Chapter 4: Business-Level Strategy

Chapter 4
Business-Level Strategy

LEARNING OBJECTIVES

1. Define business-level strategy.

2. Discuss the relationship between customers and business-level strategies in terms of who,
what, and how.
3. Explain the differences among business-level strategies.
4. Use the five forces of competition model to explain how above-average returns can be
earned through each business-level strategy.
5. Describe the risks of using each of the business-level strategies.

CHAPTER OUTLINE

Opening Case: Hain Celestial Group: A Firm Focused on “Organic” Differentiation

CUSTOMERS: THEIR RELATIONSHIP WITH BUSINESS-LEVEL STRATEGIES
Effectively Managing Relationships with Customers
Reach, Richness, and Affiliation
Who: Determining the Customers to Serve
What: Determining Which Customer Needs to Satisfy
How: Determining Core Competencies Necessary to Satisfy Customer Needs
Strategic Focus: Continuously Innovating to Satisfy Customers’ Needs
THE PURPOSE OF A BUSINESS-LEVEL STRATEGY
TYPES OF BUSINESS-LEVEL STRATEGIES
Cost Leadership Strategy
Differentiation Strategy
Strategic Focus: Apple vs. Samsung: Apple Differentiates and Samsung Imperfectly
Imitates
Focus Strategies
Integrated Cost Leadership/Differentiation Strategy
SUMMARY
MINI-CASE
REVIEW QUESTIONS
MINDTAP RESOURCES

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LECTURE NOTES

Chapter Introduction: Firms that perform well, even in very competitive industries, will
follow some pattern of decision-making and execution that is internally consistent. That
is, the firm will line up its resource commitments in a way that reinforces the direction of
the enterprise. If these decisions are inconsistent, the outcome will be resource
commitments that work against one another and hinder the progress of the business. This
chapter lays out the basic strategy patterns that can lead to competitive advantage.
Knowing these will help students understand how to make the most of the firm’s
potential.

OPENING CASE
Hain Celestial Group: A Firm Focused on “Organic” Differentiation

Hain Celestial Group has built strong capabilities in producing natural and organic foods and
has built its strategy to take advantage of the changing consumer trend in the food business.
The company grew through a series of acquisitions of entrepreneurial start-ups. These
acquisitions allowed Hain Celestial to become the largest supplier to natural food retailer
Whole Foods Markets. The natural food trend has allowed the company to sell their branded
products to traditional grocery store chains, accounting for about 60 percent of its U.S. sales.
Meanwhile, large branded food firms such as Kellogg’s, Kraft Foods Group, Campbell’s, and
ConAgra Foods Inc. that have not focused as intensely on this natural segment have stalled
their earnings in part because they have not focused on the natural and organic trend desired
by consumers as much as Hain Celestial. While larger brands seek to modify existing
products by removing less natural ingredients (Nestle) or reducing the use of high fructose
corn syrup (Hershey Co and Mars), these types of changes do not allow them to overcome
the problem of rapidly changing consumer tastes toward nature food. Grocery stores and
restaurants are also attempting to take advantage of the trend towards natural foods.

Teaching Note
Ask students to evaluate Hain Celestial’s strategy and what they would have done
differently to implement it. Ask them to identify Hain’s competitors and how these
companies differentiate themselves from one another. Aside from the dimensions listed
in the Opening Case, ask students to identify other ways that Hain’s achieves
differentiation. Students should come to realize that Hain’s and its competitors have
differentiated themselves on several dimensions and that to grow in a saturated and
highly competitive industry they need to offer value that exceeds that of its competition.
Ask students to identify other firms with a strong competitive advantage that
implemented strategies to attract customers following social trends.

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1 Define business-level strategy.

BUSINESS-LEVEL STRATEGY

Business-level strategies represent integrated and coordinated sets of actions that are taken to
exploit core competencies and gain a competitive advantage. To be more specific, strategies
are purposeful, precede the taking of actions to which they apply, and demonstrate a shared
understanding of the firm’s vision and mission. An effectively formulated strategy marshals,
integrates, and allocates the firm’s resources, capabilities, and competencies so that it will be
properly aligned with its external environment. A properly developed strategy also
rationalizes the firm’s vision and mission along with the actions taken to achieve them.
Determining the businesses in which the firm will compete is a question of corporate-level
strategy and is discussed in Chapter 6. Competition in individual product markets is a
question of business-level strategy.

The firm’s core competencies should be focused on satisfying customer needs or preferences
through business-level strategies, which detail actions taken to provide value to customers
and gain a competitive advantage by exploiting core competencies in specific, individual
product or service markets. In other words, business-level strategies are developed based on a
firm’s core competencies and indicate how an organization chooses to compete in a
particular market to gain a competitive advantage over competitors.

A customer focus requires that firms simultaneously evaluate or consider

 Whom to serve,
 What customer needs will be satisfied, and
 How those needs will be satisfied through the strategy selected.

Discuss the relationship between customers and business-

2
level strategies in terms of who, what, and how.

CUSTOMERS: THEIR RELATIONSHIP WITH BUSINESS-LEVEL STRATEGIES

Returns earned from relationships with customers (current and/or new) are the lifeblood of
all firms. To survive and achieve strategic competitiveness in the contemporary competitive
landscape, firms must:
 Identify who their customers are
 Determine customer needs or preferences
 Focus on satisfying the needs of some group of customers

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 Determine how to compete (select a strategy) that enables them to satisfy customer needs

The firm’s relationships with its customers are strengthened when it delivers superior value
to them.

Effectively Managing Relationships with Customers

Teaching Note
A number of companies have become skilled at managing all aspects of their
relationship with their customers. For example, Amazon.com is known for the quality
of information it maintains about its customers, the service it renders, and its ability to
anticipate customers’ needs. It has a strong reputation for being able to successfully
do this.

