Professional Documents
Culture Documents
Chapter 6: Business Strategy: Differentiation, Cost Leadership, and Integration
Chapter 6: Business Strategy: Differentiation, Cost Leadership, and Integration
6: Business strategy: differentiation, cost
leadership, and integration
6.1 BusinessLevel strategy: how to compete for advantage
What is businesslevel strategy?
Businesslevel strategy details the goaldirected actions managers take in their quest for
competitive advantage when competing in a single product market.
What does a businesslevel strategy involve?
Businesslevel strategy may involve a single product or a group of similar products that use
the same distribution channel.
Which question does the businesslevel concern?
Businesslevel concerns the broad question “How should we compete?”.
Which question do managers have to answer to formulate the appropriate businesslevel
strategy?
To formulate an appropriate businesslevel strategy, managers need to answer the
“whowhatwhyandhow” questions of competition.
Who → Which customer segments the firm wants to serve
What →Which customer needs, wishes, and desires the firm want to satisfy
Why → Why the firm wants to satisfy the customer needs, wishes and desires
How → How the firm will satisfy its customers’ needs.
What do managers need to keep in mind to formulate an effective businesslevel strategy?
To formulate an effective business strategy, managers need to keep in mind that competitive
advantage is determined jointly by industry and firm effects.
What do managers need to be certain about?
Managers need to be certain that the business strategy is aligned with the five forces that
shape competition.
How can managers evaluate performance differences among clusters of firm in the same
industry?
Managers can evaluate performance differences among clusters of firms in the same industry
by conducting a strategicgroup analysis.
What is the firm’s performance determined by at the firm level?
At the firm level, performance is determined by value and cost position relative to competitors.
This is the firm’s strategic position.
STRATEGIC POSITION
Which 2 primary levers do managers have at their disposal to answer the businesslevel
question of how to compete?
To answer the businesslevel strategy question of how to compete, managers have 2 primary
competitive levers at their disposal: value (V) and cost (C).
What does a firm’s businesslevel strategy determine?
A firm’s businesslevel strategy determines its strategic position, which is its strategic profile
based on value creation and cost, in a specific product market.
What does a firm attempt to stake out?
A firm attempts to stake out a valuable and unique position that meets customer needs while
simultaneously creating as large as gap as possible between the value the firm’s product
creates and the cost required to produce it.
What does higher value tend to require?
Higher value tends to require higher cost.
What do managers have to make in order to achieve a desired strategic position?
To achieve a desired strategic position, managers must make strategic tradeoffs which are
choices between a cost or value position.
What must managers address to keep cost in check?
Managers must address the tension between value creation (which tends to generate higher
cost) and the pressure to keep cost in check so as not to erode the firm’s economic value
creation and profit margin.
When is a business strategy more likely to lead to a competitive advantage?
A business strategy is more likely to lead to a competitive advantage if it allows firms to either
perform similar activities differently, or perform different activities than their rivals that result
creating more value or offering similar product or services at lower cost.
GENERIC BUSINESS STRATEGIES
2 fundamentally different generic business strategies:
There are 2 fundamentally different generic business strategies: differentiation and cost
leadership.
What is a differentiation strategy?
A differentiation strategy seeks to create higher value for customers than the value that
competitors create by delivering products or services with unique features while keeping costs
at the same or similar level.
What is a cost leadership strategy?
A cost leadership seeks to create the same or similar value for customers by delivering
products or services at a lower cost than competitors, enabling the firm to offer lower prices to
its customers.
Why are these 2 strategies called generic strategies?
These 2 strategies (differentiation and cost leadership) are called generic strategies because
they can be used by any organization in the quest for competitive advantage, independent of
industry structure.
What do differentiation and cost leadership require in order to increase a firm’s chances of
gaining and sustaining a competitive advantage?
Differentiation and cost leadership require distinct strategic positions in order to increase a
firm’s chances to gain and sustain a competitive advantage.
Why do tradeoffs exist between value creation and low cost?
Because value creation and cost tend to be positively correlated, there exist important
tradeoffs between value creation and low cost.
Can different generic strategies lead to competitive advantage in the same industry?
Yes, different generic strategies can lead to competitive advantage, even in the same
industry.
What do managers also have to define when considering different business strategies?
When considering different business strategies, managers must also define the scope of
competition. The score of competition is whether to pursue a specific, narrow part of the
market or to go after the broader market.
