4.3. Competitive advantage

Question 1

Define competitive advantage

Answer 1

the ability of a company to outperform (in terms of profitability) its competitors in a given industry

Question 2

Define willingness to pay

Answer 2

maximum amount a customer would pay for a unit

Question 3

Define opportunity cost

Answer 3

lowest price suppliers is willing to sell the input for

Question 4

In reality, what’s the problem with willingness to pay and opportunity cost?

Answer 4

defining willingness to pay for each individual customer is difficult because it differs among them. same logic applies to opportunity cost

Question 5

What’s the ideal outcome?

Answer 5

• willingness to pay = price
• opportunity cost = cost
• added value = profit captured

Question 6

What’s the reality of the outcome

Answer 6

• price < willingness to pay
• opportunity cost < cost
• added value > profit captured

Question 7

How firms create competitive advantage?

Answer 7

1. pushing cost to opportunity cost barrier

2. pushing price up to willingness to pay

Question 8

Ways to create competitive advantage

Answer 8

1. Differentiation strategy: increase consumers’ willingness to pay without increasing costs
2. Cost strategy: decrease firm
   cost without decreasing consumers’ willingness to pay
3. Dual strategy: increase consumers’ willingness to pay and at the same time decrease firm cost

Question 9

Example of cost strategy: Southwest

Answer 9

Basic strategy:
- competing only on cost
- focus on most price sensitive customer segment
- fly in small airports and from small cities to big cities
=> operate in a niche
How does strategy work:
- lower labour costs and higher usage of planes (lease)
- utilisation - pilots and airplanes are in the air longer hours - economies of fixed cost absorption
- less rigid contracts
- no meals, no services, standardised planes, smaller airports without congestion

Question 10

Example dual strategy: JetBlue

Answer 10

• is not “no frills”, it is “selective frills”:
  + in flight entertainment
  + leather seats
  + premium price on convenient routes (NYC, Miami)
  • Don’t fly the “frumpy” routes (e.g. the routes Southwest would fly)
  • Employees are not unionized; strong culture; innovative recruiting for non-pilot jobs (e.g. college students saving $ for travel)
  • We discussed how there is little differentiation in general (when talking about existing rivalry) but somehow JetBlue managed to differentiate.

Question 11

Niche strategies

Answer 11

• Identifying a specific customer segment and only targeting them (e.g. understanding preferences and habits and ignoring all other potential customers)
• The danger is often that successful firms want to grow out of their niche and gain different customers. In the process they may loose their competitive advantage

Question 12

2 types of industry structure

Answer 12

1. Cost leadership approach (total market
   or niche)
2. Differentiation approach (total market or niche)

Question 13

When to use Cost leadership approach (total market

or niche)

Answer 13

• The nature of the product does not allow benefit enhancement (e.g. a commodity)
• Consumers are price sensitive (elastic demand)
• Economies of scale => invest more to become the biggest player in the market

Question 14

When to use Differentiation approach (total market or niche)

Answer 14

• Consumers are willing to pay a premium for benefit enhancements
• No economies of scale/learning left and differentiation is the best route to value creation
• “Experience good” (product complex to evaluate before the purchase/use … )

Question 15

Dual strategy

Answer 15

• difficult to maintain

- exceptions might be if the firm has economies of scale but can still differentiate

Question 16

Where does economic performance result from?

Answer 16

2 forces:

• industry structure (industry attractiveness)
• strategic positioning (build/sustain competitive advantage)

Question 17

Porter’s opinions on strategic positioning

Answer 17

• the essence of strategy is performing different activities from rival’s or performing similar activities in different ways (not about being better, about being different)
• competing to be best = run the same race
• competing to be unique = run a different race
  => operational effectiveness is not equivalent to strategy

Question 18

Operational effectiveness

Answer 18

• means performing similar activities better than rivals (reducing defects faster, outsourcing production to a cheaper location,…etc.)
• differences in OE are important differentiators in profitability among rivals as OE directly affects relative cost positions and levels of differentiation
• BUT it is not strategy (according to Porter)

Question 19

How does a company figure out what is unique about them?

