Organization & Strategy Tools & Concepts II

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1 Tools & Concepts II February 2003

2 Contents 1 Introduction to the Strategic Process 2 Creating Competitive Advantage 3 Competitive Positioning 4 Sustaining Competitive Advantage 5 Introduction to financial analysis 1

3 Introduction to the Strategic Process What is the Strategic Process? Superior long-run Return on Investment Attractive Industry Structure Competitive Advantage Unique Competitive Position Operational Effectiveness Location 2

4 Contents 1 Introduction to the Strategic Process 2 Creating Competitive Advantage 3 Competitive Positioning 4 Sustaining Competitive Advantage 5 Introduction to financial analysis 3

5 Creating Competitive Advantage Differences in financial performance Industry structure shed some light on differences in performance. But industry averages can mask large differences in profitability within industries A firm that earns superior, long-run financial returns within its industry is said to enjoy a competitive advantage over its rivals 4

6 Creating Competitive Advantage How to create an advantage? 1. A firm must configure itself to do something unique and valuable ----> Concept of added value 2. Competitive advantage comes from the full range of a firm s activities - from finance to production, from marketing to logistics - acting in harmony To find an integrated set of choices that distinguishes a firm from its rivals 5

7 Creating Competitive Advantage Value creation and distribution Supplier opportunity cost Cost Price Willingness to pay 2.0 Mio 2.5 Mio? Mio 7.5 Mio Total value created by this transaction is the difference between customer s willingness to pay and the supplier s opportunity cost Added value of the players? 6

8 Creating Competitive Advantage Value creation and distribution Supplier H opportunity cost 2.0 Mio Willingness to pay for H 7.5 Mio Supplier K opportunity cost 2.0 Mio Willingness to pay for K 7.5 Mio Added value of the players? 7

9 Creating Competitive Advantage Value creation and distribution Supplier H opportunity cost 3.0 Mio Willingness to pay for H 9.0 Mio Supplier K opportunity cost 2.0 Mio Willingness to pay for K 7.5 Mio Added value of the players? 8

10 Creating Competitive Advantage Link with competitive advantage Firms create a competitive advantage by positioning themselves to have added value. The larger the added value, the greater the potential profit of the firm. Two ways to boost its added value = to drive a larger wedge than its rivals do between customer willingness to pay and supplier opportunity cost 1. To raise customers willingness to pay for its products without incurring a commensurate increase in supplier opportunity cost 2. To devise a way to reduce supplier opportunity cost without sacrificing commensurate willingness to pay Competitive advantage derives fundamentally from scarcity 9

11 Creating Competitive Advantage Types of competitive advantage Industry average competitor Willingness to pay Supplier opportunity cost 10

12 Creating Competitive Advantage Types of competitive advantage Raise willingness to pay a great deal with only slight increases in costs = Differentiation strategy Reap large cost savings with only slight decrease in customer willingness to pay = Low-cost strategy 11

13 Creating Competitive Advantage Activity analysis Competitive Advantage Lower cost Differentiation Activities 12

14 Creating Competitive Advantage Step 1 Catalog Activities - The Value Chain Firm infrastructure: financing, legal, accounting Human Resources: recruiting, training, incentive system Technology development: inventory system,. Support activities Procurement Inbound Logistics Operations Outbound Logistics Marketing & Sales Service Primary activities 13

15 Creating Competitive Advantage Step 2 Use activities to analyze relative costs Determine a set of cost drivers associated with each activity Focus on differences in individual activities, not just differences in total cost Pay attention to cost categories that pick up on significant differences across competitors or strategic options correspond to technically separable activities are large enough to influence the overall cost position Activities that account for a thicker slice of costs deserve deeper treatment in terms of cost drivers Sensitivity analysis is crucial because it identifies the assumptions that really matters 14

16 Creating Competitive Advantage Step 3 Use activities to analyze relative willingness to pay Willingness to pay is influenced by: Product design and manufacturing activities that influence physical product characteristics activities associated with sales and delivery activities associated with post-sale service or complementary goods signals through advertising, packaging, branding efforts support activities such as hiring, training create a helpful staff 15

17 Creating Competitive Advantage Step 4 Explore Options and Make Choices Distill the essence of the insights which drive each competitor When considering changes in activities, consider competitor reactions Managers tend to fixate on physical product characteristics and to think too narrowly about benefits to buyers. Consider the full range of ways in which all of their activities can create added value. In rapidly changing markets, pay special attention to bleeding edge customers Underserved customer segments represent a significant opportunity ----> Eliminate activities that generate costs without creating commensurate willingness to pay. Search for inexpensive ways to generate additional willingness to pay 16

18 Creating Competitive Advantage Step 4 Make choices Competitive advantage comes from an integrated set of choices about activities Think in terms of landscape Managers operate in a high-dimensional space of decisions. Each point in this space represents a different set of choices, a different configuration of activities. The elevation corresponding to each point is the added value generated by this configuration. The goal is to guide its firm to a high point on this landscape. 17

