Strategic Formulation and Simulation

SESSION 1: EVALUATING A COMPANY’S RESOURCES, CAPABILITIES AND

COMPETITIVENESS

This Chapter discusses techniques for evaluating a company’s internal situation, including its
collection of resources and capabilities and the activities it performs along its value chain.
This chapter presents the concepts and analytical tools for zeroing in on a single-business
company’s external environment.
These are tools and techniques of strategic analysis:
1. Resource and capability analysis
2. SWOT analysis
3. Value chain analysis
4. Benchmarking
5. Competitive strength assessment

QUESTION 1: HOW WELL IS THE COMPANY’S PRESENT STRATEGY

WORKING?

The three best indicators of how well a company’s strategy is working are:
1. Whether it is achieving its stated financial and strategic objectives.
2. Whether its financial performance is above the industry average.
3. Whether it is gaining customers and gaining market share.

Specific indicators of how well a firm’s strategy is working include:

• Trends in the company’s sales and earnings growth.
• Trends in the company’s stock price (if investors advice to high your stock price, it’s a
good indicator result).
• The company’s overall financial strength.
 • The company’s customer retention rate (5 forces: new entrance, substitute, customers,
suppliers and competitors).
• The rate at which new customers are acquired (important for companies like startups
that don’t measure their impact).
• Evidence of improvement in internal processes such as defect rate, order fulfillment,
delivery times, days of inventory, and employee productivity (indicators inside the
company).

Profitability Ratios How Calculated What It Shows

Gross profit Sales revenues − Cost of goods Shows the percentage of revenues available to cover
margin. sold operating expenses and yield a profit. The money
Sales revenues you made.
Operating profit Sales revenues − Operating Shows the profitability of current operations without
margin (or return expenses regard to interest charges and income taxes.
on sales). Sales revenues Earnings before interest and taxes is known as EBIT
or in financial and business accounting.
Operating income
Sales revenues
Net profit margin Profits after taxes Shows after-tax profits per dollar of sales. The
(or net return on Sales revenues money you have at the end.
sales).
Total return on Profits after taxes + Interest Shows after-tax profits per dollar of sales. How
assets. Total assets much money do you make with what you hold? The
money you generate with the money you invest.

Net return on total Profits after taxes A measure of the return earned by stockholders on
assets (ROA). Total assets the firm’s total assets. Total assets include debt,
that’s why a bite different with the previous.
Return on Profits after taxes The return stockholders are earning on their capital
stockholders’ Total stockholders’ equity investment in the enterprise. A return in the 12% to
equity (ROE). 15% range is average.
Return on invested Profits after taxes A measure of the return that shareholders are earning
capital (ROIC)— Long-term debt + on the monetary capital invested in the enterprise. A
sometimes referred Total stockholders’ equity higher return reflects greater bottom-line
to as return on effectiveness in the use of long-term capital. It is
capital employed pretty like the ROA. Measure of the financial
(ROCE). efficiency of the company.

Liquidity Ratios How Calculated What It Shows

Current ratio. Current assets Shows a firm’s ability to pay current

Current liabilities liabilities using assets that can be
Asset: what you hold, all your converted to cash in the near term. Ratio
money should be higher than 1.0.
Liabilities: what you must give, to
investors
 Working capital. Current assets − Current liabilities The cash available for a firm’s day-to-day
operations. Larger amounts mean the firm
has more internal funds to (1) pay its
current liabilities on a timely basis and (2)
finance inventory expansion, additional
accounts receivable, and a larger base of
operations without resorting to borrowing
or raising more equity capital.

Leverage Ratios How Calculated What It Shows

Total debt-to- Total debt Measures the extent to which borrowed funds (both
assets ratio. Total assets short-term loans and long-term debt) have been used
In some companies, low ratio to finance the firm’s operations. A low ratio is better
means no efficiency because —a high fraction indicates overuse of debt and greater
you don’t borrow money, so risk of bankruptcy. It measures the leverage : how
you don’t believe in your much money you can borrow based on money you
company (American way of have.
thinking), depends on the
company, the price
Long-term debt- Long-term debt A measure of creditworthiness and balance-sheet
to-capital ratio. Long-term debt + strength. A ratio below 0.25 is preferable since the
Total stockholders’ equity lower the ratio, the greater the capacity to borrow
additional funds. Debt-to-capital ratios above 0.50
indicate an excessive reliance on long-term
borrowing, lower creditworthiness, and weak balance-
sheet strength.
All the money that has been invested in long-term in
the company, the money you raise in a long-term
activity.

Leverage Ratios How Calculated What It Shows

Debt-to-equity Total debt Shows the balance between debt (funds borrowed,
ratio. Total stockholders’ equity both short term and long term) and the amount that
Way to look your leverage stockholders have invested in the enterprise. The
further the ratio is below 1.0, the greater the firm’s
ability to borrow additional funds. Ratios above 1.0
put creditors at greater risk, signal weaker balance
sheet strength, and often result in lower credit
ratings.
Long-term debt- Long-term debt Shows the balance between long-term debt and
to-equity ratio. Total stockholders’ equity stockholders’ equity in the firm’s long-term capital
Idem structure. Low ratios indicate a greater capacity to
borrow additional funds if needed.
Times-interest- Operating income Measures the ability to pay annual interest charges.
earned (or Interest expenses Lenders usually insist on a minimum ratio of 2.0, but
coverage) ratio. ratios above 3.0 signal increasing creditworthiness.
Sustainability of what you are doing. The result must
 be high not to be a “zombie company”.

