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CHAPTER 16
STRATEGIC ELEMENTS OF COMPETITIVE ADVANTAGE
SUMMARY
A. In this chapter we focused on factors that help industries and countries achieve
competitive advantage. According to Porter's five forces model, industry competition is
a function of the threat of new entrants, the threat of substitutes, the bargaining power of
suppliers and buyers, and rivalry among existing competitors. Porter's generic strategies
model can be used by managers to conceptualize possible sources of competitive
advantage. A company can pursue broad market strategies of cost leadership and
differentiation or the more targeted approaches of cost focus and focused
differentiation. Rugman and D'Cruz have developed a framework known as the flagship
model to explain how networked business systems have achieved success in global
industries. Hamel and Prahalad have proposed an alternative framework for pursuing
competitive advantage, growing out of a firm's strategic intent and use of competitive
innovation. A firm can build layers of advantage, search for loose bricks in a competitor's
defensive walls, change the rules of engagement, or collaborate with competitors and
utilize their technology and know-how.
B. Today, global competition is a reality in many industry sectors. Thus, competitive
analysis must also be carried out on a global scale. Global marketers must also have an
understanding of national sources of competitive advantage. Porter has described four
determinants of national advantage. Factor conditions include human, physical,
knowledge, capital, and infrastructure resources. Demand conditions include the
composition, size, and growth pattern of home demand. The rate of home-market growth
and the means by which a nation's products are pulled into foreign markets also affect
demand conditions. The final two determinants are the presence of related and
supporting industries and the nature of firm strategy, structure, and rivalry. Porter
notes that chance and government also influence a nation's competitive advantage.
Porter's work has been the catalyst for promising new research into strategy issues,
including D'Aveni's work on hypercompetition and Rugman's double-diamond
framework for national competitive advantage.
LEARNING OBJECTIVES
1 Identify the forces that shape competition in an industry and illustrate each force with a
specific company or industry example
2 Define competitive advantage and identify the key conceptual frameworks that guide decision
makers in the strategic planning process
3 Explain how a nation can achieve competitive advantage, and list the forces that may be
present in a national “diamond”
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4 Define hypercompetitive industry and list the key arenas in which dynamic strategic
interactions take place
OVERVIEW
In May 2011, production began at Volkswagen’s new $1 billion assembly plant in Chattanooga,
Tennessee. The Passat sedans coming off the line are a striking symbol of the German
automaker’s ambitious strategic goal: Volkswagen CEO Martin Winterkorn intends to overtake
both Toyota and GM and become the world’s number one automaker by 2018 and has decreed
that VW will sell 1 million cars in the United States by 2018.
The essence of marketing strategy is successfully relating the strengths of an organization to its
environment. As the horizons of marketers have expanded from domestic to regional and global,
so too have the horizons of competitors. The reality in almost every industry today—including
home furnishings—is global competition. This fact of life puts an organization under increasing
pressure to master techniques for conducting industry analysis and competitor analysis, and
understanding competitive advantage at both the industry and national levels. These topics are
covered in detail in this chapter.
ANNOTATED LECTURE/OUTLINE
INDUSTRY ANALYSIS: FORCES INFLUENCING COMPETITION
(Learning Objective #1)
A useful way of gaining insight into competitors is through industry analysis. As a working
definition, an industry can be defined as a group of firms that produce products that are close
substitutes for each other.
In any industry, competition works to drive down the rate of return on invested capital toward the
rate earned in the economist’s "perfectly competitive" industry.
Rates of return greater than this so-called "competitive" rate will stimulate an inflow of capital
while those below the "competitive" rate force a withdrawal from the industry and a decline in
competition.
Michael E. Porter identifies five forces that influence industry competition:
1. the threat of new entrants,
2. the threat of substitute products or services,
3. the bargaining power of buyers,
4. the bargaining power of suppliers, and
5. competitive rivalry.
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Threat of New Entrants
New entrants to an industry bring new capacity, a desire to gain market share and position, and,
quite often, new approaches to serving customer needs.
The decision to become a new entrant in an industry is often accompanied by a major
commitment of resources.
New players mean prices will be pushed downward and margins squeezed, resulting in reduced
industry profitability in the long run.
Porter describes eight major sources of barriers to entry, the presence or absence of which
determines the extent of threat of new industry entrants.
1. Economies of Scale refers to the decline in per-unit product costs as the absolute volume
of production per period increases.
2. Product differentiation is the extent of a product's perceived uniqueness; in other words,
whether or not it is a commodity. Differentiation can be achieved as a result of unique
product attributes or effective marketing communications, or both.
