CORPORATE STRATEGY PORTERS FIVE MODEL

Chapter One
Strategic
Leadership:
Managing the
Strategy-Making
Process for
Competitive
Advantage
授課老師：蘇哲仁

Why do some organizations
succeed while others fail?
 Strategic Leadership
• Task of most effectively managing a
company’s strategy-making process
 Strategy Formulation
• Task of determining and selecting strategies
 Strategy Implementation
• Task of putting strategies into action to improve a
company’s efficiency and effectiveness
Competitive Advantage
Results when a company’s strategies lead to
superior performance compared to competitors
Strategy is a set of related actions that managers
take to increase their company’s performance.

Superior Performance and
Sustainable Competitive Advantage
 Superior Performance
• One company’s profitability relative to that of other companies in
the same or similar business or industry
• Maximizing shareholder value is the ultimate goal of profit making
companies
ROIC (Profitability) = Return On Invested Capital
• Net profit Net income after tax
Capital invested
Equity + Debt to creditors
 Competitive Advantage
• When a company’s profitability is greater than the average of all
other companies in the same industry & competing for the same
customers
=ROIC =
Sustainable Competitive Advantage
When a company’s strategies enable it to maintain
above average profitability for a number of years

Determinants of
Shareholder Value
To increase shareholder value, managers must
pursue strategies that increase the profitability
of the company and grow the profits.
Figure 1.1

A business model encompasses how the company will:
Company’s Business Model
Management’s model of how strategy will allow
the company to gain competitive advantage
and achieve superior profitability
• Select its customers
• Define and differentiate
its product offerings
• Create value for its
customers
• Acquire and keep
customers
• Produce goods or
services
• Deliver those goods and
services to the market
• Organize activities within
the company
• Configure its resources
• Achieve and sustain a
high level of profitability
• Grow the business over
time

Differences in Industry
and Company Performance
A Company’s Profitability and
Profit Growth are determined
by two main factors:
The overall performance
of its industry relative
to other industries
Its relative success in its
industry as compared to the
competitors

Return on Invested Capital
in Selected Industries, 1997–2003
Data Source: Value Line Investment Survey
Figure 1.2

Performance in Nonprofit
Enterprises
Nonprofit entities such as government
agencies, universities, and charities:
• Are not in business to make a profit
• Should use their resources efficiently
and effectively
• Set performance goals unique to the
organization
• Set strategies to achieve goals and compete
with other nonprofits for scarce resources
A successful strategy gives potential
donors a compelling message as to
why they should contribute.

Strategic Managers
 Corporate Level Managers
• Oversee the development of strategies for the
whole organization
• The CEO is the principle general manager who
consults with other senior executives
 General Managers
• Responsible for overall company, business
unit, or divisional performance
 Functional Managers
• Responsible for supervising a particular task
or operation
e.g. marketing, operations, accounting, human resources

Levels of Strategic Management
Figure 1.3

The Five Steps of the
Strategy Making Process
 Select the corporate vision, mission, and values
and the major corporate goals and objectives.
 Analyze the external competitive environment to
identify opportunities and threats.
 Analyze the organization’s internal environment
to identify its strengths and weaknesses.
 Select strategies that:
• Build on the organization’s strengths and correct its
weaknesses – in order to take advantage of external
opportunities and counter external threats
• Are consistent with organization’s vision, mission, and values
and major goals and objectives
• Are congruent and constitute a viable business model
 Implement the stratstrategies.

Main
Components
of the
Strategy-
Making
Process

 


Figure 1.4

 Crafting the Organization’s
Mission Statement
Provides a framework or context within
which strategies are formulated, including:
 Mission –
The reason for existence – what an organization does
 Vision –
A statement of some desired future state
 Values –
A statement of key values that an organization is
committed to
 Major Goals –
The measurable desired future state that an
organization attempts to realize

The Mission
 What is it that the company does?
 What is the companies business?
• Who is being satisfied
(what customer groups)?
• What is being satisfied
(what customer needs)?
• How customer needs are being satisfied
(by what skills, knowledge, or distinctive competencies)?
The mission is a statement of a company’s
raison d’etre, its reason for existence today.
A company’s mission is best approached from
a customer-oriented business definition.

The Mission
Customer-Oriented Examples
The mission of Kodak is to provide “customers
with the solutions they need to capture, store,
process, output, and communicate images –
anywhere, anytime.”
Ford Motor Company describes itself as a
company that is “passionately committed to
providing personal mobility for people around
the world….We anticipate consumer need and
deliver outstanding produces and services that
improve people’s lives.”

Abell’s Framework
for Defining the Business
Figure 1.5
Source: D. F. Abell, Defining the Business: The Starting Point of
Strategic Planning (Englewood Cliffs, Prentice Hall, 1980), p. 7.

The vision of Ford is “to become the world’s
leading consumer company for automotive
products and services.”
The Vision
What would the company like to achieve?
A good vision is meant to stretch a company by
articulating an ambitious but attainable future state.
Nokia is the world’s largest manufacturer of
mobile phones and operates with a simple but
powerful vision: “If it can go mobile, it will!”

Values
In high-performance organizations, values
respect the interests of key stakeholders.
The values of a company should state:
 How managers and employees should
conduct themselves
 How they should do business
 What kind of organization they need to build
to help achieve the company’s mission
 Organizational culture
• The set of values, norms, and standards that control how
employees work to achieve an organization’s mission and
goals
• Often seen as an important source of competitive advantage

Values at Nucor
 “Management is obligated to manage Nucor in such a
way that employees will have the opportunity to earn
according to their productivity.”
 “Employees should be able to feel confident that if
they do their jobs properly, they will have a job
tomorrow.”
 “Employees have the right to be treated fairly and
must believe that they will be.”
 “Employees must have an avenue of appeal when
they believe they are being treated unfairly.”
At Nucor, values emphasizing pay for performance, job
security, and fair treatment for employees help to create
an atmosphere that leads to high employee productivity.

Key characteristics of well-constructed goals:
1. Precise and measurable – to provide a
yardstick or standard to judge performance
2. Address crucial issues – with a limited
number of key goals that help to maintain focus
3. Challenging but realistic – to provide
employees with incentive for improving
4. Specify a time period – to motivate and
inject a sense of urgency into goal attainment
Major Goals
A goal is a precise and measurable desired
future state that a company must realize if
it is to attain its vision or mission.
Focus on long-run performance and
competitiveness.

External Analysis requires an assessment of:
 Industry environment in which company operates
• Competitive structure of industry
• Competitive position of the company
• Competitiveness and position of major rivals
 The country or national environments
in which company competes
 The wider socioeconomic or macroenvironment
that may affect the company and its industry
• Social
• Government
Purpose is to identify the strategic opportunities and
threats in the organization’s operating environment
that will affect how it pursues its mission.
• Legal
• International
• Technological
 External Analysis

Internal analysis includes an assessment of:
 Quantity and quality of a
company’s resources and
capabilities
 Ways of building unique
skills and company-specific
or distinctive competencies
Purpose is to pinpoint the strengths and weaknesses
of the organization. Strengths lead to superior
performance and weaknesses to inferior performance.
 Internal Analysis
Building & sustaining a competitive advantage
requires a company to achieve superior:
• Efficiency
• Quality
• Innovations
• Responsiveness to customers

 SWOT analyses help to identify strategies that align
a company’s resources and capabilities to its
environment – in order to create and sustain a
competitive advantage.
 Functional strategies should be consistent with and
support the company’s business level and global
strategies.
• Functional-level strategy – directed at operational effectiveness
• Business-level strategy – businesses’ overall competitive themes
• Global strategy – expand, grow and prosper at a global level
• Corporate-level strategy – to maximize profitability and profit growth
 Selecting Strategies: SWOT
Analysis and Business Model
When taken together, the various strategies
pursued by a company must lead to a
viable business model.

 Strategy Implementation
 After choosing a set of congruent strategies to
achieve competitive advantage, managers must
put those strategies into action:
• Implementation and execution of the strategic plans
• Design of the best organization structure
• Consistency of strategy with company culture
• Control systems to measure and monitor progress
• Governance systems for legal and ethical compliance
• Consistency with maximizing profit and profit growth
 The feedback loop – strategic planning is ongoing
• Managers must monitor strategy execution:
» To determine if strategic goals and objectives are being achieved
» To evaluate to what extent competitive advantage is being
created and sustained
• Managers must monitor and reevaluate for the next round of
strategy formulation and implementation

Planned, Deliberate, Emergent
and Realized Strategies
Source: Adapted from H. Mintzberg and
A. McGugh, Administrative Science
Quarterly, Vol. 30. No. 2, June 1985.
Figure 1.6

Intended and Emergent Strategies
 Intended or Planned Strategies
• Strategies an organization plans to put into action
• Typically the result of a formal planning process
• Unrealized strategies are the result of unprecedented
changes and unplanned events after the formal planning is
completed
 Emergent Strategies
• Unplanned responses to unforeseen circumstances
• Serendipitous discoveries and events may emerge that can
open up new unplanned opportunities
• Must assess whether the emergent strategy fits the
company’s needs and capabilities
 Realized Strategies
• The product of whatever intended strategies are actually put
into action and of any emergent strategies that evolve

Strategic Planning in Practice
 Scenario Planning
• Recognizes that the future is inherently unpredictable
• Develops strategies for possible future scenarios
 Decentralized Planning
• Involves the functional managers
• Avoids the ivory tower approach
• Perceives procedural justice in the decision making
 Strategic Intent
• Avoids the strategic fit model, which focuses too much on the
current state
• Sets ambitious vision and goals that stretch a company and
then finds ways to build to attain those goals
Recent studies suggest that formal planning does have a
positive impact on company performance – and should
include the current and future competitive environments.

