Building And Defending Competitive Advantages - Lesson 5

BUILDING AND DEFENDING COMPETITIVE ADVANTAGES – Lesson 5 Any business strategy, to be capable of sustained success, must be predicated on building and maintaining a competitive advantage. 1. Building competitive advantage via low-cost strategy A cost advantage is achieved when a firm’s cumulative costs across the overall activity-cost chain are lower than competitors’ cumulative costs. How valuable a cost advantage is from a competitive strategy perspective depends on its sustainability. Sustainability, in turn, depends on whether a firm’s sources of cost advantage are difficult to copy or match in some other way. A cost advantage generates superior profitability when buyers consider the firm’s product to be comparable to the products of competitors. In a generic sense there are two ways to pursue a cost advantage: (1) do a better job of controlling the cost drivers vis-à-vis competitors; and (2) restructuring the activity-cost chain by doing things differently and saving enough in the process that customers can be supplied more cheaply. The two approaches are not mutually exclusive: low-cost producers usually achieve their cost advantage from any and all sources they can identify. The primary ways to achieve a cost advantage via restructuring the makeup of the activity-cost chain include: Stripping away all the extras and offering only a basic, no-frills product or service. Using a different production process. Automating a particularly high-cost activity. Finding ways to use cheaper raw materials. Using new kinds of advertising media and promotional approaches relative to the industry norm. Selling directly through one’s own sales force instead of indirectly through dealers and distributors. Relocating facilities closer to suppliers and/or customers. Achieving a more economical degree of forward or backward vertical integration relative to competitors. Going against the “something for everyone” approach of others and focusing on a limited product/service to meet a special, but important, need of the target buyer segment. Gaining a sustainable cost advantage is no easy task; there are a number of common pitfalls: Focusing too heavily or even exclusively on manufacturing costs (in many businesses, a significant portion of the activity-cost chain consists of sales and marketing, customer services, the development of new products and production process improvements, and internal staff support). Ignoring the diligent efforts to reduce the cost of purchased materials and equipment (many senior executives view purchasing as a secondary staff function). Overlooking activities that represent a small fraction of total costs. Not understanding what factors really affect costs per unit (for example, a large regional market share may be more important to unit cost than having a large national share arising from scattered sales across many regions). 1

Striving exclusively for incremental cost improvements in the existing activity-cost chain and not broadening the search to include ways to revamp the chain. Unconsciously pursuing conflicting functional strategies, as when a firm tries to gain market share to reap the benefits of scale economies and long production runs while at the same time dissipating the potential benefits of larger volume by adding more models and optional features. Pursuing cost reductions so zealously that differentiation of the firm’s product is undermined by cutting out performance features, over-standardizing models, and eliminating helpful customer services. 2. Building competitive advantage via differentiation Successful differentiation requires being unique at something buyers consider valuable. When differentiation offers value to the customer, it yields competitive advantage. Differentiation is unsuccessful when the forms of uniqueness pursued by a firm are not valued highly by enough buyers to cause them to choose the firm’s product over rivals’ products. Successful differentiation allows a firm to: (1) command a premium price; and/or (2) sell more units of its product at a given price; and/or (3) realize greater degrees of buyer loyalty. Differentiation can produce superior profitability if the price premium achieved exceeds any added costs associated with accomplishing differentiation. Differentiation strategies may be aimed at broad customer groups or narrowly focused on a limited buyer segment having particular needs. Successful differentiation strategies can grow out of activities performed anywhere in the overall activity-cost chain; they do not arise solely from marketing and advertising departments. The places in the chain where differentiation can be achieved include: The procurement of raw materials that affect the performance or quality of the end product. (McDonald’s is more selective and particular than its competitors in selecting the potatoes it uses in its french fries.) Product-oriented R&D efforts that lead to improved designs, performance features, expanded enduses and applications, product variety, shorter lead times in developing new models, and being the first to come out with new products. Production process oriented R&D efforts that lead to improved quality, reliability, and product appearance. The manufacturing process insofar as it emphasizes zero defects, carefully engineered performance designs, long-term durability, improved economy to end-users, maintenance-free use, flexible end-use application, and consistent product quality. The logistics system to the extent that it improves delivery time and accurate order fulfillment. Marketing, sales, and customer service activities that result in helpful technical assistance to buyers, faster maintenance and repair services, more and better product information provided to customers, more and better training materials for end-users, better credit terms, better warranty coverages, quicker order processing, more frequent sales calls, and greater customer convenience. Differentiation is thus much broader than just “quality and service” aspects. Quality is primarily a function of the product’s physical properties, whereas differentiation possibilities that create value to buyers can be found throughout the whole activity-cost chain. Anything a firm can do to lower the buyer’s total costs of using a product or to raise the performance the buyer gets represents a potential basis for differentiation. There are, of course, no guarantees that differentiation will produce a meaningful competitive advantage. If buyers see little value in uniqueness and a “standard” item sufficiently meets customer needs, then a low-cost strategy can easily defeat a differentiation strategy. In addition, differentiation 2