Activity Ratios How Calculated What It Shows

Days of inventory. ______ Inventory______ Measures inventory management efficiency. Fewer

Cost of goods sold ÷ 365 days of inventory are better. Just in time : inventory
ready just on time which keep the inventory down
to 0, to reduce cost.
Inventory turnover. Cost of goods sold Measures the number of inventory turns per year.
Inventory Higher is better. It’s the rotation of the stock.
Average collection Accounts receivable Indicates the average length of time the firm must
period. Total sales ÷ 365 wait after making a sale to receive cash payment. A
or shorter collection time is better. The time it takes to
Accounts receivable the customers to pay you.
Average daily sales

Other Ratios How Calculated What It Shows

Dividend yield on Annual dividends per share A measure of the return that shareholders
common stock. Current market price receive in the form of dividends. A “typical”
per share dividend yield is 2% to 3%. The dividend
yield for fast-growth firms is often below 1%;
the dividend yield for slow-growth firms can
run 4% to 5%. The one thing the investors are
checking ! It’s reflecting the raising value of a
company.
Price-to-earnings Current market price per share P/E ratios above 20 indicate strong investor
(P/E) ratio. Earnings per share confidence in a firm’s outlook and earnings
growth; firms whose future earnings are at
risk or likely to grow slowly typically have
ratios below 12. Indicates if the product is
attractive or not.
Dividend payout Annual dividends per share Indicates the percentage of after-tax profits
ratio. Earnings per share paid out as dividends.
For a startup, it should be 0 et for a mature
company it’s around 0.5 and they reinvest in
the company.
Internal cash flow. After-tax profits + Depreciation A rough estimate of the cash a firm’s business
is generating after payment of operating
expenses, interest, and taxes. Such amounts
can be used for dividend payments or funding
capital expenditures. The money available
daily company.
Free cash flow. After-tax profits + Depreciation – A rough estimate of the cash a firm’s business
Capital expenditures – Dividends is generating after payment of operating
expenses, interest, taxes, dividends, and
 desirable reinvestments in the business. The
money available at the end of operation.

QUESTION 2: WHAT ARE THE COMPANY’S STRENGTHS AND WEAKNESSES

IN RELATION TO THE MARKET OPPORTUNITIES AND EXTERNAL THREATS?

SWOT analysis is a tool for identifying situational reasons underlying a firm’s performance.
• Internal strengths (the basis for strategy).
• Internal weaknesses (deficient capabilities).
• Market opportunities (strategic objectives).
• External threats (strategic defenses).
Strengths + weaknesses = you
Opportunities + threats = around you

There are three types of competences to identify a company’s internal strengths:

A competence is an activity that a firm has learned to perform with proficiency and at an
acceptable cost—a true capability, in other words.
A core competence is an activity that a firm performs proficiently and that is also central to
its strategy and competitive success.
A distinctive competence is a competitively important activity that a firm performs better
than its rivals—it represents a competitively superior internal strength.
Examples of core competencies:
- Five Guys: offers highest quality ingredients, wide range of free toppings, simple
menu and chose not to have driven throughs or an expanded menu.
- Beats Electronics: perception of coolness marketing.
- Tesla: engineering expertise in designing battery powered motors and power trains.
- Netflix: creates proprietary algorithms-based on individual customer preferences.

A weakness is something a firm lacks or does poorly (in comparison to others) or a condition
that puts it at a competitive disadvantage in the marketplace.
Types of weaknesses:
- Inferior or unproven skills, expertise, or intellectual capital in competitively important
areas of the business.
- Deficiencies in physical, organizational, or intangible assets.

Opportunities are not fixed on who you are but on the market. Newly emerging and fast-
changing markets may represent “golden opportunities” but are often hidden in “fog of the
future.” Opportunities with market factors aligned with the firm’s strengths offer the most
potential for the firm to gain competitive advantage.

Types of threats:
- Normal course-of-business (like after an innovation in your concurrent enterprise).
- Sudden death (survival) (people don’t need your product anymore).
QUESTION 3: WHAT ARE THE COMPANY’S MOST IMPORTANT RESOURCES
AND CAPABILITIES, AND WILL THEY GIVE THE COMPANY A LASTING
COMPETITIVE ADVANTAGE?

A resource is a productive input or competitive asset that is owned or controlled by a firm

(e.g., a fleet of oil tankers).
A capability is the capacity of a firm to perform some activity proficiently (e.g., superior
skills in marketing).

Resource: something you have

Capability: something you are capable to do
Tangible resources

• Physical resources: land and real estate; manufacturing plants, equipment, or distribution

facilities; the locations of stores, plants, or distribution centers, including the overall pattern
of their physical locations; ownership of or access rights to natural resources (such as
mineral deposits).
• Financial resources: cash and cash equivalents; marketable securities; other financial assets
such as a company’s credit rating and borrowing capacity.
 • Technological assets: patents, copyrights, production technology, innovation technologies,
technological processes.
• Organizational resources: IT and communication systems (satellites, servers, workstations,
etc.); other planning, coordination, and control systems; the company’s organizational
design and reporting structure.

Intangible resources
• Human assets and intellectual capital: the education, experience, knowledge, and talent
of the workforce, cumulative learning, and tacit knowledge of employees; collective
learning embedded in the organization, the intellectual capital and know-how of
specialized teams and work groups; the knowledge of key personnel concerning important
business functions; managerial talent and leadership skill; the creativity and innovativeness
of certain personnel.
• Brands, company image, and reputational assets: brand names, trademarks, product or
company image, buyer loyalty and goodwill; company reputation for quality, service, and
reliability; reputation with suppliers and partners for fair dealing.

• Relationships: alliances, joint ventures, or partnerships that provide access to technologies,

specialized know-how, or geographic markets; networks of dealers or distributors; the trust
established with various partners.

• Company culture and incentive system: the norms of behavior, business principles, and
ingrained beliefs within the company; the attachment of personnel to the company’s ideals;
the compensation system and the motivation level of company personnel.

Organizational capabilities are more complex entities than resources; indeed, they are built up
through the use of resources and draw on some combination of the firm’s resources as they
are exercised.