Reach, Richness, and Affiliation

In the Internet age, firms can maintain competitive advantage by:

 Thinking continuously about accessing and connecting with customers (reach)
 Maintaining information with depth and detail for (and from) customers (richness)
 Facilitating useful interactions with customer (affiliation)

Who: Determining the Customers to Serve

The first step is to identify customers based on differences in needs or preferences (often
called market segmentation). This enables the firm to have a better grasp on what might be
important to customers because of the lack of any in-depth insights relevant for decision
making that are provided by central tendencies (averages) of the market in general.

Table Note
It might be interesting to ask students which of the dimensions in this table help
identify the most promising market segments for which type of business.

TABLE 4.1
Basis for Customer Segmentation

Dimensions that can be used to identify potential customers include the following factors:

For consumer markets: For industrial markets:

 Demographic factors  End-use segments

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 Socioeconomic factors  Product segments

 Geographic factors  Geographic segments
 Psychological factors  Common buying factor segments
 Consumption patterns  Customer size segments
 Perceptual factors

It is imperative that firms pay careful attention to differences in customer needs among
customer groups and not arbitrarily “lump” them together because:
 Almost any identifiable human or organizational characteristic can be used to sub-divide a
market into segments that differ from one another on a given characteristic.
 Customer characteristics are often combined to segment markets into specific groups that
have unique needs.
 Demographic factors can also be used to segment markets into generations with unique
interests and needs.

Teaching Note
In the US, the teenage market segment is a competitively relevant customer group.
Generate discussion by asking students about their assessments of the size, growth,
and spending-related characteristics of this market segment.

What: Determining Which Customer Needs to Satisfy

As noted in Chapter 3, one challenge for firms is to identify ways in which they can bundle
their resources and capabilities to create value for customers, because given the choice,
customers are most interested in purchasing products that both satisfy their needs and
provide value.

After the firm decides whom it will serve, it must identify the targeted customer group’s
needs that its goods or services can satisfy. This is important in that successful firms learn
how to deliver to customers what they want and when they want it.

In a general sense, needs (wants) are related to a product’s benefits and features. Having
close and frequent interactions with both current and potential customers helps the firm
identify those individuals’ and groups’ current and future needs. From a strategic perspective,
a basic need of all customers is to buy products that create value for them.

The most effective firms continuously strive to anticipate changes in customers’ needs.
Failure to do this results in the loss of customers to competitors who are offering greater
value in terms of product features and functionalities.

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In any given industry, there is great variety among consumers in terms of their needs, e.g.,
high-quality, lower-cost with acceptable quality, quick delivery.

Target, a retail store and online marketer, has been successful analyzing its many sources of
data through online sources of many customer demographics. It utilizes this information to
develop its promotion and marketing strategies.

How: Determining Core Competencies Necessary to Satisfy Customers’ Needs

As explained in Chapters 1 and 3, core competencies are resources and capabilities that serve
as a source of competitive advantage for the firm over its rivals. Firms use core competencies
(how) to implement value-creating strategies and thereby satisfy customers’ needs. Only
those firms with the capacity to continuously improve, innovate, and upgrade their
competencies can expect to meet and hopefully exceed customers’ expectations across time.

Companies draw from a wide range of core competencies to produce goods or services that
can satisfy customers’ needs. One such method employed by companies such as the large
pharmaceutical firm Merck and the software company SAS Institute invest heavily in R&D
to sustain competitive advantage in their industries.

3 Explain the differences among business-level strategies.

Use the five forces of competition model to explain how

4 above-average returns can be earned through each business-
level strategy.

Describe the risks of using each of the business-level

5
strategies.

Teaching Note
The next section of the chapter describes generic business-level strategies that can be
implemented to provide customers with distinctive products that meet customer needs
and enable the firm to achieve a competitive advantage and earn above-average returns.
Indicate that the business-level strategies are considered generic because they generally
apply across industries, products, and the public and private sectors.

THE PURPOSE OF A BUSINESS-LEVEL STRATEGY

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Business-level strategy creates differences between the firm’s position and those of its
competitors. To position itself differently from competitors, a firm must decide whether it
intends to perform activities differently or to perform different activities.

TYPES OF BUSINESS-LEVEL STRATEGIES

Business-level strategy is concerned with a firm’s position in an industry, relative to

competitors. Firms are challenged to select business-level strategies to position themselves
favorably by performing activities differently or performing different activities as compared
to its rivals. Thus, the firm’s business-level strategy is a deliberate choice about how it will
perform the value chain’s primary and support activities in ways that create unique value.

Figure Note: As illustrated in Figure 4.1, firms select their business-level strategies
based on a combination of competitive (market) scope and competitive advantage
(product uniqueness or low cost).

FIGURE 4.1
Five Business-Level Strategies

Firms can choose one of five strategies from the generic strategy matrix based on the source
of competitive advantage - uniqueness or cost - and breadth of competitive scope - broad or
narrow.

A firm choosing to compete across a broad market determines that it should compete in a
number of customer segments. Competitive advantage is achieved either by offering unique
products - a differentiation strategy - or by establishing a low-cost position and providing
standardized products at the lowest competitive price - a cost leadership strategy.

Firms that choose to compete in narrow customer segments select a focus strategy, which
may be either a focused differentiation strategy (few segments, unique products) or a focused
cost leadership strategy (narrow segment, standardized products at the lowest competitive
price).

An integrated cost leadership/differentiation incorporates both of these emphases.

None of the five business-level strategies shown in Figure 4.1 is inherently or universally
superior to the others. The effectiveness of each strategy is contingent both on the
opportunities and threats in a firm’s external environment and on the possibilities provided
by the firm’s unique resources, capabilities, and core competencies. It is critical, therefore,
for the firm to select a business-level strategy that is based on a match between the

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opportunities and threats in its external environment and the strengths of its internal
environment as shown by its core competencies.

Cost Leadership Strategy

The cost leadership strategy is an integrated set of actions taken to produce goods or
services with features that are acceptable to customers at the lowest cost, relative to that of
competitors.