What do we get when we combine the dimensions describing a firm’s strategic position with
the scope of competition?
When we combine the dimensions describing a firm’s strategic position (differentiation and
cost with the scope of competition (narrow and broad), we get 2 major broad business
strategies: cost leadership and differentiation.
We also get the focused versions of each:
focused costleadership strategy
focused differentiation strategy
These 2 focused versions are essentially the same as the broad generic strategies except
that the competitive scope is narrower.
6.2 Differentiation strategy: understanding value drivers
What is the goal of a generic differentiation strategy?
The goal of a generic differentiation strategy is to add unique features that will increase the
perceived value of goods and services in the minds of the consumers so they are willing to
pay a higher price.
What does a firm following a differentiated strategy aim to achieve?
A firm following a differentiation strategy aims to achieve in the minds of consumers a level of
value creation that its competitors cannot easily match.
What does the focus of competition in a differentiation strategy tend to be?
The focus of competition in a differentiation strategy can achieve tends to be on unique
product features, service, and new product launches, or on marketing and promotion rather
than price.
How can a company that uses a differentiation strategy achieve a competitive advantage?
A company that uses a differentiation strategy can achieve a competitive advantage as long
as its economic value created (VC) is greater than that of its competitors.
Other than value creation, what do managers have to control when applying a differentiation
strategy?
Although increased value creation is a defining feature of a differentiation strategy, managers
must also control costs. Rising costs reduce economic value created and erode profit
margins. Indeed, if cost rises too much as the firms attempts to create more perceived value
for customers, its value gap shrinks, negating any differentiation advantage.
Second pricing option for firms with a differentiation for firms with a differentiated strategy:
Although a differentiation strategy is generally associated with premium pricing, managers
have an important second pricing option. When a firm is able to gain market share from other
firms by charging a similar price but offering more perceived value.
What levers can managers adjust to improve a firm’s strategic position?
Managers can adjust a number of different levers to improve a firm’s strategic position. They
are: product features, customer service and complements.
PRODUCT FEATURES
What does adding unique product features allow firms to do?
Adding a unique product feature allows firms to turn commodity products into differentiated
products commanding a premium price.
What is often needed to create superior product features?
Strong R&D capabilities are often needed to create superior product features.
CUSTOMER SERVICE
How can managers increase the perceived value of their firms’ products or services?
Managers can increase the perceived value of their firms’ product or service by focusing on
customer service and responsiveness.
COMPLEMENTS
When do complements add value to a product/service?
Complements add value to a product or service when they are consumed in tandem. Finding
complements, therefore, is an important task for managers in their quest to enhance the value
of their offerings.
Increasing the perceived value of firms that choose a differentiation strategy:
By choosing the differentiation strategy as the strategic position for a product, managers focus
their attention on adding value to the product through its unique features that respond to
consumer preferences, customer service during and after the sale, or an effective marketing
campaign that communicates the value of the product’s features to the target market.
Although this positioning involves increased costs, customers will be willing to pay a premium
price for the product or service that satisfies their needs and preferences.
6.3 Cost leadership strategy: understanding cost drivers
What is the goal of a cost leadership strategy?
The goal of cost leadership strategy is to reduce the firm’s cost below that of its competitors
while offering adequate value.
What does the cost leader focus on?
The cost leader focuses its attention and resources on reducing the cost to manufacture a
product or deliver service in order to offer lower prices to its customers.
What does the cost leader do to achieve a low cost position?
The cost leader optimizes all of its value chain activities to achieve a low cost position.
Despite shaking out the lowest cost position in the industry being the overriding strategic
objective of the cost leader, what does he/she still have to do?
Although staking out the lowest cost position in the industry is the overriding strategic
objective, a cost leader still needs to offer products and services of acceptable value.
How can a cost leader achieve a competitive advantage?
A cost leader can achieve a competitive advantage as long as its economic value created
(VC) is greater than that of its competitors.
Can companies successful at cost leadership neglect value creation?
Although companies successful at low cost leadership must excel at controlling costs, this
doesn’t mean they can neglect value creation.
What are the most important cost drivers that managers can manipulate to keep their costs
low?
The most important cost drivers that managers can manipulate to keep their costs low are:
Cost of input factors
Economies of scale
Learning curve effects
Experience curve effects
COST OF INPUT FACTORS
What is one of the most basic advantages a firm can have over its rivals?