Two approaches to identifying a firm’s capabilities:

- A complete listing of resources the firm has accumulated considering whether (and to
what extent the firm has built up any related capabilities through their use).
- A functional approach that identifies capabilities related to specific functions that draw
on a limited set of resources involving a single department or organizational unit and
cross-functional capabilities that are multidimensional—they spring from effective
collaboration among people with different types of expertise working in different
organizational units.

The Total Economic Value produced by a firm is equal to V-C. It is the difference between
the buyer's perceived value (V) regarding a product or service and what it costs (C) the firm
to produce it. A competitive advantage means that you can produce more value (V) for the
customer than rivals can, or the same value at lower cost (C). In other words, your V-C is
greater than the V-C of competitors. V-C is what we call the Total Economic Value produced
by a company.

The VRIN Test for sustainable competitive advantage asks if a resource or capability is
Valuable, Rare, Inimitable, and Non-substitutable.
 V: Is the resource (or capability) competitively valuable?
R: Is it rare—is it something rivals lack?
I: Is it hard to copy (inimitable)?
N: Is it invulnerable to the threat of substitution of different types of resources and
capabilities (non-substitutable)?

Social complexity and causal ambiguity are two factors that inhibit the ability of rivals to
imitate a firm’s most valuable resources and capabilities.
- Social complexity refers to factors in a firm’s culture, the interpersonal relationships
among managers or R&D teams, its trust-based relations with customers or suppliers
that contribute to its competitive advantage.
- Causal ambiguity about the how the firm uses its resources and relationships puts
competitors at a loss in understanding how to imitate these complex resources. It’s
inimitable because you can’t understand why the company is so attractive.

Rivals that are initially unable to replicate a key resource may develop better and better
substitutes over time. Resources and capabilities can depreciate like other assets if they are
managed with benign neglect. Disruptive changes in technology, customer preferences,
distribution channels, or other competitive factors can also destroy the value of key strategic
assets. Rivals that are initially unable to replicate a key resource may develop better and better
substitutes over time.

To sustain its competitiveness and help drive improvements in its performance, a firm
requires a dynamically evolving portfolio of resources and capabilities.
A dynamic capability is the ongoing capacity of a firm to modify its existing resources and
capabilities or create new ones.
• Improve on existing resources and capabilities incrementally.
• Add new resources and capabilities to the firm’s competitive asset portfolio.

QUESTION 4: HOW DO VALUE CHAIN ACTIVITIES IMPACT A COMPANY’S

COST STRUCTURE AND ITS CUSTOMER VALUE PROPOSITION?

Signs of a firm’s competitive strength:

• Its prices and costs are in line with rivals.
• Its customer-value proposition is competitive and cost effective.
• Its bundled capabilities are yielding a sustainable competitive advantage.
Strategic Management Principle:
The higher a firm’s costs are above those of close rivals, the more competitively vulnerable it
becomes. Conversely, the greater the amount of customer value that a firm can offer
profitably relative to close rivals, the less competitively vulnerable the firm becomes.

The concept of a company value chain is based on the fact that every firm’s business consists
of a collection of activities undertaken in the course of producing, marketing, delivering, and
supporting its product or service.
All the various activities that a firm performs internally combine to form a value chain—so
called because the underlying intent of a firm’s activities is
ultimately to create value for buyers.
Comparing value chains of rival companies facilitates a comparison, activity-by-activity, of
how effectively and efficiently a firm delivers value to its customers, relative to its
competitors.
The value chain analysis process:
• Segregates a firm’s operations into different types of primary and secondary
activities to identify major components of its internal cost structure.
• Uses activity-based costing to evaluate activities.
• Same for significant competitors.
Strategic Management Principle:
A firm’s cost competitiveness depends not only on the costs of internally performed activities
(its own value chain) but also on costs in the value chains of its suppliers and distribution
channel allies.

Example of the value chain. It shows representative costs for various external and internal
value chain activities performed by Boll & Branch, a maker of luxury linens and bedding sold
directly to consumers online.
A company’s primary and secondary activities identify the major components of its internal
cost structure. The combined costs of all the various primary and support activities
constituting a company’s value chain define its internal cost structure. Evaluating a
company’s internal and external cost-competitiveness involves using what accountants call
activity-based costing to determine the costs of performing each value chain activity.

The Benchmarking involves improving internal activities based on learning from other
companies’ “best practices” and assesses whether the cost competitiveness and effectiveness
of a company’s value chain activities are in line with its competitors’ activities.
Sources of benchmarking information:
• Market data reports from consulting companies and market analysts,
publications of industry trade groups and government agencies, and customers.
• Visits to benchmark firms.

What are strategic options for remedying a cost or value disadvantage?

There are three main areas in a company’s total value chain system where company managers
can try to improve its efficiency and effectiveness in delivering customer value:
1. A company’s own internal activities,
2. Suppliers’ part of the value chain system,
3. The forward-channel portion of the value chain system.

Strategic approaches to reducing internally performed value chain activity costs that will
improve a firm’s cost-competitiveness by:
• Implementing best practices throughout the firm, particularly for high-cost activities.
• Redesigning the product and/or some of its components to eliminate high-cost
components or facilitate speedier and more economical manufacture or assembly.
• Relocating high-cost activities (such as manufacturing) to geographic areas where they
can be performed more cheaply or outsource activities to lower-cost vendors or
contractors.
• Adopting technologies that spur innovation, improve design, and enhance creativity.
Supplier-related cost disadvantages can be attacked by pressuring suppliers for lower prices,
switching to lower-priced substitute inputs, and collaborating closely with suppliers to
identify mutual cost-saving opportunities.
A firm can enhance its customer value proposition through its supplier relationship by
selecting and retaining suppliers that meet higher-quality standards, providing quality-based
incentives to suppliers, and integrating suppliers into the design process.

How to improve value chain activities of distribution partners?