Firms that choose a cost-leadership strategy generally offer relatively standardized products
with characteristics or features that typical customers accept (but with competitive levels of
differentiation) at the lowest competitive price.

Firms that wish to be successful by following a cost-leadership strategy must maintain

constant efforts aimed at lowering costs (relative to rivals’ costs) and creating value for
customers. Cost-reduction strategies can include:
 Building efficient-scale facilities
 Establishing tight control of production and overhead costs
 Minimizing the costs of sales, product research and development, and service
 Investing in state-of-the-art manufacturing technologies

Implementing and maintaining a cost leadership strategy means that a firm must consider its
value chain of primary and secondary activities (as discussed in Chapter 3) and effectively
link those activities, if it is to be successful (as illustrated in Figure 4.2).

As primary activities, inbound logistics and outbound logistics often account for much of the
total cost to produce some goods and services. Research suggests that a competitive
advantage in logistics creates more value with cost leadership strategies than with
differentiation strategies, prompting cost leaders to focus on these primary activities.

Cost leaders also carefully examine all support activities to find additional sources of
potential cost reductions.

Figure Note
Figure 4.2 points out that the critical focus in successfully implementing a cost
leadership strategy is on efficiency and cost reduction throughout the value delivery
system.

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FIGURE 4.2
Examples of Value-Creating Activities Associated with the Cost Leadership Strategy

As suggested in Figure 4.2, the firm’s focus throughout each of its value chain activities and
support functions is on the following:
 Simplification of processes and procedures
 Achieving efficiency and effectiveness
 Reducing costs
 Monitoring costs of activities provided by others that interface with the firm’s inbound or
outbound logistics

A firm that successfully implements a cost leadership strategy can earn above-average
returns even when the five competitive forces are strong.

Rivalry with Existing Competitors

Achieving the lowest cost position means that a firm’s rivals will hesitate to compete based
on price because, in a price war, the low cost firm will still earn profits even after its
competitors compete away all profits.

Having the low-cost position is a valuable defense against rivals. For example, the changes
Walmart made to attract upscale customers created vulnerability in its low-cost position to
rivals. Amazon, Dollar Store, and other took advantage of the opportunity and have siphoned
off some of Walmart’s customers.

Bargaining Power of Buyers (Customers)

Achieving the low cost position provides some protection against powerful customers who
attempt to drive down prices. If customers attempt to drive prices below the cost of the next
most efficient firm, that firm might choose to exit the market (rather than remain and earn
below average profits), leaving the low cost firm with a monopoly position. If that happens,
customers would lose any bargaining power as the monopoly firm would be in a position to
raise prices.

Bargaining Power of Suppliers

Because they have achieved the lowest cost position in the industry, the cost leadership
strategy enables a firm to absorb a greater amount of cost increases from powerful suppliers
before it must raise prices charged to customers. This may enable the firm to be alone among
its competitors in earning above-average returns.

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In addition, a low-cost leader that also has a dominant market share may be in a position to
force suppliers to reduce prices or to hold down the level of price increases, and thus reduce
the power of suppliers. Again, Walmart is a good example of a firm that follows this pattern.

Potential Entrants

Firms successfully following cost leadership strategies generally must produce and sell in
large volumes to earn above-average returns. And with a continuous focus on efficiency and
reducing costs, cost leadership firms create barriers to entry.

New entrants must either enter the industry at a large scale (large enough to achieve the same
economies of scale as the next lowest cost firm) or be satisfied with average profits until they
move sufficiently far down the experience curve to match the efficiencies of the low-cost
leader.

Product Substitutes

The cost leader is in a more attractive position relative to substitute products than are other
firms in the industry. To retain customers, the cost leader can more easily reduce prices to
maintain the price-value relationship and retain customers.

Competitive Risks of the Cost Leadership Strategy

Despite the attractiveness of the cost leadership strategy, it is accompanied by risks such as
the following:
 Technological innovations by competitors could eliminate the cost leader’s cost
advantage.
 Overly focusing on process efficiency may cause the cost leader to overlook needed
differentiation features.
 Competitors may successfully imitate the low-cost leader’s value chain configuration.

In the event of any of the above, the low-cost leader is challenged to increase value to
customers. This may mean reducing prices or adding product features without raising prices.
However, if prices are reduced too low, it may be difficult for the firm to earn satisfactory
margins and customers may resist any price increases.

Differentiation Strategy

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In contrast to the cost leadership strategy, implementation of a differentiation strategy

means that value is provided to customers through the unique features and characteristics of a
firm’s products rather than by the lowest price.

Because differentiated products satisfy customers’ unique needs or preferences, firms can
charge a premium price for differentiated products. But the premium cannot exceed what
customers are willing to pay.

For the firm to be able to outperform its competitors and earn above-average returns, the
price charged for the differentiated product must exceed the cost of differentiation. In other
words, the price charged must exceed total product cost. Because of this, the differentiated
product’s premium prices generally exceed the low price of the standard product.

Firms that follow a differentiation strategy concentrate or focus on product innovation and
developing product features that customers value rather than on maintaining the lowest
competitive price (the case for cost leadership strategy). Often this strategy seeks to
differentiate the product/service on as many dimensions as possible.

Products can be differentiated in a number of ways so that they stand apart from standardized
products:
 Superior quality
 Unusual or unique features
 More responsive customer service
 Rapid product innovation
 Advanced technological features
 Engineering design and performance
 Additional features
 An image of prestige or status

Some examples of differentiation strategies include the following:

 Ralph Lauren differentiates its clothing lines through image.
 Lexus cars are differentiated by prestige and image.
 Apple (iPod and iPhone) are differentiated by innovative design.
 McKinsey and Company offers differentiated consulting services.

Successfully implementing (and maintaining) a differentiation strategy requires a firm to

consider its value chain of primary and secondary activities and effectively link those
activities as illustrated in Figure 4.3.