19 Creating Competitive Advantage Conclusion A successful firm does not simply participate in an attractive industry. It also positions itself to have a competitive advantage within its industry. Competitive advantage derives from added value To have added value,a firm must drive a wedge between customer willingness to pay and supplier opportunity cost To attain a wider wedge, a firm has to do different things than its rivals on a day-to-day basis. These differences in activities and their effect on relative cost position and relative willingness to pay, can be analyzed in detail A firm can use its analysis of activities to generate and assess options for creating competitive advantage 18

20 Contents 1 Introduction to the Strategic Process 2 Creating Competitive Advantage 3 Competitive Positioning 4 Introduction Sustaining Competitive to financial Advantage analysis 5 Introduction to financial analysis 19

21 Competitive Positioning Three Generic Strategies Type of advantage Lower cost Differentiation Scope Broad Cost Leadership Differentiation (Variety/ Customer/ Geography) Narrow Cost Based Focus Differentiation Based Focus Source: Micro-economics for strategists is derived from HBS note

22 Competitive Positioning Origins of scope Variety-Based Limit the varieties offered Tailor activities to deliver particular varieties, features or services across customer groups (to meet a subset of their needs) Needs-based Limit the customers served based on needs Tailor activities to meet all or most of the particular needs of a distinct customer group/ purchase occasion Access-Based Limit the customers served based on means to serve Tailor activities to reach differently accessible customers with similar needs Source: Micro-economics for strategists is derived from HBS note

23 Competitive Positioning Sustaining Positions - Competitive Dynamics Choosing a unique competitive position is necessary but not sufficient to create a sustainable competitive advantage sustainability is defined as the ability to stay ahead A position must involve barriers to competitive imitation, which can take three forms: Repositioning Straddling New entry 22

24 Competitive Positioning Barriers to imitation Traditional barriers to imitation: Intrinsic difficulty of matching activities Commitments/ barriers to mobility --->These are often limited given capable rivals 23

25 Contents 1 Introduction to the Strategic Process 2 Creating Competitive Advantage 3 Competitive Positioning 4 Sustaining Competitive Advantage 5 Introduction to financial analysis 24

26 Sustaining Competitive Advantage Sustaining a Unique Position requires tradeoffs Tradeoffs are incompabilities between activities and positions that create the need for choice providing more of A necessitates less of B serving customer X well means not serving customer Y Tradeoffs substantially increase the cost of imitation Tradeoffs cause competitors not to want to 25

27 Sustaining Competitive Advantage Sources of tradeoffs Incompatible product attributes or features Differences in the best configuration of activities Inconsistencies in image or reputation Limits on internal coordination, motivation, measurement, and control 26

28 Sustaining Competitive Advantage Fit and competitive advantage Sustainable competitive advantage arises from the way activities fit and reinforce each other The configuration of one activity increases the competitive value of other activities The company s advantage rests in the activity system, not in the parts Strategic fit reinforces the uniqueness of a company s strategic position, amplifies tradeoffs, and is difficult to imitate 27

29 Sustaining Competitive Advantage Types of Fit Optimization of Effort Activity Reinforcement Effort in one activity leads to a lower cost or greater differentiation in others, coordination eliminates redundancy and minimizes wasted efforts. Reinforcement across activities or groups of activities. Activities are complementary Simple Consistency Consistency between each activity and the overall strategy 28

30 Sustaining Competitive Advantage Fit and strategy Tailor many activities to position Strengthen the fit among activities The strategic value of outsourcing depends on fit: outsourcing tends to make activities generic tailor supplier to strategy Improve the strategy (and counter rivals moves) in ways that extend and strengthen the fit 29

31 Sustaining Competitive Advantage Positioning and Industry Structure Superior long-run Return on Investment Attractive Industry Structure Competitive Advantage Good positioning offsets unfavorable aspects of industry structure Industry structure at the segment level is one determinant of the attractiveness of a positioning Positioning choices can influence industry structure positively or negatively Strategy seeks to create positive sum (positioning) competition vs. zero sum (OE) competition 30

32 Contents 1 Introduction to the Strategic Process 2 Creating Competitive Advantage 3 Competitive Positioning 4 Sustaining Competitive Advantage 5 Introduction to financial analysis 31

33 Introduction to financial analysis Using ratios to think about management strategies Du Pont Analysis Income x Sales x Assets = Return on Equity Sales Assets Equity Profit margin: relationship between the price and costs of products sold Asset turnover: emphasizes the efficient use of resources Leverage: ability to manage a high proportion of debt to shareholder contributions 32

34 Project Project Analyze industry attractiveness in which the firm operates Articulate existing positioning of the firm competitive advantage scope activities Investigate effect of location and if applicable of corporate strategy Investigate vulnerabilities/areas for improvement relative to rivals and changes in industry structure (dynamics) Submit subject on 03 March in group of 3 students maximum Submit work on 14 May Limit of 15 pages (double-space) 33

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