3. Capital requirements. Capital is required not only for manufacturing facilities (fixed
capital) but also for financing R&D, advertising, field sales and service, customer credit,
and inventories (working capital).
4. Switching costs are those costs caused by the need to change suppliers and products.
5. Access to distribution channels. If channels are full, or unavailable, the cost of entry is
substantially increased because a new entrant must invest a time and money to gain
access to existing channels or to establish new channels.
6. Government policy is frequently a major entry barrier. In some cases, the government will
restrict competitive entry.
7. Cost advantages independent of scale economies may present barriers to entry. Access to
raw materials, a large pool of low-cost labor, favorable locations, and government
subsidies are several examples.
8. Competitor response can be a major entry barrier. If new entrants expect existing
competitors to strongly oppose the entry, their expectations about the rewards of entry
will certainly be affected.
The digital revolution appears to have altered the entry barriers in many industries.
Technology has lowered the cost for new entrants. (Amazon.com vs. Barnes and Nobles is an
example).
Threat of Substitute Products
The availability of substitute products places limits on the prices market leaders can charge in an
industry; high prices may induce buyers to switch to the substitute.
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Once again, the digital revolution is dramatically altering industry structures. In addition to
lowering entry barriers, the digital era means that certain types of products can be converted to
bit and distributed in pure digital form.
Bargaining Power of Buyers
"Buyers" refers to manufacturers and retailers, rather than consumers. The ultimate aim of such
buyers is to pay the lowest possible price to obtain the products or services that they require.
Usually, if they can, buyers drive down profitability in the supplier industry.
Buyers must gain leverage over vendors in order to accomplish this. Following are ways this
may happen:
Buyers may purchase in such large quantities that supplier firms are highly dependent on
the buyers' business.
When the suppliers' products are viewed as commodities, buyers are likely to bargain
hard for low prices, because many firms can meet their needs.
Buyers will bargain hard when the supplier industry's products or services represent a
significant portion of the buying firm's costs.
Another source of buyer power is the willingness and ability to achieve backward
integration.
Bargaining Power of Suppliers
Supplier power in an industry is the converse of buyer power.
If suppliers have enough leverage over industry firms, they can raise prices high enough to
significantly influence the profitability of their organizational customers.
Suppliers' ability to gain leverage over industry firms is determined by several factors.
If they are large and relatively few in number.
When the suppliers' products or services are important inputs to user firms, are highly
differentiated, or carry switching costs.
If their business is not threatened by alternative products.
The willingness and ability of suppliers to develop their own products and brand names if
they are unable to get satisfactory terms from industry buyers.
Rivalry among Competitors
Rivalry among firms refers to all the actions taken by firms in the industry to improve their
positions and gain advantage over each other.
Rivalry manifests itself in price competition, advertising battles, product positioning, and
attempts at differentiation.
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To the extent that rivalry among firms forces companies to rationalize costs, it is a positive force.
To the extent that it drives down prices, and therefore profitability, and creates instability in the
industry, it is a negative factor.
Several factors can create intense rivalry.
When an industry becomes mature, firms focus on market share and how it can be gained
at the expense of other firms.
Once the industry accumulates excess capacity, the drive to fill capacity will push prices
—and profitability—down.
Lack of differentiation or an absence of switching costs encourages buyers to treat the
products or services as commodities and shop for the best prices.
Firms with high stakes in achieving success in an industry generally are willing to accept
below-average profit margins to establish themselves, hold position, or expand.
EMERGING MARKETS BRIEFING BOOK
Cemex
Mexico’s S.A.B. de C.V. Cemex is a global building solutions company with operations in more
than 50 countries.
Migrant workers in the United States can pay for cement that their friends and relatives in
Mexico can pick-up at a local store. Under Zambrano’s leadership, Cemex had 2010 revenues of
$14 billion. Starting in the early 1990s, Zambrano began extending Cemex’s global reach by
acquiring Spain’s two largest cement companies for $1 billion. Other acquisitions followed in
Indonesia, Panama, the Philippines, the United States, Venezuela, and elsewhere.
Unfortunately, after a string of successes, one recent acquisition turned out to be disastrous. In
2007, Zambrano paid more than $15 billion to acquire Australia’s Rinker Materials Corp. Rinker
was a major supplier to the U.S. housing market; as the economic crisis worsened, sales to the
United States declined. There was more bad news; the global credit crunch made it very difficult
for Zambrano to refinance some of the debt burden that Cemex had taken on.
The weaker peso meant that Cemex’s dollar-denominated debt was even more of a burden. Why
weren’t they more cautious? Why didn’t they ask the right questions?”
