CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Co

CHAPTER 4 Evaluating a Company’s Resources, Capabilities,
and Competitiveness
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Chapter 3 described how to use the tools of industry and
competitor analysis to assess a company’s external environment
and lay the groundwork for matching a company’s strategy to its
external situation.
Chapter 4 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.
Internal analysis enables managers to determine whether their
strategy is likely to give the company a significant competitive
edge over rival firms. Combining internal and external analyses
facilitates an understanding of how to reposition a firm to take
advantage of new opportunities and to cope with emerging
competitive threats.
© McGraw-Hill Education
Chapter 4–‹#›
Learning Objectives
This chapter will help you understand:
How to evaluate how well a firm’s strategy is working.

How to assess the company’s strengths and weaknesses in light
of market opportunities and external threats.
Why a company’s resources and capabilities are critical in
gaining a competitive edge over rivals.
How value chain activities affect a company’s cost structure and
customer value proposition.
How a comprehensive evaluation of a firm’s competitive
situation can assist managers in making critical decisions about
their next strategic moves.
© McGraw-Hill Education.
In this chapter, the analytic spotlight will be trained on six
questions:
How well is the firm’s present strategy working?
What are the firm’s most important resources and capabilities,
and will they give the firm a lasting competitive advantage over
rival companies?
What are the firm’s strengths and weaknesses in relation to the
market opportunities and external threats?
How do a firm’s value chain activities impact its cost structure
and customer value proposition?
Is the firm competitively stronger or weaker than key rivals?
What strategic issues and problems merit front-burner
managerial attention?
In probing for answers to these questions, five analytic tools —
resource and capability analysis, SWOT analysis, value chain
analysis, benchmarking, and competitive strength assessment—
will be used.
All five are valuable techniques for revealing a firm’s
competitiveness and for helping managers match their strategy
to the firm’s particular circumstances.
Chapter 4–‹#›

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:
Whether it is achieving its stated financial and strategic
objectives
Whether its financial performance is above the industry average
Whether it is gaining customers and gaining market share
Strategic success in a firm’s present competitive approach
requires asking:
Has the firm been successful actions in attracting customers and
improving its market position?
Has the firm gained a sustainable competitive advantage based
on low product costs or better product offerings?
Is the firm appropriately concentrating its resources on serving
a broad spectrum of customers or a narrow market niche?
Are the firm’s functional strategies in R&D, production,
marketing, finance, human resources, information technology
strengthening its competitive position?
Has the firm been successful in its efforts to establish alliances
with other enterprises?
Persistent shortfalls in meeting its performance targets and
weak marketplace performance relative to rivals are reliable
warning signs that the firm has a weak strategy, suffers from
poor strategy execution, or both.
Chapter 4–‹#›
FIGURE 4.1 Identifying the Components of a Single-Business
Company’s Strategy
Access the text alternative for these images.

FIGURE 4.1 Identifying the Components of a Single-Business
Company’s Strategy
Single business strategic action plan components include:
Moves to respond to changing conditions in the macro-
environment or in industry and competitive conditions
Basing competitive advantage on lower costs, better products,
superior service of a market niche or specific buyers
Expanding or narrowing geographic coverage
Partnering to build valuable partnerships and strategic alliances
with other enterprises in the same industry
Key functional strategies of the overall business strategy:
R&D, technology, product design; supply chain management;
production; sales, marketing, and distribution; information
technology; human resources; and finance.
Chapter 4–‹#›
Specific Indicators of Strategic Success
Sales and earnings growth trends
Company’s overall financial strength
Customer retention rate
Stock price trends
Rate of new customers acquired
Evidence of improvement in internal processes
defect rate, order fulfillment, delivery times, days of inventory,
and employee productivity
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.
The company’s overall financial strength.
The company’s customer retention rate.
The rate at which new customers are acquired.
Evidence of improvement in internal processes such as defect
rate, order fulfillment, delivery times, days of inventory, and
employee productivity.
Strategic Management Principle
Sluggish financial performance and second-rate market
accomplishments almost always signal weak strategy, weak
execution, or both.
Chapter 4–‹#›
TABLE 4.1 Key Financial Ratios: How to Calculate Them
and What They Mean (1 of 8)Profitability RatiosHow
CalculatedWhat It ShowsGross profit marginSales revenues −
Cost of goods sold
Sales revenuesShows the percentage of revenues available to
cover operating expenses and yield a profit.Operating profit
margin (or return on sales)Sales revenues − Operating expenses
Sales revenues
or
Operating income
Sales revenuesShows the profitability of current operations
without regard to interest charges and income taxes. Earnings
before interest and taxes is known as EBIT in financial and
business accounting.Net profit margin (or net return on
sales)Profits after taxes
Sales revenuesShows after-tax profits per dollar of sales.Total
return on assetsProfits after taxes + Interest
Total assetsA measure of the return on total investment in the
enterprise. Interest is added to after-tax profits to form the
numerator, since total assets are financed by creditors as well as
by stockholders.

The stronger a company’s current overall performance, the more
likely it has a well-conceived, well-executed strategy. The
weaker a company’s financial performance and market standing,
the more its current strategy must be questioned and the more
likely the need for radical changes.
Table 4.1 provides a compilation of the profitability ratios most
commonly used to evaluate a company’s financial performance
and balance sheet strength.
Chapter 4–‹#›
and What They Mean (2 of 8)Profitability RatiosHow
CalculatedWhat It ShowsNet return on total assets (ROA)Profits
after taxes
Total assets
A measure of the return earned by stockholders on the firm’s
total assets.Return on stockholders’ equity (ROE) Profits after
taxes
Total stockholders’ equityThe return stockholders are earning
on their capital investment in the enterprise. A return in the
12% to 15% range is average.Return on invested capital
(ROIC)—sometimes referred to as return on capital employed
(ROCE)
Profits after taxes
Long-term debt +
Total stockholders’ equityA measure of the return that
shareholders are earning on the monetary capital invested i n the
enterprise. A higher return reflects greater bottom-line
effectiveness in the use of long-term capital.

Table 4.1 provides a compilation of the financial profitability
ratios most commonly used to evaluate a company’s financial
performance and balance sheet strength.
Chapter 4–‹#›
and What They Mean (3 of 8)Liquidity RatiosHow
CalculatedWhat It ShowsCurrent ratio Current assets
Current liabilitiesShows a firm’s ability to pay current
liabilities using assets that can be converted to cash in the near
term. Ratio should be higher than 1.0.Working capitalCurrent
assets − Current liabilitiesThe 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.
Table 4.1 provides a compilation of the assets-to-liabilities
liquidity ratios most commonly used to evaluate a company’s
financial performance and balance sheet strength.
Chapter 4–‹#›

and What They Mean (4 of 8)Leverage RatiosHow
CalculatedWhat It ShowsTotal debt-to-assets ratio Total debt
Total assets
Measures the extent to which borrowed funds (both short-term
loans and long-term debt) have been used to finance the firm’s
operations. A low ratio is better—a high fraction indicates
overuse of debt and greater risk of bankruptcy.Long-term debt-
to-capital ratio Long-term debt
Long-term debt +
Total stockholders’ equityA measure of creditworthiness and
balance-sheet strength. It indicates the percentage of capital
investment that has been financed by both long-term lenders and
stockholders. A ratio below 0.25 is preferable since the 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.
Table 4.1 provides a compilation of the financial leverage ratios
most commonly used to evaluate a company’s financial
performance and balance sheet strength.
Chapter 4–‹#›

and What They Mean (5 of 8)Leverage RatiosHow
CalculatedWhat It ShowsDebt-to-equity ratio Total debt
Total stockholders’ equityShows the balance between debt
(funds borrowed, both short term and long term) and the amount
that 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-to-equity ratio Long-term debt
Total stockholders’ equityShows the balance between long-term
debt and stockholders’ equity in the firm’s long-term capital
structure. Low ratios indicate a greater capacity to borrow
additional funds if needed.Times-interest-earned (or coverage)
ratio Operating income
Interest expensesMeasures the ability to pay annual interest
charges. Lenders usually insist on a minimum ratio of 2.0, but
ratios above 3.0 signal increasing creditworthiness.
Table 4.1 provides a compilation of the debt-to-equity leverage
ratios and income-to-expenses coverage ratio most commonly
used to evaluate a company’s financial performance and balance
sheet strength.
Chapter 4–‹#›
and What They Mean (6 of 8)Activity RatiosHow
CalculatedWhat It ShowsDays of inventory Inventory

