CHAPTER 4

STRATEGIC ACTIONS: STRATEGY FORMULATION

Strategy at the Business Level

Strategic Management Management of Strategy

Competitiveness and Globalization: Concepts Seventh Concepts and Cases and Casesedition
Michael A. Hitt R. Duane Ireland Robert E. Hoskisson

PowerPoint Presentation by Charlie Cook The University of West Alabama 2007 Thomson/South-Western. All rights reserved.

KNOWLEDGE OBJECTIVES Studying this chapter should provide you with the strategic management knowledge needed to:

1. Define business-level strategy. 2. Discuss the relationship between customers and business-level strategies in terms of who, what, and how. 3. Explain the differences among business-level strategies. 4. Use the five forces of competition model to explain how above-average returns can be earned through each business-level strategy. 5. Describe the risks of using each of the business-level strategies.
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Business-Level Strategy (Defined)

An integrated and coordinated set of commitments and actions the firm uses to gain a competitive advantage by exploiting core competencies in specific product markets.

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Core Competencies and Strategy

Core Competencies Resources and superior capabilities that are sources of competitive advantage over a firms rivals

Strategy

An integrated and coordinated set of actions taken to exploit core competencies and gain competitive advantage

Business-level Strategy

Providing value to customers and gaining competitive advantage by exploiting core competencies in individual product markets

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Customers: Their Relationship to BusinessLevel Strategies

Who will be served?

Key Issues in Business-level Strategy

What needs will be satisfied?

How will those needs be satisfied?

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Effectively Managing Relationships with Customers

Firms must manage all aspects of their relationship with customers.
Reach: firms success and connection to customers Richness: depth and detail of two-way flow of information between the firm and the customer Affiliation: facilitation of useful interactions with customers

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Who: Determining the Customers to Serve

Market segmentation
A process used to cluster people with similar needs into individual and identifiable groups.

All Customers
Consumer Markets Industrial Markets

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Market Segmentation
Consumer Markets
Demographic factors Socioeconomic factors Geographic factors

Industrial Markets
End-use segments Product segments Geographic segments

Psychological factors
Consumption patterns Perceptual factors

Common buying factor segments

Customer size segments

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TABLE

4.1

Basis for Customer Segmentation

Consumer Markets Demographic factors (age, income, sex, etc.) Socioeconomic factors (social class, stage in the family life cycle) Geographic factors (cultural, regional, and national differences) Psychological factors (lifestyle, personality traits) Consumption patterns (heavy, moderate, and light users) Perceptual factors (benefit segmentation, perceptual mapping)

Industrial Markets
End-use segments (identified by SIC code) Product segments (based on technological differences or production economics) Geographic segments (defined by boundaries between countries or by regional differences within them) Common buying factor segments (cut across product market and geographic segments) Customer size segments

Source: Adapted from S. C. Jain, 2000, Marketing Planning and Strategy, Cincinnati: South-Western College Publishing, 120. 49

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What: Determining Which Customer Needs to Satisfy

Customer needs are related to a products benefits and features. Customer needs are neither right nor wrong, good nor bad. Customer needs represent desires in terms of features and performance capabilities.

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How: Determining Core Competencies Necessary to Satisfy Customer Needs

Firms use core competencies to implement value creating strategies that satisfy customers needs.
Only firms with capacity to continuously improve, innovate and upgrade their competencies can expect to meet and/or exceed customer expectations across time.

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The Purpose of a Business-Level Strategy

Business-Level Strategies
Are intended to create differences between the firms position relative to those of its rivals.

To position itself, the firm must decide whether it intends to:

Perform activities differently or Perform different activities as compared to its rivals.

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Types of Potential Competitive Advantage

Achieving lower overall costs than rivals
Performing activities differently (reducing process costs)

Possessing the capability to differentiate the firms product or service and command a premium price
Performing different (more highly valued) activities.

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FIGURE

4.1

The External Environment

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Competitive Scope
Broad Scope
The firm competes in many customer segments.

Narrow Scope
The firm selects a segment or group of segments in the industry and tailors its strategy to serving them at the exclusion of others.

