Building Competitive Advantage Through Functional-Level Strategy

Chapter
Four
Building
Competitive
Advantage
Through
Functional-
Level Strategy
“If you want truly to
understand something,
try to change it.” - Kurt
Lewin
“There is nothing more
difficult, nor dangerous,
nor doubtful of success
than to institute a new
order of things.” - Machiavelli
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Functional-Level Strategies
Functional-level strategies are
strategies aimed at improving the
effectiveness of a company’s operations.
Improves company’s ability to attain superior:

1. Efficiency 2. Quality
3. Innovation 4. Customer responsiveness
 Increases the utility that customers receive:
• Through differentiation  Creating more value
• Lower cost structure than rivals
This leads to a competitive advantage
and superior profitability and profit growth.
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The Roots of
Competitive Advantage
Distinctive competencies shape Figure 4.1
the functional-level strategies that
a company can pursue.
Function-level strategies can build

resources and capabilities to
enhance a company’s distinctive
competencies.
Achieving Superior Efficiency
Functional steps to increasing efficiency:
 Economies of Scale
 Learning Effects
 Experience Curve
 Flexible Manufacturing and Mass Customization
 Marketing
 Materials Management and Supply Chain
 R&D Strategy
 Human Resource Strategy
 Information Systems
 Infrastructure
Global Economies of Scale

 Economies of Scale
 Economies of scale
Unit cost reductions associated with a large scale of output
• Ability to spread fixed costs over a large production
volume
• Ability of companies producing in large volumes to
achieve a greater division of labor and specialization
• Specialization has favorable impact on productivity by
enabling employees to become very skilled at performing
a particular task
 Diseconomies of scale
Unit cost increases associated with a large scale of output
• Increased bureaucracy associated with large-scale
enterprises
• Resulting managerial inefficiencies

Economies and Diseconomies
of Scale
Figure 4.2

 Learning Effects
Learning Effects are:
Cost savings that come from learning by doing
• Labor productivity
Learn by repetition how to best carry out the task
• Management efficiency
Learn over time how to best run the operation
• Realization of learning effects implies a
downward shift of the entire unit cost curve
As labor and management become more efficient over time
at every level of output
When changes occur in a company’s
production system,
learning has to begin again.
The Impact of Learning and
Scale Economies on Unit Costs
Figure 4.3
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 The Experience Curve
The Experience Curve
The systematic lowering of the cost structure and
consequent unit cost reductions that occur over the
life of a product
• Economies of scale and learning effects underlie
the experience curve phenomenon
• Once down the experience curve, the company
is likely to have a significant cost advantage
over its competitors
Strategic significance of the experience curve:

Increasing a company’s product volume and
market share will lower its cost structure
relative to its rivals.
The Experience Curve
Figure 4.4

Dangers of Complacency Derived
from Experience Effects
Managers should not become complacent about
efficiency-based cost advantages derived from
experience effects:
1. The experience curve is likely to bottom out
So further unit cost reductions may be hard to come by
2. New technologies can make experience effects
obsolete
From changes always taking place in the external environment
3. Flexible manufacturing technologies may allow
small manufacturers to produce at low unit costs
Achieving both low cost and differentiation through customization
4. Some technologies may not produce lower costs
with higher volumes of output
 Flexible Manufacturing
and Mass Customization
 Flexible Manufacturing Technology
A range of manufacturing technologies that:
• Reduce setup times for complex
equipment
• Improves scheduling to increase
use of individual machines
• Improves quality control at all
stages of the manufacturing process
• Increases efficiency and lowers unit costs
 Mass Customization
Ability to use flexible manufacturing technology to
reconcile two goals that were once thought incompatible:
• Low cost and
• Differentiation through product customization
Tradeoff Between Costs
and Product Variety
Figure 4.5

 Marketing
Marketing
• Marketing strategy
Refers to the position that a company takes regarding
• Pricing  Promotion  Advertising
• Distribution  Product design
• Customer defection rates
Percentage of customers who defect every year
• Defection rates are determined by customer loyalty
• Loyalty is a function of the ability to satisfy customers
Reducing customer defection rates and

building customer loyalty can be major
sources of a lower cost structure.
Relationship between Customer
Loyalty and Profit per Customer
Figure 4.6
The longer a company holds on to a customer the greater the

volume of customer-generated unit sales that offset fixed
marketing costs and lowers the average cost of each sale.
 Materials Management and
Supply Chain
 Materials Management
The activities necessary to get inputs and components to a
production facility, through the production process, and through
the distribution system to the end-user
• Many sources of cost in this process
• Significant opportunities for cost reduction through more
efficient materials management
• Just-in-Time (JIT) Inventory System
System designed to economize on inventory holding costs:
• Have components arrive to manufacturing just prior to
need in production process
• Have finished goods arrive at retail just prior to stock out
 Supply Chain Management
Task of managing the flow of inputs to a company’s processes to
minimize inventory holding and maximize inventory turnover

 R&D Strategy
 Research and Development (R&D)
Roles of R&D in helping a company achieve greater
efficiency and lower cost structure:
1. Boost efficiency by designing products that
are easy to manufacture
• Reduce the number of parts that make up a product –
reduces assembly time
• Design for manufacturing – requires close coordination
with production and R&D
2. Help a company have a lower cost structure by
pioneering process innovations
• Reduce process setup times
• Flexible manufacturing
• An important source of competitive advantage

