of home furnishing items)
Create: Which factors should be created that the industry has never offered? (New way to shop for furniture)

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Lowering a firm’s costs is primarily achieved by eliminating and reducing the taken-for-granted factors that the firm’s rivals in their industry compete on.
Perceived buyer value is increased by raising existing key success factors and by creating new elements that the industry has not offered previously.
Consider IKEA:
Eliminated: sales people, and after sales service
Reduced: warranties
Raised: offers tens of thousands of home furnishing items
Created: a new way to shop for furniture
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Exhibit 6.10 Value Innovation vs. Stuck In the Middle

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Being stuck in the middle leads to inferior performance and a resulting competitive disadvantage.
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Exhibit 6.10 Strategy Canvas in the Airline Industry
Graphical depiction of a company’s performance relative to its competitors viewed across the industry’s key success factors
The Value Curve: Horizontal connection points located on the strategy canvas. Helps strategists determine courses of action

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Legacy carriers tend to score highly among most competitive elements in the airline industry, including different seating class choices (such as first class, business class, economy comfort, basic economy, and so on), a high level of in-flight amenities such as Wi-Fi, personal video console to view movies or play games, complimentary drinks and meals, coast-to-coast coverage via connecting hubs, plush airport lounges, international routes and global coverage, high customer service, and high reliability in terms of safety and on-time departures and arrivals. As is expected when pursuing a generic differentiation strategy, all these scores along the different competitive elements in an industry go along with a relative higher cost structure.
In contrast, the low-cost airlines tend to hover near the bottom of the strategy canvas, indicating low scores along a number of competitive factors in the industry, with no assigned seating, no in-flight amenities, no drinks or meals, no airport lounges, few if any international routes, low to intermediate level of customer service. A relatively lower cost structure goes along with a generic low-cost leadership strategy.
JetBlue value curve follows a zigzag pattern. JetBlue attempts to achieve parity or even out-compete differentiators in the U.S. airline industry along the competitive factors such as different seating classes (e.g., the high-end Mint offering discussed in the ChapterCase), higher level of in-flight amenities, higher-quality beverages and meals, plush airport lounges, and a large number of international routes (mainly with global partner airlines). JetBlue, however, looks more like a low-cost leader in terms of the ability to provide only a few connections via hubs domestically, and it recently has had a poor record of customer service, mainly because of some high-profile missteps as documented in the ChapterCase
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