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Types of Business-Level Strategies

Competitive Advantage
Cost Uniqueness

Broad Target

Cost Leadership

Differentiation

Competitive Scope
Narrow Target

Integrated Cost Leadership/ Differentiation Focused Cost Leadership Focused Differentiation

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FIGURE

4.2

Five Business-Level Strategies

Source: Adapted with the permission of The Free Press, an imprint of Simon & Schuster Adult Publishing Group, from Competitive Advantage: Creating and Sustaining Superior Performance, by Michael E. Porter, 12. Copyright 1985, 1998 by Michael E. Porter. 2007 Thomson/South-Western. All rights reserved. 417

Cost Leadership Strategy

An integrated set of actions taken to produce goods or services with features that are acceptable to customers at the lowest cost, relative to that of competitors with features that are acceptable to customers.
Relatively standardized products
Features acceptable to many customers Lowest competitive price

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Cost Leadership Strategy

Cost saving actions required by this strategy:
Building efficient scale facilities Tightly controlling production costs and overhead Minimizing costs of sales, R&D and service

Building efficient manufacturing facilities

Monitoring costs of activities provided by outsiders Simplifying production processes

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How to Obtain a Cost Advantage

Determine and control Cost Drivers Reconfigure Value Chain if needed

Alter production process Change in automation

New raw material Forward integration

New distribution channel

New advertising media Direct sales in place of indirect sales
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Backward integration Change location relative to suppliers or buyers

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FIGURE

4.3

Examples of Value-Creating Activities Associated with the Cost Leadership Strategy

SOURCE: Adapted with the permission of The Free Press, an imprint of Simon & Schuster Adult Publishing Group, from Competitive Advantage: Creating and Sustaining Superior Performance, by Michael E. Porter, 47. Copyright 1985, 1998 by Michael E. Porter.

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Value-Creating Activities for Cost Leadership

Cost-effective MIS Few management layers Simplified planning Consistent policies Effecting training Easy-to-use manufacturing technologies Investments in technologies Finding low cost raw materials Monitor suppliers performances

Link suppliers products to production processes

Economies of scale Efficient-scale facilities Effective delivery schedules Low-cost transportation Highly trained sales force Proper pricing

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Cost Leadership Strategy: Competitors

Rivalry with Existing Competitors
Threat of new entrants Rivalry among competing firms Threat of substitute products Bargaining power of suppliers

Due to cost leaders advantageous position:

Rivals hesitate to compete on basis of price. Lack of price competition leads to greater profits.

Bargaining power of buyers

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Cost Leadership Strategy: Buyers

Bargaining Power of Buyers
Threat of new entrants Rivalry among competing firms Threat of substitute products Bargaining power of suppliers

Can mitigate buyers power by:

Driving prices far below competitors, causing them to exit, thus shifting power with buyers back to the firm.

Bargaining power of buyers

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Cost Leadership Strategy: Suppliers

Bargaining Power of Suppliers
Threat of new entrants Rivalry among competing firms Threat of substitute products Bargaining power of suppliers

Can mitigate suppliers power by:

Being able to absorb cost increases due to low cost position. Being able to make very large purchases, reducing chance of supplier using power.

Bargaining power of buyers

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Cost Leadership Strategy: New Entrants

The Threat of Potential Entrants
Threat of new entrants Rivalry among competing firms Threat of substitute products Bargaining power of suppliers

Can frighten off new entrants due to:

Their need to enter on a large scale in order to be cost competitive. The time it takes to move down the learning curve.

Bargaining power of buyers

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Cost Leadership Strategy: Substitutes

Product Substitutes
Threat of new entrants Rivalry among competing firms Threat of substitute products Bargaining power of suppliers

Cost leader is well positioned to:

Make investments to be first to create substitutes. Buy patents developed by potential substitutes.

Bargaining power of buyers

Lower prices in order to maintain value position.

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Cost Leadership Strategy (contd)

Competitive Risks
Processes used to produce and distribute good or service may become obsolete due to competitors innovations. Focus on cost reductions may occur at expense of customers perceptions of differentiation Competitors, using their own core competencies, may successfully imitate the cost leaders strategy.

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Differentiation Strategy
An integrated set of actions taken to produce goods or services (at an acceptable cost) that customers perceive as being different in ways that are important to them.
Focus is on nonstandardized products

Appropriate when customers value differentiated features more than they value low cost.

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How to Obtain a Differentiation Advantage

Control
Cost Drivers

if needed

Reconfigure Value Chain to maximize

Lower buyers costs Raise performance of product or service Create sustainability through: Customer perceptions of uniqueness Customer reluctance to switch to nonunique product or service
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Figure 4.4

Examples of Value-Creating Activities Associated with the Differentiation Strategy

SOURCE: Adapted with the permission of The Free Press, an imprint of Simon & Schuster Adult Publishing Group, from Competitive Advantage: Creating and Sustaining Superior Performance, by Michael E. Porter, 47. Copyright 1985, 1998 by Michael E. Porter.