Strategic Decision Making
In spite of systematic planning, companies may adopt poor
strategies if groupthink or individual cognitive biases are
allowed to intrude into the decision-making process:
 Cognitive biases:
Rules of thumb or heuristics resulting in systematic errors
• Prior hypothesis bias
• Escalating commitment
• Reasoning by analogy
• Representativeness
• Illusion of control
 Groupthink:
Decisionmakers embark on a course of action without
questioning the underlying assumptions
• Group coalesces around a person or policy
• Decisions based on an emotional rather than an objective assessment
of the correct course of action

Processes for Improving
Decision Making
Reveals problems with
definitions, assumptions,
& recommended courses
of action
To bring out all the
reasons that might
make the proposal
unacceptable
Figure 1.7

Strategic Leadership
 Vision, eloquence, and consistency
 Commitment
 Being well informed
 Willingness to delegate and empower
 The astute use of power
 Emotional intelligence
• Self-awareness
• Self-regulation
• Motivation
• Empathy
• Social skills
Good leaders of the strategy-making process
have a number of key attributes:

Chapter
Two
External
Analysis:
The
Identification of
Opportunities
and Threats

External Analysis requires an assessment of:
 Industry environment in which company operates
• Competitive structure of industry
• Competitive position of the company
• Competitiveness and position of major rivals
 The country or national environments
in which company competes
 The wider socioeconomic or macroenvironment
that may affect the company and its industry
• Social
• Government
• Legal
• International
• Technological
External Analysis
The purpose of external analysis is to identify
the strategic opportunities and threats in the
organization’s operating environment that
will affect how it pursues its mission.

External Analysis:
Opportunities and Threats
Analyzing the dynamics of the industry in which
an organization competes to help identify:
Opportunities
Conditions in the
environment that a
company can take
advantage of to
become more
profitable
Threats
Conditions in the
environment that
endanger the integrity
and profitability of
the company’s
business

Industry Analysis:
Defining an Industry
 Industry
• A group of companies offering products or services that are
close substitutes for each other and that satisfy the same
basic customer needs
• Industry boundaries may change as customer needs evolve
and technology changes
 Sector
• A group of closely related industries
 Market Segments
• Distinct groups of customers within an industry
• Can be differentiated from each other with distinct attributes
and specific demands
Industry analysis begins by focusing on
the overall industry – before
considering market segment or sector-level issues

The Computer Sector:
Industries and Market Segments
Figure 2.1

Porter’s Five Forces Model
Source: Adapted and reprinted by permission of Harvard Business Review. From “How Competitive Forces Shape Strategy,” by
Michael E. Porter, Harvard Business Review, March/April 1979 © by the President and Fellows of Harvard College. All rights reserved.
Figure 2.2

Potential Competitors are companies that are not
currently competing in an industry but have the capability
to do so if they choose. Barriers to new entrants include:
 Risk of Entry by Potential
Competitors
1. Economies of Scale – as firms expand output unit costs fall via:
 Cost reductions – through mass production
 Discounts on bulk purchases – of raw material and standard parts
 Cost advantages – of spreading fixed and marketing costs over large volume
2. Brand Loyalty
 Achieved by creating well-established customer preferences
 Difficult for new entrants to take market share from established brands
3. Absolute Cost Advantages – relative to new entrants
 Accumulated experience – in production and key business processes
 Control of particular inputs required for production
 Lower financial risks – access to cheaper funds
4. Customer Switching Costs for Buyers – where significant
5. Government Regulation
 May be a barrier to enter certain industries

1. Industry Competitive Structure
 Number and size distribution of companies
 Consolidated versus fragmented industries
2. Demand Conditions
 Growing demand – tends to moderate competition and reduce rivalry
 Declining demand – encourages rivalry for market share and revenue
3. Cost Conditions
 High fixed costs – profitability leveraged by sales volume
 Slow demand and growth – can result in intense rivalry and lower profits
4. Height of Exit Barriers – prevents companies from leaving industry
 Write-off of investment in assets
 Economic dependence on industry
 Maintain assets - to participate
effectively in an industry
 Rivalry Among Established
Companies
Competitive Rivalry refers to the competitive struggle
between companies in the same industry to gain market
share from each other. Intensity of rivalry is a function of:
 High fixed costs of exit
 Emotional attachment to industry
 Bankruptcy regulations – allowing
unprofitable assets to remain

Industry Buyers may be the consumers or end-users who
ultimately use the product or intermediaries that distribute or
retail the products. These buyers are most powerful when:
 Bargaining Power of Buyers
1. Buyers are dominant.
 Buyers are large and few in number.
 The industry supplying the product is composed of many small companies.
2. Buyers purchase in large quantities.
 Buyers have purchasing power as leverage for price reductions.
3. The industry is dependant on the buyers.
 Buyers purchase a large percentage of a company’s total orders.
4. Switching costs for buyers are low.
 Buyers can play off the supplying companies against each other.
5. Buyers can purchase from several supplying companies at once.
6. Buyers can threaten to enter the industry themselves.
 Buyers produce themselves and supply their own product.
 Buyers can use threat of entry as a tactic to drive prices down.

Suppliers are organizations that provide inputs such as
material and labor into the industry. These suppliers are
most powerful when:
 Bargaining Power of Suppliers
1. The product supplied is vital to the industry and has few
substitutes.
2. The industry is not an important customer to suppliers.
 Suppliers are not significantly affected by the industry.
3. Switching costs for companies in the industry are significant.
 Companies in the industry cannot play suppliers against each other.
4. Suppliers can threaten to enter their customers’ industry.
 Suppliers can use their inputs to produce and compete with
companies already in the industry.
5. Companies in the industry cannot threaten to enter suppliers’
industry.

Substitute Products are the products from
different businesses or industries that can satisfy
similar customer needs.
 Substitute Products
1. The existence of close substitutes is
a strong competitive threat.
 Substitutes limit the price that companies
can charge for their product.
2. Substitutes are a weak competitive
force if an industry’s products have few
close substitutes.
 Other things being equal, companies in
the industry have the opportunity to raise
prices and earn additional profits.

Strategic Groups
Within Industries
Strategic Groups are groups of companies that
follow a business model similar to other companies
within their strategic group – but are different from
that of other companies in other strategic groups.
 Implications of Strategic Groups –
1. The closest competitors are within the same Strategic Group
and may be viewed by customers as substitutes for each other.
2. Each Strategic Group can have different competitive forces
and may face a different set of opportunities and threats.
 Mobility Barriers – factors within an industry that inhibit the
movement of companies between strategic groups
• Include barriers to enter another group or exit existing group
The basic differences between business models in
different strategic groups can be captured by a
relatively small number of strategic factors.

Strategic Groups in the
Pharmaceutical Industry
Figure 2.3

Industry Life Cycle Model analyzes the affects of
industry evolution on competitive forces over time
and is characterized by five distinct life cycle stages:
Industry Life Cycle Analysis
1. Embryonic – industry just beginning to develop
 Rivalry based on perfecting products, educating customers, and
opening up distribution channels.
2. Growth – first-time demand takes-off with new customers
 Low rivalry as focus is on keeping up with high industry growth.
3. Shakeout – demand approaches saturation, replacements
 Rivalry intensifies with emergence of excess productive capacity.
4. Mature – market totally saturated with low to no growth
 Industry consolidation based on market share, driving down price.
5. Decline – industry growth becomes negative
 Rivalry further intensifies based on rate of decline and exit barriers.

Stages in the Industry Life Cycle
    
Strength and nature of five forces change as industry evolves Figure 2.4

Growth in Demand and Capacity
Industry Shakeout:
Rivalry Intensifies
with growth in
excess capacity
Anticipate how forces will change and formulate appropriate strategy Figure 2.5

Limitations of Models
for Industry Analysis
 Life Cycle Issues
• Industry cycles do not always follow the life cycle generalization.
• In rapid growth situations embryonic stage is sometimes skipped.
• Industry growth revitalized through innovation or social change.
• The time span of the stages can vary from industry to industry.
 Innovation and Change
• Punctuated Equilibrium occurs when an industry’s long term stable
structure is punctuated with periods of rapid change by innovation.
• Hypercompetitive industries are characterized by permanent and
ongoing innovation and competitive change.
 Company Differences
• There can be significant variances in the profit rates of individual
companies within an industry.
• In addition to industry attractiveness, company resources and
capabilities are also important determinants of its profitability.
Models provide useful ways of thinking about competition
within an industry – but be aware of their limitations.

