978-0134129945 Chapter 16 Lecture Note Part 1

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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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