COMPETITIVE ADVANTAGE
(Learning Objective #2)
Competitive advantage exists when there is a match between a firm's distinctive competencies
and the factors critical for success within its industry.
Competitive advantage can be achieved in two ways: First, a firm can pursue a low-cost strategy
that enables it to offer products at lower prices than competitors’ prices. Competitive advantage
may also be gained by a strategy of differentiating products so customers perceive unique
benefits, often accompanied by a premium price.
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Ultimately, customer perception decides the quality of a firm’s strategy. Operating results such as
sales and profits are measures that depend on the level of psychological value created for
customers: The greater the perceived consumer value, the better the strategy.
A firm may market a better mousetrap, but the ultimate success of the product depends on
customers deciding for themselves whether to buy it.
Value is like beauty; it’s in the eye of the beholder. In sum, creating more value than the
competition achieves competitive advantage, and customer perception defines value.
Two different models of competitive advantage exist. The first offers “generic strategies,” four
routes or paths that organizations choose to offer superior value and achieve competitive
advantage.
According to the second model, generic strategies alone did not account for the astonishing
success of many Japanese companies in the 1980s and 1990s. The more recent model, based on
the concept of “strategic intent,” proposes four different sources of competitive advantage.
Generic Strategies for Creating Competitive Advantage
Michael Porter has developed a framework of generic business strategies based on the two
sources of competitive advantage: low-cost and differentiation.
These sources combined with the scope of the target market (narrow or broad) or product mix
width (narrow or wide) yields four generic strategies: cost leadership, product differentiation,
cost focus, and focused differentiation.
Achieving competitive advantage or superior marketing strategy demands that the firm makes
choices.
Firms decide the type of competitive advantage (based on cost or differentiation) and the market
scope or product mix width.
By choosing a given generic strategy, a firm always risks making the wrong choice.
Broad Market Strategies: Cost Leadership and Differentiation
Cost leadership advantage is based on a position as a low-cost producer, in broadly defined
markets or across a wide mix of products.
The firm must obtain the largest market share so its cost per unit is the lowest in the industry.
Cost leadership is sustainable only if barriers prevent competitors from achieving the same low
costs.
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When a product has an actual or perceived uniqueness, in a broad market, it is said to have
achieved competitive advantage by differentiation.
This can be effective for defending market position and obtaining superior financial returns (e.g.,
Maytag in large home appliances).
Narrow Target Strategies: Cost Focus and Focused Differentiation
Strategies to achieve a narrow-focus advantage target a narrowly defined market or customer.
This advantage is based on an ability to create more customer value for a narrowly targeted
segment and results from a better understanding of customer needs and wants.
A narrow-focus strategy can be combined with either a cost- or differentiation—advantage
strategies. In other words, while a cost focus means offering a narrow target market lower prices,
a firm pursing focused differentiation will offer a narrow target market the perception of product
uniqueness at a premium price.
German’s Mittlestand companies have been extremely successful pursing focused
differentiation strategies backed by strong export effort. The world of “high-end” audio
equipment offers another example of focused differentiation.
The final strategy is cost focus, when a firm’s lower-cost position enables it to offer a narrow
target market and lower prices than the competition. (Exhibit 16-5)
The issue of sustainability is central to this strategy concept. As noted, cost leadership is a
sustainable source of competitive advantage, only if barriers exist that prevent competitors from
achieving the same low costs.
Sustained differentiation depends on continued perceived value and the absence of imitation by
competitors.
Several factors determine whether or not focus can be sustained as a source of competitive
advantage.
A cost focus is sustainable if a firm's competitors are defining their target markets more
broadly.
A firm's differentiation focus advantage is sustainable only if competitors cannot define
the segment even more narrowly.
Creating Competitive Advantage via Strategic Intent
An alternative framework for understanding competitive advantage focuses on competitiveness
as a function of the pace at which a company implants new advantages deep within its
organization.
This framework identifies strategic intent as the means for achieving competitive advantage.
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This approach is founded on the principles of W. E. Deming, who stressed that a company must
commit itself to continuing improvement in order to be a winner in a competitive struggle.
Many firms have gained competitive advantage by disadvantaging rivals through "competitive
innovation."
Hamel and Prahalad define competitive innovation as "the art of containing competitive risks
within manageable proportions," and they identify four successful approaches used by Japanese
competitors. These are building layers of advantage, searching for loose bricks, changing the
rules of engagement, and collaborating.
1. Layers of Advantage. A company faces less risk in competitive encounters if it has a wide
portfolio of advantages.
Successful companies steadily build portfolios by establishing layers of advantage on top of one
another.