Figure Note

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Use Figure 4.3 to show that the critical focus in a successful differentiation strategy is on
quality and product innovation, regardless of the value-creating activity.

FIGURE 4.3
Examples of Value-Creating Activities Associated with the Differentiation Strategy

As suggested in Figure 4.3, the firm’s focus in its value chain activities and support functions
is on:
 Establishing the importance of quality
 Accuracy, speed, and responsiveness
 Understanding and meeting customers’ unique preferences
 Monitoring the speed, reliability, and quality of activities provided by others that interface
with the firm’s inbound and outbound logistics

Teaching Note
The chapter mentions that firms following differentiation strategies cannot
completely ignore costs and the need for minimal spending on process-related
innovations. Porter refers to this as maintaining “parity” on the alternative dimension.
When speaking of cost leadership strategies, a useful example of “differentiation
parity” comes from the automobile manufacturing industry. Hyundai has been able to
compete based on cost, but it still produces a car that is “in the ballpark” on
differentiation. Failed manufacturer Yugo offered a very inexpensive car (introduced
at a mere $1995 in the early 1980s), but these were of such poor quality that buyers
refused to purchase them once news of their reliability problems got out. A car that
will not run is not a value, even if it sells for only a fraction of the price of all other
available models! In a similar way, a company that competes on differentiation must
maintain “cost parity” so that the differentiated features that customers want are not
beyond the reach of their pocketbooks. Consumers recognize the superior quality of
Sony televisions, but the premium charged is justifiable, given the quality of the
product. Obviously, controlling costs plays an important part in pricing possibilities.

A firm that successfully implements a differentiation strategy can earn above-average returns
even when the five competitive forces are strong.

Rivalry with Existing Competitors

Achieving customer loyalty means differentiating products in ways that are meaningful to
customers. Brand loyalty means that customers will be less sensitive to price increases. As
long as the firm satisfies the differentiated needs of loyal customers, it may be insulated from
price-based competition.

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Bargaining Power of Buyers (Customers)

Through meaningful differentiation, firms develop products that are considered unique. This
uniqueness may insulate the firm from competitive rivalry and reduce customer sensitivity to
price increases (similar to the insulation from rivalry with existing competitors).

STRATEGIC FOCUS
Apple vs. Samsung: Apple Differentiates and Samsung Imperfectly Imitates

Apple is a successful product innovator that creates new markets and then dominates
them as a first mover. Samsung has become a successful challenger to Apple by imitating
Apple’s innovations as a fast second mover. Using this strategic approach Samsung
imitates desirable Apple features (with some changes) and improves on some in ways
that customers value. The cycle of innovation/imitation occurs in multiple product
groups. Even though Samsung appears to be an imitator, it invests about three times as
much money in R&D as Apple (5.4% of sales vs 2.2%).

Teaching Note
Students will undoubtedly be familiar with products of both companies profiled in the
Strategic Focus. Ask students to speculate about the future battles involving Apple and
Samsung? Based on information in the Strategic Focus, do they think Samsung is
destined to be a perpetual second mover, or will its R&D investments overtake Apple’s
leadership position? Ask them to identify other companies that are locked into similar
cycles of innovation and imitation.

By satisfying customer preferences in ways that no competitor can, firms also are able to
charge higher prices (because there are no comparable product alternatives).

Bargaining Power of Suppliers

Because of the differentiator’s focus on product quality and responsiveness to customer

preferences, suppliers also may be forced to provide differentiators with higher quality
materials, components, or services, which can drive up the firm’s per-unit costs.

Since the differentiator charges premium prices, they are somewhat insulated from suppliers’
price increases (as the differentiator can absorb a greater level of cost increases from
powerful suppliers through its higher margins). Alternatively, because of lower price
sensitivity by customers, differentiators may be able to raise prices to cover increased
supplier-related costs.

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Potential Entrants

The principal barrier to entry is customers’ loyalty to the uniquely differentiated brand. This
means that a potential entrant must either overcome (or surpass) the uniqueness of existing
products or provide similarly differentiated products at a lower price to increase customer
value.

Product Substitutes

Brand loyalty may insulate differentiated products from substitutes. Without brand loyalty,
customers may switch to substitutes that offer similar features at a lower price or to products
with more attractive features at the same price.

Competitive Risks of the Differentiation Strategy

Like the cost leadership strategy, the differentiation strategy also carries risks such as the
following:
 Customers may decide that the cost of uniqueness is too high. In other words, the price
differential between the standardized and differentiated product is too high. Perhaps the
firm provides a greater level of uniqueness than customers are willing to pay for.
 The firm’s means of differentiation no longer provides value to customers. For instance,
what is the value of prestige or exclusivity? And, how long will they last as customers
become more sophisticated?
 Customer learning may reduce the customer’s perception of the value of the firm’s
differentiation. Through experience, customers may learn that the extra price for a
differentiated good is no longer a value.

Teaching Note
This loss of value through customer learning or changes in customer perceptions can
be illustrated by the experiences of IBM. Initially, the IBM name on a personal
computer signaled value to customers; however, clones soon challenged IBM’s
preeminent position in the PC market. As customers learned that the clone machines
offered similar features at lower prices, the value attached to the IBM brand name
diminished and IBM’s sales suffered.

 A fourth risk is concerned with counterfeiting. Increasingly, counterfeit goods (products

that attempt to convey differentiated features to customers at significantly reduced prices)
are a concern for many firms using the differentiated strategy.

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In the event of any of the above, differentiators are challenged to increase value to customers.
This may mean reducing prices, adding product features without raising prices, or developing
new efficiencies in its value chain of primary and secondary activities.

Focus Strategies

By implementing a cost leadership or differentiation strategy, firms choose to compete by

exploiting their core competencies on an industry-wide basis and adopt a broad competitive
reach.

