Alternative Model of Superior Returns

Industrial Organization Model

Resource-Based Model

I/O Model of Superior Returns The Industrial Organization Model suggests that above-average returns for any firm are largely determined by characteristics outside the firm. The I/O model largely focuses on industry structure or attractiveness of the external environment rather than internal characteristics of the firm.

I/O Assumptions
Environment determines strategy Firms possess similar resources and thus pursue similar strategies. Resources are mobile Decision-makers rational & act in the best interests of the firm.

I/O Model of Superior Returns

External Environment
General Environment Industry Environment Competitive Environment

Action required: Study the external environment, especially the industry environment.

I/O Model of Superior Returns

External Environment An Attractive GeneralIndustry Environment
Industry Environment An industry whose Competitive structural characteristics Environment above-average suggest returns are possible

Action required: Locate an industry with high potential for aboveaverage returns.

I/O Model of Superior Returns

External Environment Attractive GeneralIndustry Environment Industry Environment Strategy An industry whose Competitive Formulation structural characteristics Action required: Identify strategy called for by the industry to earn above-average returns.

Environment Selection of a strategy linked suggest above-average with possible returns are above-average returns in a particular industry

I/O Model of Superior Returns

Action required: External Develop or acquire assets Environment Attractive and skills needed to GeneralIndustry Environment implement the strategy. Strategy Industry Environment An industry whose Formulation Competitive structural characteristics Environment above-averageAssets and Skills Selection of a strategy suggest
returns arelinked with abovepossible Assets and average returns in a skills required particular industry to implement a chosen strategy

I/O Model of Superior Returns

Action required: External Use the firms strengths Environment Attractive (its assets or skills) to GeneralIndustry Environment implement the strategy. Strategy Industry Environment An industry whose Formulation Competitive structural characteristics Environment above-averageAssets and Skills Selection of a strategy suggest returns arelinked with above- Strategy possible Assets and average returns in a skills required Implementation particular industry to implement
a chosen strategy of strategic Selection actions linked with effective implementation of the chosen strategy

I/O Model of Superior Returns

Action required: External Maintain selected strategy Environment Attractive in order to outperform GeneralIndustry Environment industry rivals. Strategy Industry Environment An industry whose Formulation Competitive structural characteristics Environment above-averageAssets and Skills Selection of a strategy suggest
returns arelinked with abovepossible Assets and skills average returns in a Strategy required Implementation particular industry to implement a chosen strategy Superior Returns Selection of strategic actions linked with Earning of aboveeffective implementation average returns of the chosen strategy

Resource Based View

Introduction Assumptions: Firms are unique bundles of resources Resources are relatively immobile

RBV Concepts:
Resource
Stocks Flows

Capability Capacity Durability Specificity

helps to identify which resources and capabilities can add value

Value Chain Analysis

Firm Infrastructure
Support Activities

Human Resource Management Technological Development Procurement

M A RG IN

Operations

Outbound Logistics

Marketing & Sales

Inbound Logistics

Primary Activities

M A R G IN

Service

The Value Chain System

Upstream Value Chains A Companys Own Value Chain Downstream Value Chains

Activities, Costs, & Margins of Suppliers

Internally Performed Activities, Costs, & Margins

Activities, Costs, & Margins of Forward Channel Allies & Strategic Partners

Buyer/User Value Chains

The Value Chain System

Cost competitiveness -- comparing costs along the industrys value chain Suppliers value chains are relevant because

Costs, quality, and performance of inputs influence a firms own costs and product performance

Forward channel allies value chains are relevant because

Forward channel allies costs and margins are part of price paid by ultimate end-user Activities performed affect end-user satisfaction

Example: Key Value Chain Activities

SOFT DRINK INDUSTRY
Processing of basic ingredients Syrup manufacture Bottling and can filling Wholesale distribution Retailing
Kroger

Competencies, Core Competencies, and Distinctive Competencies

Competencies: Internal capabilities that a company performs better than other capabilities. Core competencies: Competencies that are central, not peripheral, to a companys strategy and operations. Distinctive competencies: Competencies that are sources of sustainable competitive advantage.

Strategic Assets & Distinctive Competencies

Characteristics: In Demand (valuable) Scarce (rare) Difficult & costly to imitate Appropriability Nonsubstitutable Sources of Economic Rents: Ricardian Rents Schumpeterian Rents

R&C Characteristics and Implications

Is the R/C valuable? Is the R/C Is the R/C rare? difficult or costly to imitate? Is the R/C nonsubstitutable? Competitive Consequences Performance Implications

No Yes Yes Yes

No No Yes Yes

No No No Yes

No Yes/No Yes/No Yes

Competitive Disadvantage Competitive Parity Temporary Advantage Sustainable Competitive Advantage

Below AIR AIR AIR to Above AIR Above AIR

Resource = R Capability = C AIR = Average Industry Returns Assumption: Rents are appropriated by the firm.

