4.3. Competitive advantage Flashcards
Define competitive advantage
the ability of a company to outperform (in terms of profitability) its competitors in a given industry
Define willingness to pay
maximum amount a customer would pay for a unit
Define opportunity cost
lowest price suppliers is willing to sell the input for
In reality, what’s the problem with willingness to pay and opportunity cost?
defining willingness to pay for each individual customer is difficult because it differs among them. same logic applies to opportunity cost
What’s the ideal outcome?
- willingness to pay = price
- opportunity cost = cost
- added value = profit captured
What’s the reality of the outcome
- price < willingness to pay
- opportunity cost < cost
- added value > profit captured
How firms create competitive advantage?
- pushing cost to opportunity cost barrier
2. pushing price up to willingness to pay
Ways to create competitive advantage
- Differentiation strategy: increase consumers’ willingness to pay without increasing costs
- Cost strategy: decrease firm
cost without decreasing consumers’ willingness to pay - Dual strategy: increase consumers’ willingness to pay and at the same time decrease firm cost
Example of cost strategy: Southwest
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
Example dual strategy: JetBlue
- 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.
Niche strategies
- 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
2 types of industry structure
- Cost leadership approach (total market
or niche) - Differentiation approach (total market or niche)
When to use Cost leadership approach (total market
or niche)
- 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
When to use Differentiation approach (total market or niche)
- 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 … )
Dual strategy
- difficult to maintain
- exceptions might be if the firm has economies of scale but can still differentiate
Where does economic performance result from?
2 forces:
- industry structure (industry attractiveness)
- strategic positioning (build/sustain competitive advantage)
Porter’s opinions on strategic positioning
- 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
Operational effectiveness
- 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)
How does a company figure out what is unique about them?
Activity analysis:
- Catalog activities (the value chain) - primary activities engaged in for the primary purpose of making a profit
- Analyse relative costs
- Analyse willingness to pay
- Explore options and make choices
Analyse relative costs
- must calculate the costs associated with each activity
- quantification and comparison of those costs
- determine the cost drivers associated with each activity
- compare to competitors
Analyse the willingness to pay
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
Important remark about willingness to pay and relative costs
- 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
What does sustainable positioning require?
Trade offs
Trade offs
• 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
Failure of evaluating trade offs: Air Berlin
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)
IKEA strategy
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
Why does competitive advantage do not last in perfect competition?
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
Why does competitive advantage do not last in monopoly?
- Imitation
2. Substitution
Imitation
Imitation increases the supply of what a firm “uniquely” provides • Sources: – Herd behavior – Risk aversion – Following the path of least resistance
Barriers to imitation
- 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
Substitution
• 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
Responses to substitution
• 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
Process of strategy
- Analysis: internal and external
- Formulate strategy
• Strategies at business level and corporate level (diversification, acquisitions…)
• Use your resources/capabilities including intangible things like culture, leadership - Implementation
How to stay unique?
- Activity Analysis: understand what your customers actually value, understand what actually drives your costs
- Resources, resources, resources: understand the value of your tangible and intangible (culture, values) and
human capital (employees’ skills, motivation) - Trade Offs: Understand that a strategy means doing something and not doing something else (opportunity cost)
- Threats to your uniqueness (imitation, substitution): be aware and address if possible