 Human Resource Strategy
The key challenge of the Human Resource
function: improve employee productivity.
 Hiring strategy
Assures that the people a company hires have the attributes
that match the strategic objectives of the company
 Employee training
Upgrades employee skills to perform tasks faster and more
accurately
 Self-managing teams
Members coordinate their own activities and make their own
hiring, training, work, and reward decisions.
 Pay for performance
Linking pay to individual and team performance can help to
increase employee productivity
 Information Systems
Information systems’ impact on
productivity is wide-ranging:
 Web-based information
systems can automate many of
the company activities
 Potentially affects all the
activities of a company
 Automates interactions between
• Company and customers
• Company and suppliers

 Infrastructure
A Company’s Infrastructure:
The company’s structure, culture, style of
strategic leadership, and control system:
• Determines the context within which all other value
creation activities take place
• Strategic leadership is especially important in
building a companywide commitment to efficiency
• The leadership task is to articulate a vision for all
functions and coordinate across functions
Achieving superior performance requires an
organization-wide commitment.
Top management plays a major role in this process.
Primary Roles of
Value-Creation Functions
Table 4.1

Achieving Superior Quality
Quality can be thought of in terms
of two dimensions and gives a
company two advantages:
Quality as reliability
They do the jobs they were designed
for and do it well
Quality as excellence
Perceived by customers to have superior attributes
1. A strong reputation for quality allows a
company to differentiate its products.
2. Eliminating defects or errors reduces waste,
increases efficiency, and lowers the cost
structure – increasing profitability.
Improving Quality as Reliability
Six Sigma methodology: the principal tool
now used to increase reliability and is a direct
descendant of Total Quality Management (TQM)
TQM is based on the following five-step chain
reaction:
1. Improved quality means that
costs decrease.
2. As a result, productivity also
improves.
3. Better quality leads to higher market
share and allows increased prices.
4. This increases a company’s profitability.
5. Thus the company creates more jobs.
Deming’s Steps in a
Quality Improvement Program
1. A company should have a clear business model.
2. Management should embrace philosophy that
mistakes, defects, and poor quality are not
acceptable.
3. Quality of supervision should be improved.
4. Management should create an environment in
which employees will not be fearful of reporting
problem or making suggestions.
5. Work standards should include some notion of
quality to promote defect-free output.
6. Employees should be trained in new skills.
7. Better quality requires the commitment of
everyone in the workplace.
Roles Played in Implementing
Reliability Improvement Methods
Table 4.2

Implementing Reliability
Improvement Methodologies
Imperatives that stand out among companies that have
successfully adopted quality improvement methods:
 Build organizational commitment to quality
 Create quality leaders
 Focus on the customer
 Identify processes and the source of defects
 Find ways to measure quality
 Set goals and create incentives
 Solicit input from employees
 Build long-term relationships with suppliers
 Design for ease of manufacture
 Break down barriers among functions
Improving Quality as Excellence
A product is a bundle of attributes
and can be differentiated by attributes that
collectively define product excellence.
Developing Superior Attributes:
• Learn which attributes are most important
to customers
• Design products and associate services to
embody the important attributes
• Decide which attributes to promote and how
best to position them in consumers’ minds
• Continual improvement in attributes and
development of new-product attributes
Attributes Associated with a
Product Offering
Table 4.3

Achieving Superior Innovation
Building distinctive competencies that result in
innovation is the most important source of
competitive advantage.
 Innovation can:
• Result in new products that satisfy
customer needs better
• Improve the quality of existing products
• Reduce costs
 Innovation can be imitated -
 So it must be continuous
Successful new product launches are
major drivers of superior profitability.
The High Failure Rate
of Innovation
Failure rate of innovative new products is high
with evidence suggesting that only 10 to 20% of major
R&D projects give rise to a commercially viable product.
Most common explanations for failure:
 Uncertainty
• Quantum innovation – radical departure with higher risk
• Incremental innovation – extension of existing technology
 Poor commercialization
• Definite demand for product
• Product not well adapted to customer needs
 Poor positioning strategy
• Good product but poorly positioned in the marketplace
 Technological myopia
• Technological “wizardry” vs. meeting market requirements
 Slow to market
Building Competencies in
Innovation
Companies can take a number of steps to build
competencies in innovation and reduce failures:
1. Building skills in basic and applied research
2. Project selection and management
Using the product development funnel
» Idea generation » Project refinement » Project execution
3. Achieving cross-functional integration
1. Driven by customer needs 2. Design for manufacturing
3. Track development costs 4. Minimize time-to-market
5. Close integration between R&D & marketing
4. Using product development teams
5. Partly-parallel development process
 To compress development time & time-to-market
The Development Funnel
Figure 4.7

Sequential and Partly Parallel
Development Processes
Figure 4.8
Reduced
Reduced
development
development time
time
& time-to-market
& time-to-market

Functional Roles for Achieving
Superior Innovation
Table 4.4
1. Top management must bear primary responsibility for overseeing the whole
development process.
2. The effectiveness of R&D in developing new products and processes depends
on its ability to cooperate with marketing and production.

Achieving Superior
Responsiveness to Customers
Customer responsiveness: giving customers what
they want, when they want it, and at a price they are willing
to pay - as long as the company’s long-term profitability is
not compromised.
 Focusing on the customer
• Demonstrating leadership
• Shaping employee attitudes
• Bringing customers into the
company
 Satisfying customer needs
• Customization
» Tailor to unique needs of groups of customers
• Response time
» Increase speed » Premium pricing
Primary Roles of Functions in Achieving
Superior Responsiveness to Customers
Table 4.5

“Preparation is
everything.
Noah did not
start building
the ark when
it was raining.”
- Warren Buffett
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Chapter

Improves company’s ability to attain superior:

Function-level strategies can build

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Strategic significance of the experience curve:

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Reducing customer defection rates and

The longer a company holds on to a customer the greater the

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