Business 42001- Knez

Business 42001- Knez

Competitive Strategy

Lecture 4: Mid-Quarter Review

1 University of Chicago/Knez

Topics Covered Through Week 4

 Competitive Strategy Basics – – – –

Industry Analysis (Five Forces) Core Business Strategy - VP, Target Markets, Critical Capabilities Strategic Positioning and Competitive Advantage Sustainable Competitive Advantage

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Five Forces - Basic Questions 

Barriers to Entry - the key question:

–

To what extent does the threat or incidence of entry erode the profitability of a typical firm in the industry?



Supplier Power - The key question: –



To what extent do suppliers have stronger outside options than buyers, and hence, a stronger bargaining position?

Buyer Power - The key question To what extent do buyers have stronger outside options than buyers, and hence, a stronger bargaining position? Substitutes - The key question: – To what extent does competition from substitute products outside the defined boundaries of the industry erode the profitability of a typical firm in the industry? Rivalry - The key question: – To what extent does price competition or non-price competition (e.g., advertising) erode the profitability of a typical firm in the industry? –





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How the Five Forces Affect Economic Profitability

Substitutes

Supplier Power

-

+

-

Economic Profit = (Price - Average Cost) X Sales Volume - Cost of Capital x Capital Invested

Buyer Power

-

-

+

Threat of Entry

Rivalry

-

Actual Entry

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Industry Analysis - Additional Considerations 

Determining the scope of the industry analysis entails –

Scope of product/services

–

Scope of customer segments



A natural dividing line on industry scope is where distinct value chains are required to generate and deliver a particular type of value - e.g. Rail versus Air within the more broadly defined Transportation industry.



Within a defined industry scope (e.g. the PC industry in the US) there will be sub-segments (large enterprise versus consumer in PC industry). The degree to which each of the five forces limits profitability of the industry may vary across the market sub-segments (and will almost always vary between the low-end and high-end of a defined industry).



Given that firms in the industry can choose to compete in all segments of the industry (broad scope) or a limit number of segments (focus strategy), the relative performance of these firms may vary according to the differences in one or more of the five industry forces they face. 5 University of Chicago/Knez

Industry Factors Vs. Industry Forces*  An industry’s 5-forces determine the long-run profit potential of the industry - how much of the value is retained by companies in the industry, versus:

– – – –

Bargained away by customers or suppliers Limited by substitutes Constrained by potential new entrants Competed away through high levels of rivalry

 Industry (or Environmental) Factors are external forces or industry attributes that also impact the profitability of the industry, but in ways that may be positive or negative depending on the broader industry context (most importantly, the five forces). Common industry factors include:

– – – –

Macro and Industry Growth Rate Technological change Government – Political and Regulatory conditions Importance of complementary products and services

*See – The Five Competitive Forces that Shape Strategy, by Michael Porter, HBR Jan. 2008.

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Business Strategy = Core Elements + Strategic Positioning Business Strategy Group of customers that have a need and willingness-to-pay for the Value Proposition

A formula for creating distinctive value in a well defined set of markets through a distinctive set of capabilities (resources and activities).

Business Strategy

Core Elements Target Customers Characteristics of the good or service that generates value at a particular price

Business Strategy

Strategic Positioning Value Proposition

+ Critical Capabilities

How the core elements of the business strategy are intended to create greater value than the competition through higher relative benefits (differentiation) or lower costs.

Set of resources and activities necessary to create and deliver the value proposition to the target market.

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Describing the Core Business Strategy  The (generic) description below represents the objective. It represents a formula for creating a competitive advantage.  For the purposing of actually analyzing and assessing a company’s business strategy, a more comprehensive description is required to support the analysis.

Value Proposition

Target Market Segments

Distinctive elements of the products & services offered to target market?

Groups of customers that are the target of the distinctive value proposition?

Critical Capabilities The critical capabilities (resources and activities) that generate distinctive outcomes created (higher Benefits, or lower Costs) relative to the competition. 8

Analyzing the Core Business Strategy 

It is critical that the approach taken to describing company’s strategy allows for the possibility that it has a competitive disadvantage. Put differently, the description needs to be broader than just those elements that are distinctive relative to the competition because this may be a very short list. At a high level, the process goes as follows:

1.

