Competitive Advantage

Michael Porter’s Five Forces (Internal)

There are six major sources of entry barriers:

1. Economics of scale
2. Product differentiation
3. Capital requirements
4. Switching cost
5. Access to distribution channels
6. Cost disadvantages independent of scale

The threat of New Entrants is the possibility that the profits of established firms in the industry may
be eroded by new competitors.

Bargaining power of buyers is the threat that buyers may force down prices, bargain for higher
quality or more services, and play competitors against each other.

Bargaining power of suppliers is the threat that suppliers may raise prices or reduce the quality of
purchased goods or services.

Substitutes products or services. Substitutes limit the potential returns of an industry by placing a
ceiling on the prices that firms in that industry can profitably charge. The more attractive the
price/performance ratio of substitute products, the tighter the lid on an industry’s profits.
Rivalry among competitors in an industry is the threat that customers will switch their business to
competitors within the industry.

VRIN (External)
1. Valuable (is the resources valuable?)
2. Rare (Are the resources rare?)
3. Costly to Imitate (can the resource be imitated easily?)
4. Nonsubstituable (are substitutes readily available?)

VRIO (External)
1. Valuable
2. Rare
3. Inimitable
4. Organized

Inimitable have at least one of the following four characteristics:

1. Physical Uniqueness first source of inimitability is physical uniqueness, which by definition is

inherently difficult to copy. Examples: locations, patents, etc.
2. Path Dependency. This simply means that resources are unique and therefore scarce
because of all that has happened along the path followed in their development and/or
accumulation. Competitors cannot go out and buy these resources quickly and easily; they
must be built up over time in ways that are difficult to accelerate.
3. Causal Ambiguity is a characteristic of a firm’s resources that is costly to imitate because a
competitor cannot determine what the resource is and/or how it can be recreated.
4. Social Complexity is a characteristic of a firm’s resources that is costly to imitate because the
social engineering required is beyond the capability of competitors, including interpersonal
relations among managers, organizational culture, and reputation with suppliers and
customers.

Resource-Based View (RBV)

Firms’ competitive advantages are due to their endowment of strategic resources that are
valuable, rare, costly to imitate, and costly to substitute.

Firm resources are all assets, capabilities, organizational processes, information, knowledge,
and so forth, controlled by a firm that enable it to develop and implement value-creating strategies.
Three key types of firm resources are:

1. Tangible Resources are organizational assets that are relatively easy to identify, including
physical assets, financial resources, organizational resources, and technological resources.
a. Financial resources (e.g., a firm’s cash, accounts receivable, and its ability to borrow
funds)
b. Physical resources (e.g., the company’s plant, equipment, and machinery as well as
its proximity to customers and suppliers)
c. Organizational resources (e.g., the company’s strategic planning process and its
employee development, evaluation, and reward systems)
d. Technological resources (e.g., trade secrets, patents, and copyrights).
 2. Intangible Resources are organizational assets that are difficult to identify and account for
and are typically embedded in unique routines and practices, including human resources,
innovation resources, and reputation resources.
a. Human resources (e.g., experience and capability of employees, trust, effectiveness
of work teams, managerial skills)
b. Innovation resources (e.g., technical and scientific expertise, ideas)
c. Reputation resources (e.g., brand name, reputation with suppliers for fairness and
with customers for reliability and product quality)
3. Organizational Capabilities are the competencies and skills that a firm employs to transform
inputs into outputs. Capacity to combine tangible and intangible resources, using
organizational processes to attain the desired end.
a. Outstanding customer service
b. Excellent product development capabilities
c. Super innovation processes
d. Flexibility in manufacturing processes

Product Life Cycle

The Industry Life Cycle refers to the stages of introduction, growth, maturity, and decline
that occur over the life of an industry.

Introduction
In the Introduction stage, products are unfamiliar to consumers. Market segments are not
well-defined, and product features are not clearly specified.

The early development of an industry typically involves low sales growth, rapid
technological change, operating losses, and the need for strong sources of cash to finance
operations. Since there are few players and not much growth, competition tends to be limited

Success requires an emphasis on research and development and marketing activities to

enhance awareness.

The challenge becomes one of:

1. Developing the product and finding a way to get users to try it.
 2. Generating enough exposure so the product emerges as the “standard” by which all
other rivals’ products are evaluated.

Growth
The Growth stage is characterized by strong increases in sales. Such potential attracts other
rivals. In the growth stage, the primary key to success is to build consumer preferences for specific
brands.

This requires strong brand recognition, differentiated products, and the financial resources
to support a variety of value-chain activities such as marketing and sales, and research and
development.

Whereas marketing and sales initiatives were mainly directed at spurring aggregate demand
—that is, demand for all such products in the introduction stage—efforts in the growth stage are
directed toward stimulating selective demand, in which a firm’s product offerings are chosen instead
of a rival’s.