Because cost advantage could be temporary, the Japanese also added additional layers of
advantage:
Quality and reliability
Global brand franchise
Regional manufacturing
2. Loose Bricks. This approach takes advantage of the "loose bricks" left in the defensive walls
of competitors whose attention is narrowly focused on a market segment or a geographic area
to the exclusion of others. Intel’s focus on microprocessors provided opportunities for other
manufactures for non-PC consumer electronics products.
3. Changing the Rules. This approach involves changing the "rules of engagement" and
refusing to play by the rules set by industry leaders. Canon wrote a new rulebook in the
copier market with a copier with “connectivity”.
4. Collaborating. This source of competitive advantage is using know-how developed by other
companies.
GLOBAL COMPETITION AND NATIONAL COMPETITIVE ADVANTAGE
(Learning Objective #3)
An inevitable consequence of the expansion of global marketing activity is the growth of
competition on a global basis.
Global competition occurs when a firm takes a global view of competition and sets about
maximizing profits worldwide, rather than on a country-by-country basis. If, when expanding
abroad, a company encounters the same rival in market after market, then it is engaged in global
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competition.
The effect of global competition has been highly beneficial to consumers around the world.
In the two examples cited, detergents and automobiles, consumers have benefited. In Central
America, detergent prices have fallen as a result of global competition.
Global competition expands the range of products and increases the likelihood that consumers
will get what they want.
In the United States, foreign companies have provided consumers with products with
performances and prices they wanted.
The downside of global competition is its impact on the producers of goods and services.
Global competition creates value for consumers, but it also has the potential to destroy jobs and
profits.
This section addresses the following issue: Why is a particular nation a good home base for
specific industries?
According to Porter, the presence or absence of particular attributes in individual countries
influences industry development, not just the ability of individual firms to create core
competences and competitive advantage.
Porter describes these attributes—factor conditions, demand conditions, related and supporting
industries, and firm strategy, structure, and rivalry—in terms of a national "diamond".
Activity in any one of the four points of the diamond impacts on all the others and vice versa.
Factor Conditions
Factor conditions refer to a country's endowment with resources. Basic factors may be inherited
or created without much difficulty; because they can be replicated in other nations, they are not
sustainable sources of national advantage.
Specialized factors are more advanced and provide a more sustainable source for advantage.
Porter describes five categories of factor conditions: human, physical, knowledge, capital, and
infrastructure.
Human Resources. The quantity of workers available, the skills possessed by these
workers, the wage levels, and the overall work ethic of the workforce together constitute
a nation's human resource factor.
Physical Resources. The availability, quantity, quality, and cost of land, water, minerals,
and other natural resources determine a country's physical resources. (Exhibit 16-6)
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Knowledge Resources. The availability within a nation of a significant population having
scientific, technical, and market-related knowledge means that the nation is endowed
with knowledge resources.
Capital Resources. Countries vary in the availability, amount, cost, and types of capital
available to the country's industries.
Infrastructure Resources. Infrastructure includes a nation's banking system, healthcare
system, transportation system, communications system, as well as the availability and
cost of using these systems.
Competitive advantage accrues to a nation's industry if the mix of factors available to the
industry is such that it facilitates pursuit of a generic strategy.
Nations that have selective factor disadvantages may also indirectly create competitive
advantage.
INNOVATION, ENTREPRENEURSHIP, AND THE GLOBAL STARTUP
Italian Entrepreneurs Combine Fashion and Function
As Michael Porter notes in The Competitive Advantage of Nations:
Entrepreneurship thrives in Italy, feeding rivalry in existing industries and the formation of clusters.
Italians are risk takers. Many are individualistic and desire independence. They aspire to have their own
company. They like to work with people they know well, as in the family, and not as part of a hierarchy.
…Recently, the entrepreneur has become celebrated in Italy, and a number of business magazines are full
of nothing but profiles of successful entrepreneurs.
Leonardo del Vecchio is an entrepreneur. He developed an innovative approach to an existing
product and, in 1961, founded a company that manufactures and markets it. By applying the
basic tools and principles of modern marketing, del Vecchio has achieved remarkable success. In
the 1960s, del Vecchio approached Milan-based designer Giorgio Armani and asked, “Have you
ever thought about glasses and your brand name and your style?” Armani’s response? “Great
idea! Let’s go!” he said. The rest, as they say, is history.
Del Vecchio’s business principles include the following:
• “Made in Italy” is important!
• Must cut costs to keep production at home.
• Invest in automation: Robots, not workers, weld on hinges, set rhinestones, affix brand logos.
Analyst Davide Vimercati notes, “…if you manage your brand consistently and you build brand
equity over the years, you reach a stage where demand remains strong, even in tough times.”
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