One of the most basic advantages a firm can have over its rivals is access to lower cost input
factors such as raw materials, capital, labor and IT services.
What do some companies do to lower labor costs for some types of tasks?
To lower labor costs for some types of tasks, some companies outsource certain activities.
ECONOMIES OF SCALE
What are economies of scale?
Economies of scale are decreases in cost per unit as output increases.
What do economies of scale allow firms to do?
1. Spreading fixed cost over larger outputs: larger output allows firms to spread their
fixed costs over more units.
2. Employing specialized systems and equipment: larger output also allows firms to
invest in more specialized systems and equipment, such as enterprise resource
planning (ERP).
3. Taking advantage of certain physical properties: one such property is known as the
cubesquare rule whereby firms can stock much more merchandise and handle
inventory more efficiently.
→ The minimum efficient scale (MES) is the output range needed to bring the cost per
unit down as much as possible, allowing a firm to stake out the lowest cost position
achievable through economies of scale.
→ The concept of minimum efficient scale applies not only to manufacturing processes
but also to managerial tasks such as how to organize work.
What are diseconomies of scale?
Diseconomies of scale are increases in cost as output increases.
LEARNING CURVE
When can we expect more learning curves?
The more complex the production process, the more learning effects we can expect.
Differences between economies of scale and learning effects:
Learning effects can occur over time as output is accumulated, while economies of scale are
captured at one point in time when output is increased.
In some production processes (simple onestep processes for example), effects from
economies of scale can be quite significant, while learning effects are minimal. In contrast, in
some professions (brain surgeries or the practice of estate law), learning effects can be
substantial, while economies of scale are minimal.
EXPERIENCE CURVE
What does the concept of experience curve attempt to capture?
The concept of experience curve attempts to capture both learning effects and process
improvements.
How can a firm gain competitive advantage?
A firm can gain competitive advantage by moving further down a given learning curve than
competitors.
What does learning by doing allow a firm to do?
Learning by doing allows a firm to lower its perunit cost by moving down a given learning
curve.
What does combining experience based learning and process innovation allow a firm to do?
Combining experiencebased learning and process innovation allows the firm to leapfrog to a
steeper learning curve, thereby further driving down its perunit costs.
6.4 Businesslevel strategy and the five forces: benefits and risks
6.5 Integration strategy: combining cost leadership and
differentiation
What might competing conditions in an industry require firms to do?
Competitive conditions in an industry may require firms to develop skills in lowering costs as
well as adding uniqueness.
What is an integration strategy?
An integration strategy is a businesslevel strategy that successfully combines differentiation
and costleadership activities.
What does a successful integration strategy require?
A successful integration strategy requires that tradeoffs between differentiation and low cost
are reconciled. This is often difficult because differentiation and low cost are distinct strategic
positions that require the firm to effectively manage internal value chain activities that are
fundamentally different from one another.
What does an integration strategy allow a firm to do?
An integration strategy allows a firm to offer a differentiated product or service at low cost.
Consequence of integration gone bad:
The consequence of an integration strategy gone bad is that the firm ends up being “stuck in
the middle”, meaning the firm has neither a clear differentiation strategy nor a clear
costleadership profile.
The goal of an integration strategy:
The goal of an integration strategy is to achieve a larger economic value created than that of
rivals pursuing a differentiation or lowcost leadership strategy.
The 2 pricing options that a successfully implemented integration strategy allows:
A successfully implemented integration strategy allows firms 2 pricing options:
the firm can charge a higher price than the cost leader, reflecting its higher value
creation and thus generating greater profit margins.
the firm can lower its price below that of the differentiator because of its lowercost
structure. If the firm offers lower prices than the differentiator, it can gain market share
and make up the loss in margin through increased sales.
VALUE & COST DRIVERS OF INTEGRATION STRATEGY
What must managers resolve in order for an integration strategy to succeed?
For an integration strategy to succeed, managers must resolve tradeoffs between the 2
generic strategic positions: low cost and differentiation.
What are some levers managers can use to overcome the challenges facing the success of
an integration strategy?
Some possible levers managers can use to overcome these challenges include:
Quality
Economies of scope
Customization
Innovation
Structure, culture, and routines
QUALITY
The quality of a product denotes its durability and reliability. Quality not only can increase a
product’s perceived value, but also can lower its cost.