Any of three means can be used to achieve better cost-competitiveness in the forward portion
of the industry value chain:
1. Pressure distributors, dealers, and other forward-channel allies to reduce their costs
and markups.
2. Collaborate with forward channel intermediaries to identify win–win opportunities to
reduce costs
3. Change to a more economical distribution strategy, including switching to cheaper
distribution channels (selling direct via the Internet) or integrating forward into
company-owned retail outlets.

How to enhance differentiation through activities at the forward end of the value chain
system?
1. Engage in cooperative advertising and promotions with forward-channel allies.
2. Use exclusive arrangements with downstream sellers or other mechanisms that
increase their incentives to enhance delivered customer value.
3. Create and enforce standards for downstream activities and assist in training channel
partners in business practices.
Strategic Management Principle:
Performing value chain activities with capabilities that permit the firm to either outmatch
rivals on differentiation or beat them on costs will give the firm a competitive advantage.

How to translate proficient performance of value chain activities into competitive advantage?
1. Beat rivals by creating more customer value from value chain activities, for a
differentiation-based competitive advantage.
2. Beat rivals by conducting value chain activities more efficiently, for a cost-based
competitive advantage.
A company that does a first-rate job of managing its activities of its value chain relative to
competitors stands a good chance of profiting from its competitive advantage. A company’s
external value-creating activities in its value can offer a competitive advantage.

QUESTION 5: IS THE COMPANY COMPETITIVELY STRONGER OR WEAKER

THAN KEY RIVALS?

Using resource analysis, value chain analysis, and benchmarking to determine a company’s
competitiveness on value and cost is necessary but not sufficient. A more comprehensive
assessment needs to be made of the firm’s overall competitive strength. The answers to two
questions are of particular interest: First, how does the firm rank relative to competitors on
each of the important factors that determine market success? Second, all things considered,
does the firm have a net competitive advantage or disadvantage versus major competitors?
Strategic Management Principles:
High-weighted competitive strength ratings signal a strong competitive position and
possession of competitive advantage; low ratings signal a weak position and competitive
disadvantage.

Steps in the competitive strength assessment process:

Step 1.Make a list of the industry’s key success factors and other telling measures of
competitive strength or weakness (6 to 10 measures usually suffice).
Step 2.Assign weights to each competitive strength measure based on its perceived
importance. (The sum of the weights for each measure must add up to 1.)
Step 3.Calculate weighted strength ratings by scoring each competitor on each
strength measure (using a 1-to-10 rating scale, where 1 is very weak and 10 is very strong)
and multiplying the assigned rating by the assigned weight.
Step 4.Sum the weighted strength ratings on each factor to get an overall measure of
competitive strength for each company being rated.
Step 5.Use the overall strength ratings to draw conclusions about the size and extent
of the company’s net competitive advantage or disadvantage and to take specific note of areas
of strength and weakness.
This is an example of competitive strength assessment in which a hypothetical firm (ABC
Company) competes against two rivals. In the example, relative cost is the most telling
measure of competitive strength, and the other strength measures are of lesser importance.
The firm with the highest rating on a given measure has an implied competitive edge on that
measure, with the size of its edge reflected in the difference between its weighted rating and
rivals’ weighted ratings.
The overall competitive strength scores indicate how all the different strength measures add
up—whether the firm is at a net overall competitive advantage or disadvantage against each
rival. The higher a firm’s overall weighted strength rating, the stronger its overall
competitiveness versus rivals.
Question 6: What Strategic issues and problems merit front-burner managerial attention?

Which and how serious are the strategic issues that managers must address—and resolve—for
the firm to be more financially and competitively successful in the years ahead.
A good strategy must contain ways to deal with all the strategic issues and obstacles that stand
in the way of the firm’s financial and competitive success in the years ahead.

SESSION 2: THE FIVE GENERIC COMPETITIVE STRATEGIES

 This chapter describes the five basic competitive strategy options—which of the five to
employ is a company’s first and foremost choice in crafting overall strategy and beginning its
quest for competitive advantage.

Key factors that distinguish one strategy from another:

- Is the firm’s market target broad or narrow?
- Is the competitive advantage being pursued linked to low cost or product
differentiation?

Types GENERIC COMPETITIVE STRATEGIES

Broad, Striving to achieve broad lower overall costs than rivals on comparable
Low-cost products that attract a broad spectrum of buyers, usually by underpricing
Strategy: rivals.

Broad Seeking to differentiate the firm’s product offering from its rivals with
Differentiation attributes that will appeal to a broad spectrum of buyers.
Strategy:

Focused Concentrating on a narrow buyer segment (or market niche) striving to

Low-cost meet these needs at lower costs than rivals (thereby being able to serve
Strategy: niche members at a lower price).

Focused Concentrating on a narrow buyer segment (or market niche) by offering its
Differentiation members customized attributes that meet their specific tastes and
Strategy: requirements of niche members better than rivals.

Best-cost Striving to incorporate upscale product attributes at a lower cost than

(Hybrid) rivals. Being the “best-cost” producer of an upscale, multifeatured product
Strategy: allows a firm to give customers more value for their money by
underpricing rivals whose products have similar upscale, multifeatured
attributes.
BROAD LOW-COST STRATEGIES

Effective low-cost approaches pursue cost savings that are difficult to imitate and avoid
reducing product quality to unacceptable levels.
Competitive advantages and risks:
• Greater total profits and increased market share gained from underpricing
competitors.
• Larger profit margins when selling products at prices comparable to and
competitive with rivals.
• Low pricing does not attract enough new buyers.
• Rival’s retaliatory price-cutting sets off a price war.
• Cumulative costs across the overall value chain must be lower than
competitors’ cumulative costs.
Options for translating a low-cost advantage over rivals into attractive profit performance:
• Perform value-chain activities more cost-effectively than rivals.
• Revamp the firm’s overall value chain to eliminate or bypass cost-producing
activities.