Punctuated Equilibrium
and Competitive Structure
Periods of long
term stability
Periods of long
term stability
Industry
Structure
revolutionized
by innovation
Figure 2.6

The Role of the Macroenvironment
Changes in the
forces in the macro-
environment can
directly impact:
• The Five Forces
• Relative Strengths
• Industry
Attractiveness
Figure 2.7

Chapter
Three
Internal
Analysis:
Distinctive
Competencies,
Competitive
Advantage,
and
Profitability

Internal Analysis includes an assessment of:
 Quantity and quality of a company’s
resources and capabilities
 Ways of building unique skills
and company-specific or
distinctive competencies
Internal Analysis
The purpose of internal analysis is to pinpoint the
strengths and weaknesses of the organization.
Strengths lead to superior performance.
Weaknesses lead to inferior performance.
Building and sustaining a competitive advantage
requires a company to achieve superior:
• Efficiency
• Quality
• Innovations
• Responsiveness to customers

Internal Analysis:
Strengths and Weaknesses
Internal analysis - along with the external analysis of
the company’s environment - gives managers the
information to choose the strategies and business
model to attain a sustained competitive advantage.
Strengths
Of the enterprise
are assets that
boost
profitability
Weaknesses
Of the enterprise
are liabilities that
lead to lower
profitability

Internal Analysis:
A Three-Step Process
1. Understand the process by which companies
create value for customers and profit for
themselves.
 Resources
 Capabilities
 Distinctive competencies
2. Understand the importance of superiority in
creating value and generating high profitability.
 Efficiency
 Quality
3. Analyze the sources of the company’s
 Strengths – that are driving profitability
 Weaknesses – opportunities for improvement
 Innovation
 Responsiveness to Customers

Competitive Advantage
• A firm’s profitability is greater than the average
profitability for all firms in its industry.
 Sustained Competitive Advantage
• A firm maintains above average and superior
profitability and profit growth for a number of
years.
The Primary Objective of Strategy
is to achieve a
Sustained Competitive Advantage
which in turn results in
Superior Profit and Profit Growth.

Strategy, Resources,
Capabilities, and Competencies
Figure 3.1

Competitive Advantage,
Value Creation, and Profitability
1. VALUE or UTILITY the customer gets from
owning the product
2. PRICE that a company charges for its
products
3. COSTS of creating those products
 Consumer surplus is the “excess” utility a
consumer captures beyond the price paid.
Basic Principle: the more utility that consumers
get from a company’s products or services, the
more pricing options the company has.
How profitable a company becomes
depends on three basic factors:

Value Creation per Unit
Figure 3.2

Value Creation
and Pricing Options
There is a dynamic
relationship among utility,
pricing, demand, and costs.
Figure 3.3

Comparing Toyota and
General Motors
Superior value creation requires that the gap between
perceived utility (U) and costs of production (C)
be greater than that obtained by competitors.
Figure 3.4

The Value Chain
A company is a chain of activities for transforming
inputs into outputs that customers value –
including the primary and support activities.
Figure 3.5

Building Blocks
of Competitive Advantage




The Generic
Distinctive Competencies
Allow a company to:
• Differentiate product offering
• Offer more utility to customer
• Lower the cost structure
regardless of the industry,
its products, or its services
Figure 3.6

 Efficiency
 Measured by the quantity of inputs it
takes to produce a given output:
Efficiency = Outputs / Inputs
 Productivity leads to greater efficiency
and lower costs:
• Employee productivity
• Capital productivity
Superior efficiency helps a company
attain a competitive advantage
through a lower cost structure.

 Quality
• Reliable and
• Differentiated by attributes that customers
perceive to have higher value
The impact of quality on competitive
advantage:
• High-quality products differentiate and increase
the value of the products in customers’ eyes.
• Greater efficiency and lower unit costs are
associated with reliable products.
Superior quality = customer perception
of greater value in a product’s attributes
Form, features, performance, durability, reliability, style, design
Quality products are goods and services that are:

A Quality Map for Automobiles
When customers
evaluate the quality of a
product, they commonly
measure it against two
kinds of attributes:
1. Quality as Excellence
2. Quality as Reliability
Figure 3.7

 Innovation
Innovation is the act of creating
new products or new processes
• Product innovation
» Creates products that customers
perceive as more valuable and
» Increases the company’s pricing options
• Process innovation
» Creates value by lowering production costs
Successful innovation can be a major
source of competitive advantage –
by giving a company something unique,
something its competitors lack.

 Responsiveness to Customers
 Superior quality and innovation are integral to
superior responsiveness to customers.
 Customizing goods and services to the unique
demands of individual customers or customer
groups.
 Enhanced customer responsiveness
Customer response time, design,
service, after-sales service and support
Superior responsiveness to customers
differentiates a company’s products and services
and leads to brand loyalty and premium pricing.
Identifying and satisfying customers’
needs – better than the competitors

Competitive Advantage:
The Value Creation Cycle
Figure 3.8

Analyzing Competitive
Advantage and Profitability
• When a companies profitability is greater than the average of all
other companies in the same industry that compete for the same
customers
 Benchmarking
• Comparing company performance against that of competitors and
the company’s historic performance
 Measures of Profitability
• Return On Invested Capital (ROIC)
• Net profit Net income after tax
Capital invested Equity
+ Debt to creditors
• Net Profit
Net Profit = Total revenues – Total costs
=ROIC =

Definitions of
Basic Accounting Terms
Table 3.1

Drivers of Profitability (ROIC)
Figure 3.9

Comparing Wal-Mart to Target
Figure 3.10

The Durability of Competitive
Advantage
1.Barriers to Imitation
Making it difficult to copy a company’s distinctive competencies
 Imitating Resources
 Imitating Capabilities
2.Capability of Competitors
 Strategic commitment
Commitment to a particular way of doing business
 Absorptive capacity
Ability to identify, value, assimilate, and use knowledge
2.Industry Dynamism
Ability of an industry to change rapidly
The DURABILITY of a company’s competitive advantage over
its competitors depends on:
Competitors are also seeking to develop distinctive
competencies that will give them a competitive edge.

Why Companies Fail
 Inertia
• Companies find it difficult to change their
strategies and structures
 Prior Strategic Commitments
• Limit a company’s ability to imitate and
cause competitive disadvantage
 The Icarus Paradox
• A company can become so specialized and inner directed
based on past success that it loses sight of market realities
• Categories of rising and falling companies:
• Craftsmen • Builders • Pioneers • Salespeople
When a company loses its competitive advantage,
its profitability falls below that of the industry.
 It loses the ability to attract and generate resources.
 Profit margins and invested capital shrink rapidly.

Avoiding Failure:
Sustaining Competitive Advantage
1. Focus on the Building Blocks of Competitive
Advantage
Develop distinctive competencies and superior performance in:
 Efficiency  Quality
 Innovation  Responsiveness to Customers
2. Institute Continuous Improvement and Learning
Recognize the importance of continuous learning within the organization
3. Track Best Practices and Use Benchmarking
Measure against the products and practices of the most efficient global
competitors
4. Overcome Inertia
Overcome the internal forces that are barriers to change
Luck may play a role in success,
so always exploit a lucky break - but remember:
“The harder I work, the luckier I seem to get.”J P Morgan

Chapter
Four
Building
Competitive
Advantage
Through
Functional-
Level Strategy

Functional-Level Strategies
Functional-level strategies are
strategies aimed at improving the
effectiveness of a company’s operations.
Improves company’s ability to attain superior:
1. Efficiency 2. Quality
3. Innovation 4. Customer responsiveness
 Increases the utility that customers receive:
• Through differentiation  Creating more value
• Lower cost structure than rivals
This leads to a competitive advantage
and superior profitability and profit growth.

Achieving Superior Efficiency
Functional steps to increasing efficiency:
 Economies of Scale
 Learning Effects
 Experience Curve
 Flexible Manufacturing and Mass Customization
 Marketing
 Materials Management and Supply Chain
 R&D Strategy
 Human Resource Strategy
 Information Systems
 Infrastructure

 Economies of Scale
 Economies of scale
Unit cost reductions associated with a large scale of output
• Ability to spread fixed costs over a large production
volume
• Ability of companies producing in large volumes to
achieve a greater division of labor and specialization
• Specialization has favorable impact on productivity by
enabling employees to become very skilled at performing
a particular task
 Diseconomies of scale
Unit cost increases associated with a large scale of output
• Increased bureaucracy associated with large-scale
enterprises
• Resulting managerial inefficiencies

Economies and Diseconomies
of Scale
Figure 4.2

 Learning Effects
Learning Effects are:
Cost savings that come from learning by doing
• Labor productivity
Learn by repetition how to best carry out the task
• Management efficiency
Learn over time how to best run the operation
• Realization of learning effects implies a
downward shift of the entire unit cost curve
As labor and management become more efficient over time
at every level of output
When changes occur in a company’s
production system,
learning has to begin again.

The Impact of Learning and
Scale Economies on Unit Costs
Figure 4.3

 The Experience Curve
The Experience Curve
The systematic lowering of the cost structure and
consequent unit cost reductions that occur over the
life of a product
• Economies of scale and learning effects underlie
the experience curve phenomenon
• Once down the experience curve, the company
is likely to have a significant cost advantage
over its competitors
Strategic significance of the experience curve:
Increasing a company’s product volume and
market share will lower its cost structure
relative to its rivals.