Examples: Distinctive Competencies

Sharp Corporation

Competencies in flat-panel display technology Low-cost, high-quality manufacturing capabilities and short design-to-market cycles Capability to design and manufacture ever more powerful microprocessors for PCs

Toyota, Honda, Nissan

Intel

Practical Implications I
Inventory Analysis of Resources & Capabilities
I.D. strategic assets & distinctive competencies

Invest in / Upgrade SA & DC

ex ante identification entrenchment vs. flexibility ways to upgrade

Rebundle / Reconfigure Leverage SA & DC

Practical Implications II
Assessing the Firms Relative Strengths Strategic Cost Analysis Managing the Value Chain System

Assessing a Companys Competitive Strength versus Key Rivals

1. List industry key success factors and other relevant measures of competitive strength 2. Rate firm and key rivals on each factor using rating scale of 1 - 10 (1 = weak; 10 = strong) 3. Decide whether to use a weighted or unweighted rating system 4. Sum individual ratings to get overall measure of competitive strength for each rival 5. Determine whether the firm enjoys a competitive advantage or suffers from competitive disadvantage

An Unweighted Competitive Strength Assessment

KSF/Strength Measure Quality/product performance Reputation/image Manufacturing capability Technological skills Dealer network/distribution New product innovation Financial resources Relative cost position Customer service capability Overall strength rating ABC Co. 8 8 2 10 9 9 5 5 5 61 Rival 1 5 7 10 1 4 4 10 10 7 58 Rival 2 10 10 4 7 10 10 7 3 10 71 Rival 3 1 1 5 3 5 5 3 1 1 25 Rival 4 6 6 1 8 1 1 1 4 4 32

Rating Scale: 1 = Very weak; 10 = Very strong

A Weighted Competitive Strength Assessment

KSF/Strength Measure Quality/product performance Reputation/image Manufacturing capability Technological skills Dealer network/distribution New product innovation Financial resources Relative cost position Customer service capability Sum of weights Overall strength rating Weight 0.10 0.10 0.10 0.05 0.05 0.05 0.10 0.35 0.15 1.00 6.20 8.20 7.00 2.10 2.90 ABC Co. 8/0.80 8/0.80 2/0.20 10/0.50 9/0.45 9/0.45 5/0.50 5/1.75 5/0.75 Rival 1 5/0.50 7/0.70 10/1.00 1/0.05 4/0.20 4/0.20 10/1.00 10/3.50 7/1.05 Rival 2 10/1.00 10/1.00 4/0.40 7/0.35 10/0.50 10/0.50 7/0.70 3/1.05 10/1.50 Rival 3 1/0.10 1/0.10 5/0.50 3/0.15 5/0.25 5/0.25 3/0.30 1/0.35 1/0.15 Rival 4 6/0.60 6/0.60 1/0.10 8/0.40 1/0.05 1/0.05 1/0.10 4/1.40 4/1.60

Rating Scale: 1 = Very weak; 10 = Very strong

Why Do a Competitive Strength Assessment ?

Reveals firms competitive position Pinpoints the companys competitive strengths and weaknesses Identifies competitive advantage, parity, or disadvantage Identifies possible offensive attacks Identifies possible defensive actions

Strategic Cost Analysis

Analyze firms costs relative to rivals Compare firms costs activity by activity against costs of key rivals

From raw materials purchase to Price paid by ultimate customer

Pinpoints which internal activities sources of cost advantage disadvantage

or

are

Activity-Based Costing: A Key Tool in Strategic Cost Analysis

Compare companys costs with those of rivals activity-by-activity--from one end of the value chain to the other This requires accounting data that measures the cost of each value chain activity Activity-based accounting systems provide a way of measuring costs for each relevant value chain activity

Traditional Cost Accounting vs. Activity-Based Costing

Departmental Activities Using Activity-Based Cost Accounting $350,000 115,000 6,500 2,400 17,000 124,000 25,520 $640,150 Evaluate Suppliers Process Purchase Orders Expedite Deliveries Expedite Internal Process Check Item Quality Check Deliveries Against Purchase Orders Resolve Problems Internal Administration $135,750 82,100 23,500 15,840 94,300 48,450 110,000 130,210 $640,150

itional Cost Accounting gories in Department get

es & Salaries loyee Benefits plies el eciation er Fixed Charges ellaneous erating Expenses

Benchmarking the Costs of Key Value Chain Activities

Cross-company comparisons of how well activities are performed:

Purchase of materials Payment of suppliers Management of inventories Training of employees Processing of payrolls Getting new products to market Performance of quality control Filling and shipping of customer orders

Determining Cost Competitiveness

Cost competitiveness comes from managing the value chain system better than competitors Three areas contribute to cost differences
1. Suppliers activities 2. The companys own internal activities 3. Forward channel activities
Activities, Costs, & Margins of Suppliers Internally Performed Activities, Costs, & Margins
Activities, Costs, & Margins of Forward Channel Allies & Strategic Partners

Buyer/User Value Chains

Correcting Supplier-Related Cost Disadvantages: Options

Negotiate more favorable prices with suppliers Work with suppliers to help them achieve lower costs Integrate backward Use lower-priced substitute inputs Do a better job of managing linkages between suppliers value chains and firms own chain Make up difference by initiating cost savings in other areas of value chain

Correcting Forward Channel Cost Disadvantages: Options

Push for more favorable terms with distributors and other forward channel allies Work closely with forward channel allies and customers to identify win-win opportunities to reduce costs Change to a more economical distribution strategy Make up difference by initiating cost savings earlier in value chain

Correcting Internal Cost Disadvantages: Options

Reengineer high-cost activities or business processes Eliminate some cost-producing activities altogether by revamping value chain system Relocate high-cost activities to lower-cost geographic areas See if high-cost activities can be performed cheaper by outside vendors/suppliers Invest in cost-saving technology Simplify product design Make up difference by achieving savings in backward or forward portions of value chain system