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Value-Creating Activities and Differentiation

Highly developed MIS Emphasis on quality High quality replacement parts Superior handling of incoming raw materials Attractive products Rapid response to customer specifications

Worker compensation for creativity/productivity

Use of subjective performance measures

Basic research capability

Technology High quality raw materials Delivery of products

Order-processing procedures
Customer credit Personal relationships

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Differentiation Strategy: Competitors

Rivalry with Competitors
Threat of new entrants

Defends against competitors because brand loyalty to differentiated product offsets price competition.

Rivalry among competing firms

Threat of substitute products

Bargaining power of suppliers

Bargaining power of buyers

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Differentiation Strategy: Buyers

Bargaining Power of Buyers
Threat of new entrants Rivalry among competing firms Threat of substitute products Bargaining power of suppliers

Can mitigate buyers power because well differentiated products reduce customer sensitivity to price increases.

Bargaining power of buyers

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Differentiation Strategy: Suppliers

Bargaining Power of Suppliers
Threat of new entrants Rivalry among competing firms Threat of substitute products Bargaining power of suppliers

Can mitigate suppliers power by:

Absorbing price increases due to higher margins. Passing along higher supplier prices because buyers are loyal to differentiated brand.

Bargaining power of buyers

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Differentiation Strategy: New Entrants

The Threat of Potential Entrants
Threat of new entrants Rivalry among competing firms Threat of substitute products Bargaining power of suppliers

Can defend against new entrants because:

New products must surpass proven products. New products must be at least equal to performance of proven products, but offered at lower prices.

Bargaining power of buyers

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Differentiation Strategy: Substitutes

Product Substitutes
Threat of new entrants Rivalry among competing firms Threat of substitute products Bargaining power of suppliers

Well positioned relative to substitutes because:

Brand loyalty to a differentiated product tends to reduce customers testing of new products or switching brands.

Bargaining power of buyers

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Competitive Risks of Differentiation

The price differential between the differentiators product and the cost leaders product becomes too large.

Differentiation ceases to provide value for which customers are willing to pay.
Experience narrows customers perceptions of the value of differentiated features. Counterfeit goods replicate differentiated features of the firms products.

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Focus Strategies
An integrated set of actions taken to produce goods or services that serve the needs of a particular competitive segment.
Particular buyer groupyouths or senior citizens Different segment of a product lineprofessional craftsmen versus do-it-yourselfers Different geographic marketsEast coast versus West coast

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Focus Strategies (contd)

Types of focused strategies
Focused cost leadership strategy Focused differentiation strategy

To implement a focus strategy, firms must be able to:

Complete various primary and support activities in a competitively superior manner, in order to develop and sustain a competitive advantage and earn aboveaverage returns.

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Factors That Drive Focused Strategies

Large firms may overlook small niches. A firm may lack the resources needed to compete in the broader market. A firm is able to serve a narrow market segment more effectively than can its larger industry-wide competitors.

Focusing allows the firm to direct its resources to certain value chain activities to build competitive advantage.

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Competitive Risks of Focus Strategies

A focusing firm may be outfocused by its competitors. A large competitor may set its sights on a firms niche market. Customer preferences in niche market may change to more closely resemble those of the broader market.

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Integrated Cost Leadership/ Differentiation Strategy

A firm that successfully uses an integrated cost leadership/differentiation strategy should be in a better position to:
Adapt quickly to environmental changes.
Learn new skills and technologies more quickly. Effectively leverage its core competencies while competing against its rivals.

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Integrated Cost Leadership/ Differentiation Strategy (contd)

Commitment to strategic flexibility is necessary for implementation of integrated cost leadership/differentiation strategy.
Flexible manufacturing systems (FMS)
Information networks Total quality management (TQM) systems

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Flexible Manufacturing Systems

Computer-controlled processes used to produce a variety of products in moderate, flexible quantities with a minimum of manual intervention.
Goal is to eliminate the low-cost-versus-wide product-variety tradeoff. Allows firms to produce large variety of products at relatively low costs.

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Information Networks
Link companies electronically with their suppliers, distributors, and customers.
Facilitate efforts to satisfy customer expectations in terms of product quality and delivery speed.
Improve flow of work among employees in the firm and their counterparts at suppliers and distributors. Customer relationship management (CRM)

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Total Quality Management (TQM) Systems

Emphasize total commitment to the customer through continuous improvement using:
Data-driven, problem-solving approaches Empowerment of employee groups and teams

Benefits
Increased customer satisfaction Lower costs Reduced time-to-market for innovative products

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Risks of the Integrated Cost Leadership/ Differentiation Strategy

Often involves compromises
Becoming neither the lowest cost nor the most differentiated firm.

Becoming stuck in the middle

Lacking the strong commitment and expertise that accompanies firms following either a cost leadership or a differentiated strategy.

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