Alternatively, firms can choose to follow a focus strategy by seeking to use their core
competencies to serve the needs of a particular customer group in an industry. In other
words, firms focus on specific, smaller segments (or niches) of customers rather than across
the entire market.

Markets can be segmented by:

 Particular buyer group (e.g., youths or senior citizens)
 Different segments of a product line (e.g., products for professionals or “do-it-
yourselfers”)
 Different geographic market (e.g., the eastern or western United States)

Firms may choose to follow a focus strategy because:

 They can serve a narrow segment more effectively than competitors that choose to
compete industry wide
 The narrow segment’s needs are so special that industry-wide competitors choose not to
meet them
 Certain narrow segments are being poorly served by industry-wide competitors

Teaching Note
Emphasize again that focus strategies can be based either on cost leadership or
differentiation.

Focused Cost Leadership Strategy

Firms that compete by following cost leadership strategies to serve narrow market niches
generally target the smallest buyers in an industry. They look for those who purchase in such
small quantities that industry-wide competitors cannot serve them at the same low cost.

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Global furniture retailer IKEA provides customers with “good design and function at low
prices” through use of the focused cost leadership strategy. IKEA does this by offering low-
cost, modular furniture (assembled by customers), using self-service as an alternative to
having sales associates follow and pressure customers to buy. IKEA displays its products in
room-like settings so that customers can view different combinations of furniture, eliminating
the need for assistance from sales associates or decorators to visualize the setting and
reducing employee costs. Customers also pick up their own purchases to reduce the firm’s
costs. However, the company also differentiates somewhat. For example, stores address the
needs of shoppers (e.g., extended hours and in-store childcare) while they shop.

Focused Differentiation Strategy

Firms following focused differentiation strategies produce customized products for small
market segments.

They can be successful when either the quantities involved are too small for industry-wide
competitors to handle economically, or when the extent of customization (or differentiation)
requested is beyond the capabilities of the industry-wide competitors. The text uses the new
generation of lunch trucks offering high-end fare prepared by highly trained chefs and often
owned by well-known restaurants to illustrate this strategy.

Teaching Note: Other examples of focused differentiators include:

 Upscale apartment buildings in various locations are being designed to serve the
needs of technologically savvy city dwellers, offering differentiated features such
as high-speed digital Internet access and other sophisticated telecommunications
services.
 Manufacturers such as Ferrari, Aston Martin, and Lamborghini compete in the tiny
supercar category with prices starting at $150,000 and running as high as
$600,000. These cars are more than just transportation.

Just as was noted for industry-wide differentiators and low-cost producers, firms choosing to
focus must be particularly adept at completing primary and secondary value chain activities
in a superior way. Issues related to the five competitive forces are similar to those discussed
for the differentiation and cost leadership strategies; however, the competitive scope of the
focus is on a narrow segment rather than the industry. Students should review Figures 4.3
and 4.4 (Value-Creating Activities) as well as the earlier discussion of the five competitive
forces for the cost leadership and differentiation strategies.

Competitive Risks of Focus Strategies

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The competitive risks of focus firms are similar to those previously noted for the cost
leadership and differentiation strategies with the following additions:
 Competitors may successfully focus on an even smaller segment of the market,
“outfocusing” the focuser, or focus only on the most profitable slice of the focuser’s
chosen segment.

Teaching Note
For example, Confederate Motor Co. is producing a highly differentiated motorcycle
that might appeal to some of Harley-Davidson’s customers. Obsessed with making a
“fiercely American motorcycle” (one that is even more American than are Harley’s
products), Confederate’s motorcycles are produced entirely by hand labor. In fact, a
full week is required to make a single bike. Digital technology is used to design
Confederate’s products, which have a radical appearance. At a price of $62,000 or
more, the firm’s products will appeal only to customers wanting to buy a truly
differentiated product such as the F113 Hellcat (which is receiving “rave reviews in
the motorcycling press”).

 An industry-wide competitor may recognize the attractiveness of the segment served by

the focuser and mobilize its superior resources to better serve the segment’s needs.
 Preferences and needs of the narrow segment may become more similar to the broader
market, reducing or eliminating the advantages of focusing.

STRATEGIC FOCUS
RadioShack’s Failed Focus Strategy: Strategic Flip-Flopping

The Strategic Focus makes the point that in many industries, firms must continually
innovate to provide superior value to customers. However, many firms are slow to
innovate for fear of losing current customers. This allows new entrants in the industry to
introduce innovations that capture customers served by incumbent firms. RadioShack,
after filing for bankruptcy in February 2015, failed to maintain a consistent strategic
approach, resulting in unrecoverable financial deterioration after nearly a century of
being a mainstay throughout the United States.

Teaching Note: Students will undoubtedly be familiar with the company profiled in the
Strategic Focus. Ask students to speculate about what information the innovation decisions
were based on? Ask them to identify other companies’ innovations in the same market and
speculate about what drove these innovations. The discussion should address how conditions
in the external environment created opportunities to provide customer value.

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Integrated Cost Leadership/Differentiation Strategy

This hybrid strategy may become even more important - and more popular - as global
competition rises.

Compared to firms relying on a single generic strategy, firms that integrate the generic
strategies may position themselves to improve their ability to adapt quickly to environmental
changes.

Successfully pursuing the cost leadership and differentiation strategies simultaneously yields
additive benefits:
 Differentiation enables the firm to charge premium prices.
 Cost leadership enables the firm to charge the lowest competitive price.
 The firm is thus able to achieve a competitive advantage by delivering value to customers
based on both product features and low price.
 A variety of other factors also may enable firms to gain a competitive advantage and earn
above-average returns from an integrated cost leadership/differentiation strategy.

Flexible Manufacturing Systems

A flexible manufacturing system is a computer-controlled process used to produce a variety

of products in moderate, flexible quantities. It enables firms to achieve the flexibility
necessary to simultaneously respond to changes in customer needs and preferences while
maintaining the low-cost advantages of large-scale manufacturing. This increases a firm’s
ability to engage in an integrated low-cost/differentiation strategy.