Cost of goods sold ÷ 365Measures inventory management
efficiency. Fewer days of inventory are better.Inventory
turnoverCost of goods sold InventoryMeasures the number of
inventory turns per year. Higher is better.Average collection
periodAccounts receivable
Total sales ÷ 365
or
Accounts receivable
Average daily salesIndicates the average length of time the firm
must wait after making a sale to receive cash payment. A
shorter collection time is better.
Table 4.1 provides a compilation of the inventory and accounts
receivable collection activity ratios most commonly used to
evaluate a company’s financial performance and balance sheet
strength.
Chapter 4–‹#›
and What They Mean (7 of 8)Other RatiosHow CalculatedWhat
It ShowsDividend yield on common stockAnnual dividends
per share
Current market price
per shareA measure of the return that shareholders receive in
the form of dividends. A “typical” 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%.Price-

to-earnings (P/E) ratioCurrent market price
per share
Earnings per shareP/E ratios above 20 indicate strong investor
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.Dividend payout ratioAnnual
dividends
per share
Earnings per shareIndicates the percentage of after-tax profits
paid out as dividends.
Table 4.1 provides a compilation of dividend yield, price-to-
earnings, and dividend payout ratios most commonly used to
evaluate a company’s financial performance and balance sheet
strength.
Chapter 4–‹#›
and What They Mean (8 of 8)
Copyright ©McGraw-Hill Education. Permission required for
reproduction or display.Other RatiosHow CalculatedWhat It
ShowsInternal cash flowAfter-tax profits + DepreciationA 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.Free cash flowAfter-tax profits + Depreciation –
Capital expenditures – Dividends
A rough estimate of the cash a firm’s business is generating

after payment of operating expenses, interest, taxes, dividends,
and desirable reinvestments in the business. The larger a firm’s
free cash flow, the greater its ability to internally fund new
strategic initiatives, repay debt, make new acquisitions,
repurchase shares of stock, or increase dividend payments.
Table 4.1 provides a compilation of cash flow ratios most
commonly used to evaluate a company’s financial performance
and balance sheet strength.
Chapter 4–‹#›
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)
SWOT can help explain why a strategy is working well (or not)
by taking a close look a company's strengths in relation to its
weaknesses and in relation to the strengths and weaknesses of
competitors. Are the firm’s strengths enough to make up for its
weaknesses? Has the firm’s strategy built on these strengths

and shielded the firm from its weaknesses? Do the firm's
strengths exceed those of its rivals? Similarly, a SWOT
analysis can help determine whether a strategy has been
effective in fending off external threats and positioning the firm
to take advantage of market opportunities.
SWOT analysis is a widely used diagnostic tool popular for its
ease of use, also because it can be used to evaluate the efficacy
of a strategy and as the basis for crafting a strategy from the
outset to determine whether the firm is positioned to pursue new
market opportunities and to defend against emerging threats to
its future well-being.
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Chapter 4–‹#›
Identifying 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.

A firm’s strengths represent its competitive assets. Basing a
firm’s strategy on its most competitively valuable strengths
gives the firm its best chance for market success. When a
company’s proficiency rises from that of mere ability to
perform an activity to the point of being able to perform it
consistently well and at acceptable cost, it is said to have a
competence—a true capability, in other words. If a firm’s
competence level in some activity domain is superior to that of
its rivals it is known as a distinctive competence. A core
competence is a proficiently performed internal activity that is
central to a firm’s strategy and is typically distinctive as well.
A core competence is a more competitively valuable strength
than a competence because of the activity’s key role in the
firm’s strategy and the contribution it makes to the firm’s
market success and profitability
Chapter 4–‹#›
Identifying a Company’s Internal Weaknesses
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
A firm’s weaknesses are shortcomings that constitute
competitive liabilities, weakness, or competitive deficiency, and
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. A firm’s internal weaknesses can relate to

(1) inferior or unproven skills, expertise, capabilities, or
intellectual capital in competitively important areas of the
business; (2) deficiencies in competitively important physical,
organizational, or intangible assets.
Chapter 4–‹#›
Identifying a Company’s Market Opportunities
Characteristics of market opportunities
Newly emerging and fast-changing markets may represent
“golden opportunities” but are often hidden in “fog of the
future.”
Opportunities can evolve in mature markets.
Opportunities with market factors aligned with the firm’s
strengths offer the most potential for the firm to gain
competitive advantage.
Depending on the prevailing circumstances, a firm’s
opportunities can be plentiful or scarce, fleeting or lasting, and
can range from wildly attractive to marginally interesting to
unsuitable. A firm is well advised to pass on a particular market
opportunity unless it has or can acquire the competencies
needed to capture it.
Chapter 4–‹#›
Identifying External Threats
Types of threats
Normal course-of-business
Sudden-death (survival)
Considering threats
Identify threats to the firm’s future prospects
Evaluate strategic actions to be taken to neutralize or lessen

impact
Simply making lists of a firm’s strengths, weaknesses,
opportunities, and threats is not enough. The payoff from
SWOT analysis comes from the conclusions about a firm’s
situation and the implications for strategy improvement that
flow from the four lists.
Chapter 4–‹#›
TABLE 4.2 What to Look for in Identifying a Company’s
Strengths, Weaknesses, Opportunities, and Threats (1 of
4)Strengths and Competitive AssetsWeaknesses and
Competitive DeficienciesAmple financial resources to grow the
businessNo distinctive core competenciesStrong brand-name
image or company reputationLack of attention to customer
needsCost advantages over rivalsWeak balance sheet, too much
debtAttractive customer baseHigher costs than
competitorsProprietary technology, superior technological
skills, important patentsToo narrow a product line relative to
rivalsStrong bargaining power over suppliers or buyersWeak
brand image or reputation
Table 4.2-1 lists many of the things to consider in compiling a
company’s strengths and weaknesses. Sizing up a company’s
complement of strengths and deficiencies is akin to constructing
a strategic balance sheet, where strengths represent competitive
assets and weaknesses represent competitive liabilities. Ideally,
the company’s competitive assets should outweigh its
competitive liabilities by an ample margin.