can be defeated when competitors are able to quickly copy most kinds of differentiation attempts. Rapid imitation, of course, means that real differentiation is never achieved and that competing brands remain pretty much alike despite the efforts of sellers to create uniqueness. Thus, to be successful at differentiation a firm must search out durable sources of uniqueness that are protected by barriers to quick or cheap imitation. The most common pitfalls to pursuing differentiation include: Trying to differentiate on the basis of something that does not lower buyer cost or enhances the buyer’s well-being, as perceived by the buyer. Over-differentiating so that price is too high as compared to competitors or that product quality or service levels go well past the needs of buyers. Trying to charge too high a price (the bigger the premium the more buyers can be attracted to competitors by means of a lower price). Not knowing the cost of differentiation and plodding ahead on the blind assumption that differentiation makes good economic and competitive sense. Not understanding or identifying what the buyer will consider as value. 3. Building competitive advantage via focusing Buyer segments within an industry are far from homogeneous. The strengths of the five competitive forces vary from segment to segment, and different segments can have significantly different activitycost chains. As a consequence, segments differ in competitive attractiveness and in what it takes to achieve competitive advantage in each segment. It is these differences that give rise to the appeal of a focus strategy. The two crucial issues concerning adoption of a focus strategy revolve around (1) choosing which industry segments to compete in and (2) how to build competitive advantage in the target segments. Deciding which segments to compete in depends on the attractiveness of the various segments. Segment attractiveness is typically a function of segment size and growth rate, the intensity of the five competitive forces in the segment, segment profitability, the strategic importance of the segment to other major competitors, and the match between a firm’s capabilities and the segment’s needs. The segments most attractive for focusing have one or more of the following characteristics:

The segment is of sufficient size and purchasing power to be profitable. The segment has good growth potential. The segment is not crucial to the success of major competitors. The focusing firm has the skills and resources to serve the segment effectively. The focuser can defend itself against challengers via the customer goodwill it has built up and its superior ability to serve buyers in the segment. Segments are often related in ways that affect the choice of segments in which to compete. The most important of these is the opportunity to share activities in the overall activity-cost chain across segments. There are times when (1) the same sales force can effectively sell to different buyer groups, (2) the same manufacturing plants can produce enough product varieties to supply two or more segments, (3) R&D can be done simultaneously for several product groups within the industry family, or (4) outbound shipping and distribution activities for two or more buyer groups can be closely coordinated, all with resultant cost savings in serving multiple segments. Such sharing interrelationships become strategically important whenever the benefits of sharing exceed the cost of sharing. This can occur when sharing promotes significant scale economies, more rapid learning, improved capacity utilization, increased differentiation, or lower differentiation costs. However, the benefits associated with segment interrelationships can be offset when: 3

The costs of coordinating shared activities are high (because of greater operating complexity). The activity-cost chain designed to serve one segment is not optimally suitable for serving another segment, thereby compromising a firm’s ability to serve both segments well. Sharing activities across segments limits the flexibility of modifying strategies in the target segments The net competitive advantage of focusing on one versus several target segments is a function of the balance between the benefits and costs of sharing activities. In general, the stronger the interrelationships among several segments, the more attractive is a multisegment focus strategy. A focuser, to achieve competitive advantage, has to succeed at low-cost leadership or differentiation in its chosen segment or segments. If a focuser opts to pursue low-cost leadership, then the same kinds of cost-reducing approaches as explained above for industrywide cost leadership have to be used in managing the activity-cost chain for the segment. If a focusing firm opts for differentiation, then it must look at buyer needs and develop ways to lower their costs or enhance the performance they get from the product. The specific kinds of differentiating approaches are the same for focusers as for broad competitors. What sets the creation of competitive advantage by focusing apart is that focus strategies are grounded in differences among segments. A focuser excels in serving the target segment. A focuser can gain a segment-based competitive advantage whenever differences across segments make it more costly for broadly targeted competitors to meet the specific needs of buyers in the focuser’s target segments at the same time they are trying to serve other specific needs of buyers in other segments. This is the condition that makes focusing really attractive. When the differences among the segments are slight, a focuser has little defense against more broadly targeted competitors because they can serve the needs of the buyers’ segment about as well as the focuser can. For a focus strategy to be successful over time, three conditions must be present: A focuser must be able to defend its position against inroads from more broadly targeted competitors. This is easier when segment differences are big and harder when they are small. A focuser needs to erect barriers to imitation from other focusers. Another competitor, either new to the industry or one dissatisfied with its current strategy, may try to replicate the focus strategy. The more attractive the segment and the more successful a focuser’s strategy, the greater the threat of imitation (unless the focuser has built a good defense against imitation). A focuser must not be threatened by conditions that will cause the segment to dissolve into the broader market or to shrink to an unattractive size. Competitors serving broader parts of the industry may well use product innovation, advertising, promotional efforts, and other marketing tactics to induce buyers to leave the focuser’s segment and come into theirs. Focusing on a segment or group of segments is not by itself a basis for competitive advantage. For focusing to have a chance for real success, the target segment must involve buyers with different needs or require a seller to employ an activity-cost chain that is different from the chain needed to serve other segments. When more broadly targeted competitors do not face much compromise in serving multiple segments, a focus strategy involves an uphill struggle. A second focus strategy pitfall is viewing the choice of segments served as a permanent decision. The strategically relevant segments evolve over time due to shifts in buyer behavior, demographic changes in the demand side of the marketplace, the emergence of new buyer groups, and developments in new technology. The nature of the target segment must be continually monitored. Two other pitfalls are: choosing a segment that cannot be successfully defended against challengers attracted by the segment’s size and profitability; and going with a single-segment focus strategy and then having the target segment dry up.