Information Networks

Information networks enable a firm to coordinate interdependencies between internally and

externally performed value-creating activities to increase flexibility and responsiveness.
Examples include real-time linkages between manufacturers and suppliers or subcontractors,
or between retailers and suppliers. These linkages can improve time-to-market of new
products by coordinating design and production activities and reduce out-of-stock
occurrences by shortening the order-restock cycle.

Customer relationship management (CRM) is one form of an information-based network

process that firms use to better understand customers and their needs. An effective CRM
system provides a 360-degree view of the company’s relationship with customers,
encompassing all contact points, involving all business processes, and incorporating all
communication media and sales channels. The firm can then use this information to

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determine the trade-offs its customers are willing to make between differentiated features and
low cost, which is vital for companies using the integrated cost leadership/differentiation
strategy.

Enterprise Resource Planning Systems: A Mini-Lecture

Enterprise Resource Planning is an information system used to identify and plan the
resources required across the firm to receive, record, produce, and ship customer
orders. For example, salespeople for aircraft parts distributor Aviall use handheld
equipment to scan barcode labels on bins in customers’ facilities to determine when
parts need to be restocked. Data gathered through this procedure are uploaded via the
Web to the Aviall back-end replenishment and ERP system, allowing the order
fulfillment process to begin within minutes of scanning. Growth in ERP applications
such as the one used at Aviall has been significant. Full installations of an ERP system
are expensive, running into the tens of millions of dollars for large-scale applications.

Improving efficiency on a company-wide basis is a primary objective of using an ERP

system. Efficiency improvements result from the use of systems through which
financial and operational data are moved rapidly from one department to another. The
transfer of sales data from Aviall salespeople to the order entry point at the firm’s
manufacturing facility demonstrates the rapid movement of information from one
function to another. Integrating data across parties that are involved with detailing
product specifications and then manufacturing those products and distributing them in
ways that are consistent with customers’ unique needs enable the firm to respond with
flexibility to customer preferences relative to cost and differentiation.

Total Quality Management Systems

These systems have been established to improve product quality (from a customer
perspective) and to improve productivity in the performance of the internal value-creating
activities.

Firms develop and use TQM systems in order to (1) increase customer satisfaction, (2) cut
costs, and (3) reduce the amount of time required to introduce innovative products to the
marketplace.

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Improving product quality focuses on product reliability, performance, and utility, and
enables the firm to differentiate its products and charge higher prices, while lowering the
costs of manufacturing and service.

Teaching Note
The following are the key assumptions on which total quality management (TQM)
systems are based:
 The costs of poor quality exceed the costs of developing processes that produce
high quality products and services (in other words, it is less costly to do things
right the first time).
 Employees care about their work and will take the initiative to improve it (but only
if the firm provides the resources, tools, and training necessary and management
listens to their ideas).
 Since organizations are systems of highly interdependent parts, decision processes
must be integrated and include participation from all affected functional areas.
 Responsibility for effective TQM rests with top-level managers who must support
TQM processes and appropriately design the firm so that employees can function
effectively.

Competitive Risks of the Integrated Cost Leadership/Differentiation Strategy

This is an appealing yet risky strategy, as it is difficult for firms to perform primary and
support activities in ways that allow them to produce relatively inexpensive products with
levels of differentiation that create value for the target customers. Moreover, to properly use
this strategy across time, firms must be able to simultaneously reduce costs incurred to
produce products (as required by the cost leadership strategy) while increasing products’
differentiation (as required by the differentiation strategy).

Being “stuck-in-the-middle” implies that the firm will not be able to manage successfully the
five competitive forces and will not achieve strategic competitiveness. In fact, these firms
can only earn average profits when industry structure is favorable or when other firms in the
industry also are “stuck-in-the-middle.”

ANSWERS TO REVIEW QUESTIONS

1. What is a business-level strategy?

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 Chapter 4: Business-Level Strategy

Business-level strategy (the focus of Chapter 4) is an integrated and coordinated set of

commitments and actions designed to provide value to customers and gain a competitive
advantage by exploiting core competencies in specific, individual product markets. Thus, a
business-level strategy reflects a firm’s belief about where and how it has an advantage over
its rivals, while guiding decisions to choose to perform activities differently or to perform
different activities than competitors.

Key issues the firm must address when choosing a business-level strategy are the good or
service to offer, how to manufacture or create it, and how to distribute it to the marketplace.
Once formed, the business-level strategy reflects where and how the firm has an advantage
over its rivals. The essence of a firm’s business-level strategy is choosing to perform
activities differently or to perform different activities from rivals.

2. What is the relationship between a firm’s customers and its business-level strategy in
terms of who, what, and how? Why is this relationship important?

The relationship between a firm’s customers and its business-level strategy is that, to survive
and achieve strategic competitiveness, firms must create value that satisfies some group of
customers’ needs. In other words, successful business-level strategies are founded or based
on customers’ needs.

Who represents the determination of specific customer groups to be served? The primary
focus here is market segmentation. What is concerned with customer needs that will be
satisfied? How represents the core competencies of the firm that can be used to satisfy
customers’ needs that have been identified.

Increasing segmentation of markets throughout the global economy creates opportunities for
firms to identify increasingly unique customer needs they can try to serve by using one of the
business-level strategies.

3. What are the differences among the cost leadership, differentiation, focused cost
leadership, focused differentiation, and integrated cost leadership/differentiation
business-level strategies?

Strategy Source(s) of Competitive Advantage

Cost Leadership Lowest cost with a level of product features or

characteristics acceptable to the most typical
customers in the industry

Differentiation Product’s unique attributes and characteristics that are

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valued by a broad group of customers

Focused Cost Leadership Lowest cost with a level of product features or

characteristics targeted to a particular customer group
or segment in an industry

Focused Differentiation Product’s unique attributes and characteristics that are

valued by a particular customer group (niche) or
segment in an industry

Integrated Cost Leadership/
Differentiation
Products have attributes of both relatively low cost and
unique attributes, characteristics, or features; the level
of product differentiation is less than the pure
differentiator while cost is higher than that of the low-
cost leader

4. How can each one of the business-level strategies be used to position the firm relative
to the five forces of competition in a way that helps the firm earn above-average
returns?