A cost driver is a factor that has a strong influence on a firm’s costs. A low-cost advantage
over rivals can translate into better profitability than rivals attain.
Particular attention must be paid to a set of factors known as cost drivers that have a strong
effect on a company’s costs and can be used as levers to lower costs.
1. Capturing all available economies of scale.
2. Taking full advantage of experience and learning-curve effects.
3. Operating facilities at full or near-full capacity.
4. Improving supply chain efficiency.
5. Substituting lower-cost inputs wherever there is little or no sacrifice in product quality
or performance.
6. Using the firm’s bargaining power vis-à-vis suppliers or others in the value chain
system to gain concessions.
7. Using online systems and sophisticated software to achieve operating efficiencies.
8. Improving process design and employing advanced production technology.
9. Being alert to the cost advantages of outsourcing or vertical integration.
10. Motivating employees through incentives and company culture.

How to revamp the value chain system to lower costs?

- Selling direct to consumers and bypassing the activities and costs of distributors and
dealers by using a direct sales force and a company website.
- Streamlining operations to eliminate low value-added or unnecessary work steps and
activities.
- Reduce materials-handling and shipping costs by having suppliers locate their plants
or warehouses close to the firm’s own facilities.
Dramatic cost advantages can often emerge from redesigning the company’s value chain
system in ways that eliminate costly work steps and entirely bypass certain cost-producing
value chain activities.
The keys to a successful low-cost strategy:
• Spending aggressively on resources and capabilities that promise to drive costs
out of the business.
• Carefully estimating the cost savings of new technologies before investing in
them.
• Constantly reviewing cost-saving resources to ensure they remain
competitively superior.
A low-cost producer strategy becomes increasingly appealing and competitively powerful
when the forces of competition are favorable to a particular competitor’s market position.
Reducing price does not lead to higher total profits unless the added gains in unit sales are
large enough to bring in a bigger total profit despite lower margins per unit sold. A low-cost
producer’s product offering must always contain enough attributes to be attractive to
prospective buyers. Low price, by itself, is not always appealing to buyers.

BROAD DIFFERENTIATION STRATEGIES

Differentiation enhances profitability whenever a company’s product can command a

sufficiently higher price or produce sufficiently greater unit sales to more than cover the
added costs of achieving the differentiation.
The essence of a broad differentiation strategy is to offer unique product attributes that a
wide range of buyers find appealing and worth paying for.
Advantages of differentiation:
• Command premium prices for the firm’s products.
• Increased unit sales due to attractive differentiation.
• Brand loyalty that bonds buyers to the differentiating features of the firm’s
products.

A value driver is a factor that can have a strong differentiating effect.

A value driver can:
• Have a strong differentiating effect.
• Be based on physical as well as functional attributes of a firm’s products.
• Be the result of superior performance capabilities of the firm’s human capital.
• Have an effect on more than one of the firm’s value chain activities.
• Create a perception of value (brand loyalty) in buyers where there is little reason
for it to exist.

Differentiation is not something hatched in marketing and advertising departments, nor is it

limited to the catchalls of quality and service. Differentiation opportunities can exist in
activities all along an industry’s value chain. The most systematic approach that managers can
take, however, involves focusing on the value drivers, a set of factors—analogous to cost
drivers—that are particularly effective in creating differentiation.
1. Create product features and performance attributes that appeal to a wide range of
buyers.
2. Improve customer service or add extra services.
3. Invest in production-related R&D activities.
4. Strive for innovation and technological advances.
5. Pursue continuous quality improvement.
6. Increase marketing and brand-building activities.
7. Seek out high-quality inputs.
8. Emphasize HRM activities that improve the skills, expertise, and knowledge of
company personnel.

How to revamp the value chain system to increase differentiation?

By coordinating with downstream channel allies to enhance customer perceptions of value.

Broad Differentiation: Offering Customers

Something That Rivals Cannot or Do Not
1. Incorporate product attributes and user features that lower the buyer’s overall costs of using
the firm’s product.
2. Incorporate tangible features (e.g., styling) that increase customer satisfaction with the
product.
3. Incorporate intangible features (e.g., buyer image) that enhance buyer satisfaction in
noneconomic ways.

4. Signal the value of the firm’s product offering to buyers (e.g., price, packaging, placement,
advertising).

Differentiation can be based on tangible or intangible attributes. Easy-to-copy differentiating

features cannot produce a sustainable competitive advantage.
The value of certain differentiating features is rather easy for buyers to detect, but in some
instances, buyers may have trouble assessing what their experience with the product will be.
Successful differentiators go to great lengths to make buyers knowledgeable about a product’s
value and employ various signals of value.

Differentiation that is difficult for rivals to duplicate or imitate:

• Company reputation.
• Long-standing relationships with buyers.
• A unique product or service image.

Any differentiating feature that works well is a magnet for imitators. This is why a firm must
seek out sources of value creation that are time-consuming or burdensome for rivals to match
if it hopes to use differentiation to win a sustainable competitive edge. Over differentiating
and overcharging are fatal strategy mistakes.
FOCUSED STRATEGY APPROACHES
Focused low-cost strategy and focused differentiation strategy

A focused strategy aimed at securing a competitive edge based on either low costs or
differentiation becomes increasingly attractive when:
- The target market niche is big enough to be profitable and offers good growth
potential.
- Industry leaders chose not to compete in the niche; focusers avoid competing against
strong competitors.
- It is costly or difficult for multi-segment competitors to meet the specialized needs of
niche buyers.
- The industry has many different niches and segments.
- Rivals have little or no entry interest in the target segment.

The risks of a focused low-cost or focused differentiation strategy:

1. Competitors will find ways to match the focused firm’s capabilities in serving the
target niche.
2. The specialized preferences and needs of niche members shift over time toward the
product attributes desired by the majority of buyers.
3. As attractiveness of the segment increases, it draws in more competitors, intensifying
rivalry and splintering segment profits.