OFFENSIVE AND DEFENSIVE STRATEGIES 4

1. Offensive strategies To the extent that a firm can capture and maintain the initiative, competitors are forced to respond to the initiator’s moves defensively and to do so under conditions not of their own choosing. The strategic management challenge in capturing and retaining an offensive initiative involves planning a series of moves aimed at throwing competitors off balance, keeping them on the defensive, and giving them little time to launch initiatives of their own. Strategic offensive options are: • initiatives to match or exceed rivals’ strengths by: developing low-cost edge, under pricing rivals, boosting advertising, introducing new features to appeal to rivals’ customers, attacking with equally good product and lower price; • initiatives to capitalize on rivals’ weaknesses by concentrating one’s competitive strengths and resources directly against rivals’ weaknesses (concentrate on geographic regions where rival has weak market share, go after buyer segments rival is neglecting, go after more performance-conscious customers of rivals who lag behind challenger, attack rivals with weaker advertising and brand recognition); • simultaneous initiatives on many fronts by launching several major initiatives to throw rival off-balance, splinter its attention in many directions, and force it to use substantial resources to defend its position; a challenger with superior resources can overpower a weaker rival by outspending it across-the-board long enough to “buy its way into the market”; • bypass offensives to gain first-mover advantage by: being the first to expand into new geographic markets, trying to create new segments via the introduction of products with different attributes and performance features, being the first to introduce new technologies for products and/or production process; the bypass approaches are: move aggressively into new geographic markets where rivals have no market presence, introduce products with different attributes and features to better meet buyer needs, introduce next-generation technologies, come up with more support services for customers; • guerrilla offensives use principles of surprise and hit-and-run to attack in locations and at times where conditions are most favorable to initiator; it is well-suited to small challengers with limited resources; the options are: focus on narrow target weakly defended by rivals, challenge rivals where they are overextended & when they are encountering problems, make small random attacks; • preemptive strategies involve such moves to secure an advantageous position that rivals are foreclosed or discouraged from duplicating; the options are: expand capacity ahead of demand in hopes of discouraging rivals from following with expansions, tie up best or cheapest sources of essential raw materials, move to secure best geographic locations, obtain business of prestigious customers, build an image in buyers’ minds that is unique and hard to copy, secure exclusive or dominant access to best distributors, acquire desirable, but struggling, competitor. Competitive advantage areas offering strongest basis for a strategic offensive are: develop lowercost product design, make changes in production operations that lower costs or enhance differentiation, develop product features that deliver superior performance or lower users’ costs, give more responsive customer service, escalate marketing effort, pioneer new distribution channel, sell direct to end-users.

2. Defensive strategies

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Represent strategic moves meant to lower the risk of being attacked, to lessen the intensity of any attack, and to influence challengers to opt for less threatening offensive strategies. Can protect and strengthen firm’s competitive advantage, but RARELY are the basis for achieving competitive advantage. The purpose of defensive strategies is to lower the risk of being attacked, to lessen the intensity of any attack that occurs, influence challengers to opt for less threatening offensive strategies, influence challengers to aim attacks at other rivals, strengthen firm’s present position, and help sustain any competitive advantage held. There are substantial numbers of defensive tactics to choose from in formulating a comprehensive defensive strategy. One category of defensive tactics involves trying to block off the avenues that challengers can take in mounting an offensive. The options are: • Broaden product line to fill gaps rivals may go after • Keep prices low on models that match rivals • Sign exclusive agreements with distributors • Offer free training to buyers’ personnel • Give better credit terms to buyers • Reduce delivery times for spare parts • Increase warranty coverages • Patent alternative technologies • Sign exclusive contracts with best suppliers • Protect proprietary know-how A second category of defensive tactics consists of ways to signal challengers that there is a real threat of strong retaliation if the challenger attacks. The defensive moves are: • Publicly announce management’s strong commitment to maintain present market share • Publicly announce plans to construct new production capacity to meet forecasted demand • Give out advance information about new products, technological breakthroughs, and other moves • Publicly commit firm to policy of matching prices and terms offered by rivals • Maintain war chest of cash reserves • Make occasional counter-responses to rivals’ moves

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