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Strategic Management II
1. Competitive advantage - Chapter 9
The superior profitability of a firm within the industry is driven by its competitive advantage,
the strategic resources, the superior internal organization (capabilities) and/or its business
Firms develop competitive advantage by differentiation within the industry, that happens when a firm earns a higher rate of the economic profit than the average rate of economic profit in its industry. And firm’s profitability depends jointly on the economics of its market and its success in creating more value than its competitors. The amount of value the firm creates compared to competitors depends on its cost and benefits position relative to competitors.
Value Creation - - Consumer surplus: The difference between Benefit and Price.
Producer surplus: The difference between Price and Cost.
Value created: Consumer surplus+Producer surplus, that is, the difference between Benefit and Cost.
To achieve competitive advantage, a firm must create more value than its rivals: With superior value creation, the firm can offer as much or more consumer surplus as its rivals while making a higher profis. When a firm fails to offer as much consumer surplus as its rivals, its sales will decline.
Value Redistribution A firm could also increase economic profits through value redistribution, which can be accomplished through harsh bargaining with buyers and suppliers and by identifying and 1 acquiring undervalued businesses. Firms cannot outperform their rivals solely through value redistribution, since this strategy is constrained by market competition (Competition to redistribute is fiercer than competition to create value). The only strategy to have higher profits than the rivals is by creating higher value.
The Competitive Advantage To obtain a competitive advantage, the firm must understand how its product creates economic value and whether it can continue to do so. This involves understanding what drives consumer benefits and what drives costs. In the longer run, firms must also evaluate how the fundamental economic foundations of the business are likely to evolve.
There are two ways in which a firm can create more value than other firms in the industry.
- It can configure its value chain differently from competitors.
- It can perform activities more effectively than competitors using a similar value chain, because firm have resources and capabilities than others do not have.
o Resources: the firm benefits from resources that cannot be replicated by competitors. Are firm-specific assets which generate greater value for the firm than for competitors. They are generally intangible (patents and brands, know-how, reputation, installed base…) and specific, because competitors cannot duplicate them or acquire them in (well-functioning) markets.
Must be heterogeneously distributed across firms.
Must be imperfectly mobile. They cannot be extracted from the firms that possess them without loss of value.
Knowledge Value: the resource enables value-creating strategies.
Rareness: Not all firms have access to the resource.
Substitutability: No other resources exist that are equivalent substitutes.
Imperfect imitability: Usually created by history (determined by unique historic conditions), causal ambiguity (the relationship between the resource and the competitive advantage it enabes is ambiguous or complex) and social complexity (Existence of a social phenomenon that is out of control of the firm that posseses the resource).
o Activities (capabilities): the firm organizes its activities (along the value chain) in a way that generates higher value than its competitors.
o Business models: the firm operates with an internal logic that performs well when interacting against that of competitors. Hybrid approach that encompasses the previous ones.
The First-Mover Advantage There are four mechanisms falling under the category of first (or early) mover advantage: - Learning curve effects - Reputation and buyer uncertainty - Switching costs - Network Effects 2 A simple model of Competitive Advantage Imagine a market with an homogeneous product, where firms can have an AVC of 1, 3, 5, 7 and 9, all equally likely. Imagine an equilibrium price of 6. In equilibrium, potential entrants must be indifferent between entering or no the market, and incumbents with a marginal cost higher than price won’t produce.
[ ] ( [ ] ) ( ) ( ) ( ) ( ( ) ) ( ( ) ) ( ) ( ) So, at least an expected profit of 1.8M is needed for a firm to enter. Here we see that some firms have a competitive advantage in equilibrium, given that with the same price and product, they earn more profits (for example, the firm has a resource that decreases production costs a lot.
Reminder: Asymmetric Cournot In the asymmetric case, firms vary in the marginal cost, so firms with a lower cost obtain larger market shares and higher profits. This justifies investments in R&D, because reduces costs, and enable firms to obtain a higher level of efficiency than competitors. Those benefits will depend on the size of the market (demand) and the intensity of competition. One important consideration: if competitors can also invest in lowering costs, then the firm’s advantage may only be temporary.