Given the target market, and the set of needs being served in this target market, what elements of a company’s value proposition must be provided (at some threshold level) for a firm to be competitive? –

Being competitive does not mean the firm has a competitive advantage. It means that they meet the threshold values of the core elements of any value proposition (e.g. table stakes).

–

In the typical strategy exercise the analysis begins with a broadly defined addressable market. Within the addressable market the market sub-segments that will represent target market segments.

–

In many cases, the target market segment (while identified to support a single value proposition) will require aggregating across multiple types of customers within that target market segment. Hence, there will still be the ability to focus on smaller subsegments that have a willingness pay for either exceeding the threshold values, and or, additional elements not on the list of core elements. These sub-segments are the basis for a differentiation strategy within a more broadly defined target market 9 segment.

Analyzing the Core Strategy: Process Cont. 2.

Given the core elements of the value proposition and their respective threshold values (e.g. the table stakes), and the identified competitors, on what dimensions does the company have an advantage relative to the competition? A disadvantage? –

– –

–

The competition includes those companies that can meet the table stakes, but is usually identified in terms of existing market shares (which implies that they are meeting the table stakes). Often the table stakes can be initially characterized by examining the value propositions of the major players serving the target market. Note that price is always a critical element of the value proposition. Moreover, the threshold values for each table stake are the basis for a low cost (low price) strategy. In many, if not most, business strategy contexts, the target market should be defined broadly enough to allow for alternative strategic positions along Porter’s classic typology - low cost versus differentiation, broad versus focused. With this in mind, it is critical that the relevant sub-segment(s) be clearly defined when identifying a competitive advantage (or disadvantage). Note that potential benefit advantages can be identified by simply comparing the company’s value propositions to it’s competition. However, a cost advantage cannot be necessarily identified through lower price (although it is a strong indicator.) For example, we can identify Dell’s benefit advantage of quicker delivery times by simply looking at delivery time data, without necessarily needing to know how it is able to provided faster delivery times. That said, in some cases it is possible to make an “apples-to-apples” comparison and conclude a cost advantage (e.g. hedged fuel prices in the airline industry). 10

Analyzing the Core Strategy: Process Cont. 3.

Given the identified advantages or disadvantages, what are the existing critical capabilities that are either generating the advantages, or missing critical capabilities that are generating the disadvantage? – –

–

This is when the detailed activity analysis comes into play, recognizing that an activity analysis may have been required to identify a cost advantage (as mentioned above). In general, • Benefit advantages are identified by identifying differences across value propositions. Understanding how the benefit advantage (or disadvantage) is created requires activity analysis. • Cost advantages (while potential indicated by lower price) may need to be uncovered by the activity analysis. – In some cases this is easy because the company has a different business model that allows it to avoid costly activities (e.g. Dell). – In other case, the cost advantage may be the result of more complex reasons that involve a company’s ability to better execute on a set of activities that all players need to conduct. Where possible, the performance requirements of the activity should be tied to the appropriate benefit drivers (elements of the value proposition) and to cost drivers factors that drive the company’s relative cost position. 11

Competitive Advantage and tradeoffs Theme 1: Competitive Advantage, tradeoffs, activity fit: Three key points from Porter - What is Strategy?: – Strategy is the creation of a unique and valuable position, involving a different set of activities. – Strategies requires you to make trade-offs in competing - to choose what not to do. – Strategy involves creating “fit” among a company’s activities. Theme 2: Strategic Positioning Tradeoffs (Benefit, Cost, and degree of Focus) – Benefit focus entails providing a differentiated value proposition that is (almost always) more costly to provide. Success requires that the benefits provides, along with the effectiveness of execution, overcome the higher costs – Cost focus entails providing sufficiently high benefits at a lower price. Success requires maintaining the cost advantage, while ensuring sufficient benefits are provided to capture sufficient market share. 12

Taxonomy of Isolating Mechanisms

“They can’t get the resources they need to imitate my competitive position”

Barriers to imitation

“They can’t figure out my formula for success or re-create the process by which I became successful” “They know how to imitate my competitive position, but they wouldn’t want to since it would be unprofitable for them to do so.”