Strategy Dealing with the Five Forces of Competition

Cost Leadership Can compete against rivals on price

Can price below rivals to interest buyers
Can absorb prince increases by suppliers better than
rivals
Discourages new entrants that can’t endure low profit
margins
Can reduce prices to maintain attractiveness over
substitutes

Differentiation Customers are loyal to firms offering differentiated

products
Uniqueness reduces sensitivity of buyers to price
increases
High margins shield the firm from losses to powerful
suppliers
Customer loyalty to differentiated products deters new
entrants
Unlikely to switch to substitutes when loyal to

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Focused Cost Leadership
Focused Differentiation
Integrated CL/Differentiation
5. What are the specific risks associated with using each business-level strategy?
Strategy
Cost Leadership
Differentiation
Focused Cost Leadership &
Focused Differentiation
Integrated Cost Leadership/
Differentiation
products
An adaptation of the above
An adaptation of the above
An adaptation and combination of the above
Risk(s) of Selecting and Implementing
Minimal investment in technology could result in
process obsolescence; firm misses change in customers’
needs due to cost-only focus; competitors imitate
strategy
Customers decide price differential between low cost
producer and differentiator is too large; too many
features offered; product’s means of differentiation no
longer provides value to customers; customer learning
(experience) may change their perception of the value
of differentiation; counterfeit products displace the
firm’s offerings
Beyond the general risks noted for the low-cost leader
and the differentiator, focus strategies have the
following risks: competitor “outfocuses” the focuser by
defining a narrower segment; a firm competing on an
industry-wide basis may decide that the segment served
by the focus strategy firm is attractive and decides to
pursue that segment; the needs of customers within the
narrow segment may become more similar to all
customers in the market, reducing or eliminating the
advantages of a focus strategy
Product features not sufficiently valued by customers;
product is not sufficiently differentiated; product is too
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expensive to compete with low-cost leader’s products

MINI CASE
Is JCPenney Killing Itself with a Failed Strategy?

JCPenney was a struggling retailer when Ron Johnson, its new CEO, announced a
major strategy shift. The store would now carry specific brands of clothes and
home goods, and offer all of the items in the store at a single discounted rate, with
no special sales. Unfortunately, this strategy didn't appeal to JCPenney's current
customers, and the store lost almost $1 billion in 2012. Although Johnson
reinstituted sale pricing and started a program to make sure JCPenney prices were
comparable with those of their competitors, he was fired by the company in 2013,
just a year and a half after he became CEO. It remains to be seen if JCPenney can
recover from his strategic decisions.

ANSWERS TO MINI CASE DISCUSSION QUESTIONS

1. What strategy was the new CEO at JC Penney seeking to implement given the
generic strategies found in Chapter 4?

The new CEO primarily employed a strategy of Focused Differentiation by creating a

shopping space that had unique attributes (the “store-within-a-store” concept) that aimed to
attract new customers to the fledging retailer while maintaining its current customers by
offering a “better deal” on all products as opposed to providing special high discounts on
selected products.

2. What was the result of change in strategy implemented?

The first year of this new strategy appeared to be a failure. Total sales in 2012 were $4.28
billion less than in 2011 and the firm’s stock price declined by 55 percent. Internet sales also
declined by 34 percent compared to an increase of 48 percent for its new rival. All of this
translated into a net loss for the year of slightly less than $1 billion for JCP.

3. Why was this strategy a disaster for JC Penney?

The changes overlooked the firm’s current customers; JCP began competing for customers
who normally shopped at Target, Macy’s and Nordstrom, but it seems the executive team at
Penney’s thought that they could retain their current customer base while attracting

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competitors’ customers. However, it appears JCP was not attracting customers from its rivals
but rather cannibalizing customers from its old stores, resulting in an overall decline in
customers

4. What does it mean to be “stuck in the middle” between two strategies (i.e., between
low cost and differentiation strategies)?

Being stuck in the middle means that the firm’s cost structure is not low enough to allow it to
attractively price its products and that its products are not sufficiently differentiated to create
value for the target customer. This appears to be the problem experienced by J.C. Penney.

ADDITIONAL QUESTIONS AND EXERCISES

The following questions and exercises can be presented for in-class discussion or assigned as
homework.

Application Discussion Questions

1. Students are customers of the university or college. What actions does your school take to
recognize and satisfy its students’ needs? Students should be prepared to discuss their
views.
2. Students should select a local firm, and based on interactions with this company,
determine which business-level strategy they think the firm is implementing. Ask what
evidence they can provide to support their opinions. Is the Internet affecting the firm’s
strategic actions? If so, how?
3. Assuming that students have decided to establish and operate a restaurant in your local
community, ask them what market segment would they intend to serve? What needs do
these customers have that the students could satisfy with their restaurant? How would they
satisfy those needs? They should be prepared to discuss their responses.
4. What business-level strategy do students think your school is implementing? What core
competencies are being used to implement this strategy?
5. Propose the following statement to the class: “It is impossible for a firm to produce a
relatively low-cost, yet somewhat highly differentiated product.” Is this statement true or
false? Ask students for their reasoning behind their answer.
6. Do students feel the Internet is potentially of more value for firms implementing either the
differentiation strategy or the focused differentiation strategy than for those using either
the cost leadership or focused cost leadership strategy? If so, why?
7. Is it possible for a traditional firm to become too reliant on the Internet? If so, why? If not,
why not?