Chapter 4–‹#›
4)Strengths and Competitive Assets (continued)Weaknesses and
Competitive Deficiencies (continued)Superior product
qualityLack of adequate distribution capabilityWide geographic
coverage or strong global distribution capabilityLack of
management depthAlliances or joint ventures that provide
access to valuable technology competencies, or attractive
geographic marketsA plague of internal operating problems or
obsolete facilities
Too much underutilized plan capacity
Table 4.2-2 lists many of the things to consider in compiling a
company’s strengths and weaknesses. Sizing up a company’s
complement of strengths and deficiencies is akin to constructing
a strategic balance sheet, where strengths represent competitive
assets and weaknesses represent competitive liabilities. Ideally,
the company’s competitive assets should outweigh its
competitive liabilities by an ample margin.
Chapter 4–‹#›
4)Market OpportunitiesExternal ThreatsMeet sharply rising
buyer demand for the industry’s productIncreasing intensity of
competitionServe additional customer groups or market
segmentsSlowdowns in market growthExpand into new
geographic marketsLikely entry of potent new
competitionsExpand the company’s product line to meet a
broader range of customer needsGrowing bargaining power of

customers or suppliersEnter new product lines or new
businessesA shift in buyer needs and tastes away from the
industry’s productTake advantage of failing trade barriers in
attractive foreign marketsAdverse demographic changes that
threaten to curtail demand for the industry’s product
Table 4.2-3 displays a sampling of potential threats and market
opportunities. Sizing up a company’s complement of strengths
and deficiencies is akin to constructing a strategic balance
sheet, where strengths represent competitive assets and
weaknesses represent competitive liabilities. Ideally, the
company’s competitive assets should outweigh its competitive
liabilities by an ample margin.
Chapter 4–‹#›
4)Market Opportunities (continued)External Threats
(continued)Take advantage of an adverse change in the fortunes
of rival firmsAdverse economic conditions that threaten critical
suppliers or distributorsAcquire rival firms or companies with
attractive technological expertise or competenciesChanges in
technology—particularly disruptive technology that can
undermine the company’s distinctive competenciesTake
advantage of emerging technological developments to innovate
Enter into alliances or other cooperative venturesRestrictive
foreign trade policies
Costly new regulatory requirements
Tight credit conditions
Rising prices on energy or other key inputs

Table 4.2-4 displays a sampling of potential threats and market
opportunities. Sizing up a company’s complement of strengths
and deficiencies is akin to constructing a strategic balance
sheet, where strengths represent competitive assets and
weaknesses represent competitive liabilities. Ideally, the
company’s competitive assets should outweigh its competitive
liabilities by an ample margin.
Chapter 4–‹#›
What Do SWOT Listings Reveal?
New strategy
SWOT is the foundation for positioning the firm to use its
strengths to seize opportunities and to shore up its competitive
deficiencies to mitigate external threats.
Existing strategy
SWOT insights into the firm’s overall business situation can
translate into recommended strategic actions.
The SWOT analysis process involves more than making four
lists. In crafting a new strategy, it offers a strong foundation
for understanding how to position the firm to build on its
strengths in seizing new business opportunities and how to
mitigate external threats by shoring up its competitive
deficiencies. In assessing the effectiveness of an existing
strategy, it can be used to glean insights regarding the firm's
overall business situation (thus the name Situational Analysis);
and it can help translate these insights into …
CHAPTER 3 Evaluating a Company’s External Environment

Chapter 3 presents the concepts and analytical tools for
assessing a company’s external environment. Attention centers
on the competitive arena in which a company operates, together
with the technological, societal, regulatory, or demographic
influences in the macro-environment that are acting to reshape
the company’s future market arena.
3–1
Learning Objectives
This Chapter Will Help You Understand:
How to recognize the factors in a company’s broad macro-
environment that may have strategic significance.
How to use analytic tools to diagnose the competitive
conditions in a company’s industry.
How to map the market positions of key groups of industry
rivals.
How to determine whether an industry’s outlook presents a
company with sufficiently attractive opportunities for growth
and profitability.

This chapter presents the concepts and analytical tools for
zeroing in on a single-business company’s external
environment.
3–2
FIGURE 3.1 From Analyzing the Company’s Situation to
Choosing a Strategy
Chapter 3 External Environment
Chapter 4 Internal Environment
As depicted in Figure 3.1, strategic thinking begins with an
appraisal of the company’s external and internal environments
(as a basis for deciding on a long-term direction and developing
a strategic vision), moves toward an evaluation of the most
promising alternative strategies and business models, and
culminates in choosing a specific strategy.
3–3
Analyzing the Company's Macro-Environment
PESTEL Analysis
Focuses on principal components of strategic significance in the
macro-environment
Political factors
Economic conditions (local to worldwide)
Sociocultural forces
Technological factors
Environmental factors (the natural environment)
Legal and regulatory conditions

The macro-environment encompasses the broad environmental
context in which a company’s industry is situated that includes
strategically relevant components over which the firm has no
direct control.
Analysis of the impact of these factors is often referred to as
PESTEL analysis, an acronym that serves as a reminder of the
six components involved (Political, Economic, Sociocultural,
Technological, Environmental, Legal/Regulatory).
3–4
FIGURE 3.2 The Components
of a Company’s Macro-Environment
Figure 3.2, The Components of a Company’s Macro-
environment identifies the arenas within an organization’s
macro-environment.
3–5
Assessing the Company’s Industry and Competitive
Environment
Thinking strategically about the competitive environment
requires managers to use some well validated concepts and
analytical tools.

Five forces framework
The value net
Driving forces
Strategic groups
Competitor analysis
Key success factors
Thinking strategically about a company’s industry and
competitive environment entails using some well-validated
concepts and analytic tools. These include the five forces
framework, the value net, driving forces, strategic groups,
competitor analysis, and key success factors. Proper use of
these analytic tools can provide managers with the
understanding needed to craft a strategy that fits the company’s
situation within their industry environment. The remainder of
this chapter is devoted to describing how managers can use
these tools to inform and improve their strategic choices.
3–6
The Five Forces Framework
The five competitive forces
Competition from rival sellers
Competition from potential new entrants
Competition from producers of substitute products
Supplier bargaining power
Customer bargaining power
The character and strength of the competitive forces operating

in an industry are never the same from one industry to another.
The most powerful and widely used tool for diagnosing the
principal competitive pressures in a market is the five forces
framework.
3–7
FIGURE 3.3 The Five Forces Model of Competition:
A Key Analytical Tool
Sources: Adapted from M.E. Porter, “How Competitive Forces
Shape Strategy,” Harvard Business Review 57, no. 2 (1979),
pp.137-145; M.E. Porter, “The Five Competitive Forces That
Shape Strategy,” Harvard Business Review 86, no 1 (2008), pp.
80-86.
This five forces framework, depicted in Figure 3.3, holds that
competitive pressures on companies within an industry come
from five sources. These include (1) competition from rival
sellers, (2) competition from competition from producers of
substitute products, (3) potential new entrants, (4) supplier
bargaining power, and (5) customer bargaining power.
3–8
Using the Five-forces Model of Competition
STEP 1: For each of the five forces, identify the different
parties involved, along with the specific factors that bring about
competitive pressures.
STEP 2: Evaluate how strong the pressures stemming from
each of the five forces are (strong, moderate, or weak).