The Experience Curve
Figure 4.4

Dangers of Complacency Derived
from Experience Effects
1. The experience curve is likely to bottom out
So further unit cost reductions may be hard to come by
2. New technologies can make experience effects
obsolete
From changes always taking place in the external environment
3. Flexible manufacturing technologies may allow
small manufacturers to produce at low unit costs
Achieving both low cost and differentiation through customization
4. Some technologies may not produce lower costs
with higher volumes of output
Managers should not become complacent about
efficiency-based cost advantages derived from
experience effects:

 Flexible Manufacturing
and Mass Customization
 Flexible Manufacturing Technology
A range of manufacturing technologies that:
• Reduce setup times for complex
equipment
• Improves scheduling to increase
use of individual machines
• Improves quality control at all
stages of the manufacturing process
• Increases efficiency and lowers unit costs
 Mass Customization
Ability to use flexible manufacturing technology to
reconcile two goals that were once thought incompatible:
• Low cost and
• Differentiation through product customization

Tradeoff Between Costs
and Product Variety
Figure 4.5

 Marketing
Marketing
• Marketing strategy
Refers to the position that a company takes regarding
• Pricing  Promotion  Advertising
• Distribution  Product design
• Customer defection rates
Percentage of customers who defect every year
• Defection rates are determined by customer loyalty
• Loyalty is a function of the ability to satisfy customers
Reducing customer defection rates and
building customer loyalty can be major
sources of a lower cost structure.

Relationship between Customer
Loyalty and Profit per Customer
The longer a company holds on to a customer the greater the
volume of customer-generated unit sales that offset fixed
marketing costs and lowers the average cost of each sale.
Figure 4.6

 Materials Management
The activities necessary to get inputs and components to a
production facility, through the production process, and through
the distribution system to the end-user
• Many sources of cost in this process
• Significant opportunities for cost reduction through more
efficient materials management
• Just-in-Time (JIT) Inventory System
System designed to economize on inventory holding costs:
• Have components arrive to manufacturing just prior to
need in production process
• Have finished goods arrive at retail just prior to stock out
 Supply Chain Management
Task of managing the flow of inputs to a company’s processes to
minimize inventory holding and maximize inventory turnover
 Materials Management and
Supply Chain

 Research and Development (R&D)
Roles of R&D in helping a company achieve greater
efficiency and lower cost structure:
1. Boost efficiency by designing products that
are easy to manufacture
• Reduce the number of parts that make up a product –
reduces assembly time
• Design for manufacturing – requires close coordination
with production and R&D
2. Help a company have a lower cost structure by
pioneering process innovations
• Reduce process setup times
• Flexible manufacturing
• An important source of competitive advantage
 R&D Strategy

 Human Resource Strategy
Hiring strategy
Assures that the people a company hires have the attributes
that match the strategic objectives of the company
Employee training
Upgrades employee skills to perform tasks faster and more
accurately
Self-managing teams
Members coordinate their own activities and make their own
hiring, training, work, and reward decisions.
Pay for performance
Linking pay to individual and team performance can help to
increase employee productivity
The key challenge of the Human Resource
function: improve employee productivity.

 Information Systems
Information systems’ impact on
productivity is wide-
ranging:
 Web-based information
systems can automate many
of the company activities
 Potentially affects all the
activities of a company
 Automates interactions
between
• Company and customers
• Company and suppliers

A Company’s Infrastructure:
The company’s structure, culture, style of
strategic leadership, and control system:
• Determines the context within which all other value
creation activities take place
• Strategic leadership is especially important in
building a companywide commitment to efficiency
• The leadership task is to articulate a vision for all
functions and coordinate across functions
Achieving superior performance requires an
organization-wide commitment.
Top management plays a major role in this process.
 Infrastructure

Primary Roles of
Value-Creation Functions
Table 4.1

Achieving Superior Quality
Quality as reliability
They do the jobs they were designed
for and do it well
Quality as excellence
Perceived by customers to have superior attributes
1. A strong reputation for quality allows a
company to differentiate its products.
2. Eliminating defects or errors reduces waste,
increases efficiency, and lowers the cost
structure – increasing profitability.
Quality can be thought of in terms
of two dimensions and gives a
company two advantages:

Improving Quality as Reliability
TQM is based on the following five-step chain
reaction:
1. Improved quality means that
costs decrease.
2. As a result, productivity also
improves.
3. Better quality leads to higher market
share and allows increased prices.
4. This increases a company’s profitability.
5. Thus the company creates more jobs.
Six Sigma methodology: the principal tool
now used to increase reliability and is a direct
descendant of Total Quality Management (TQM)

Deming’s Steps in a
Quality Improvement Program
1. A company should have a clear business model.
2. Management should embrace philosophy that
mistakes, defects, and poor quality are not
acceptable.
3. Quality of supervision should be improved.
4. Management should create an environment in
which employees will not be fearful of reporting
problem or making suggestions.
5. Work standards should include some notion of
quality to promote defect-free output.
6. Employees should be trained in new skills.
7. Better quality requires the commitment of
everyone in the workplace.

Roles Played in Implementing
Reliability Improvement Methods
Table 4.2

Implementing Reliability
Improvement Methodologies
 Build organizational commitment to quality
 Create quality leaders
 Focus on the customer
 Identify processes and the source of defects
 Find ways to measure quality
 Set goals and create incentives
 Solicit input from employees
 Build long-term relationships with suppliers
 Design for ease of manufacture
 Break down barriers among functions
Imperatives that stand out among companies that have
successfully adopted quality improvement methods:

Improving Quality as Excellence
Developing Superior Attributes:
• Learn which attributes are most important
to customers
• Design products and associate services to
embody the important attributes
• Decide which attributes to promote and how
best to position them in consumers’ minds
• Continual improvement in attributes and
development of new-product attributes
A product is a bundle of attributes
and can be differentiated by attributes that
collectively define product excellence.

Attributes Associated with a
Product Offering
Table 4.3

Achieving Superior Innovation
 Innovation can:
• Result in new products that satisfy
customer needs better
• Improve the quality of existing products
• Reduce costs
 Innovation can be imitated -
 So it must be continuous
Building distinctive competencies that result in
innovation is the most important source of
Successful new product launches are
major drivers of superior profitability.

The High Failure Rate
of Innovation
Most common explanations for failure:
 Uncertainty
• Quantum innovation – radical departure with higher risk
• Incremental innovation – extension of existing technology
 Poor commercialization
• Definite demand for product
• Product not well adapted to customer needs
 Poor positioning strategy
• Good product but poorly positioned in the marketplace
 Technological myopia
• Technological “wizardry” vs. meeting market requirements
 Slow to market
Failure rate of innovative new products is high
with evidence suggesting that only 10 to 20% of major
R&D projects give rise to a commercially viable product.

Building Competencies in
Innovation
1. Building skills in basic and applied research
2. Project selection and management
Using the product development funnel
» Idea generation » Project refinement » Project execution
3. Achieving cross-functional integration
1. Driven by customer needs 2. Design for manufacturing
3. Track development costs 4. Minimize time-to-market
5. Close integration between R&D & marketing
4. Using product development teams
5. Partly-parallel development process
 To compress development time & time-to-market
Companies can take a number of steps to build
competencies in innovation and reduce failures:

The Development Funnel
Figure 4.7

Sequential and Partly Parallel
Development Processes
Figure 4.8
Reduced
development time
& time-to-market
Reduced
development time
& time-to-market

Achieving Superior
Responsiveness to Customers
 Focusing on the customer
• Demonstrating leadership
• Shaping employee attitudes
• Bringing customers into the
company
 Satisfying customer needs
• Customization
» Tailor to unique needs of groups of customers
• Response time
» Increase speed » Premium pricing
Customer responsiveness: giving customers what
they want, when they want it, and at a price they are willing
to pay - as long as the company’s long-term profitability is
not compromised.

Primary Roles of Functions in Achieving
Superior Responsiveness to Customers
Table 4.5

Chapter
Five
Building
Competitive
Advantage
Through
Business-
Level Strategy

Business-Level Strategy
They must decide on:
1. Customer needs –
WHAT is to be satisfied
2. Customer groups –
WHO is to be satisfied
3. Distinctive competencies –
HOW customers are to be satisfied
A successful business model results from
business level strategies that create a
competitive advantage over its rivals.
These decisions determine
which strategies are formulated & implemented
to put a business model into action.

Customer Needs:
Product Differentiation
 Customer needs
The desires, wants, or cravings that can be satisfied
through product attributes
 Customers choose a product based on:
1. The way the product is differentiated from
other products of its type
2. The price of the product
 Product differentiation
Designing products to satisfy customers’ needs in
ways that competing products cannot:
• Different ways to achieve distinctiveness
• Balancing differentiation with costs
• Ability to charge a higher or premium price

Customer Needs:
Market Segmentation
 Market Segmentation
The way customers can be grouped based on
important differences in their needs or preferences
 In order to gain a competitive advantage
 Main Approaches to Segmenting Markets
1. Ignore differences in customer segments –
Make a product for the typical or average customer
2. Recognize differences between customer groups –
Make products that meet the needs
of all or most customer groups
3. Target specific segments –
Choose to focus on and serve just
one or two selected segment

Identifying Customer Groups
and Market Segments
Figure 5.1

Three Approaches
to Market Segmentation
Figure 5.2

Implementing the Business Model
To develop a successful business model,
strategic managers must devise a set of
strategies that determine:
• How to DIFFERENTIATE their product
• How to PRICE their product
• How to SEGMENT their markets
• How WIDE A RANGE of products to develop
A profitable business model depends on
providing the customer with the most value
while keeping cost structures viable.