Early mover advantages

“By the time they imitate my current position, I’ll be in a superior position.”

feedback effects

*Generated by David Besanko (NW), used with his permission. University of Chicago/Knez

• Legal barriers (patents, trademarks, licenses) • Privileged access to inputs, channels, or customers • Causal ambiguity • Path dependence • Social complexity • Positional barrier to imitation based on economies of scale and sunk costs • Experience advantages in markets with learning curves • Product “track records” in markets for experience goods • Consumer switching costs • Installed base advantage in markets with network externalities

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Sustainability - Summary 

Business strategy is about formulating and executing a strategy that both creates a competitive advantage, and is sustainable over time.



Sustaining a competitive advantage requires: – A clear understanding of the isolating mechanisms that support sustainability – Investments and adjustments that either strengthen existing isolating mechanisms, or create new ones.



Beyond innovative strategies from competitors that threaten sustainability, sustainability is always eventually threatened by changes at the industry level: –

Technology: Exogenous technological change that impacts an industry or endogenous investments in R&D by firms in industry

–

Consumer taste and demographics • Exogenous change from demographic shifts or industry life cycle (market saturation) • Endogenous change from innovative marketing or product design

–

Regulatory Changes

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Midterm Details 

Start time: 6:05 (1:35 on Campus, 9:05 on Saturday) Sharp! Total Time 1 hour and 30 minutes



Materials: The Arborite case (which you can write on) and a “cheat sheet” - one page, double-side



All readings fair game, but focus is on topics covered in class. I will not ask questions that require an understanding of a topic that I did not explicitly cover in class.



Concerning the Arborite case, be sure to consider the strategies of all the players discussed, not just Arborite.



Bring legal pad to record answers, I’ll bring lined paper if you need it.



All preparation should be done individually. If need help with a basic concept, it is okay to ask a classmate for help, but the case itself should not be discussed in anyway.

 It is a violation of the honor code to share the exam with students in other sections that have not yet taken the exam. 

After the mid-term you will participate in the Shrimp Exercise described on the next slide. 15 University of Chicago/Knez

In-Class Shrimp Exercise  

Arnold, Beatrice, and Charlotte own the only three shrimp boats on the island of Cournot. Each incurs a cost of $5.00 per pound of shrimp (this includes the opportunity cost of time) and each can catch at most 75 pounds per day. At the end of each day, they bring their catch to market where price is determined by market demand and the supply of fish. Let QA, QB, and QC denote Arnold’s, Beatrice’s and Charlotte’s catch, respectively. Once each has decided when to stop fishing and has brought his or her shrimp to market, the price is determined by the following equation: 



Each shrimper agrees that the above equation correctly predicts the market price of shrimp, and each tries to catch enough shrimp so as to maximize his or her dollar profits. All shrimp goes bad after one day, so a shrimper cannot keep shrimp off the market and sell them the next day. The profits for each shrimper equals the number of pounds caught multiplied by its profit margin, that is 



 



P(QA, QB, QC) = 45 - .2 (QA + QB + QC).

PA(QA, QB, QC ) = QA [P(QA, QB, QC) - 5].

You are Arnold, Beatrice, or Charlotte. Each day you will be asked to set that day’s level of production. Note that you are not able to catch more than 75 pounds of shrimp per day. The amount of money you earn at the end of the day will equal the value described above. Remember your goal is to maximize your own profits; you do not care at all about the profits of the other shrimpers. All shrimp is traded at the Cournot Fish Market. When trade takes place each shrimper reveals its level of production for that day, so this information becomes public knowledge. The three shrimpers have a history of family feuds and no personal contact. Each will have to set its shrimp production for the day without knowing what levels the other two shrimpers set. However, as described above, at the end of each day the production levels that were set by each shrimper will become public knowledge. In class, you will be divided into teams and asked to make quantity decisions for one of the shrimpers. There will be several rounds and several different scenarios. In some cases, all decisions will be made simultaneously, while in others, one shrimper will go before the other two. In the latter case, the first-mover’s decision will be announced to its two rivals before they make their decisions.

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