The Value Chain Value is generated in the industry with the advance of products through the supply chain.
Porter proposes the value chain to analyze how each activity in the supply chain as well as the interdependence among activities generate value for consumers and costs for the firm.
The value chain identifies five primary activities and four support activities: 3 To get a competitive advantage: - Developing capabilities: creating higher value or incurring lower costs than rivals by performing activities more effectively.
- Capabilities, also known as core competences or distinctive competences, are generally based on resources and are: o Valuable across multiple products or markets o Embedded in organizational routines (do not depend on an individual) o Tacit knowledge (not explicit). Difficult to reduce to simple algorithms or procedure guides. Difficult to copy. (e.g. organizational culture).
- Reconfiguring the value chain: a firm may configure its value chain differently from competitors in order to focus on certain market segments (creating higher value or incurring lower costs).
Sustaining Competitive Advantage A competitive advantage is sustainable if it persists despite competitors’ efforts to duplicate it or neutralize it. Sustainability can occur in two possible ways: - Firms may differ with respect to resources and capabilities and the differences persist.
- Isolating mechanisms (analogous to barriers to entry) may work to protect the competitive advantage of firms. Isolating mechanisms are to firms what entry barriers are to industries. Two types: o Impediments to imitation: These mechanisms impede the potential entrants from duplicating the resources and capabilities of the incumbent firm. Types: Legal restrictions. Such as patents and copyrights as well as government regulation through licensing and certification can impede imitation.
Superior access to inputs/customers. Firms often achieve exclusive access to key resources either through vertical integration or long term contracts.
Market size and scale economies.
4 o Intangible barriers (casual ambiguity, historical circumstances, social complexity) Early mover advantage Strategic Positioning - Cost Leadership A firm with a competitive advantage based on cost leadership has lower costs than its competitors, such as Ikea, Walmart or Ryanair. Some of the factors that determine the level of costs with respect to competitors are scale, scope and learning economies, firm’s boundaries and strategic commitments. The two main options for a firm with this position are: - Charge industry price: higher profit from larger price-cost margins.
- Undercut industry price: higher profit from increased quantity.
This position is attractive when: - Economies of scale and learning economies are potentially significant, but no single firm is already exploiting them.
When the nature of the product does not allow benefit enhancement.
When consumers relatively price sensitive and are unwilling to pay much of a premium for enhanced product quality, performance, or image (low-valuation of quality).
When the product is a search good rather than an experience good - Differentiation Leadership - A firm with a 5 competitive advantage based on differentiation leadership generates higher value for consumers than competitors, such as Apple. The opportunities for differentiation in the market will depend on the heterogeneity of consumer preferences and the nature of the product or service. The two main options for a firm with this position are: - Charge industry price: higher profit from increased quantity.
- Above industry price: higher profit from larger price-cost margins.
This position is attractive when: - When consumers are willing to pay a premium for benefit enhancements.
When economies of scale and learning have been already exploited and differentiation is the best route to value creation.
When the product is an experience good Depending on the position and elasticity of demand the firm face, we have these possible scenarios: Stuck in the Middle Being stuck in the middle means that you are not competing in costs neither in differentiation. This double competitive advantage may be incompatible. Some studies showed that mixed strategies don’t work, but economic theory doesn’t suggest that both competitive advantages are necessarily incompatible. The firm must position itself on the efficiency frontier.
6 Focus The industry may be decomposed in several segment levels, where the degree of concentration and barriers to entry may vary across segments. Segments are determined by economic factors that differ on: - Demand side: variations in the willingness to pay or valuation of quality among customer groups.
- Supply side: cost of producing different varieties.
Firms may develop a competitive advantage based on market segmentation. A broad coverage strategy is based on serving all (or most) of the segments, which can exploit scale economics in production, distribution and marketing. Also related to the concept of one-sizefits-all.
Thus, a focus strategy is based on serving only some of the segments: - Customer specialization: product range that caters to a specific set of customers (differentiation).
- Product specialization: specific products for a wide range of customers (scale and learning economies).
- Niche strategy: Serve a single segment.
- Geographic specialization: serve only some geographic areas of the market. It can exploit particular conditions of its geographic environment and limit competition.
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