Microsoft in 2004

Take Aways

A common finding in empirical analyses is that

consistent out-performance is the exception
rather than the rule
40

ROI in Year 0
39%

ROI%

30

10

3%
Bottom Half

20

Top Half
0
1

10

Year
Source:PankajGhemawat,Commitment(NewYork:TheFreePress,1991)

Division of value between buyers and sellers

Willingness
to Pay
Value Captured
by Buyer
Price
Added Value
Value Captured
by Seller

Opportunity
Cost

Competitive advantage is achieved through

increasing overall value added (and capturing
more value than competitors)
Willingness
to Pay
Value Captured
by Buyer
Price
Added Value
Value Captured
by Seller*

Opportunity
Cost

*Also known
as value
appropriated

Link between the Value Net and Added Value

Customers

Competitors

Company

Complementors
Players that increase
customers WTP or reduce
suppliers opportunity costs

Players that reduce

customers WTP or increase
suppliers opportunity costs

Suppliers

Source: Brandenburger and Nalebuff, Co-opetition (New York: Doubleday, 1985), p.17.

Link between the Value Net and Added Value

Customers Willingness to Pay

Added Value

Price to customer
Companys WTP for Supply

Price to supplier
Companys Opportunity Cost
for Production
Suppliers Opportunity Cost

Appropriated
Value

Four types of threats to the sustainability of

competitive advantage
Substitution

Imitation
Wal-Mart, K-mart & Target
Nutrasweet vs HSC
BSB vs. Sky
Oakland As

Added Value

Appropriated
Value

Talent at Microsoft

Slack
Source:Ghemawat,1999

Barnes & Noble v Amazon

Netscape vs. Microsoft
(The Browser)
Sun vs. Microsoft
(Platform-independent SW)
Linux vs. Microsoft
(Open source SW)

Unions at Wal-Mart
Players in MLB
Govt, competitors in
Microsoft (may depend on
your view on the legality
of MSs competitive tactics)

Hold-up

Imitation

Imitation increases the supply of what a firm uniquely

provides

Imitation is pervasive and can be deadly

Profits draw a crowd

Intel in DRAMs
Apple in user-friendly PCs
Netscape in browsers
Ben & Jerrys in super-premium ice cream
Bridal registries on the Internet

But imitation can be deterred

Source:Ghemawat,1999

Continental Lite vs. Southwest Airlines

Progressives high service offering

Barriers to imitation

Scale or Scope Economies

Experience/Learning (Tacit Knowledge)
Relationships
Reputation
Retaliation
Response Lags
Upgrading/Investments
Fit

Source:Ghemawat,1999

Substitution

Substitution reduces the demand for what a firm

uniquely provides by shifting the demand elsewhere

Substitution threats can be subtle and unexpected

The better mousetrap

Due to changes in technology, customer needs, input prices,
etc.
Videoconferencing vs. air travel
Conventional contact lenses vs. disposables

For this reason, substitution is an especially effective

way to attack dominant players

Source:Ghemawat,1999

Responses to substitution threats

Before:

Scan the landscape broadly

for threats

Understand underlying
customer needs

After: Your Options

Fight the threat

But be prepared to ignore

the needs of current
customers

Source:Ghemawat,1999

Incorporate their benefits (e.g.,

orange juice supplemented with
calcium)
Incorporate their cost reductions (
Face up to your loss of added
value, and reduce price before the
substitute gets a foothold

If you cant beat them, join them

Take the money and run

Hold-up

Hold-up diverts value to customers, suppliers, or

complementors who have some bargaining leverage

They have bargaining leverage because they have something

you need and cant get elsewhere (added value)

Ex: Who makes all the profits from PCs?

Hold-up is especially threatening when parties in a
relationship have invested in assets that are specific to
that relationship (so its hard to walk away)
An electric plant built at the mouth of a coal mine

Source:Ghemawat,1999

A railroad spur laid to a particular factory

Skills that are tailored to a particular employer

Hold-up in the PC industry

Operating Margin

40%

30%

20%

10%

other components

personal computers

software

peripherals
services

microprocessors

Share of Industry Revenue

Source: Orit Gadiesh and James L. Gilbert, Profit Pools: A Fresh Look at Strategy, Harvard Business Review, May-June 1998, p.145

Responses to hold-up

Multiple sourcing

Tough negotiation
Contractual arrangements

But investments in relationship-specific assets are important

But contractual incompleteness limits this option

Vertical integration

Dont base your competitive advantage on specific

assets you cant own (like a particular individual)

Source:Ghemawat,1999

Slack

Slack, or waste within the firm, dissipates value

Slack is hard to identify...

but slack is thought to be large

Plush carpets for their own sake are slack

But plush carpets to win customers and recruit talent might be
wise investments
10-40% of revenues, typically!?!

Slack tends to be worst under certain conditions

Source:Ghemawat,1999

Forgiving competitive environments

Settings in which managers must have wide discretion over
productive processes

Slack: the theory of free cash flow

Principal-agent problems between managers and

stakeholders
Managers have incentives to grow the resources
under their control
Free cash flow enhances managers ability to

Source:Ghemawat,1999

Invest resources in negative-return activities

Waste resources

Responses to slack

Monitoring of performance

Managerial incentives

On average, top executives get roughly $3.25 for each $1,000

of shareholder value created (Jensen and Murphy)

Commitments to return cash to shareholders

Benchmarking
Time-motion studies
Outsiders on Boards

e.g., dividends

Appeals to a higher calling, a sense of mission

Source:Ghemawat,1999

Responses to slack

Gathering information
Monitoring behavior
Offering performance incentives
Shaping norms
Bonding resources
Changing governance
Mobilizing for change

Source:Ghemawat,1999

Building sustainable advantages

Understand your own uniqueness

Scan the environment for

Technological changes
Variations in input supply
Demand shifts

Invest in opportunities that fit

Source:Ghemawat,1999

Conclusions

The best defense is a good offense, i.e., defend your

advantage by continually upgrading it

Seek out ways to increase willingness to pay without incurring

commensurate supplier opportunity costs
Seek out ways to reduce supplier opportunity costs without
sacrificing commensurate willingness to pay

Make yourself a moving target

Remember that the landscape can shift under your
feet

Source:Ghemawat,1999