BEST-COST STRATEGIES

Best-cost strategies are a hybrid of low cost and differentiation strategies, incorporating
features of both simultaneously. They may target either a broad or narrow (focused) base of
value-conscious customers.

The target market for a best-cost strategy is value-conscious middle-market buyers who are
looking for appealing extras and functionality at a comparatively low price, regardless of
whether they represent a broad or more focused segment of the market.
 The risk of a best-cost strategy is that a company’s biggest vulnerability in employing a best-
cost strategy is getting squeezed between the strategies of firms using low-cost and high-end
differentiation strategies.

THE CONSTRASTING FEATURES OF THE GENERIC COMPETITIVE

STRATEGIES

Each generic strategy:

• Positions the firm differently in its market.
• Establishes a central theme for how the firm intends to outcompete rivals.
• Creates boundaries or guidelines for strategic change as market circumstances
unfold.
• Entails different ways and means of maintaining the basic strategy.
The choice of which generic strategy to employ spills over to affect many aspects of how the
business will be operated and the manner in which value chain activities must be managed.
Deciding which generic strategy to employ is perhaps the most important strategic
commitment a company makes—it tends to drive the rest of the strategic actions a company
decides to undertake.

Broad Focused Low- Focused

FEATURE Low-Cost Differentiation Cost Differentiation Best-Cost
Strategic A broad cross- A broad cross- A narrow market A narrow market Value-conscious
target: section of the section of the niche where buyer niche where buyer buyers. Or a
market. market. needs, and needs, and middle-market
preferences are preferences are range.
distinctively distinctively
different. different.

Basis of Lower overall Ability to offer Lower overall cost Attributes that Ability to offer
competitive costs than buyers something than rivals in appeal specifically better goods at
strategy: competitors. attractively different serving niche to niche members. attractive prices.
from competitors’ members.
offerings.

Product line: A good basic Many product Features and Features and Items with
product with few variations, wide attributes tailored attributes tailored appealing
frills (acceptable selection, emphasis to the tastes and to the tastes and attributes and
quality and limited on differentiating requirements of requirements of assorted features;
selection). features. niche members. niche members. better quality, not
best.
Production A continuous Build in whatever A continuous Small-scale Build in appealing
emphasis: search for cost differentiating search for cost production or features and better
reduction without features buyers are reduction for custom-made quality at lower
sacrificing willing to pay for; products that meet products that cost than rivals.
acceptable quality strive for product basic needs of match the tastes
and essential superiority. niche members. and requirements
features. of niche members.

Marketing Low prices, good Tout differentiating Communicate Communicate how Emphasize
emphasis: value features. attractive features product offering delivery of best
Also, try to make Also, charge a of a budget-priced does the best job value for the
a virtue out of premium price to product offering of meeting niche money.
product features cover the extra costs that fits niche buyers’
that lead to low of differentiating buyers’ expectations.
cost. features. expectations.

Keys to Economical Stress constant Stay committed to Stay committed to Unique expertise
maintaining prices, good value innovation to stay serving the niche serving the niche in simultaneously
the strategy: Also, strive to ahead of imitative at the lowest better than rivals; managing costs
manage costs competitors overall cost; don’t don’t blur the down while
down, year after Also, concentrate blur the firm’s firm’s image by incorporating
year, in every area on a few key image by entering entering other upscale features
of the business. differentiating other market market segments and attributes.
features. segments or or adding other
adding other products to widen
products to widen market appeal.
market appeal.
Resources and Capabilities for Capabilities Capabilities to Capabilities to Capabilities to
capabilities driving costs out concerning quality, lower costs on meet the highly simultaneously
required: of the value chain design, intangibles, niche goods specific needs of deliver lower cost
system. and innovation Examples: Lower niche members and higher-quality
Examples: large- Examples: input costs for the Examples: custom or differentiated
scale automated marketing specific product production, close feature
plants, an capabilities, R&D desired by the customer relations. Examples: TQM
efficiency- teams, technology. niche, batch practices, mass
oriented culture, production customization.
bargaining power. capabilities.

A company’s competitive strategy should be well-matched to its internal situation and

predicated on leveraging its collection of competitively valuable resources and capabilities.
For all types of generic strategies, success in sustaining the competitive edge depends on
having resources and capabilities that rivals have trouble duplicating and for which there are
no good substitutes.
The figure shows how a low-cost generic strategy achieves lower costs than an average
competitor, at the sacrifice of some perceived value to the consumer. If the decrease in
producer costs is less than the decrease in perceived value by the consumer, then the total
economic value (V-C) for the low-cost leader will be greater than the total economic value
produced by its average rival, creating a competitive advantage for the low-cost leader.

SESSION 3: STRENGTHENING A COMPANY’S COMPETITIVE POSITION,

STRATEGIC MOVES, TIMING AND SCOPE OF OPERATIONS

Considering strategy – enhancing measures:

• Whether to go on the offensive and initiate aggressive strategic moves to improve the
company’s market position.
• Whether to employ defensive strategies to protect the company’s market position.
• When to undertake new strategic initiatives—whether advantage or disadvantage lies
in being a first mover, a fast follower, or a late mover.
• Whether to bolster the company’s market position by merging with or acquiring
another company in the same industry.
• Whether to integrate backward or forward into more stages of the industry value chain
system.
• Which value chain activities, if any, should be outsourced.
• Whether to enter into strategic alliances or partnership arrangements.
OFFENSIVE STRATEGIES

Strategic offensive principles:

1. Focusing relentlessly on building competitive advantage and then striving to
convert it into sustainable advantage.
2. Applying resources where rivals are least able to defend themselves.
3. Employing the element of surprise as opposed to doing what rivals expect and
are prepared for.
4. Displaying a capacity for swift, decisive, and overwhelming actions to
overpower rivals.
Sometimes a company’s best strategic option is to seize the initiative, go on the attack, and
launch a strategic offensive to improve its market position. No matter which of the five
generic competitive strategies a firm employs, there are times when a company should go on
the offensive to improve its market position and performance.