Revenues increase at an accelerating rate because:

1. New consumers are trying the product

2. A growing proportion of satisfied consumers are making repeat purchases.

Maturity
In the Maturity stage, aggregate industry demand softens. As markets become saturated,
there are few new adopters.

It’s no longer possible to “grow around” the competition, so direct competition becomes
predominant. With few attractive prospects, marginal competitors exit the market.

At the same time, rivalry among existing rivals intensifies because of fierce price
competition at the same time that expenses associated with attracting new buyers are rising.

Advantages based on efficient manufacturing operations and process engineering become

more important for keeping costs low as customers become more price-sensitive.

It also becomes more difficult for firms to differentiate their offerings, because users have a
greater understanding of products and services.

Decline
The Decline stage occurs when industry sales and profits begin to fall. Typically, changes in
the business environment are at the root of an industry or product group entering this stage.
Changes in consumer tastes or technological innovation can push a product into decline.

In the decline stage, a firm’s strategic options become dependent on the actions of rivals. If
many competitors leave the market, sales and profit opportunities increase. On the other hand,
prospects are limited if all competitors remain.

Four basic strategies are available in the decline phase:

1. Maintaining
 Maintaining refers to keeping a product going without significantly reducing
marketing support, technological development, or other investments, in the hope that
competitors will eventually exit the market.

2. Harvesting
Harvesting involves obtaining as much profit as possible and requires that costs be
reduced quickly. Managers should consider the firm’s value-creating activities and
cut associated budgets. The objective is to wring out as much profit as possible.
3. Exiting the market
Exiting the market involves dropping the product from a firm’s portfolio. Since a
residual core of consumers exists, eliminating it should be carefully considered. If
the firm’s exit involves product markets that affect important relationships with
other product markets in the corporation’s overall portfolio, an exit could have
repercussions for the whole corporation.
4. Consolidation
Consolidation involves one firm acquiring at a reasonable price the best of the
surviving firms in an industry. This enables firms to enhance market power and
acquire valuable assets.

Types of Competitive Advantages

1. Overall Cost Leadership
Overall cost leadership is a firm’s generic strategy based on appeal to the industrywide
market using a competitive advantage based on low cost. Overall cost leadership requires a
tight set of interrelated tactics that include:
 Aggressive construction of efficient-scale facilities.
 Vigorous pursuit of cost reductions from experience.
 Tight cost and overhead control.
 Avoidance of marginal customer accounts.
 Cost minimization in all activities in the firm’s value chain, such as R&D, service, sales
force, and advertising.

One factor often central to an overall cost leadership strategy is the experience curve,
which refers to how a business “learns” to lower costs as it gains experience with production
processes. With experience, unit costs of production decline as output increases in most
industries.

However, experience curve gains will be the foundation for a cost advantage only if the
firm knows the source of the cost reduction and can keep these gains proprietary

Potential pitfalls of overall cost leadership strategies:

 Too much focus on one or a few value chain activities

 Increase in the cost of the inputs on which the advantages are based
 A strategy that can be imitated too easily
 A lack of parity in differentiation
  Reduced flexibility
 Obsolescence of the basis of cost advantages.
2. Differentiation
As the name implies, a differentiation strategy consists of creating differences in the
firm’s product or service offering by creating something that is perceived industry-wide as
unique and valued by customers.

Differentiation can take many forms:

 Prestige or brand image (Hotel Monaco, BMW automobiles).

 Quality (Apple, Ruth’s Chris steak houses, Michelin tires).
 Technology (Martin guitars, North Face camping equipment).
 Innovation (Medtronic medical equipment, Tesla Motors).
 Features (Cannondale mountain bikes, Ducati motorcycles).
 Customer service (Nordstrom department stores, USAA financial
services).
 Dealer network (Lexus automobiles, Caterpillar earthmoving
equipment).

Potential pitfalls of differentiation strategies:

 Uniqueness that is not valuable

 Too much differentiation
 Too high a price premium
 Differentiation that is easily imitated
 Dilution of brand identification through product line extensions
 Perceptions of differentiation that vary between buyers and sellers
3. Focus
A focus strategy is based on the choice of a narrow competitive scope within an
industry. A firm following this strategy selects a segment or group of segments and tailors
its strategy to serve them.
The essence of focus is the exploitation of a particular market niche. As you might
expect, narrow focus itself (like merely “being different” as a differentiator) is simply not
sufficient for above-average performance.
In a cost focus, a firm strives to create a cost advantage in its target segment. In a
differentiation focus, a firm seeks to differentiate in its target market. Both variants of the
focus strategy rely on providing better service than broad-based competitors that are trying
to serve the focuser’s target segment. Cost focus exploits differences in cost behavior in
some segments, while differentiation focus exploits the special needs of buyers in other
segments.