Wal-Mart’s Business Model
Figure 5.3

Competitive Positioning
at the Business Level
Source: Copyright © C. W. L. Hill & G. R. Jones,
“The Dynamics of Business-Level Strategy,”
(unpublished manuscript, 2002).
Maximizing the profitability of the company’s business
model is about making the right choices with regard to value
creation through differentiation, costs, and pricing.
Figure 5.4

Generic
Business-Level Strategies
Specific business-level strategies that give a
company a specific competitive position
and advantage vis-à-vis its rivals
Characteristics of Generic Strategies
• Can be pursued by all businesses
regardless of whether they are
manufacturing, service, or nonprofit
• Can be pursued in different kinds of
industry environments
• Results from a company’s consistent
choices on product, market, and distinctive
competencies

The Four Principal Generic
Business-Level
Strategies
1. Cost Leadership
Lowest cost structure vis-à-vis competitors
allowing price flexibility & higher profitability
2. Focused Cost Leadership
Cost leadership in selected market niches where
it has a local or unique cost advantage
3. Differentiation
Features important to customers & distinct from
competitors that allow premium pricing
4. Focused Differentiation
Distinctiveness in selected market niches where
it better meets the needs of customers than the
broad differentiators

Cost Leadership
Generic Business-Level Strategies
Cost leaders establish a cost structure that
allows them to provide goods and services
at lower unit costs than competitors.
Strategic Choices
• The cost leader does not try to be the
industry innovator.
• The cost leader positions its products to
appeal to the “average” or typical customer.
• The overriding goal of the cost leader is to
increase efficiency and lower its costs
relative to industry rivals.

Advantages of
Cost Leadership Strategies
 Protected from industry competitors by
cost advantage
 Less affected by increased prices of
inputs if there are powerful suppliers
 Less affected by a fall in price of
inputs if there are powerful buyers
 Purchases in large quantities increase
bargaining power over suppliers
 Ability to reduce price to compete
with substitute products
 Low costs and prices are a barrier to entry
Cost leader is able to charge a lower price
or is able to achieve superior profitability
than its competitors at the same price.

Disadvantages
Cost Leadership Strategies
 Competitors may lower
their cost structures.
 Competitors may
imitate the cost
leader’s methods.
 Cost reductions may
affect demand.

Why Focus Strategies
Are Different
 

Figure 5.7

Focus
Generic Business-Level
StrategiesThe focuser strives to serve the need of
a targeted niche market segment
where it has either a low-cost or
differentiated competitive advantage.
Strategic Choices
• The focuser selects a specific market niche
that may be based on:
 Geography
 Type of customer
 Segment of product line
• Focused company positions itself as either:
 Low-Cost or
 Differentiator

Advantages:
Focus Strategies
 The focuser is protected from rivals to the
extent it can provide a product or service
they cannot.
 The focuser has power over buyers because
they cannot get the same thing from anyone
else.
 The threat of new entrants is limited by
customer loyalty to the focuser.
 Customer loyalty lessens the threat from
substitutes.
 The focuser stays close to its customers and
their changing needs.

Disadvantages:
Focus Strategies
 The focuser is at a disadvantage with regard
to powerful suppliers because it buys in
small volume but it may be able to pass costs
along to loyal customers.
 Because of low volume, a focuser may have
higher costs than a low-cost company.
 The focuser’s niche may disappear because
of technological change or changes in
customers’ tastes.
 Differentiators will compete for a focuser’s
niche.

Companies with a differentiation strategy
create a product that is different or distinct
from its competitors in an important way.
Strategic Choices
• A differentiator strives to differentiate itself
on as many dimensions as possible.
• Differentiator focuses on quality, innovation,
and responsiveness to customer needs.
• May segment the market in many niches.
• A differentiated company concentrates on
the organizational functions that provide a
source of distinct advantages.
Differentiation:
Generic Business-Level Strategies

Advantages of
Differentiation Strategies
 Customers develop brand loyalty.
 Powerful suppliers are not a problem because the
company is geared more toward the price it can
charge than its costs.
 Differentiators can pass price increases on to
customers.
 Powerful buyers are not a problem because the
product is distinct.
 Differentiation and brand loyalty are barriers to entry.
 The threat of substitute products depends on
competitors’ ability to meet customer needs.
Differentiators can create demand for their
distinct products and charge a premium price,
resulting in greater revenue and higher profitability.

 Difficulty maintaining long-term
distinctiveness in customers’ eyes.
• Agile competitors can quickly imitate.
• Patents and first-mover advantage are
limited.
 Difficulty maintaining premium price.
Disadvantages of
Differentiation Strategies

Broad Differentiation:
Cost Leadership and Differentiation
A broad differentiation business model may result when a
successful differentiator has pursued its strategy in a way
that has also allowed it to lower its cost structure:
 Using robots and flexible manufacturing cells reduces costs
while producing different products.
 Standardizing component parts used in different end
products can achieve economies of scale.
 Limiting customer options reduces production and
marketing costs.
 JIT inventory can reduce costs and improve quality and
reliability.
 Using the Internet and e-commerce can provide information
to customers and reduce costs.
 Low-cost and differentiated products are often both
produced in countries with low labor costs.

Implications of Strategic Groups for Competitive Positioning:
1. Strategic managers must map their competitors:
• Map according to their choice of business model
• Use this knowledge to position themselves closer to customers
• Differentiate themselves from their competitors
2. Use the map to better understand changes in the industry
• Affecting its relative position vis-à-vis differentiation & cost structure
• To identify opportunities and threats
• Identify emerging threats from companies outside the strategic group
3. Determine which strategies are successful
 Why certain business models are working or not
4. Fine tune or radically alter business models and strategies to
improve competitive position
Strategic Groups are groups of companies that
follow a business model similar to other companies
within their strategic group, but are different from
that of other companies in other strategic groups.
Competitive Positioning:
Strategic Groups

Failures in
Competitive Positioning
Successful competitive positioning requires
that a company achieve a fit between its
strategies and its business model.
 Many companies, through neglect, ignorance or error:
• Do not work continually to improve their business model
• Do not perform strategic group analysis
• Often fail to identify and respond to changing opportunities
and threats in the industry environment
 Companies lose their position on the value frontier –
• They have lost their source of competitive advantage
• Their rivals have found ways to push out the value-creation
frontier and leave them behind
There is no more important task than ensuring
that the company is optimally positioned against
its rivals to compete for customers.

Chapter
Six
Business-
Level Strategy
and the
Industry
Environment

The Industry Environment
 Different industry environments present
different opportunities and threats.
 A company’s business model and strategies
have to change to meet the environment.
 Companies must face the challenges of
developing and maintaining a competitive
strategy in:
• Fragmented Industries • Mature Industries
• Embryonic Industries • Declining Industries
• Growth Industries
There is the need to continually formulate and
implement business-level strategies to sustain
competitive advantage over time in different industry
environments.

Fragmented Industries
 Reasons for fragmented industries
• Low barriers to entry due to lack of economies of scale
• Low entry barriers permit constant entry by new companies
• Specialized customer needs require small job lots of
products - no room for a mass-production
• Diseconomies of scale
 Strategies
• Chaining – networks of linked outlets to
achieve cost leadership
• Franchising – for rapid growth with proven business concepts,
reputation, management skills and economies of scale
• Horizontal Merger – acquisition to obtain economies and growth
• IT and Internet – to develop new business models
A fragmented industry is one composed of a large
number of small and medium-sized companies.

An embryonic industry is one that is just
beginning to develop when technological innovation
creates new market or product opportunities.
A growth industry is one in which first-
time demand is expanding rapidly as
many new customers enter the market.
Embryonic and Growth Industries
Strategy is determined by market demand
• Innovators and early adopters have different needs from
the early and late majority
• Company must be prepared to cross the chasm between
the early adopters and the later majority
Companies must understand the factors that affect a
market’s growth rate – in order to tailor the business
model to the changing industry environment.

Market Characteristics:
Embryonic and Growth Industries
 Reasons for slow growth in market demand
• Limited performance and poor quality of the first products
• Customer unfamiliarity with what the new product can do for
them
• Poorly developed distribution channels
• Lack of complementary products
• High production costs
 Mass markets typically start to develop when:
• Technological progress makes a product easier to use and
increases its value to the average customer.
• Key complementary products are developed that do the same.
• Companies find ways to reduce production costs allowing
them to lower prices.

Market Development
and Customer Groups
Both innovators and early adopters enter the market
while the industry is in its embryonic state.
Figure 6.1

Market Share of Different
Customer Segments
Most market demand and industry
profits arise during the early and
late majority customer segments.
Figure 6.2

Strategic Implications:
Crossing the Chasm
 Innovators and Early Adopters are
(While the Early Majority are NOT):
• Technologically sophisticated and tolerant of engineering
imperfections
• Typically reached through specialized distribution channels
• Relatively few in number and not particularly price-sensitive
 To cross the chasm between the
Early Adopters and the Early Majority
• Correctly identify the needs of the first
wave of early majority users.
• Alter the business model in response.
• Alter the value chain and distribution
channels to reach the early majority.
• Design the product to meet the needs of the early majority so
that the product can be modified and produced or provided at
low cost.
• Anticipate the moves of competitors.

The Chasm: AOL and Prodigy
The business model and strategies required to compete in an
embryonic market populated by Early Adopters and
Innovators are very different than those required to compete
in a high-growth mass market populated by the Early Majority.
Figure 6.3

Strategic Implications
of Market Growth Rates
 Different markets develop at different rates.
 Growth rate measures the rate at which the
industry’s product spreads in the marketplace.
 Growth rates for new kinds of products seem to
have accelerated over time:
• Use of mass media • Low-cost mass production
 Factors affecting market growth rates:
• Relative advantage • Complexity
• Compatibility • Observability
• Availability of • Trialability
complementary products
Business-level strategy is a major determinant of
industry profitability. The choice of business model
and strategies can accelerate or retard market growth.