The best offensives use a company’s most powerful resources and capabilities to attack rivals
in the areas where they are competitively weakest. Strategic offensives are called for when a
company spots opportunity to gain profitable market share at its rivals’ expense or when a
company has no choice but to try to whittle away at a strong rival’s competitive advantage.
How long it takes for an offensive move to improve a company’s market standing—and
whether the move will prove successful—depends in part on whether market rivals recognize
the threat and begin a counter-response. Whether rivals will respond depends on whether they
are capable of making an effective response and if they believe that a counterattack is worth
the expense and the distraction.

The Blue Ocean strategy is a special kind of offensive. The business universe is divided into:
• An existing market with boundaries and rules in which rival firms compete for
advantage.
• A “blue ocean” market space, where the industry has not yet taken shape, with
no rivals and wide-open long-term growth and profit potential for a firm that
can create demand for new types of products.

DEFENSIVE STRATEGIES
Good defensive strategies can help protect a competitive advantage but rarely are the basis for
creating one. Defensive strategies can take either of two forms: actions to block challengers or
actions to signal the likelihood of strong retaliation.

How to block the avenues open to challengers?

- Introduce new features and models to broaden product lines to close off gaps and
vacant niches.
- Maintain economy-pricing to thwart lower price attacks.
- Discourage buyers from trying competitors’ brands.
- Make early announcements about new products or price changes to induce buyers to
postpone switching.
- Offer support and special inducements to current customers to reduce the
attractiveness of switching.
- Challenge quality or safety of rivals’ products.
- Grant discounts or better terms to intermediaries who handle the firm’s product line
exclusively.

Signaling is an effective defensive strategy when the firm follows through by:
• Publicly announcing its commitment to maintaining the firm’s present market
share.
• Publicly committing to a policy of matching competitors’ terms or prices.
• Maintaining a war chest of cash and marketable securities.
• Making a strong counter-response to the moves of weaker rivals to enhance its
tough defender image.
The goal of signaling challengers that strong retaliation is likely in the event of an attack is
either to dissuade challengers from attacking at all or to divert them to fewer threatening
options.

TIMING A COMPANY’S STRATEGIC MOVES

Timing’s importance:
• Knowing when to make a strategic move is as crucial as knowing what move to
make.
• Moving first is no guarantee of success or competitive advantage.
• The risks of moving first to stake out a monopoly position versus being a fast
follower or even a late mover must be carefully weighed.
There are six conditions in which first-mover advantages are likely to arise:
- When pioneering helps build a firm’s reputation and creates strong brand loyalty.
- When a first mover’s customers will thereafter face significant switching costs.
- When property rights protections thwart rapid imitation of the initial move.
- When an early lead enables swift movement down the learning curve ahead of rivals.
- When a first mover can set the industry’s technical standards.
- When strong network effects compel increasingly more consumers to choose the first
mover’s product or service.
In some instances, there are advantages to being an adept follower rather than a first mover.
Late-mover advantages (or first-mover disadvantages) arise in the instances listed on this
slide:
- When pioneering is more costly than imitating and offers negligible experience or
learning-curve benefits.
- When an innovator’s products are somewhat primitive and do not live up to buyer
expectations.
- When rapid market evolution allows fast followers to leapfrog a first mover’s products
with more attractive next-version products.
- When market uncertainties make it difficult to ascertain what will eventually succeed.
- When customer loyalty is low and a first mover’s skills, know-how, and actions are
easily copied or surpassed.
- When the first mover must make a risky investment in complementary assets or
infrastructure (and these are available at low cost or risk by followers).

In weighing the pros and cons of being a first mover, a fast follower, or a late mover, it
matters whether the race to market leadership in a particular industry is a marathon or a sprint.
First-mover advantages can be fleeting, and there’s ample time for fast followers and
sometimes even late movers to catch up.

STRENGTHENING A FIRM’S MARKET POSITION VIA ITS SCOPE OF

OPERATIONS

Defining the horizontal and vertical scope of a firm’s operations:

- Range of its activities performed internally.
- Breadth of its product and service offerings.
- Extent of its geographic market presence and its mix of business.
- Size of its competitive footprint on its market or industry.

HORIZONTAL MERGER AND ACQUISITION STRATEGIES

Merger:
• Is the combining of two or more firms into a single corporate entity that often
takes on a new name.
Acquisition:
• Is a combination in which one firm, the acquirer, purchases and absorbs the
operations of another firm, the acquired.
Merger and acquisition strategies typically set the company’s sights on achieving any of five
objectives:
- Creating a more cost-efficient operation out of the combined firms.
- Expanding the firm’s geographic coverage.
- Extending the firm’s business into new product categories.
- Gaining quick access to new technologies or other resources and capabilities.
- Leading the convergence of industries whose boundaries are being blurred by
changing technologies and new market opportunities.

Despite many successes, mergers and acquisitions do not always produce the hoped-for
competitive and financial outcomes.
Strategic issues:
• Cost savings may prove smaller than expected.
• Gains in competitive capabilities take longer to realize or never materialize at
all.
Organizational issues:
• Cultures, operating systems and management styles fail to mesh due to
resistance to change from organization members.
• Key employees at the acquired firm are lost.
• Managers overseeing integration make mistakes in melding the acquired firm
into their own.