ECONOMIES OF SCOPE
The concept of economies of scope describes the savings that come from producing 2 or
more outputs at less cost than producing each output individually, even though using the
same resources and technology.
CUSTOMIZATION
Customization allows firms to go beyond merely adding differentiating features to tailoring
products and services for specific customers. Advances in manufacturing and information
technology have made feasible mass customization. Mass customization is the manufacture
of a large variety of customized products or services done at a relatively low unit cost.
INNOVATION
Innovation describes any new product and process, or any modification of existing ones.
Innovation is frequently required to resolve existing tradeoffs when companies pursue an
integration strategy.
STRUCTURE, CULTURE AND ROUTINES
A firm’s structure, culture, and routines are critical when pursuing an integration strategy. The
challenge that managers face is to structure their organizations so that they both control cost
and allow for creativity that can lay the basis for differentiation.
What is the goal of managers who want to pursue an integration strategy?
The goal for managers who want to pursue an integration strategy should be to build an
ambidextrous organization which is an organization that enables managers to balance and
harness different activities in tradeoff situations.
What do these levers allow?
These levers are critical: they allow managers to simultaneously increase perceived value and
lower cost.
INTEGRATION STRATEGY GONE BAD: “STUCK IN THE MIDDLE”
Why is an integration strategy difficult to translate into reality?
An integration strategy is quite difficult to translate into reality because differentiation and cost
leadership are distinct strategic positions that require important tradeoffs.
Why is an integration strategy difficult to implement?
An integration strategy is difficult to implement because it requires the reconciliation of
fundamentally different strategic positions (differentiation and low cost), which in turn require
distinct internal value chain activities in order to allow the firm to increase value and lower
cost at the same time.
Why do many firms that attempt to pursue an integration strategy fail?
Many firms that attempt to pursue an integration strategy fail because they end up being stuck
in the middle: they succeed at neither a differentiation not a costleadership strategy. In a
world of strategic tradeoffs, increasing value and lowering cost have opposite effects. For
example, improved features, customer services, and customization all result in higher cost
while offering a nofrills product reduces perceived value.
6.6 The dynamics of competitive positioning
What is the productivity frontier?
The productivity frontier is the valuecost relationship that captures the result of performing
best practices at any given time.
Which firms reach the productivity frontier?
Firms that exhibit effectiveness and efficiency reach the productivity frontier, others are left
behind.
What does the productivity frontier represent?
The productivity frontier represents a set of bestinclass strategic positions the firm can take
relating to value creation and low cost at a given point in time.
What does a firm’s business strategy determine?
A firm’s business strategy determines which strategic position it aspires to along the
productivity frontier.
Are strategic positions fixed?
Strategic positions are not fixed. They can, and need to, change as the environment changes.
It is critical for managers, therefore, to understand the dynamic of competitive positioning, or
how strategy shapes a firm’s position over time.
What does reaching the productivity frontier at a given point in time increase the likelihood of?
Reaching the productivity frontier at a given point in time increases the likelihood of achieving
a competitive advantage,
What does falling behind the productivity frontier result in?
Falling behind the productivity frontier results in competitive disadvantage.
What do changes in industry environment allow firms to stake out?
Changes in industry environment allow firms to stake out more valuable positions and turn
inferior performance into a competitive advantage.
6.7 Implications for the strategist
What is critical to gaining competitive advantage?
Strategic positioning is critical to gaining competitive advantage.
What do wellformulated and implemented generic business strategies enhance?
Wellformulated and implemented generic business strategies enhance the firm’s chances of
obtaining superior performance.
What does strategic positioning require?
Strategic positioning requires making important tradeoffs.
When are firms able to reconcile the significant tradeoffs between increasing value and
lowering production costs?
In rare instances, firms are able to reconcile the significant tradeoffs between increasing
value and lowering production costs by pursuing both business strategies (differentiation and
low cost) simultaneously.
When do integration strategies tend to be successful?
These integration strategies tend to be successful only if a firm is able to rely on an innovation
that allows it to reconcile the tradeoffs involved in an integration strategy.
The dynamics of competitive positioning:
Given the dynamics of competitive positioning, firms cannot stand still but must constantly
refine and improve their strategic position over time. The goal is to not fall behind the
productivity frontier, which is defined by the theoretically possible best practice at any given
time.