Differences in Diffusion Rates
Source: Peter Brimelow, “The Silent Boom,” Forbes, July 7, 1997, pp. 170-171. Reprinted by permission of Forbes Magazine © 2002 Forbes, Inc.
Different markets develop at different growth rates.
Figure 6.4

Navigating Through the Life Cycle
to Maturity
 Embryonic stages – share building strategies
• Development of distinctive competencies and competitive advantage.
• Requires capital to develop R&D and sales/service competencies.
 Growth stages – maintain relative competitive position
• Strengthen business model to prepare to survive industry shakeout.
• Requires investment to keep up with rapid growth of the market.
 Shakeout stage – increase share during fierce competition
• Invest in share-increasing strategies at expense of weak competitors.
• Weak companies should exit the industry during the harvest stage.
 Maturity stage – hold-and-maintain to defend business model
• Dominant companies want to reap the reward of prior investments.
• A company’s investment depends on the level of competition and
source of the company’s competitive advantage.
1. Competitive advantage of company’s business model
2. Stage of the industry life cycle
The amount and type of resources and capital needed to pursue
a company’s business model depends on two crucial factors:

Mature Industries
 Evolution of mature industries
• Industry becomes consolidated as a result of the fierce
competition during the shakeout stage.
• Business level strategy is based on how established companies
collectively try to reduce strength of competition.
• Interdependent companies try to protect industry profitability.
 Strategies
• Deter entry into industry
 Product proliferation  Maintaining
 Price cutting excess capacity
• Manage industry rivalry
 Price signaling  Capacity control
 Price leadership  Nonprice competition
A mature industry is dominated by a small number of large
companies whose actions are so highly interdependent that success
of one company’s strategy depends on the response of its rivals.

Product Proliferation in the
Restaurant Industry
Where the product
spaces have been
filled, it is difficult for
a new company to
gain a foothold in the
market and
differentiate itself.
Figure 6.6

Four Nonprice Competitive
Strategies
Figure 6.8

Toyota’s Product Lineup
Toyota has used market development to become a broad differentiator and
has developed a vehicle for almost every main segment of the car market.
Figure 6.9

Game Theory
Basic principles that underlie game theory:
 Look Forward and Reason Back – Decision Trees
 Look forward, think ahead, and anticipate how rivals will respond
to whatever strategic moves they make
 Reason backwards to determine which strategic moves to pursue
today based on how rivals will respond to future strategic moves
 Know Thy Rival – how is the rival likely to act
 Find the Dominant Strategy – Payoff Matrix
 One that makes you better off if you play that strategy
 No matter what strategy your opponent uses
 Strategy Shapes the Payoff Structure of the Game
Companies in an industry can be viewed as players that are all
simultaneously making choices about which business models
and strategies to pursue in order to maximize their profitability.
These basic principles of game theory can be used in
determining which business model and strategies to pursue.

A Decision Tree
for UPS’s Pricing Strategy
Figure 6.10

A Payoff Matrix
for GM and Ford
Figure 6.11

Altered Payoff Matrix
for GM and Ford
Figure 6.12

Declining Industries
 Reasons for and severity of the decline
• Reasons - technological change, social trends, demographic shifts
• Intensity of competition is greater when:
 The decline is rapid versus slow and gradual.
 The industry has high fixed costs.
 The exit barriers are high.
 The product is perceived as a commodity.
• Not all industry segments typically decline at the same rate
 Creating pockets of demand
 Strategies
• Leadership – seeks to become dominant player in declining industry
• Niche – focuses on pockets of demand that are declining more slowly
• Harvest – optimizes cash flow
• Divestment – sells business to others
A declining industry is one in which market demand has
leveled off or is falling and the size of total market starts to shrink.
Competition tends to intensify and industry profits tend to fall.

Factors for Intensity of Competition
in Declining Industries
Figure 6.13

Strategy Selection
in a Declining Industry
Choice of strategy is
determined by:
• Severity of the
industry decline
• Company strength
relative to the
remaining pockets
of demand
Figure 6.14

Chapter
Seven
Strategy in
High-
Technology
Industries

High-Technology Industries
Technology is:
• The body of scientific knowledge used
in the production of goods or services
• Accounting for an even larger share
of economic activity
• Revolutionizing aspects of the
product or production system in
industries not thought of as high-tech
High-tech industries are those in which the
underlying scientific knowledge that companies in
the industry use is advancing rapidly.
By implication, the attributes of the products and services
that result from its application are also advancing rapidly.

Technical Standards
and Format Wars
Format wars
• Often, only one standard will
come to dominate a market.
• Many battles in high-tech industries revolve
around companies competing to be the one
that sets the standard.
Technical standards are a set of technical
specifications that producers adhere to when
making the product or a component of it.
The source of product differentiation
and competitive advantage
is based on the technical
standard.

Technical Standards
for Personal Computers
Figure 7.1

Benefits of Standards
Standards help:
 Guarantee compatibility between products and
their compliments
 Reduce confusion in the minds of consumers
 Reduce production costs through mass-
production
 Reduce the risks associated with supplying
complementary products and help
Standards emerge because there are
economic benefits associated with them.
Standards lead to both low-cost and differentiation
advantages for individual companies.

Establishments of Standards
1. Companies may lobby the government to
mandate an industry standard.
2. Standards are often set by cooperation among
businesses or industry forums.
 May become part of the public domain
3. Standards are often selected competitively by
market demand.
• Network effects – size of the network for complementary
products determines industry demand
• Positive feedback loop – increase in demand
further increases the value of owning a product
• Lockout – from the market occurs for companies promoting
alternate standards when consumers are unwilling to bear the
switching costs (unless benefits outweigh costs of switching)
Standards emerge in one of three ways:

Positive Feedback in
the Market for VCRs
Figure 7.2

Strategies for Winning
a Format War
 Ensure a supply of complements.
• In addition to the product itself
 Leverage killer applications.
• New products that are so compelling that customers adopt
them in droves, killing demand for competing formats
 Aggressively price and market.
• Pricing the product low to increase the installed base,
then pricing complements high to make profits
 Cooperate with competitors.
• To speed up adoption of the technology
 License the format.
• Reduce financial incentive for competitors to develop their own
Successful strategies revolve around finding
ways to make network effects work in their
favor and against their competitors:

Cost Structures in
High-Technology Industries
Figure 7.3

Intellectual property rights apply to the
product of any intellectual and creative efforts.
Managing
Intellectual Property Rights
 Patents, copyrights, and trademarks give individuals
and companies incentives to engage in the expense
and risk of creating new intellectual property.
 Digitalization and piracy rates
• Large scale problem with high piracy rates
• Legal and technological solutions are required
 Strategies for managing digital rights
• Low costs of copying and distributing digital media
» Can be used to the company’s advantage
» Drive down costs of purchasing media
• Encryption software
• Vigorous defense of intellectual property rights

Capturing First-Mover Advantages
If the new product satisfies unmet
consumer needs and demand is high:
• First mover may be in a monopoly position to
capture significant revenues and profits.
• Strong revenues and profits signal an
opportunity to potential rivals.
• Rival imitators may enter market in the absence of strong
barriers to imitation resulting in lower market returns.
First-mover advantage: the first to develop and
pioneer revolutionary new products that can lead
to an enduring competitive advantage
Being a first-mover does not guarantee success.
Success depends on the first-mover strategy
that is pursued.

The Impact of Imitation on Profits
of a First Move
Figure 7.4

First-Mover Advantages
1. Exploit network effects and positive feedback loops
Locking customers into its technology
2. Establish significant brand loyalty
Expensive for later entrants to break down
3. Enable economies of scale and learning effects
So first-mover has cost advantage and can respond to new
entrants by cutting price to maintain market share
4. Create switching costs for customers
Making it difficult for rivals to take customers away
4. Accumulate valuable knowledge
Regarding customers, distribution, and technology that late
entrants will find difficult or expensive to match
The five main sources of first-mover advantages:

First-Mover Disadvantages
1. Pioneering costs
To develop technology and distribution channels
and to educate the customers
Later entrants ‘free-ride’ on first-mover’s investments.
2. More prone to make mistakes
Because of the uncertainties in a new market
Later entrants learn from the mistakes of first-movers.
3. Risk of building the wrong resources and
capabilities
Mass-market may differ from the needs of early adopters
First-movers risk ‘Plunging into the chasm’.
4. May invest in inferior or obsolete technology
If the underlying technology is advancing rapidly
Late entrants may be able to ‘leap frog’ the technology.

Strategies for Exploiting
First-Mover Advantages
1. Going it alone
Develop and market the innovation itself.
2. Strategic alliance or joint venture
Develop and market the innovation jointly
with other companies.
3. License the innovation to others
Let them develop the market.
Key questions in choosing a strategy:
• Does the company have the complementary assets
to exploit its innovation?
• How difficult is it for imitators to copy the
company’s innovation (height of barriers to
imitation)?
• Are there capable competitors who could rapidly
imitate the innovation?

Strategies for Profiting
from Innovation
Table 7.1

Technological Paradigm Shifts
Occur when new technologies emerge that:
• Revolutionize the structure of the industry
• Dramatically alter the nature of the competition
• Requires companies to adopt new strategies to
survive
Paradigm shifts are more likely to occur with:
• Natural limits to technology
The established technology in the industry is mature
and approaching its natural limit.
• New disruptive technology
Has entered the marketplace and is taking root in
niches that are poorly served by incumbent companies
using established technology.