VERTICAL INTEGRATION STRATEGIES

A vertically integrated firm is one that performs value chain activities along more than one
stage of an industry’s value chain system.
Vertically integrated firm:
• One that participates in multiple segments or stages of an industry’s overall
value chain.
Vertical integration strategy:
• Can expand the firm’s range of activities backward into its sources of supply or
forward toward end users of its products.
Vertical integration strategies can aim at full integration (participating in all stages of the
vertical chain) or partial integration (building positions in selected stages of the vertical
chain). Firms can also engage in tapered integration strategies, which involve a mix of in-
house and outsourced activity in any given stage of the vertical chain.
Under the right conditions, a vertical integration strategy can add materially to a company’s
technological capabilities, strengthen the firm’s competitive position, and boost its
profitability.
But it is important to keep in mind that vertical integration has no real payoff strategy-wise or
profit-wise unless the extra investment can be justified by compensating improvements in
company costs, differentiation, or competitive strength.

Backward integration involves entry into activities previously performed by suppliers or

other enterprises positioned along earlier stages of the industry value chain system.
Integrating backward by:
• Achieving same scale economies as outside suppliers: low-cost based
competitive advantage.
• Matching or beating suppliers’ production efficiency with no drop-off in
quality: differentiation-based competitive advantage.
Reasons for integrating backwards:
• Reduction of supplier power.
• Reduction in costs of major inputs.
• Assurance of the supply and flow of critical inputs.
• Protection of proprietary know-how.

Forward integration involves entry into value chain system activities closer to the end user.
Reasons for integrating forward:
• To lower overall costs by increasing channel activity efficiencies relative to
competitors.
• To increase bargaining power through control of channel activities.
• To gain better access to end users.
• To strengthen and reinforce brand awareness.
• To increase product differentiation.

Vertical integration has some substantial drawbacks beyond the potential for channel conflict.
There are the most serious drawbacks to vertical integration:
- Increased business risk due to large capital investment.
- Slow acceptance of technological advances or more efficient production methods.
- Less flexibility in accommodating shifting buyer preferences that require non-
internally produced parts.
- Internal production levels may not reach volumes that create economies of scale.
- Efficient production of internally produced components and parts hampered by
capacity matching problems.
- New or different resources and capabilities requirements.

OUTSOURCING STRATEGIES: NARROWING THE SCOPE OF OPERATIONS

Outsourcing involves contracting out certain value chain activities that are normally
performed in-house to outside vendors. The conditions that favor farming out certain value
chain activities to outside parties are listed on this slide.
Outsource an activity if it:
• Can be performed better or more cheaply by outside specialists.
• Is not crucial to achieving sustainable competitive advantage.
 • Improves organizational flexibility and speeds time to market.
• Reduces risk exposure due to new technology or buyer preferences.
• Allows concentration on core businesses, leverages key resources, and is more
successful outsourced.
A company must guard against outsourcing activities that hollow out the resources and
capabilities, lead to loss of control of key activities, and discourage investment in the
company.

STRATEGIC ALLIANCES AND PARTNERSHIPS

Strategic alliances and cooperative partnerships provide a way to gain benefits offered by
vertical integration, outsourcing, and horizontal mergers and acquisitions, while minimizing
the associated problems.
Strategic alliances and cooperative arrangements are now a common means of narrowing a
company’s scope of operations as well, serving as a useful way to manage outsourcing.
If a strategic alliance is not working out, a partner can choose at any time to simply walk
away or reduce its commitment to collaborating.

Strategic Alliance:
• A formal agreement between two or more separate companies in which they
agree to work cooperatively toward some common objective.
Joint Venture:
• A partnership involving the establishment of an independent corporate entity
that the partners own and control jointly, sharing in its revenues and expenses.

An alliance becomes “strategic”, as opposed to just a convenient business arrangement, when

it serves any of the purposes listed here:
1. Facilitates achievement of important business objectives.
2. Helps build, sustain, or enhance a core competence or competitive advantage.
3. Helps remedy an important resource deficiency or competitive weakness.
4. Helps defend against a competitive threat or mitigates a significant risk to a
company’s business.
5. Increases the bargaining power over suppliers or buyers.
6. Helps create important new market opportunities.
7. Speeds development of new technologies or product innovations.
The best alliances are highly selective, focusing on particular value chain activities and on
obtaining a specific competitive benefit. They enable a firm to build on its strengths and to
learn.

Why and how are strategic alliances advantageous?

Strategic Alliances:
• Expedite development of promising new technologies or products.
• Help overcome deficits in technical and manufacturing expertise.
• Bring together the personnel and expertise needed to create new skill sets and
capabilities.
• Improve supply chain efficiency.
• Help partners allocate venture risk sharing.
• Allow firms to gain economies of scale.
 • Provide new market access for partners.
Companies that have formed a host of alliances need to manage their alliances like a portfolio.

While strategic alliances provide a way of obtaining the benefits of vertical integration,
mergers and acquisitions, and outsourcing, they also suffer from some of the same drawbacks
such as:
- Culture clash and integration problems due to different management styles and
business practices.
- Anticipated gains not materializing due to an overly optimistic view of the potential
for synergies or the unforeseen poor fit of partners’ resources and capabilities.
- Risk of becoming dependent on partner firms for essential expertise and capabilities.
- Protection of proprietary technologies, knowledge bases, or trade secrets from partners
who are rivals.

Principal advantages of strategic alliances over vertical integration or horizontal mergers and
acquisitions:
- They lower investment costs and risks for each partner by facilitating resource pooling
and risk sharing.
- They are more flexible organizational forms and allow for a more adaptive response to
changing conditions.
- They are more rapidly deployed—a critical factor when speed is of the essence.
While the track record for strategic alliances is poor on average, many companies have
learned how to manage strategic alliances successfully and routinely defy this average.
Companies that have greater success in managing their strategic alliances and partnerships
often credit these factors.

A successful alliance requires real in-the-trenches collaboration, not merely an arm’s-length

exchange of ideas. Unless partners place a high value on the contribution each brings to the
alliance and the cooperative arrangement results in valuable win–win outcomes, it is doomed
to fail.