Economics of Strategy

Unit 4Chapter 13

Strategic Positioning for Competitive Advantage

Whole Foods Market, Inc case

No class Wed, Oct 26

Whole Foods Preliminary Case: Wed, Nov 2

Final case: Monday, Nov 7

Source: http://www.wholefoodsmarket.com/company/

Strategic Positioning

Firms within the same industry can position themselves in different ways

Not all positions will be equally profitable or lead to the same odds of survival

Why do profits vary across firms? A firm’s ability to create value and enjoy a

competitive advantage over other firms depends on how it positions itself within its industry

Competitive Advantage and Value Creation

A firm is said to have a competitive advantage in a market if it earns a higher rate of economic profit compared to the average economic profit in the industry

Economic profit earned by a firm depends on the market conditions as well as the economic value created by the firm

Competitive Advantage and Value Creation

A firm can achieve competitive advantage only if it can create more economic value than its competitors

A firm’s ability to create value depends on its cost position as well as its benefit position relative to its competitors

Framework for Competitive Advantage

Value Leadership Strategy

Benefit leaders– Woodford Reserve– Coca Cola– Fresh Market Stores– Godiva Chocolates– Dean Foods– Nest Fresh Eggs

Cost leaders– Jim Beam– Big K Cola (pvt labels)– Save-A-Lot– Hersheys– Kroger/Aldi– Cal Maine, pvt label

Value Creation and Profitability

Value created = consumer surplus + producer’s profit

Consumer surplus is the difference between the maximum the consumer is willing to pay (monetary value of the perceived benefit) and the price

Components of Consumer Surplus

A firm can increase consumer surplus by increasing the perceived benefit or by selling at a lower price

The firm can also increase consumer surplus by reducing the cost of using the product and the transactions costs that the consumer incurs

Competition in Price-Quality Continuum

When products differ in quality, competing firms can be viewed as submitting consumer surplus bids with their quality-price combinations

When a firm fails to offer as much consumer surplus as its rivals, its sales will decline

“preferred supplier” criteria

Example of Coffee Brands

Kroger Brand Nescafe instant Maxwell House, Folgers Millstone Dunkin Donuts Starbucks Kona ……many other products with variable prices and

quality – wine, beer, cheese, meat, dining menus

The Value Map

PriceP,

q, quality

Product A

Product B

indifference curve

Lower consumer surplusProduct D

Higher consumer surplus

Product C

Value Map: An Illustration

Points on the indifference curve represent price-quality with the same consumer surplus

The steepness of the indifference curve reflects the tradeoff between price and quality that the consumers are willing to make

Value Map: An Illustration

Products A and B exhibit consumer surplus parity

Product C has a higher consumer surplus than A and B

Product D has a lower consumer surplus

Value Created and Economic Profits

Value created = Consumer surplus +

Producer surplus

= (B - P) + (P - C)

= B - C

If (B-C) is not positive the product offers

no competitive advantage.

Value Created and Competitive Advantage

To achieve competitive advantage, a firm must produce more value than its rivals

Consumers will demand the same consumer surplus from the firm as from its rivals

With superior value creation, the firm can offer as much consumer surplus as the rivals and still make an economic profit

Consonance Analysis of Value Creation

Consonance (harmony, agreement) analysis looks at a firm’s prospects for continuing to create value

Ability to create value will be affected by– changes in market demand– changes in technology and– threats from other firms in the industry and from

other industries– Quality of supply chain relationships

The Value Chain

The value chain or the vertical chain is the representation of the firm as a set of value creating activities

Activities in the value chain include primary activities like production and marketing as well as support activities such as human resource management and finance

Value Creation and Resources and Capabilities

Two ways in which a firm can create more economic value than its competitors– Configure its value chain differently from

competitors– Perform the activities more effectively than the

rivals

If the firm’s value chain is similar to its rivals’ the firm needs resources and capabilities that the rivals do not have to create superior value

LEAN Manufacturing (Toyota)

1 The seven wastes – 1.1 Overproduction – 1.2 Unnecessary transportation – 1.3 Inventory – 1.4 Motion – 1.5 Defects – 1.6 Over-Processing – 1.7 Waiting