The Technology S-Curve
Figure 7.5

Established and Successor
Technologies
Figure 7.6

Swarm of Successor
Technologies
Figure 7.7

Disruptive Technology
 Revolutionizes the industry
structure and competition
 Causes a technological
paradigm shift
Disruptive technology is a new technology that
gets its start away from the mainstream of a market
and invades the main market as its functionality
improves over time.
Disruptive technology often causes the
decline of established companies –
because they listen to customers
who say they do not want it.

Strategic Implications of Paradigm
Shifts for Established Companies
 Having access to knowledge about how
disruptive technologies can revolutionize
markets is in itself a valuable asset.
 It is important for established enterprises to
invest in newly emerging technologies that may
become disruptive.
 Commercialization of disruptive technology may
require a different value chain with a different
cost structure.
Internal forces suppress change.
Chances of success in developing and
commercializing disruptive technology will be
enhanced if it is placed in its own organization.

Strategic Implications of Paradigm
Shifts for New Entrants
 Pressure to continue the out-of-date existing
business model does not hamper new entrants.
 New entrants need not worry about established
customer base, distribution channels, or suppliers.
New entrants, or attackers, have several
advantages over established enterprises:
 May be constrained by lack of capital
 Need to manage the organizational problems
associated with rapid growth
 Find a way to take the technology from a small niche
into the mass-market
 Decide whether to go it alone or partner with an
established company
But new entrants face important new issues:

Chapter
Eight
Strategy
in the Global
Environment

The Global and National
Environments
International expansion represents a way of earning
greater returns by transferring the skills and product
offerings derived from distinctive competencies to
markets where indigenous competitors lack these skills.
The trend toward globalization has many implications:
1. Industries are becoming global in scope
Industry boundaries no longer stop at national borders.
2. Shift from national to global markets
This has intensified competition in industry after industry.
3. Steady decline in barriers to cross-border
trade and investment
This has opened up many once protected markets to
companies based outside of them.

Increasing Profitability and Profit
Growth Through Global Expansion
 Expanding the market by leveraging products
• Taking goods or services developed at home and
selling them internationally
• Utilizing the distinctive competencies that underlie
the production and marketing
 Cost economies from global volume
• Economies of scale from additional sales volume
• Lower unit costs and spreading of fixed costs
 Location economies
• Economic benefits from performing a value
creation activity in the optimal location
• Leveraging the skills of global subsidiaries
• Applying these skills to other operations within firm’s global network
Must also consider transportation costs, trade
barriers, as well as the political and economic risks.

Pressures for Cost Reductions
and Local Responsiveness
Figure 8.2
The best strategy for a
company to pursue may
depend on the kinds of
pressures it must cope
with:
• Cost Reductions or
• Local Responsiveness

Pressures for Cost Reductions
 Where differentiation on
non-price factors is difficult
 Where competitors are
based in low-cost location
 Where consumers are
powerful and face low switching costs
 Where there is persistent excess capacity
 The liberalization of the world trade and
investment environment
Pressures for cost reductions are greatest in
industries producing commodity-type products
where price is the main competitive weapon:

Pressures for Local
Responsiveness
 Differences in customer
tastes and preferences
 Differences in
infrastructure and
traditional practices
 Differences in
distribution channels
 Host government
demands
The greatest pressures for local responsiveness
arise from:
Dealing with these contradictory pressures is a
difficult strategic challenge, primarily because
being locally responsive tends to raise costs.

Choosing a Global Strategy
 Standard Globalization Strategy
• Reaping the cost reductions that come from economies
of scale and location economies
• Business model based on pursuing a low-cost strategy
on a global scale
Makes the most sense when there are strong pressures for
cost reduction and the demand for local responsiveness is
minimal
 Localization Strategy
• Customizing the company’s goods or services so that
thy provide a good match to tastes and preferences in
different national markets
Most appropriate when there are substantial differences
across nations with regard to consumer tastes and
preferences and where cost pressures are not too intense

Choosing a Global Strategy
 Transnational Strategy
• Difficult to pursue due to its conflicting demands
• Business model that simultaneously:
» Achieves low costs » Differentiates across markets
» Fosters a flow of skills between subsidiaries
Building an organization capable of supporting a
transnational strategy is a complex and challenging task.
 International Strategy
• Multinational companies that sell products that serve
universal needs (minimal need to differentiate) and do not
face significant competitors (low cost pressure).
In most international companies the head office retains tight
control over marketing and product strategy.

Basic Entry Decisions
1. Which overseas markets to enter
• Assessment of long-run profit potential
» A function of the size of the market, purchasing power of
consumers, the likely future purchasing power of consumers
• Balancing the benefits, costs, and risks associate
with doing business in a country
» A function of economic development and political stability
2. Timing of entry
• First-mover advantages: preempt and build share
• First-mover disadvantages: pioneering costs
3. Scale of Entry and Strategic Commitments
• Entering on a large scale is a major strategic
commitment
» With long term impacts that may be difficult to reverse
• Benefits and drawbacks of small-scale entry

The Choice of Entry Mode
1. Exporting
Most manufacturing companies begin their global expansion as
exporters and later switch to one of the other modes.
2. Licensing
A foreign licensee buys the rights to produce a company’s product
for a negotiated fee; licensee puts up most of the overseas capital.
3. Franchising
Franchising is a specialized form of licensing. The franchiser not
only sells intangible property, but also insists that franchisee agrees
to follow strict rules as to how it does business.
4. Joint Ventures
Typically a 50/50 venture – a favored mode for entering a new market
5. Wholly-Owned Subsidiaries
Parent company owns 100% of subsidiary’s stock – setup or acquire
When and how to enter a new national market raise the
question of how to determine the best mode or vehicle for
entry. The optimal one depends on the company’s strategy:

Advantages and Disadvantages
of Different Entry Modes
Table 8.1

Choosing Among Entry Modes
 Distinctive Competencies and Entry Mode
To earn greater returns from differentiated products or where
competitors lack comparable products, the optimal mode of entry
depends on the nature of the company’s distinctive competency:
• Technological know-how
» Wholly-owned subsidiary is preferred over licensing and joint
ventures to minimize risk of losing control.
• Management know-how
» Franchising, joint ventures, or subsidiaries are preferred as risk
is low of losing management know-how.
 Pressures for Cost Reduction and Entry Mode
The greater the cost pressure, the more likely a company will want to
pursue some combination of exporting and wholly-owned subsidiary:
• Export finished goods from wholly-owned subsidiary
• Marketing subsidiaries for overseeing distribution
» Tight control over local operations allows company to use profits
generated in one market to improve position in other markets.

Global Strategic Alliances
 Advantages
• Facilitate entry into a foreign market
• Share fixed costs and associated risks
• Bring together complementary skills and assets
• Set technological standards for its industry
 Disadvantages
• Give competitors a low-cost route to gain new
technology and market access
Global Strategic Alliances are cooperative agreements between
companies from different countries that are actual or potential
competitors. They range from short-term contractual cooperative
arrangements to formal joint ventures with equity participation.
Some alliances benefit the company.
Beware, alliances can end up giving away technology
and market access with very little gained in return.

Making Strategic Alliances Work
The failure rate for international strategic alliances is quite
high. Success seems to be a function of three main factors:
Successful partners view the alliance as an opportunity to
learn rather than purely as a cost- or risk-sharing device.
1. Partner selection – A good partner:
• Helps the company achieve strategic goals
• Shares the firm’s vision for the purpose of the alliance
• Is unlikely to try to exploit the alliance to its own ends
 Conduct research on potential partners
2. Alliance structure
• Risk of giving too much away is at an acceptable level
• Guard against opportunism by partner in alliance agreement
3. Manner in which alliance is managed
• Sensitivity to cultural differences
• Build relationship capital through interpersonal relationships

Structuring Alliances
to Reduce Opportunism
Figure 8.5Opportunism includes
the expropriation of
technology or markets

Chapter Nine
Corporate
Strategy:
Horizontal
Integration,
Vertical
Integration,
and Strategic
Outsourcing

Corporate-Level Strategy should allow a company, or its
business units, to perform the value-creation functions at lower cost
or in a way that allows for differentiation and premium price.
Companies must adopt a long-term perspective
Consider how changes in the industry and its products,
technology, customers, and competitors will affect its
current business model and future strategies.
Corporate-Level Strategy
Corporate strategy is used to identify:
1. Businesses or industries that the company should
compete in
2. Value creation activities that the company should
perform in those businesses
3. Method to enter or leave businesses or industries
in order to maximize its long-run
profitability

Corporate-Level Strategy:
The Multi-Business Model
A multi-business company must construct its
business model at two levels:
1. Business models and strategies
for each business unit or division in every industry in
which it competes
2. Higher-level multi-business model
that justifies its entry into different businesses and
industries
A company’s corporate-level strategies
should be chosen to promote the success of
a company’s business model – and to allow
it to achieve a sustainable competitive
advantage at the business level.