STEP 3: Determine whether the five forces, overall, are
supportive of high industry profitability.
Using the five forces model to determine the nature and strength
of competitive pressures in a given industry involves three
steps:
∙ Step 1: For each of the five forces, identify the different
parties involved, along with the specific factors that bring about
competitive pressures.
∙ Step 2: Evaluate how strong the pressures stemming from each
of the five forces are (strong, moderate, or weak).
∙ Step 3: Determine whether the five forces, overall, are
supportive of high industry profitability.
3–9
Competitive Pressures That Increase Rivalry among Competing
Sellers
Buyer demand is growing slowly or declining.
It is becoming less costly for buyers to switch brands.
Industry products are becoming less differentiated.
There is unused production capacity, or products have high
fixed costs or high storage costs.
The number of competitors is increasing, or they are becoming
more equal in size and competitive strength.
The diversity of competitors is increasing.
High exit barriers keep firms from exiting the industry.
The strongest of the five competitive forces is often the rivalry

for buyer patronage among competing sellers of a product or
service. The intensity of rivalry among competing sellers within
an industry depends on several identifiable factors.
3–10
FIGURE 3.4 Factors Affecting the Strength of Rivalry
Figure 3.4 summarizes these factors affecting rivalry in the
industry, identifying those that intensify or weaken rivalry
among direct competitors in an industry.
3–11
Competitive Pressures Associated with the Threat of New
Entrants
Entry threat considerations
Expected defensive reactions of incumbent firms
Strength of barriers to entry
Attractiveness of a particular market’s growth
in demand and profit potential
Capabilities and resources of potential entrants
Entry of existing competitors into market segments
in which they have no current presence
New entrants into an industry threaten the position of rival
firms since they will compete fiercely for market share, add to

the number of industry rivals, and add to the industry’s
production capacity in the process.
3–12
Market Entry Barriers Facing New Entrants
Sizable economies of scale in production, distribution,
advertising, or other activities
Hard-to-replicate learning curve and industry relationship cost
advantages of incumbents
Strong brand preferences and high customer loyalty
Patents and other intellectual property protection
Strong “network effects” in customer demand
High capital requirements
Building distributor and/or dealer networks and securing
adequate space on retailers’ shelves
Restrictive regulatory and trade policies
The strength of the threat of entry is governed to a large degree
by the height of the industry's entry barriers. High barriers
reduce the threat of potential entry, whereas low barriers enable
easier entry.
Whether an industry’s entry barriers ought to be considered
high or low depends on the resources and capabilities possessed
by the pool of potential entrants. High entry barriers and weak
entry threats today do not always translate into high entry
barriers and weak entry threats tomorrow.
3–13
FIGURE 3.5 Factors Affecting the Threat of Entry

Figure 3.5 summarizes the factors that cause the overall
competitive pressure from potential entrants to be strong or
weak. An analysis of these factors can help managers determine
whether the threat of entry into their industry is high or low.
3–14
Competitive Pressures from the Sellers of Substitute Products
Substitute products considerations
Readily available and attractively priced?
Comparable or better in terms of quality, performance, and
other relevant attributes?
Offer lower switching costs to buyers?
Indicators of substitutes’ competitive strength
Increasing rate of growth in sales of substitutes
Substitute producers adding new output capacity
Increasing profitability of substitute producers
Companies in one industry are vulnerable to competitive
pressure from the actions of companies in a closely adjoining
industry whenever buyers view the products of the two
industries as good substitutes.
3–15
FIGURE 3.6 Factors Affecting Competition from

Substitute Products
Figure 3.6 depicts three factors that determine whether the
competitive pressures from substitute products are strong or
weak. Competitive pressures are stronger when:
Good substitutes are readily available and attractively priced.
Buyers view the substitutes as comparable or better in terms of
quality. performance, and other relevant attributes.
The costs that buyers incur in switching to the substitutes are
low.
3–16
Competitive Pressures Stemming from Supplier Bargaining
Power
Supplier bargaining power depends on:
Strength of demand for and availability of suppliers’ products.
Whether suppliers provide a differentiated input that enhances
the performance of the industry’s product.
Industry members’ costs for switching among suppliers.
Size and number of suppliers relative to industry members.
Possibility of backward integration into suppliers’ industry.
Fraction of the cost of the supplier’s product relative to the
total cost of the industry’s product.
Availability of good substitutes for suppliers’ products.
Whether industry members are major customers of suppliers.

Whether the suppliers of industry members represent a weak or
strong competitive force depends on the degree to which
suppliers have sufficient bargaining power to influence the
terms and conditions of supply in their favor. Suppliers with
strong bargaining power are a source of competitive pressure
because of their ability to charge industry members higher
prices, pass costs on to them, and limit their opportunities to
find better deals.
3–17
FIGURE 3.7 Factors Affecting the Bargaining Power of
Suppliers
Figure 3.7 shows a variety of factors that determine the strength
of suppliers’ bargaining power.
3–18
Competitive Pressures Stemming from Buyer Bargaining Power
and Price Sensitivity
Buyer bargaining power considerations
Strength of buyers’ demand for sellers’ products
Degree to which industry goods are differentiated
Buyers’ costs for switching to competing sellers or substitutes
Number and size of buyers relative to number of sellers
Threat of buyers’ integration into sellers’ industry
Buyers’ knowledge of products, costs and pricing
Buyers’ discretion in delaying purchases
Buyers’ price sensitivity due to low profits, size of purchase,

and consequences of purchase
Product quality not at issue price is primary concern
Whether buyers can exert strong competitive pressures on
industry members depends on (1) the degree to which buyers
have bargaining power, and (2) the extent to which buyers are
price-sensitive. Buyers with strong bargaining power can limit
industry profitability by demanding price concessions, better
payment terms, or additional features and services that increase
industry members’ costs. Buyer price sensitivity limits the
profit potential of industry members by restricting the ability of
sellers to raise prices without losing revenue due to lost sales.
3–19
FIGURE 3.8 Factors Affecting the Bargaining Power of
Buyers
Figure 3.8 summarizes the factors determining the strength of
buyer power in an industry. Note that the first five factors are
the mirror image of those determining the bargaining power of
suppliers.
3–20
Is the Collective Strength of the Five Competitive Forces
Conducive to Good Profitability?

Answers to three questions are needed:
Is the state of competition in the industry stronger than normal?
Can industry firms expect to earn decent profits given
prevailing competitive forces?
Are some of the competitive forces sufficiently powerful to
undermine industry profitability?
Even one powerful competitive force may be enough to make
the industry unattractive in terms of its profit potential.
Assessing whether each of the five competitive forces gives rise
to strong, moderate, or weak competitive pressures sets the
stage for evaluating whether, overall, the strength of the five
forces is conducive to good profitability. Are any of the
competitive forces sufficiently powerful to undermine industry
profitability? Can industry firms reasonably expect to earn
decent profits considering the prevailing competitive forces?
The strongest of the five forces determines the extent of the
downward pressure on an industry’s profitability. Having more
than one strong force means that an industry has multiple
competitive challenges with which to cope.
3–21
Matching Company Strategy to
Competitive Conditions
Effectively matching a firm’s business strategy to prevailing
competitive conditions has two aspects:
Pursuing avenues that shield the firm from as many competitive
pressures as possible
Initiating actions calculated to shift competitive forces in the
firm’s favor by altering underlying factors driving the five

forces
Working through the five forces model step by step aids
strategy-makers in assessing whether the intensity of
competition allows good profitability and promotes sound
strategic thinking about how to better match company strategy
to the specific competitive character of the marketplace.
A company’s strategy is strengthened when it provides some
insulation from competitive pressures, shifts the competitive
battle in the company’s favor, and positions firms to take
advantage of attractive growth opportunities.
3–22
Complementors and the Value Net
How the value net differs from the five forces
Focuses on the interactions of industry participants with a
particular (focal) company
Defines the category of competitors to include the focal firm’s
direct competitors, industry rivals, the sellers of substitute
products, and potential entrants
Introduces a new category of industry participant—
complementors—producers of products that enhance the value
of the focal firm’s products when they are used together
Not all interactions among industry participants are necessarily
competitive in nature. Some have the potential to be
cooperative, as the value net framework demonstrates. Like the

