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Chapter 4: Business-Level Strategy

 Business-level strategy: integrated/coordinated set of commitments and actions the firm uses to gain a competitive advantage by exploiting core competencies in specific product markets.

o Long-term performance is linked to a firm’s strategies. Choices will be difficult when competing in the global economy.

o Every firm must develop/implement a business-level strategy. Every firm must develop/use at least one business-level strategy.

 Business-level strategy is the core strategy-strategy that firm forms to describe how it intends to compete in a product market.

4.2 Purpose of Business-Level Strategy

 *create differences b/w firm’s position and those of its competitors (by deciding whether it intends to perform activities differently or to perform different activities).

o Strategy defines the path which provides direction of actions to be taken by leaders of organization.

 “Choosing to perform activities differently or to perform different activities than rivals” is essence of business-level strategy.

 Firm’s business-level strategy is a deliberate choice about how it will perform value chain’s primary and support activities to create unique value.

 Successful use of business-level strategy results from firm learning how to integrate activities it performs in ways that create superior value for customers.

o Strategic fit among many activities is critical for competitive advantage.

4.3 Types of Business-Level Strategies (5)

 Each business-level strategy helps firm to establish/exploit a specific competitive advantage within particular competitive scope.

o How firms integrate activities they perform within each different business-level strategy demonstrates how they differ from one another.

 When selecting a business-level strategy, firms evaluate two types of potential competitive advantages: “lower cost than rivals or ability to differentiate and command a premium price that exceeds the extra cost of doing so.”

o Having lower costs results from firm’s ability to perform activities differently than rivals; being able to differentiate indicates firm’s capacity to perform different (and valuable) activities.

 Based on nature/quality of its internal resources, capabilities, and core competencies, firm seeks to form either a cost competitive advantage or distinctiveness competitive advantages as basis for implementing its business-level strategy.

o Two types of target markets are broad markets and narrow market segment(s)

 Firms serving broad market seek to use their capabilities to create value for customers on an industry-wide basis.

 Narrow market segment means that firm intends to serve the needs of narrow customer group. (ex: buyers with special needs and buyers located in specific geographic regions)

 None of the five business-level strategies is inherently or universally superior to the others.

o Effectiveness of each strategy is contingent both on opportunities and threats in firm’s external environment and on strengths and weaknesses derived from firm’s resource portfolio.

 Critical for firm to select business-level strategy that represents effective match b/w opportunities and threats in external environment and strengths of internal organization based on its core competencies.

 After firm chooses strategy, it should emphasize actions that are required to successfully use it.

 Cost-Leadership Strategy: integrated set of actions taken to produce goods/services with features that are acceptable to customers at lowest cost, relative to that of competitors.

o Firms commonly sell standardized goods or services, but with competitive levels of differentiation, to industry’s most typical customers.

 Process innovations (newly designed production and distribution methods/techniques) are critical to successful use of cost-leadership strategy.

o Cost leaders’ goods/services must have competitive levels of differentiation to create value for customers.

 Inbound logistics (materials handling, warehousing, and inventory control) and outbound logistics (collecting, storing, and distributing products to customers) account for significant portions of total cost to produce some goods/services.

 Having competitive advantage in logistics crates more value with cost leadership strategy than with differentiation strategy.

 Cost leaders seeking competitively valuable wats to reduce costs may want to concentrate on primary activities of inbound and outbound logistics.

o Many firms choose to outsource their manufacturing operations to low-cost firms with low-wage employees.

o Care must be taken b/c outsourcing makes firm more dependent on supplier firms over which they have little control.

 Outsourcing creates interdependencies b/w outsourcing firm and suppliers. If dependencies become too great, it gives supplier more power with which the supplier may increase prices of goods/services provided, harming firm’s ability to maintain a low-cost a competitive advantage.

 Cost leaders should carefully examine all support activities to find additional potential cost reductions (find optimal combo of low cost and acceptable levels of differentiation).

 Companies unable to effectively integrate value-chain activities and functions lack core competencies needed to successfully use cost leadership strategy.

 Effective use of cost leadership strategy allows firm to earn above-average returns in spite of the presence of strong competitive forces.

o Rivalry with Existing Competitors

 Having low-cost position is valuable when dealing with rivals. B/c of cost leader’s advantage position, rivals hesitate to compete on basis of price, especially before evaluating potential outcomes of such competition.

 Degree of rivalry present is based on # of different factors; firms may take actions to reduce the amount of rivalry that they face.

o Bargaining Power of Buyers (Customers)

 Powerful customers can force cost-leader to reduce its prices, but not below level at which cost leader’s next most-efficient industry competitor can earn average returns.

 Prices that are low enough to prevent the next-most-efficient competitor from earning above-average returns would force that firm to exit the market, leaving cost leader with less competition and in an even-stronger position.

o Customers would lose their power and pay higher prices if they were forced to purchase from a single firm operating in industry w/out rivals.