Answer 19

Activity analysis:

1. Catalog activities (the value chain) - primary activities engaged in for the primary purpose of making a profit
2. Analyse relative costs
3. Analyse willingness to pay
4. Explore options and make choices

Question 20

Analyse relative costs

Answer 20

1. must calculate the costs associated with each activity
2. quantification and comparison of those costs
3. determine the cost drivers associated with each activity
4. compare to competitors

Question 21

Analyse the willingness to pay

Answer 21

every activity in the value chain generates not only costs but also willingness to pay
it heavily depends on intangible factors and perceptions (hard to measure):
• Who is the real buyer of your
product/service?
• What the buyers want (final
consumer of supermarket)?
• How successfully are you, and
your competitors, at fulfilling
consumer’s needs?
• Which activities satisfy these
needs?
- analyse in terms of price, brand image, freshness, variety, size

Question 22

Important remark about willingness to pay and relative costs

Answer 22

• Reducing (increasing) costs drastically lowers firm cost, but often it also lowers (raises) willingness to pay
• What is the ultimate effect on firm profit, and its relative size (i.e. compared to competitors)?
  • How are our customers reacting?
  • How are competitors reacting?
  • More generally, eliminate costs that do not contribute to willingness to pays

Question 23

What does sustainable positioning require?

Answer 23

Trade offs

Question 24

Trade offs

Answer 24

• Trade-offs occur when activities are incompatible
• Trade-offs arise for 3 main reasons:
1. inconsistencies in image/reputation
2. different positions require different activity
sets
3. internal focus requires priority setting
• A trade-off means firms must actively decide NOT to do something

Question 25

Failure of evaluating trade offs: Air Berlin

Answer 25

Air Berlin – low performance for almost a decade; now bankruptcy.
Why?
• Probably several reasons, one being the close relationship between Lufthansa and the German government (some speak of anti-competitive behavior)
• Also note: “Air Berlin had some massive structural challenges. One basic problem: The airline never settled on a strategy. For a long time, it wanted to be a discount airline focused on attracting leisure customers. But it never could get its costs to to match other low cost airlines in Europe.” (half ass)

Question 26

IKEA strategy

Answer 26

do:
- low cost appeal for mass market
- low cost, ready to assemble furniture
- display products in room like setting
- self service model
- in house design
- target young price sensitive customers
not do:
- both high end and low cost furniture
- high level of service
- manufacture own furniture
- target all kinds of customers

Question 27

Why does competitive advantage do not last in perfect competition?

Answer 27

In perfectly competitive markets, profits will tend to zero and competitive advantage cannot be sustained
• Homogeneous products: price competition
• Non-homogeneous products: free entry and costless imitation

Question 28

Why does competitive advantage do not last in monopoly?

Answer 28

1. Imitation

2. Substitution

Question 29

Imitation

Answer 29

Imitation increases the supply of what a firm “uniquely” provides
• Sources:
– Herd behavior
– Risk aversion
– Following the path of least resistance

Question 30

Barriers to imitation

Answer 30

• Economies of scale and scope
• Learning / private information
• Contracts and relationships / legal restrictions - patents
• High switching costs
• Complexity (we’ll look at IKEA again)
• First mover advantage / Upgrading

Question 31

Substitution

Answer 31

• Substitution reduces the “demand” for what a firm uniquely provides by shifting the demand elsewhere
– Due to changes in technology, customer needs, input prices, etc.
– Provides higher WTP and / or lower costs to substantial segment of customer base
• Substitution threats can be subtle and unexpected
– Videoconferencing vs. air travel – On-line vs. conventional trading – Analog vs. digital photography

Question 32

Responses to substitution

Answer 32

• Fight the threat
– Face up to your loss of uniqueness, and reduce price before the substitute gets a foothold
• If you can’t beat them, join them
– Will you have a competitive advantage? – Will you accelerate cannibalization?
• Take the money and run

Question 33

Process of strategy

Answer 33

1. Analysis: internal and external
2. Formulate strategy
   • Strategies at business level and corporate level (diversification, acquisitions…)
   • Use your resources/capabilities including intangible things like culture, leadership
3. Implementation

Question 34

How to stay unique?

Answer 34

1. Activity Analysis: understand what your customers actually value, understand what actually drives your costs
2. Resources, resources, resources: understand the value of your tangible and intangible (culture, values) and
   human capital (employees’ skills, motivation)
3. Trade Offs: Understand that a strategy means doing something and not doing something else (opportunity cost)
4. Threats to your uniqueness (imitation, substitution): be aware and address if possible