five forces framework, the value net includes an analysis of
buyers, suppliers, and substitutors. But it differs from the five
forces framework in several important ways.
3–23
FIGURE 3.9 The Value Net
Figure 3.9 depicts the value net used in an analysis of buyers,
suppliers, and substitutors.
Complementors are the producers of complementary products,
which are products that enhance the value of the focal firm’s
products when they are used together.
3–24
Industry Dynamics and the Forces Driving Change
Driving forces analysis has three steps.
Identifying what the driving forces are
Assessing whether the drivers of change are
acting to make the industry more or less attractive
Determining what strategy changes are needed to prepare for the
impact of the driving forces
Driving forces are the major underlying causes of change in
industry and competitive conditions. Driving forces analysis has
three steps: (1) identifying what the driving forces are; (2)

assessing whether the drivers of change are acting to make the
industry more or less attractive; and (3) determining what
strategy changes are needed to prepare for the impact of the
driving forces.
3–25
Identifying the Forces Driving Industry Change
Changes in the long-term industry growth rate
Increasing globalization
Emerging new Internet capabilities and applications
Shifts in buyer demographics
Technological change and manufacturing process innovation
Product and marketing innovation
Entry or exit of major firms
Diffusion of technical know-how across firms and countries
Changes in cost and efficiency
Reductions in uncertainty and business risk
Regulatory influences and government policy changes
Changing societal concerns, attitudes, and lifestyles
The most important part of driving forces analysis is to
determine whether the collective impact of the driving forces
will increase or decrease market demand, make competition
more or less intense, and lead to higher or lower industry
profitability.
The real payoff of driving-forces analysis is to help managers
understand what strategy changes are needed to prepare for the
impacts of the driving forces
3–26

Assessing the Impact of the Factors Driving Industry Change
Are the driving forces, on balance, acting to cause demand for
the industry’s product to increase or decrease?
Is the collective impact of the driving forces making
competition more or less intense?
Will the combined impacts of the driving forces lead to higher
or lower industry profitability?
The second step in driving forces analysis is to determine
whether the prevailing change drivers are acting to make the
industry environment more or less attractive. Three questions
need to be answered:
Are the driving forces, on balance, acting to cause demand for
the industry’s product to increase or decrease?
Is the collective impact of the driving forces making
competition more or less intense?
Will the combined impacts of the driving forces lead to higher
or lower industry profitability?
Getting a handle on the collective impact of the driving forces
requires looking at the likely effects of each factor separately,
since the driving forces may not all be pushing change in the
same direction.
3–27
Adjusting Strategy to Prepare for the Impacts of Driving Forces
What strategy adjustments will be needed
to deal with the impacts of the driving forces?
What adjustments must be made immediately?
What actions currently being taken should be halted or
abandoned?
What can we do now to prepare for adjustments we anticipate

making in the future?
The third step in the strategic analysis of industry dynamics—
where the real payoff for strategy making comes—is for
managers to draw some conclusions about what strategy
adjustments will be needed to deal with the impacts of the
driving forces. But taking the “right” kinds of actions to prepare
for the industry and competitive changes being wrought by the
driving forces first requires accurate diagnosis of the forces
driving industry change and the impacts these forces will have
on both the industry environment and the company’s business.
3–28
Strategic Group Analysis
Strategic group
Consists of those industry members with similar competitive
approaches and positions in the market
Having comparable product-line breadth
Emphasizing the same distribution channels
Depending on identical technological approaches
Offering the same product attributes to buyers
Offering similar services and technical assistance
Within an industry, companies commonly sell in different
price/quality ranges, appeal to different types of buyers, have
different geographic coverage, and so on. Some are more
attractively positioned than others. Understanding which

companies are strongly positioned and which are weakly
positioned is an integral part of analyzing an industry’s
competitive structure. The best technique for revealing the
market positions of industry competitors is strategic group
mapping.
3–29
Using Strategic Group Maps to Assess the Market Positions of
Key Competitors
Constructing a strategic group map
Identify the competitive characteristics that delineate strategic
approaches used in the industry.
Plot the firms on a two-variable map using pairs of competitive
characteristics.
Assign firms occupying about the same map location to the
same strategic group.
Draw circles around each strategic group, making the circles
proportional to the size of the group’s share of total industry
sales revenues.
A strategic group is a cluster of industry rivals that have similar
competitive approaches and market positions.
Strategic group mapping is a technique for displaying the
different market or competitive positions that rival firms occupy
in the industry.
Evaluating strategy options entails examining what strategic
groups exist, identifying the companies within each group, and
determining if a competitive “white space” exists where
industry competitors can create and capture new demand.

3–30
Typical Variables Used in
Creating Group Maps
Price and quality range (high, medium, low)
Geographic coverage (local, regional, national, global)
Product-line breadth (wide, narrow)
Degree of service offered (no frills, limited, full)
Distribution channels (retail, wholesale, Internet, multiple)
Degree of vertical integration (none, partial, full)
Degree of diversification into other industries (none, some,
considerable)
3–31
Guidelines for Creating Group Maps
Variables selected as map axes should not be highly correlated.
Variables should reflect important (sizable) differences among
rival approaches.
Variables may be quantitative, continuous, discrete, or defined
in terms of distinct classes and combinations.
Drawing group circles proportional to the combined sales of
firms in each group will reflect the relative sizes of each
strategic group.
Drawing maps using different pairs of variables will show the
different competitive positioning relationships present in the
industry’s structure.

Two variables selected as axes for the map should not be highly
correlated; if they are, the circles on the map will fall along a
diagonal and reveal nothing more about the relative positions of
competitors than would be revealed by comparing the rivals on
just one of the variables.
Strategic group maps reveal which firms are close competitors
and which are distant competitors.
3–32
Illustration Capsule 3.1 Comparative Market Positions of
Selected Companies in the Casual Dining Industry: A Strategic
Group Map Example
Footnote: Circles are drawn roughly proportional to the sizes of
the chains, based on revenues.
Illustration Capsule 3.1 shows a two-dimensional group
mapping diagram for the U.S. casual dining industry.
3–33
Examining the Comparative Market Positions of Strategic
Groups in the Casual Dining Industry
Which strategic group is located in the least favorable market
position? Which group is in the most favorable position?
Which strategic group is likely to experience increased
intragroup competition?
Which groups are most threatened by the likely strategic moves

of members of nearby strategic groups?
Strategic group maps using different pairs of variable can be
drawn to give different exposures to the competitive positioning
relationships present in the industry’s structure —there is not
necessarily one best map for portraying how competing firms
are positioned.
3–34
The Value of Strategic Group Maps
Maps are useful in identifying which industry members are
close rivals and which are distant rivals.
Not all map positions are equally attractive
Prevailing competitive pressures from the industry’s five forces
may cause the profit potential of different strategic groups to
vary.
Industry driving forces may favor some strategic groups and
hurt others.
Some strategic groups are more favorably positioned than others
because they confront weaker competitive forces or because
they are more favorably impacted by industry driving forces.
Part of strategic group map analysis always entails drawing
conclusions about where on the map is the “best” place to be
and why. Which firms/strategic groups are destined to prosper
because of their positions? Which firms/strategic groups seem
destined to struggle? What accounts for why some parts of the
map are better than others?