 Rather than forcing firms to reduce prices, powerful customers may pressure firms to provide innovative products/services.

 Buyers can develop a counterbalancing power to customers’ power by thoroughly analyzing and understanding each of their customers.

 Buyers can participate in customers’ networks. They can share info, build trust, and participate in joint problem solving with their customers.

o Use info obtained to provide a product that provides superior value to customers by most effectively satisfying their needs.

o Bargaining Power of Suppliers

 Cost leader operates with margins greater than those of competitors and tries to increase its margin by driving costs lower.

 Higher gross margins relative to those of competitors make it possible for the cost leader to absorb its suppliers’ price increases.

 When industry faces substantial increases in cost of its supplies, only cost leader may be able to pay higher prices and continue to earn either average or above-average returns.

o Powerful cost leader may force its suppliers to hold down their prices, reducing suppliers’ margins in prices.

 Firms create dependencies on suppliers by outsourcing whole functions to reduce overall costs. They may outsource activities to reduce their costs b/c of earnings pressures from stakeholders in industry. Outsourcing can create new costs, as suppliers/partners demand larger share of value created.

 Firm may see foreign suppliers whose costs are lower, providing them the capability to offer goods at lower prices.

 When firms outsource (to a foreign supplier), they need to invest time and effort into building a good relationship, developing trust b/w firms.

o Facilitate integration of supplier into firm’s value chain.

o Potential Entrants

 B/c increasing levels of efficiency enhance profit margins, they serve as significant entry barrier to potential competitors.

 New entrants must be willing to accept less than average returns until they gain experience required to approach cost leader’s efficiency.

 To earn average returns, new entrants must have competencies required to match cost levels of competitors other than cost leader.

o Low profit margins make it necessary for cost leader to sell large volumes of its product to earn above-average returns.

o Firms striving to be cost leader must avoid pricing their products so low that they cannot operate profitably, even though volume increases.

o Product Substitutes

 Cost leader holds attractive position relative to product substitutes.

 Product substitute becomes concern for cost leader when its features/characteristics, in terms of cost/differentiation, are potential attractive to firm’s customers.

 Cost leader has more flexibility than its competitors when faced with possible substitutes. To retain customers, it can reduce price of its good/service.

o W/ lower prices and competitive levels of differentiation, cost leader increases probability that customers prefer its product over substitute.

o Competitive Risks of Cost Leadership Strategy

 Cost-leadership strategy is not risk free.

 1) Processes used by cost leader to produce/distribute its good/service could become obsolete b/c of competitors’ innovations.

o Innovations allow rivals to produce goods/services at costs lower than those of original cost leader or to provide additional differentiated features w/out increasing product’s price to customers.

 2) Too much focus by cost leader on cost reductions may occur at expense of trying to understand customers’ perceptions of competitive levels of differentiation.

 3) Imitation-using their own core competencies, competitors sometimes learn how to successfully imitate cost leader’s strategy.

o Cost leader must increase value its good/service provides to customers.

o Value is increased by selling current product at even lower-price or by adding differentiated features that create value for customers while maintaining price.

 Differentiation Strategy: integrated set of actions taken to produce goods/services (at an acceptable cost) that customers perceive as being different in ways that are important to them.

o Target customers for whom value is created by manner where the firm’s products differ from those produced/marketed by competitors.

 Product innovation, (bring to life new way to solve customer’s problem), through new product/service development that benefits both customer and sponsoring company, is critical to successful use of differentiation strategy.

o Firms must be able to produce differentiated products at competitive costs to reduce upward pressure on price that customers pay.

 When product’s differentiated features are produced at noncompetitive costs, price for product may exceed what the firm’s target customers are willing to pay.

 If firm has thorough understanding of when its target customers value, relative importance they attach to satisfaction of different needs and for what they’re willing to pay a premium, differentiation strategy helps them earn above-average returns.

 Firm must apply its knowledge capital (held by employees/managers) to provide customers with differentiated product that provides them with superior value.

o Firm produces distinctive products for customers who value differentiated features more than they value low cost.

o To maintain success with differentiation strategy results, firm must consistently upgrade differentiated features that customers value and/or create new valuable features w/out significant cost increases (requires firms to constantly change their product lines).

 Firms offer portfolio of products that complement each other, enriching differentiation for customer and satisfying portfolio of consumer needs.

 Firms can charge premium prices when a differentiated product satisfies customers’ unique needs.

 The ability to sell good/service at price that substantially exceeds cost of creating its differentiated features allows firm to outperform rivals and earn above-average returns. Firms can concentrate on investing in/developing features that differentiate product in ways that create value for customers.

o Firms using differentiation strategy seeks to be different from its competitors on as many dimensions as possible.

 Good/service can be differentiated in many ways: unusual features, responsive customer service, rapid product innovations/technological leadership, perceived prestige and status, different tastes, and engineering design and performance (examples).