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Ethics Questions

1. Can a commitment to ethical conduct on issues such as the environment, product quality,
and fulfilling contractual agreements affect a firm’s competitive advantage? If so, how?
2. Is there more incentive for differentiators or cost leaders to pursue stronger ethical
conduct? Think of an example to support your answer.
3. Can an overemphasis on cost leadership or differentiation lead to ethical challenges (such
as poor product design and manufacturing) that create costly problems (e.g., product
liability lawsuits)?
4. Reexamine the assumptions about effective TQM systems presented in the chapter. Do
these assumptions urge top-level managers to maintain higher ethical standards than they
now have? If so, how?
5. As discussed in Chapter 3, a brand image is one way a firm can differentiate its good or
service. However, many questions are now being raised about the effect brand images
have on consumer behavior. For example, considerable concern has arisen about brand
images that are managed by tobacco firms and their effect on teenage smoking habits.
Should firms be concerned about how they form and use brand images? Why or why not?
6. What ethical issues do you believe are associated with use of the Internet to implement the
firm’s business-level strategy?
7. If ethical issues do exist regarding Internet use, who do you believe should be responsible
for addressing them: governments or companies themselves? Why?

INSTRUCTOR'S NOTES FOR MINDTAP

Cengage offers additional online activities, assessments and resources inside MindTap, our
online learning platform. The following activities can be assigned within MindTap for
students to complete.

INSTRUCTOR'S NOTES FOR EXPERIENTIAL EXERCISES

Hitting the Target: Understanding Customer Needs With Market

Segmentation

By asking students to identify business-level strategy of various companies, this exercise

provides the opportunity for students to identify how market segmentation is used by firms to
craft advertising campaigns that target a specific customer base. The instructor should

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encourage students to clearly identify the strategy employed by the brand, and how the poster
is a visual representation of that strategy at work.

The instructor may also challenge the students to discuss how to build brand loyalty using
different business-level strategies.

INSTRUCTOR'S NOTES FOR BRANCHING EXERCISE

Branching Exercises are real-world activities that allow each student to work through
challenges by choosing from different decision-making options. These exercises provide
students with the opportunity to practice strategic management in a business scenario
utilizing company case studies. Students are placed in the role of a decision maker and asked
to consider the needs and priorities of stakeholders as they determine strategy
recommendations for a company.

TESLA MOTORS
Tesla is a 10-year-old company that specializes in electric power technology. The firm sells
its powertrain components to other car companies. At the same time, it is selling a high-
performance electric Roadster and the Model S and Model X luxury cars. The company is
serving two customers at the same time, both with a Focused Differentiation Strategy.

However, Tesla Motors founder Elon Musk believes that electric cars should be available for
everyone. Students will be shown how this is a potential conflict of interest, and must make a
decision which strategy the company should pursue moving forward to align itself with the
founder’s beliefs.

Students will be asked to analyze the situation, then decide whether they, as members of the
company, should make the decision to sell only cars to end-user consumers, or to continue
selling both cars and their technology to competitors. After the initial decision is made,
students will be presented with several more opportunities to make decisions that will include
identifying and handling different types of competitive forces and choosing a business-level
strategy based on the effects of competitive forces.

Students will review these concepts:

 Types of business-level strategies

 Risks associated with each type of business-level strategy
 Relationship between customers and business-level strategy
 Supplier bargaining power
 Customer bargaining power

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The ideal path that earns a perfect score is the following:

 Choose to continue selling both cars and the technology to competitors

 Continue in our Differentiation Strategy. We need to continue to invest in R&D to
make our batteries even better, extending our mileage range, so that the car
manufacturers have to choose our batteries and equipment to satisfy their customers’
needs.
 Customer Bargaining Power
 Our focus must be on extending the range of our batteries. We have the best
equipment and that’s the only way we can justify the premium price. The
manufacturers will have to come back to us if we have the only battery that truly
meets drivers’ needs.
 Correct Answer: Components: We stayed focused on our R&D for electric cars, and
proved that we can build the best EV components in the business. With our
differentiation of longer battery usage and efficiency, we’ve been able to justify a
premium price for our components.

INSTRUCTOR'S NOTES FOR VIDEO EXERCISES

The media quiz offers additional opportunities for students to apply the concepts in the
chapter to a real-world scenario as it is described in news reports.

Title: Differentiation Strategy: Value Creation At Burberry

RT: 3:34
Topic Key: Business-Level Strategy, Managing Relationships with Customers, Market
Segmentation, Differentiation Strategy, Five Forces of Competition

The video opens with a short survey of differing opinions of the clothing company Burberry.
Immediately, two distinct opinions emerge:
 Burberry is the height of luxury
 Burberry is only for ‘chavs’, a British term suggesting the brand is often worn by
less-than-upstanding people

Due to an unexpected change in price and loss of control of its image, Burberry has, in recent
years, been striving to recreate its former brand image of absolute luxury. In order to do this,
the company hired a new head designer and began holding regular fashion shows featuring
their newest designs. Burberry has also been updating their image by holding events attended

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by celebrities who proudly wear and support the company’s clothing. This has helped to
change the image of the company over the last few years, as it is once again seen as the
luxury brand it once was and wishes to be.

Suggested Discussion Questions and Answers

1. Describe Burberry’s business-level strategy.

Burberry has implemented a differentiation strategy by redefining their brand image
to more subtly incorporate their iconic ‘check’ clothing pattern.

2. How is Burberry managing its relationship with customers?

Burberry holds fashion shows to showcase their newest clothing, and hosts events
attended by celebrities who both wear Burberry clothing and share with the media
their favorable opinions of the company.

3. Is the differentiation strategy appropriate for Burberry? Why or why not? Now or in
the future?
Providing high luxury clothing products at luxury prices has worked well for
Burberry in the past; it helped to build the company’s brand image that is now in the
process of being restored. At the moment, the strategy seems to be working for the
company, as it did in the past. In the future, an economic downturn may result in a
steep drop in Burberry clothing prices, once again resulting in the clothing being sold
at low costs, tarnishing the brand’s luxury image.

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