3–35
Competitor Analysis
Competitive intelligence
Information about rivals that is useful in anticipating their next
strategic moves
Signals of the likelihood of strategic moves
Rivals under pressure to improve financial performance
Rivals seeking to increase market standing
Public statements of rivals’ intentions
Profiles developed by competitive intelligence units
Studying competitors’ past behavior and preferences provides a
valuable assist in anticipating what moves rivals are likely to
make next and in outmaneuvering them in the marketplace.
The question is where to look for such information since rivals
rarely reveal their strategic intentions openly. If information is
not directly available, what are the best indicators?
3–36
FIGURE 3.10 The SOAR Framework for Competitor
Analysis
Copyright ©McGraw-Hill Education. Permission required …
CHAPTER 5 The Five Generic Competitive Strategiwes

Chapter 5 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.
5–1
Learning Objectives
What distinguishes each of the five generic strategies and why
some of these strategies work better in certain kinds of
competitive conditions than in others.
The major avenues for achieving a competitive advantage based
on lower costs.
The major avenues to a competitive advantage based on
differentiating a company’s product or service offering from the
offerings of rivals.
The attributes of a best-cost strategy—a hybrid of low-cost and
differentiation strategies
This chapter describes the five generic competitive strategy
options. Each of the five generic strategies represents a
distinctly different approach to competing in the marketplace.
Each of the five generic strategies represents a distinctly
different approach to competing in the marketplace. Which of

the five to employ is a company’s first and foremost choice in
crafting an overall strategy and beginning its quest for
competitive advantage.
2
Why Do Strategies Differ?
A firm’s competitive strategy deals exclusively with the
specifics of its efforts to position itself in the market-place,
please customers, ward off competitive threats, and achieve a
particular kind of 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 costs
or product differentiation?
A company’s competitive strategy deals exclusively with the
specifics of management’s game plan for competing
successfully— its specific efforts to please customers,
strengthen its market position, counter the maneuvers of rivals,
respond to shifting market conditions, and achieve a particular
kind of competitive advantage.
The biggest and most important differences among competitive
strategies boil down to:
Whether a company’s market target is broad or narrow
Whether the company is pursuing a competitive advantage
linked to low costs or product differentiation
5–3
Types of Generic Competitive StrategiesTypesGENERIC
COMPETITIVE STRATEGIESBroad,
Low-cost

StrategyStriving to achieve broad lower overall costs than rivals
on comparable products that attract a broad spectrum of buyers,
usually by underpricing rivalsBroad
Differentiation
StrategySeeking to differentiate the firm’s product offering
from its rivals’ with attributes that will appeal to a broad
spectrum of buyers.Focused
Low-cost
StrategyConcentrating on a narrow buyer segment (or market
niche striving to meet these needs at lower costs than rivals
(thereby being able to serve niche members at a lower
price)Focused
Differentiation
StrategyConcentrating on a narrow buyer segment (or market
niche) by offering its members customized attributes that meet
their specific tastes and requirements of niche members better
than rivalsBest-cost
(Hybrid)
StrategyStriving to incorporate upscale product attributes at a
lower cost than rivals. Being the “best-cost” producer of an
upscale, multifeatured product allows a firm to give customers
more value for their money by underpricing rivals whose
products have similar upscale, multifeatured attributes
Five distinct competitive strategy approaches stand out:
A low-cost strategy: striving to achieve lower overall costs than
rivals and appealing to a broad spectrum of customers, usually
by under pricing rivals.
A broad differentiation strategy: seeking to differentiate the
company’s product/ service offering from rivals’ in ways that
will appeal to a broad spectrum of buyers
A focused low-cost strategy: concentrating on a narrow buyer
segment and outcompeting rivals by serving niche members at a

lower cost than rivals
A focused differentiation strategy: concentrating on a narrow
buyer segment and outcompeting rivals by offering niche
members customized attributes that meet their tastes and
requirements better than rivals products
A best-cost producer strategy: giving customers more value for
the money by incorporating good-to-excellent product attributes
at a lower cost than rivals; the target is to have the lowest (best)
costs and prices compared to rivals offering products with
comparable attributes
5–4
FIGURE 5.1 The Five Generic Competitive Strategies
Source: This is an expanded version of a three-strategy
classification discussed in Michael E. Porter, Competitive
Strategy (New York: Free Press, 1980).
Figure 5.1 The Five Generic Competitive Strategies examines
how each of the five strategies stake out a different market
position.
5–5
Low-Cost Strategies
Effective low-cost approaches
Pursue cost savings that are difficult to imitate
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
A low-cost producer’s basis for competitive advantage is lower
overall costs than competitors. Successful low-cost leaders, who
have the lowest industry costs, are exceptionally good at finding
ways to drive costs out of their businesses and still provide a
product or service that buyers find acceptable.
5–6
The Two Major Avenues for Achieving a Cost Advantage
Low-cost advantage
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 company has two options for translating a low-cost advantage

over rivals into attractive profit performance.
5–7
Cost-Efficient Management of Value Chain Activities (1 of 2)
Cost driver
A factor with a strong influence on a firm’s costs
Can be asset-based or activity-based
Securing a cost advantage
Use lower-cost inputs and hold minimal assets
Offer only “essential” product features or services
Offer only limited product lines
Use low-cost distribution channels
Use the most economical delivery methods
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.
5–8
FIGURE 5.2 Cost Drivers: The Keys to Driving Down Company
Costs
Source: Adapted from Michael E. Porter, Competitive
Advantage: Creating and Sustaining Superior Performance (New
York: Free Press, 1985).

Figure 5.2 shows the most important cost drivers.
5–9
Cost-Cutting Methods (1 of 2)
Capturing all available economies of scale
Taking full advantage of experience and learning-curve effects
Operating facilities at full or near-full capacity
Improving supply chain efficiency
Substituting lower-cost inputs wherever there is little or no
sacrifice in product quality or performance
Using the firm’s bargaining power vis-à-vis suppliers or others
in the value chain system to gain concessions
Using online systems and sophisticated software to achieve
operating efficiencies
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.
5–10
Cost-Cutting Methods (2 of 2)
Improving process design and employing advanced production
technology
Being alert to the cost advantages of outsourcing or vertical
integration
Motivating employees through incentives and company culture

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.
5–11
Revamping 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.
5–12
Vanguard’s Path to Becoming the Low-Cost Leader in
Investment Management
Describe Vanguard’s business segment.
How well are Vanguard’s competitive strengths matched to the
five forces in its competitive environment?
Which of Vanguard’s value chain activities would be most
easily overcome by rivals? most difficult to overcome?

Assume you have been tasked to revamp a rival’s value chain
activities to better compete with Vanguard. In what order of
expected payoff should you attempt to revamp its value chain
activities?
Illustration Capsule 5.1 shows how Vanguard managed its value
chain to achieve a huge low-cost advantage over rival
supermarket chains.
5–13
The Keys to a Successful Low-Cost Strategy
Success in achieving a low-cost edge over rivals comes from
out-managing rivals in finding ways to perform value chain
activities faster, more accurately, and more cost-effectively by:
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
Success in achieving a low-cost edge over rivals comes from
out-managing rivals in finding ways to perform value chain
activities faster, more accurately, and more cost-effectively.
A low-cost producer is in the best position to win the business
of price-sensitive buyers, set the floor on market price, and still
earn a profit.

5–14
When a Low-Cost Strategy Works Best
Price competition among rival sellers is vigorous.
Identical products are available from many sellers.
There are few ways to differentiate industry products.
Most buyers use the product in the same ways.
Buyers incur low costs in switching among sellers.
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.
5–15
Pitfalls to Avoid in Pursuing a Low-Cost Strategy
Engaging in overly aggressive price cutting that does not result
in unit sales gains sufficient to recoup forgone profits
Relying on a cost advantage that is not sustainable because rival
firms can easily copy or overcome it
Becoming so fixated on cost reduction such that the firm’s
offerings lack the primary features that attract buyers
Having a rival discover a new lower-cost value chain approach
or develop a cost-saving technological breakthrough
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.
5–16
Broad Differentiation Strategies
Effective Differentiation Approaches
Carefully study buyer needs and behaviors, values, and
willingness to pay for a unique product or service
Incorporate features that both appeal to buyers and create a
sustainably distinctive product offering
Use higher prices to recoup differentiation costs
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
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.