Value Creation and Resources and Capabilities

Capabilities have some of the following characteristics– They are typically valuable across multiple

markets and products– They are embedded in organizational routines

that survive when individuals are replaced– They represent tacit knowledge in the

organization

Strategic Positioning

Two broad approaches to strategic positioning– Cost leadership– Benefit leadership

Alternative is to use a narrow focus strategy

The Strategic Logic of Cost Leadership

A cost leader can create more value than its competitors by– offering the same benefits as the competitors do

(benefit parity)…at a lower cost Private label mustard

– offering a slightly lower benefit (benefit proximity)– offering a qualitatively different product

Cubic zirconium vs diamonds

100% Kona Kona “Blend”

The Strategic Logic of Benefit Leadership

A benefit leader firm can create superior values by offering– cost parity– cost proximity– substantially higher benefit and higher cost

Still need isolating mechanisms that keep firms from quick benefit duplication

Marksbury Farms Products

Exploiting a Competitive Advantage Through Pricing

When the product differentiation is weak (small opportunity to be a benefit leader) the firm should follow a market share strategy

With a cost advantage, the firm should under price its rivals and build share

With a benefit advantage, the firm should maintain price parity and let the benefit build the share (rather than building share through lower cost)

Exploiting a Competitive Advantage Through Pricing

When the product differentiation is strong the firm should follow a profit margin strategy (max gross margin)

With a cost advantage, the firm should maintain price parity with its rivals

With a benefit advantage, the firm should charge a price premium over the competitors

Search goods vs experience goods

Search goods – objective quality attributes can largely be assessed by the typical buyer prior to the point of purchase (photo services, commodity products)

Experience goods – quality can only be assessed after the consumer has purchased it and used it for awhile (electronics, wine, appliances, education, medical service – movies, plays, music, concerts…..,apple picking?)

Conditions Suitable for Seeking a Cost Advantage

Cost advantage should be sought– when the nature of the product does not allow

benefit enhancement (commodity characteristics)– when consumers are relatively price sensitive and– when the product is a search good rather than an

experience good

Conditions Suitable for Seeking a Benefit Advantage

Benefit advantage should be sought– when consumers are willing to pay a premium for

benefit enhancements– when economies of scale and learning have been

already exploited and differentiation is the best route to value creation and

– when the product is an experience good

Diversity of Strategies

Firms need to deliver a distinct bundle of economic value through their strategy choices

When consumers differ in their willingness to pay for product attributes, different strategies can coexist – but tough to manage

“Stuck in the Middle”

It can be argued that firms should either pursue a cost advantage or a benefit advantage but not both

Firms that pursue both could, according to this argument, get stuck in the middle and have neither advantage

In reality, successful firms appear to have both types of advantages simultaneously

Cost and Benefit Leadership

Learning economies may be more important for high quality production than for low quality production

The high quality producers may also be more efficient producers than low quality producers

Strategic Positioning

Two specific strategy questions are important– How will the firm create value? [Benefit, cost]– Where will the firm do it? [Broad or narrow

segments]

Segmenting an Industry

An industry can be represented in two dimensions– Product varieties – families of related products

Snack foods

– Customer groups LOHAS

A potential segment is the intersection of a particular product group with a particular customer group

Segmenting with a market-customer diagram

Product Possibilities

………

Customer Groups

………

Extension Possibilities for Pumpkins

Customer GroupsFamiliesState ParksRestaurantsSelected Age GroupsGeographic marketsHomeownersSchools....

Product PossibilitiesPumpkinsMiniature pumpkinsGourdsMiniature hay balesMumsHalloween ensembles....

Segmenting an Industry

Differences in segments arise due to– Customer preferences– Supply conditions– Segment size

Customers within a group should have common features

Broad Coverage Strategies

Offer a full line of products to serve a range of customer groups

Economies of scope can arise from – Production– Distribution– Marketing

Focus Strategies

Customer specialization: A wide range of products to a narrow customer group

Product specialization: Limited product variety for a wide range of customers

Geographic specialization: Exploit the unique conditions of the region

Product Possibilities

………

Customer Groups

………