 Virtually anything a firm can do to create real/perceived value is basis for differentiation.

o Companies w/out skills needed to link value-created activities can’t expect to successfully use differentiation strategy.

o Rivalry with Existing Competitors

 Customers tend to be loyal purchasers of products differentiated in ways that are meaningful to them. As loyalty to brand increases, customers’ sensitivity to price increases is reduced.

 Relationship b/w loyalty and price sensitivity insulates of firm from competitive rivalry. Reputations can sustain competitive advantage of firms following differentiation strategy.

o Bargaining Power of Buyers (Customers)

 Distinctiveness of differentiated goods/services reduces customers’ sensitivity to price increases. Customer are willing to accept a price increase when a product still satisfies their unique needs, better than a competitors’ offering.

 Purchasers of brand-name food items accept price increases in those products if they continue to perceive that the product satisfies their distinctive needs at an acceptable cost.

o Customers are relatively insensitive to price increases b/c they do no think an acceptable product alternative exists.

o Bargaining Power of Suppliers

 B/c firm using differentiation strategy charges premium price for its products, suppliers must provide high-quality components, driving up firm’s costs.

 High margins firm earns in these cases insulate it from influence of suppliers in that higher supplier costs can be paid through these margins.

o Due to buyers’ relative insensitivity to price increases, differentiated firm might choose to pass additional cost of supplies on to the customer by increasing price of its unique product.

o When buyer firms outsource total function or large portions of its to a supplier, they can become dependent on and vulnerable to that supplier.

o Potential Entrants

 Customer loyalty and need to overcome uniqueness of differentiated products creates substantial barriers to potential entrants, demanding significant investments of resources and patience while seeking customers’ loyalty when trying to enter industry under those conditions.

 Potential entrants may decide to make smaller investments to see if they can gain “foothold” in market. If it does not work, they will not lose major resources, but if it works, they can invest greater resources to enhance their competitive position.

o Potential Substitutes

 Firms selling brand-name goods/services to loyal customers are positioned effectively against product substitutes.

 Companies w/out brand loyalty face higher probability of customers switching either to products that offer differentiated features that serve same function or to products that offer more features and perform more attractive functions.

 May be vulnerable to innovations from outside industry that better satisfy customers’ needs.

o Competitive Risks of Differentiation Strategy

 1) Customers might decide that price differential b/w differentiator’s product and cost leader’s product is too large.

 Firm may be offering differentiated features that exceed target customers’ needs. Firm becomes vulnerable to competitors that are able to offer customers a combo of features and prices that is more consistent with their needs.

 2) Firm’s means of differentiation may cease to provide value for which customers are willing to pay.

 Differentiated product becomes less valuable if imitation by rivals causes customers to perceive that competitors offer essentially same goods/services, but at lower price.

 3) Experience narrows customers’ perception of value of product’s differentiated features

 To counter this risk, firms must continue to meaningfully differentiate their product for customers at price they are willing to pay.

 4) Counterfeiting: products labeled w/ trademark or logo that is identical to or indistinguishable from legal logo owned by another party-infringing rights of legal owner. When customer purchases such product and discovers deception, regret creates distrust of branded product and reduces differentiation.

 Focus Strategies: integrated set of actions taken to produce goods/services that serve needs of particular competitive segment.

o Use when firms utilize their core competencies to serve needs of particular industry segment or niche to exclusion of others.

o Examples of specific market segments that can be targeted by focus strategy include:

 Particular buyer group; different segment of product line; & different geographic markets

o Essence of focus strategy is exploitation of narrow target’s differences from balance of industry. Firms using focus strategy intend to serve a particular segment of an industry more effectively than can industry-wide competitors.

o Focused Cost Leadership Strategy (ex: IKEA)

o Focused Differentiation Strategy (ex: food trucks)

o With focus strategy, firms must be able to complete various primary value-chain activities and support functions in competitively superior manner to develop and sustain a competitive advantage and earn above-average returns.

 Activities required to use focused cost leadership strategy are virtually identical to those of industry-wide cost leadership strategy and activities required to use focused differentiation strategy are largely identical to those of industry-wide differentiation strategy. The manner that each of two focus strategies allows firm to deal successfully with five competitive forces parallels those of two broad strategies.

 Only difference is in firm’s competitive scope; the firm focuses on a narrow industry segment.

 Competitive forces in given industry often favor either cost leadership or differentiation strategy.

o Competitive Risks of Focus Strategies (additional to those general risks when using cost-leadership or differentiation strategies on industry-wide basis)

 1) Competitor may be able to focus on a more narrowly defined competitive segment and “out-focus” the focuser.

 2) Company competing on industry-wide basis may decide that market segment served by firm using a focus strategy is attractive and worthy of competitive pursuit.

 3) Needs of customers within narrow competitive segment may become more similar to those of industry-wide customers as a whole over time.

 As a result, advantages of focus strategy are either reduced or eliminated.