5–17
Cost-Efficient Management of Value Chain Activities (2 of 2)
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
A value driver is a factor that can have a strong differentiating
effect.
5–18
FIGURE 5.3 Value Drivers: The Keys to Creating a
Differentiation Advantage
Source: Adapted from Michael E. Porter, Competitive
Advantage: Creating and Sustaining Superior Performance (New
York: Free Press, 1985).
Figure 5.3 contains a list of important value drivers.

5–19
Managing the Value Chain to Create the Differentiating
Attributes
Create product features and performance attributes that appeal
to a wide range of buyers.
Improve customer service or add extra services.
Invest in production-related R&D activities.
Strive for innovation and technological advances.
Pursue continuous quality improvement.
Increase marketing and brand-building activities.
Seek out high-quality inputs.
Emphasize HRM activities that improve the skills, expertise,
and knowledge of company personnel.
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.
5–20
Revamping the Value Chain System to Increase Differentiation
Approaches to enhancing differentiation through changes in the
value chain system
Coordinating with downstream channel allies to enhance
customer perceptions of value
Coordinating with suppliers to better address customer needs

Just as pursuing a cost advantage can involve the entire val ue
chain system, the same is true for a differentiation advantage.
Activities performed upstream by suppliers or downstream by
distributors and retailers can have a meaningful effect on
customers’ perceptions of a company’s offerings and its value
proposition
5–21
Delivering Superior Value via a Broad Differentiation
StrategyBroad 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 product2. Incorporate
tangible features (e.g., styling) that increase customer
satisfaction with the product3. Incorporate intangible features
(e.g., buyer image) that enhance buyer satisfaction in
noneconomic ways4. Signal the value of the firm’s product
offering to buyers (e.g., price, packaging, placement,
advertising)
Differentiation strategies depend on meeting customer needs in
unique ways or creating new needs through activities such as
innovation or persuasive advertising. The objective is to offer
customers something that rivals can’t—at least in terms of the
level of satisfaction. The four basic routes to achieving this aim
are listed in the slide content.
5–22

Differentiation: Signaling Value
Signaling value is important when:
The nature of differentiation is based on intangible features and
is therefore subjective or hard to quantify by the buyer.
Buyers are making a first-time purchase and are unsure what
their experience will be with the product.
Product or service repurchase by buyers is infrequent.
Buyers are unsophisticated.
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.
5–23
Successful Approaches to Sustainable Differentiation
Differentiation that is difficult for rivals to duplicate or imitate
Company reputation
Long-standing relationships with buyers
A unique product or service image
Differentiation that creates substantial switching costs that lock
in buyers
Patent-protected product innovation
Relationship-based customer service

The most successful approaches to differentiation are those that
are difficult for rivals to duplicate. Indeed, this is the route to a
sustainable competitive advantage.
While resourceful competitors can, in time, clone almost any
tangible product attribute, socially complex intangible attributes
such as company reputation, long-standing relationships with
buyers, and image are much harder to imitate.
Differentiation that creates switching costs that lock in buyers
also provides a route to sustainable advantage.
5–24
When a Differentiation Strategy Works Best
Market Circumstances Favoring Differentiation
Buyer needs and uses for the product are diverse.
There are many ways that differentiation can have value to
buyers.
Few rival firms are following a similar differentiation approach.
There is rapid change in the product’s technology and features.
Differentiation strategies tend to work best in market
circumstances where differentia tion yields a longer-lasting and
more profitable competitive edge that is based on a well -
established brand image, patent-protected product innovation,
complex technical superiority, a reputation for superior product
quality and reliability, relationship-based customer service, and
unique competitive capabilities.
5–25
Pitfalls to Avoid in Pursuing a
Differentiation Strategy

Relying on product attributes easily copied by rivals
Introducing product attributes that do not evoke an enthusiastic
buyer response
Eroding profitability by overspending on efforts to differentiate
the firm’s product offering
Offering only trivial improvements in quality, service, or
performance features vis-à-vis the products of rivals
Over-differentiating the product quality, features, or service
levels exceeds the needs of most buyers
Charging too high a price premium
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. Overdifferentiating and overcharging are fatal
strategy mistakes.
5–26
Focused (or Market Niche) Strategies
Focused Strategy Approaches
Focused Low-Cost Strategy
Focused Market Niche Strategy
What sets focused strategies apart from broad low -cost and
broad differentiation strategies is their concentrated attention
on a narrow piece of the total market.

5–27
Clinícas del Azúcar’s Focused Low-Cost Strategy
Which uniqueness drivers are responsible for the success of
Clinícas del Azúcar?
Which competitive conditions would mitigate against successful
entry of the Clinícas del Azúcar into the U.S. diabetes care
market?
What part do customer expectations about patient-doctor
relationships play in the delivery of health care in the United
States?
Illustration Capsule 5.2 describes how Clinícas del Azúcar’s
focus on lowering the costs of diabetes care is allowing to
address a major health issue in Mexico.
5–28
When a Focused Low-Cost or Focused Differentiation Strategy
Is Attractive
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.
A focused strategy aimed at securing a competitive edge based

on either low costs or differentiation becomes increasingly
attractive as more of the following favorable conditions listed
in the slide are met.
5–29
The Risks of a Focused Low-Cost or Focused Differentiation
Strategy
Competitors will find ways to match the focused firm’s
capabilities in serving the target niche.
The specialized preferences and needs of niche members shift
over time toward the product attributes desired by the majority
of buyers.
As attractiveness of the segment increases, it draws in more
competitors, intensifying rivalry and splintering segment
profits.
There are several inherent risks related to increased
attractiveness of the focuser’s segment, changes in competitor
capabilities and changes in the characteristics of the segment’s
customers.
5–30
Canada Goose’s Focused Differentiation Strategy
Which decisions did CEO Dani Reiss make that launched
Canada Goods on its chosen strategic path?
Which uniqueness drivers are responsible for the success of
Canada Goose?
Which of Canada Goose’s uniqueness drivers are competitors
likely to attempt to copy first?

Illustration Capsule 5.3 describes how Canada Goose has been
gaining attention with its focused differentiation strategy.
5–31
Best-Cost (Hybrid) Strategies
Differentiation:
Providing desired quality, features, performance,
service attributes
Low Cost Producer:
Charging a lower price
than rivals with similar
caliber product offerings
Best-Cost Hybrid Approach
Value-Conscious Buyer
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.
5–32
When a Best-Cost Strategy Works Best
Product differentiation is the market norm.
There are a large number of value-conscious buyers who prefer
mid-range products.
There is competitive space near the middle of the market for a

competitor with either a medium-quality product at a below-
average price or a high-quality product at an average or slightly
higher price.
Economic conditions have caused more buyers to become value-
conscious.
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.
5–33
T he Risk of a Best-Cost Strategy
Best-Cost Strategy
Low-Cost Producers
High-End Differentiators
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.
5–34
Trader Joe’s Focused Best-Cost Strategy
How can higher product quality lower product costs?
In which stages of an industry life cycle are low-cost
leadership, differentiation, focused niche, and best-cost

provider strategies most appropriate?
Could the lower-selling prices of its groceries versus its
competitors be used as a proxy for measuring the strength of its
focused best-cost strategy?
Illustration Capsule 5.4 describes how Trader Joe’s has applied
the principles of a focused best-cost strategy to thrive in the
competitive grocery store industry.
5–35
The Contrasting 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.
5–36