 Horizontal Integration
• The process of acquiring or merging with industry
competitors
 Vertical Integration
• Expanding operations backward into an industry that
produces inputs for the company or forward into an
industry that distributes the company’s products
 Strategic Outsourcing
• Letting some value creation activities within a business
be performed by an independent entity
Repositioning and Redefining
A Company’s Business Model
Corporate-level strategies are primarily directed
toward improving a company’s competitive advantage
and profitability in its present business or product line:

Horizontal Integration
Single-Industry Strategy
 Focus resources
Its total managerial,
technological, financial and functional
resources and capabilities are
devoted to competing
successfully in one area.
 ‘Stick to its knitting’
Company stays focused on what it does
best, rather than entering new industries where its
existing resources and capabilities add little value.
Horizontal Integration is the process of acquiring or merging
with industry competitors in an effort to achieve the
competitive advantages that come with large scale and scope.
Staying inside a single industry
allows a company to:

Benefits of
Profits and profitability increase when horizontal
integration:
1. Lowers the cost structure
• Creates increasing economies of scale
• Reduces the duplication of resources between two companies
2. Increases product differentiation
• Product bundling – broader range at single combined price
• Total solution – saving customers time and money
• Cross-selling – leveraging established customer relationships
3. Replicates the business model
• In new market segments within same industry
4. Reduces industry rivalry
• Eliminate excess capacity in an industry
• Easier to implement tacit price coordination among rivals
5. Increases bargaining power
• Increased market power over suppliers and buyers
• Gain greater control

Problems with
A wealth of data suggests that the majority of mergers
and acquisitions DO NOT create value and that many
may actually DESTROY value.
 Implementing a horizontal integration is not an easy
task.
• Problems associated with merging very different company
cultures
• High management turnover in the acquired company when
the acquisition is a hostile one
• Tendency of managers to overestimate the benefits to be had
in the merger
• Tendency of managers to underestimate the problems
involved in merging their operations
 The merger may be blocked if merger is perceived to:
• Create a dominant competitor
• Create too much industry consolidation
• Have the potential for future abuse of market power

Vertical Integration
Entering New Industries
A company may expands its operations backward into
industries that produces inputs to its products or forward
into industries that utilize, distribute or sell it products.
 Backward Vertical Integration
• Company expands its operations into an industry
that produces inputs to the company’s products.
 Forward Vertical Integration
• Company expands into an industry that uses,
distributes, or sells the company’s products.
 Full Integration
• Company produces all of a particular input
from its own operations.
• Disposes of all of its completed products through its own outlets.
 Taper Integration
• In addition to company-owned suppliers, the company will also use
other suppliers for inputs or independent outlets in addition to
company-owned outlets.

Stages in the Raw Material
to Consumer Value Chain
Figure 9.1

Raw Material to Consumer Value Chain
in the Personal Computer Industry
Figure 9.2

Full and Taper Integration
Figure 9.3

A company pursues vertical integration to strengthen
the business model of its original or core business
or to improve its competitive position:
Increasing Profitability Through
1. Facilitates investments in efficiency-enhancing
specialized assets
• Allows company to lower the cost structure or
• Better differentiate its products
2. Enhances or protects product quality
• To strengthen its differentiation advantage through either
forward or backward integration
3. Results in improved scheduling
• Makes it easier and more cost-effective to plan, coordinate,
and schedule the transfer of product within the value-added
chain
• Enables a company to respond better to changes in demand

Problems with
Companies may disintegrate or exit industries adjacent
to the industry value chain when encountering
disadvantages from the vertical integration:
Vertical integration can weaken business model when:
• Company-owned suppliers lack incentive to reduce costs
• Changing demand or technology reduces ability to be competitive
 Cost structure is increasing.
• Company-owned suppliers develop a higher cost structure
than those of the independent suppliers
• Bureaucratic costs of solving transaction difficulties
 The technology is changing fast.
• Vertical integration may lock into old or inefficient technology
• Prevent company from changing to a new technology that
could strengthen the business model
 Demand is unpredictable.
 Creates risk in vertical integration investments.

Alternatives to Vertical Integration:
Cooperative Relationships
 Short-term contracts and competitive bidding
• May signal a company’s lack of commitment to its supplier
 Strategic alliances and long-term contracting
• Enables creation of a stable long-term relationship
• Becomes a substitute for vertical integration
• Avoids the problems of having to manage a company located in an
adjacent industry
 Building long-term cooperative relationships
• Hostage taking – creating a mutual dependency
• Credible commitments – a believable promise or pledge
• Maintaining market discipline – power to discipline supplier
• Periodic contract renegotiation  Parallel sourcing policy
Strategic Alliances are long-term agreement between two or
more companies to jointly develop new products or processes
that benefit all companies concerned.

Strategic Outsourcing
 Company is choosing to focus on a fewer
number of value-creation activities
 In order to strengthen its business model
 Company’s typically focus on noncore or
nonstrategic activities
 In order to determine if they can be performed more
effectively and efficiently by independent specialized
companies
 Virtual Corporation
 Describes companies that have pursued extensive
strategic outsourcing
Strategic Outsourcing allows one or more of a company’s
value-chain activities or functions to be performed by
independent specialized companies that focus all their
skills and knowledge on just one kind of activity.

Strategic Outsourcing of Primary
Value Creation Functions
Figure 9.4

Benefits of Outsourcing
1. Reducing the cost structure
• The specialist company cost is less than what it would cost
to perform the activity internally.
2. Enhanced differentiation
• The quality of the activity performed by the specialist is
greater than if the activity were performed by the company.
3. Focus on the core business
• Distractions are removed.
• The company can focus attention and resources on
activities important for value creation and competitive
advantage.
Strategic outsourcing may be detrimental when:
• Holdup – company becomes too dependent on specialist provider
• Loss of information – company loses important customer contact or
competitive information

Chapter Ten
Corporate-Level
Strategy:
Formulating
and
Implementing
Related and
Unrelated
Diversification

Corporate-Level Strategy should allow a company, or one of
its business units, to perform the value-creation functions at lower
cost or in a way that allows for differentiation and premium price.
Companies must adopt a long-term perspective
Consider how changes in the industry and its products,
technology, customers, and competitors will affect its
current business model and future strategies.
Corporate strategy is used to identify:
1. Businesses or industries that the company should
compete in
2. Value creation activities which the company should
perform in those businesses
3. Method to enter or leave businesses or industries
in order to maximize its long-run
profitability

Diversification Strategy is the company’s decision to
enter one or more new industries (that are distinct from
its established operations) to take advantage of its
existing distinctive competencies and business model.
of Diversification
Types of diversification:
 Related diversification
 Unrelated diversification
Methods to implement a
diversification
strategy:
 Internal new ventures
 Acquisitions
 Joint ventures

Expanding
Beyond a Single Industry
BUT a company’s fortunes are tied closely to
the profitability of its original industry:
 Can be dangerous if the industry matures and goes into
decline
 May be missing the opportunity to leverage their
distinctive competencies in new industries
 Tendency to rest on their laurels and not engage in
constant learning
Staying inside a single industry allows a company to:
• Focus its resources  ‘Stick to its knitting’
To stay agile, companies must leverage –
find new ways to take advantage of their distinctive
competencies and core business model
in new markets and industries.

A Company as a Portfolio of
Distinctive Competencies
 Consider how those competencies
might be leveraged to create
opportunities in new industries
 Existing competencies versus new
competencies that would need to
be developed
 Existing industries in which a
company competes versus new
industries
Reconceptualize the company as a
portfolio of distinctive
competencies . . . rather than a
portfolio of products:

Establishing a
Competency Agenda
Source: Reprinted by permission of Harvard Business School Press. From Competing for the Future: Breakthrough Strategies for
Seizing Control of Your Industry and Creating the Markets of Tomorrow by Gary Hamel and C. K. Prahalad, Boston, MA. Copyright ©
1994 by Gary Hamel and C. K. Prahalad. All rights reserved.
Figure 10.1

Increasing Profitability
Through Diversification
 Transferring competencies
among existing businesses
 Leveraging competencies
to create new businesses
 Sharing resources
to realize economies of scope
 Using product bundling
 Managing rivalry
by using diversification as a means in one or more industries
 Exploiting general organizational competencies
that enhance performance within all business units
A diversified company can create value by:
Managers often consider diversification when their
company is generating free cash flow – with resources in
excess of those needed to maintain competitive advantage.

 Transferring Competencies
• The competencies transferred must involve
activities that are important for establishing
competitive advantage
• Tend to acquire businesses related to their
existing activities because of the commonality
between one or more value-chain functions
Transferring competencies across industries:
taking a distinctive competency developed in one
industry and implanting it in an EXISTING business
unit in another industry
For such a strategy to work,
the distinctive competency being
transferred must have real strategic value.

Transfer of Competencies
at Philip Morris
Figure 10.2

• The difference between
leveraging and transferring
competencies is that an entirely
NEW business is created
• Different managerial processes
are involved
• Tend to use R&D competencies
to create new business
opportunities in diverse areas
Leveraging competencies: taking a
distinctive competency developed by a business
in one industry and using it to create a NEW
business unit in a different industry
 Leveraging Competencies

Economies of scope arise when
business units are able to effectively
able to pool, share, and utilize
expensive resources or capabilities:
1. Companies that can share resources
have to invest proportionately less
than companies that cannot share.
2. Resource sharing can result in economies of scale.
Sharing resources and capabilities
across two or more business units in different
industries to realize economies of scope.
Economies of scope are possible only when
there are significant commonalities between
one or more value-chain functions.
 Sharing Resources

Sharing Resources
at Procter & Gamble
Figure 10.3

CORPORATE STRATEGY PORTERS FIVE MODEL

CORPORATE STRATEGY PORTERS FIVE MODEL

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