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Creating and capturing value

MBA 299: Strategy

Ian Larkin & Evan Rawley

4-8-2004

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Agenda

CSG update Introduction to today Value creation frameworks

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Update on CSG Round 3 has been turned in; results posted

later today Only one round due next week: Round 4 by

noon on Tuesday, April 12 Round 5 due by noon Monday, April 18

Critical re-investment round! Will discuss in section next week

Round 5 strategy memo due in class on Monday

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Strategy memos Some of the round 1 strategy memos were very good; others

showed a lack of effort Most focused very heavily on costs instead of other potentially

important topics, and were quite static. Important topics: Market dynamics (importance of different cost drivers, likely

pricing, etc) Competitive dynamics – anticipating likely competitor

moves (or scenarios) and how this will affect (or has affected) your strategies

Both of these, especially the latter, are very important for the remaining 2 memos

Note: this should be a “mini case write-up”; as such, long lists of bullet points, a lack of organization, no topic sentences, etc, are all negatives Write an organized memo, not a list of talking points!

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Where are we in the CSG? Important questions to think about at this point:

Since most markets haven’t yet reached an equilibrium…. What equilibrium are you hoping for? What other possible equilibria are out there? What levers do you have to get to this equilibrium?

Price is not your only lever….. Given where the markets are today, are you on a path to

make money? How much? Are you satisfied with this? Given 2 rounds of selling, what do your ACTUAL average costs look like? How does this compare with your initial plans?

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Agenda

CSG update Introduction to today Value creation frameworks

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Introduction to today’s topic A recurring question in the cases is how well

positioned a company is to capture profits Industry analysis (a la Porter) is part of the story, but even

within industry, there is a wide variation in profitability Today’s discussion is about different frameworks

researchers in strategy use to talk about whether and how a firm can sustain profits, given industry characteristics Cost/differentiation framework Core competencies framework Value-net framework Vertical integration frameworks

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Agenda

Cost/differentiation framework Core competencies framework Value-net framework Vertical integration framework

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Two generic sources of competitive advantage – 3rd dimension is degree of focus Low cost – focus on operations

Essential in a commodity business but can work in almost every business Ruthlessly efficient/lean – Dell, Ryanair, CCS High scale/utilization – Beer giants

Highly differentiated – focus on unique quality Strong brand - Coke IP protected product – Pharmaceuticals Selecting good customers – Progressive

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Many types of cost advantages

General drivers of cost advantages Economies of scale or scope Capacity management/utilization Cumulative experience (learning curve) Transaction cost advantages (vertical integration,

long-term contracting) Location Access to better input prices

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Many types of differentiation possible General drivers of differentiation

Physical characteristics of the product (size, shape, features, color, durability, ease of use…)

Quality of complementary goods (customer service, warranty, spare parts, adjacent goods)

Strong sales or delivery (speed, credit, convenience, etc)

Strength in customer perceptions (brand, status, prestige, large installed base)

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Which type to choose? Choose cost strategy

when… Economies of scale are

critical (but perhaps unexploited)

Demand by customers is relatively homogenous

Few opportunities to enhance product and increase WTP

Customers are price sensitive

Cost is a potential source of competitive advantage

Choose a differentiation strategy when… Customers are very

heterogeneous in their product demands Half like Coke, half like

Pepsi…. Some customer segments

willing to pay a premium for quality

Economies of scale or learning don’t exist or are already exploited by market leader, who focuses on “mid-range” segment

You have expertise in the area to be differentiated

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Generic risks to generic strategies Can you defend your low cost position?

Technological or preference changes can erase scale advantages Ford’s 1st assembly line was down for years to install paint lines

Hard to be lean and mean forever Often advantage lies in one stage in the value chain (more on

this later) – is it vulnerable?

Can you defend your highly differentiated position? Brand is not always a sufficient BTE – imitators can get close Preferences change, new brands can outflank old tired ones

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Agenda

Cost/differentiation framework Core competencies framework Value-net framework Vertical integration framework

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What are core competencies?

Core competencies lie at the heart of a firm’s source of competitive advantage Some special ability to control costs or produce

differentiated products Progressive’s IT system made it able to offer lower price

and high service to profitable segment of the market Dell’s working capital and supply chain management

Supposed to be a combination of hard to imitate processes and knowledge

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Sales Mark eting

Identifying core competencies Value chains are a good place to start

Then benchmark cost and capabilities against competitors If you are the “best” in a segment of the value chain you probably

have a core competency in that activity The deeper/more specific you can be when identifying/defining

core competencies the better

Manu facturing

Develop-ment

Research

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Core competencies often take advantage of competitors’ weaknesses What is Dell’s core competency? Why

did it work? Why couldn’t IBM/HP replicate it?

What is Wal-Mart’s core competency? Why did it work? Why couldn’t Kmart replicate it?