Table 5.1 Distinguishing Features of the Five Generic
Competitive Strategies (1 of 2)FEATURELow-CostBroad
DifferentiationFocused low-costFocused differentiationBest-
CostStrategic targetA broad cross-section of the marketA broad
cross-section of the marketA narrow market niche where buyer
needs and preferences are distinctively differentA narrow
market niche where buyer needs and preferences are
distinctively differentValue-conscious buyers. Or, a middle-
market rangeBasis of competitive strategyLower overall costs
than competitorsAbility to offer buyers something attractively
different from competitors’ offeringsLower overall cost than
rivals in serving niche membersAttributes that appeal
specifically to niche membersAbility to offer better goods at
attractive pricesProduct lineA good basic product with few frills
(acceptable quality and limited selection)Many product
variations, wide selection, emphasis on differentiating
featuresFeatures and attributes tailored to the tastes and
requirements of niche membersFeatures and attributes tailored
to the tastes and requirements of niche membersItems with
appealing attributes and assorted features; better quality, not
bestProduction emphasisA continuous search for cost reduction
without sacrificing acceptable quality and essential
featuresBuild in whatever differentiating features buyers are
willing to pay for; strive for product superiorityA continuous
search for cost reduction for products that meet basic needs of
niche membersSmall-scale production or custom-made products
that match the tastes and requirements of …
CHAPTER 6 Strengthening a Company’s Competitive Position:
Strategic Moves, Timing, and Scope of Operations

Chapter 6 discusses that once a company has settled on which of
the five generic competitive strategies to employ, attention
turns to what other strategic actions it can take to complement
its competitive approach and maximize the power of its overall
strategy.
6–1
Learning Objectives
How and when to deploy offensive or defensive strategic moves.
When being a first mover, a fast follower, or a late mover is
most advantageous.
The strategic benefits and risks of expanding a firm’s horizontal
scope through mergers and acquisitions.
The advantages and disadvantages of extending the company’s
scope of operations via vertical integration.
The conditions that favor outsourcing certain value chain
activities to outside parties.
How to capture the benefits and minimize the drawbacks of
strategic alliances and partnerships.
The chapter presents the pros and cons of taking strategy-
enhancing measures to strengthen a company’s competitive
position.

6–2
Maximizing the Power of a Strategy
Making choices that complement a competitive approach and
maximize the power of strategy
Offensive and defensive competitive actions
Competitive dynamics and the timing of strategic moves
Scope of operations along the industry’s value chain
To maximize the power of a strategy, a company must make
choices about its competitive actions, how and when to take
those actions, and increasing or decreasing the scope of its
operations.
6–3
Considering Strategy-Enhancing Measures
Whether and when to go on the offensive strategically
Whether and when to employ defensive strategies
When to undertake strategic moves—first mover, a fast
follower, or a late mover
Whether to merge with or acquire another firm
Whether to integrate backward or forward into more stages of
the industry’s activity chain
Which value chain activities, if any, should be outsourced
Whether to enter into strategic alliances or partnership
arrangements
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
6–4
Launching Strategic Offensives to Improve a Company’s Market
Position
Strategic offensive principles
Focusing relentlessly on building competitive advantage and
then striving to convert it into sustainable advantage
Applying resources where rivals are least able to defend
themselves
Employing the element of surprise as opposed to doing what
rivals expect and are prepared for
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.

6–5
Choosing the Basis For Competitive Attack
Avoid directly challenging a targeted competitor where it is
strongest.
Use the firm’s strongest strategic assets to attack a competitor’s
weaknesses.
The offensive may not yield immediate results
if market rivals are strong competitors.
Be prepared for the threatened competitor’s counter-response.
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 opportunities 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.
6–6
Principal Offensive Strategy Options
Offering an equally good or better product at a lower price
Leapfrogging competitors by being first to market with next-
generation products
Pursuing continuous product innovation to draw sales and
market share away from less innovative rivals
Pursuing disruptive product innovations to create new markets
Adopting and improving on the good ideas of other companies
(rivals or otherwise)
Using hit-and-run or guerrilla marketing tactics to grab market
share from complacent or distracted rivals
Launching a preemptive strike to secure an industry’s limited

resources or capture a rare opportunity
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.
6–7
Choosing Which Rivals to Attack
Best Targets for Offensive Attacks
Market leaders that are in vulnerable competitive positions
Runner-up firms with weaknesses in areas where the challenger
is strong
Struggling enterprises on the verge of going under
Small local and regional firms with limited capabilities
Offensive-minded firms need to analyze which of their rivals to
challenge as well as how to mount the challenge.
6–8
Blue-Ocean Strategy—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.
A blue-ocean strategy offers growth in revenues and profits by
discovering or inventing new industry segments that create
altogether new demand. The "blue ocean" represents wide-open
opportunity, offering smooth sailing in uncontested waters for
the company first to venture out upon it.
6–9
Bonobos’s Blue-Ocean Strategy in the U.S. Men’s Fashion
Retail Industry
Given the rapidity with which most first-mover advantages
based on Internet technologies can be overcome by competitors,
what has Bonobos done to retain its competitive advantage?
Is Bonobos’s unique focused-differentiation entry into brick-
and-mortar retailing a sufficiently strong strategic move?
What would you predict is the likelihood of long-term success
for Bonobos in the retail clothing sector?
Blue-ocean strategies provide a company with a great
opportunity in the short run. But they don’t guarantee a
company’s long-term success, which depends more on whether a
company can protect the market position it created and sustain
its early advantage.
6–10
Defensive Strategies—Protecting Market Position and
Competitive Advantage

Purposes of Defensive Strategies
Lower the firm’s risk of being attacked
Weaken the impact of an attack that does occur
Influence challengers to aim their efforts at other rivals
In a competitive market, all firms are subject to offensive
challenges from rivals. The purposes of defensive strategies are
to lower the risk of being attacked, weaken the impact of any
attack that occurs, and induce challengers to aim their efforts at
other rivals. While defensive strategies usually don’t enhance a
firm’s competitive advantage, they can help fortify the firm’s
competitive position, protect its most valuable resources and
capabilities from imitation, and defend whatever competitive
advantage it has.
6–11
Forms of Defensive Strategies
Defensive strategies can take either of two forms:
Actions to block challengers.
Actions to signal the likelihood of strong retaliation.
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.
6–12
Blocking 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 and safety of competitor’s products.
Grant discounts or better terms to intermediaries who handle the
firm’s product line exclusively.
There are many ways to throw obstacles in the path of would-be
challengers. The most frequently employed approach to
defending a company’s present position involves actions that
restrict a challenger’s options for initiating a competitive
attack.
6–13
Signaling Challengers That
Retaliation Is Likely
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 less threatening options.
To be an effective defensive strategy, signaling needs to be
accompanied by a credible commitment to follow through.
6–14
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.
Because of first-mover advantages and disadvantages,
competitive advantage can spring from when a move is made as
well as from what move is made.
6–15
Conditions that Lead to First-Mover Advantages
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 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
There are six conditions in which first-mover advantages are
likely to arise.
6–16
Tinder Swipes Right for First-Mover Success
Which first-mover advantages contributed to Tinder’s gaining
over a million monthly active users in less than a year?
How long can Tinder protect its first-mover advantages?
How has Tinder monetized its success while its rivals are
having to play catch-up?
Illustration Capsule 6.2 describes how Tinder’s fast start had
much to do with its ease of use, no questionnaires and fun
game-like addictive aspects. Tinder targeted college campuses
using viral marketing techniques to quickly gain acceptance
among social circles, where “key influencers” boosted its
popularity to a critical mass.
Its sustained success has enabled Tinder to reap a substantial
first-mover advantage as the first major entrant into the field of
mobile dating.
And while other apps have been trying to play catch-up, Tinder

CHAPTER 4 Evaluating a Company’s Resources, Capabilities, and Co

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