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Core competencies in vertical integration decisions and corporate strategy Can be a very useful tool for thinking about the

boundary of the firm At the business unit level think about what activities in the

value chain are best performed internally and which can be outsourced

At the corporate level think about which business units are central to the firm and which can be spun off

Note the close relationship between synergies and core competencies in this set-up

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Core competencies as a model Very intuitive mental model of a firm

Create profit by focusing on what you are good at

Not always clear what is a core competency and/or how the concept differs from sources of competitive advantage

Can be tautological (we’re good at what we’re good at)

Not a dynamic model Sony was supposed to have a core competency in

miniaturization but they missed the iPod market

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Agenda

Cost/differentiation framework Core competencies framework Value-net framework Vertical integration framework

Customers

Company

Suppliers

ComplementorsCompetitors

The value net The value net holds that the amount of

value a company can capture is both defined and constrained by other players in the “net”

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Key questions asked in “Value Net” analysis What are the sources of value in a firm’s

interactions? How can a firm increase total value

created in the web? How can a firm increase its share of total

value created? Increasing total value in the web doesn’t mean

you will necessarily capture it! Lucent, Xerox, IBM……

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Vertical axis is “traditional” Total economic surplus = customer

willingness to pay minus your suppliers’ costs of production minus the costs you add

Your share of the surplus is your total price charged to customers minus what your suppliers charged you minus your other costs Very complementary with “cost” vs.

“differentiation” strategies

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Complementor vs. Competitor axis looks at your ability to sustain value capture A player is a complementor if customers

value your product more when they have the other player’s product than when they have your product alone. Oscar Mayer and Coleman’s mustard

A player is a competitor if customers value your product less when they have the other player’s product than when they have your product alone. Pepsi and Coke

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Who are the complementors? Cars Auto loans, insurance, roads Televisions VCRs, satellite TV TV shows TV guide Fax machines Phone lines Catalogs Delivery services Hardware Software GameCube Game titles

Complementors are critical to business success!

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However, complementors can steal value! Computer industry example

Microsoft and Intel are complementors of computer hardware companies, yet they constrain the value hardware players can capture

How is Dell a complementor rather than a computer manufacturer?

Value net is also complementary to “core competencies” – you may figure out “non-central” activities allow most value capture

These dynamics mean you may have uneasy relationships with complementors, even though they are necessary to increase total value of an industry

Changing the players can increase your value capture

Bring in customers - Increase industry demand. This helps competitors, but may be worthwhile for you. To do this…

Educate consumers about your product (Diapers in Asia) Pay customers (esp. early adopters) to play Subsidize some customers, other full paying customers will follow

(Initial discount to lower risk) Bring in suppliers

Compaq / AMD / Intel Bring in complementors

Do it yourself. Nintendo - both h/w & s/w. Intel Pay complementors to play (at least initially)

Bring in competitors – does this ever make sense? Sometimes!

There are methods to increase your value-added

Your value added = Size of the pie when you are in the game - Size of the pie when you are not in the game. How to increase added value?

Limit your supply DeBeers and diamonds Downside: Shrinks the pie today; invites entry

Lower competitors’ value Take over critical complementary functions Questions to ask:

What is your added value? How can you increase value by changing supply, buyers,

suppliers, complementors, or substitutors in your value net?

What is the value added by other players? Should you be increasing or decreasing their added values?

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Agenda

Cost/differentiation framework Core competencies framework Value-net framework Vertical integration frameworks

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Two major rationales for vertical integration Rationale 1: Increase market power

Ability to charge higher prices or price discriminate Eliminate double marginalization Foreclose competitors from suppliers or customers

Rationale 2: Improve economic efficiency Improve technical or productive efficiency

Lower costs by joining parts of value chain Improve transaction efficiency

Reduce hold-up when suppliers have power Increase investments which may be risky due to hold-up

Improve incentives (“agency efficiency”) Reduce incentive conflicts or allow better monitoring

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However, vertical integration has costs Costs of vertically integrating

Can add layers of bureaucracy or management Outside core competencies, can we get it cheaper from

the market? Are market incentives better in motivating managers?

E.g. McDonalds franchises to ensure quality Can raise intra-organization influence costs (lobbying,

decisions that are inefficient but benefit one part of the firm)

Can turn previous suppliers or customers into competitors, increasing costs or decreasing market size

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Transaction cost economics focuses on relationship-specific investments A relationship-specific investment is one that isn’t

very valuable for another trading partner except the one who benefits from it Site specificity: you locate your plant right next to a

customer’s factory Technical specificity: you build expensive metal molding

equipment for a specific car Dedicated asset specificity: you undertake a major specific

investment with a specific customer in mind, and a very thin market

Human capital specificity: you train all of your employees on the specialized equipment of a certain supplier

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Relationship-specific investments can cause market failure Sources of market failure with relationship-

specific investments Underinvestment due to risk aversion or

uncertainty Fear of hold-up or other opportunistic behavior

Vertical integration can limit these problems Align investment incentives Remove incentives for hold-up or opportunism

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Horizontal integration is a different ballgame Why horizontally integrate?

Scale Market power, exploit economies of scale, increase

power with suppliers Gain access to new technologies Gain access to new customer sets Gain access to new geographies Provide synergies between product lines

Comcast/Disney, AOL/TW

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Next time

Talk about your round 5 decision for the CSG (re-investment decision)

Introduction to game theory, and applications to cases we’ve studied so far, the CSG, and new cases