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Chapter 3 Exhibits. from Strategy and the Business Landscape. Average Economic Profits in the Steel Industry, 1978 -1996. ROE-Ke Spread. 40%. Great Northern Iron. 30%. 20%. Worthington Inds. Nucor. Steel Technologies. 10%. Oregon Mills. Commercial Metals. 0%. Carpenter.

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Chapter 3 Exhibits

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Chapter 3 exhibits

Chapter 3 Exhibits

from

Strategy and the Business Landscape


Average economic profits in the steel industry 1978 1996

Average Economic Profits in the Steel Industry, 1978 -1996

ROE-Ke Spread

40%

Great Northern Iron

30%

20%

Worthington Inds

Nucor

Steel Technologies

10%

Oregon Mills

Commercial Metals

0%

Carpenter

British Steel PLC

Cleveland-Cliffs

Birmingham

Quanex

Lukens

(10%)

USX-US Steel

ACME Metals

Ampco

Inland Steel

(20%)

Armco

WHX

Bethlehem

Average Invested Equity ($B)

(30%)

$0

$1

$2

$3

$4

$5

$6

$7

$8

$9

$10

$11

$12

$13

$14

$15

Source: Compustat, Value Line, Marakon Associates Analysis


Average economic profits in the drug industry 1978 1996

Average Economic Profits in the Drug Industry, 1978 -1996

ROE-Ke Spread

60%

SmithKline

40%

Schering Plough

American

Amgen

Watson

Rhone-Poulenc

Home

Mylan Labs

Glaxo

Products

Bristol

Merck

Warner Lambert

Perrigo

Myers

20%

Pharmacia & Upjohn

Eli Lilly

Pfizer

Forest Labs

Alza

0%

ICN

Scherer

Ivax

(20%)

Genetech

Biogen

Roberts

Genzyme

(40%)

Dura

Chiron

Cephalon

Gensia

Cygnus

(60%)

Immunex

Average Invested Equity ($B)

(80%)

$0

$5

$10

$15

$20

$25

$30

Source: Compustat, Value Line, Marakon Associates Analysis


Cost analysis

Cost Analysis

  • Began with the Experience Curve

  • Focus on costs of doing business

  • Caused firms to begin disaggregating cost structures.

  • Value chain (McKinsey’s Business System) is developed.

  • Shared costs in large corporations required special treatment.

  • A interest in capacity utilization emerged.


Experience curve for semiconductor memories

Experience Curve for Semiconductor Memories

1976

100

1977

75

1978

50

1979

Price per bit

(millicents)

25

1980

10

1981

1982

1983

1984

0.1

1.0

10

100

Cumulated output

(bits x 1012)

Source:Integrated Circuit Engineering Corporation


Mckinsey s business system

McKinsey’s Business System

Technology

Manufacturing

Distribution

Marketing

Service

Design

Development

Procurement

Assembly

Transport

Inventory

Retailing

Advertising

Parts

Labor

Source: Carter F. Bales, P.C. Chatterjee, Donald J. Gogel, and Anapam P. Puri,

“Competitive Cost Analysis,” McKinsey & Co. Staff Paper (January 1980)


Differentiation analysis

Differentiation Analysis

  • Experience curve recognized as relevant only to commodity industries.

  • Competitive analysis refocused on differentiation.

  • Value chain emerges in current form (Porter)


Value chain for an internet start up

Value Chain for an Internet Start-Up

Firm

Infrastructure

  • Financing, legal support, accounting

Human Resources

  • Recruiting, training, incentive system, employee feedback

Technology

Development

  • Inventory system

  • Site software

  • Pick & pack procedures

  • Site look & feel

  • Return procedures

Support

Activities

  • Customer research

Procurement

  • CDs

  • Shipping

  • Computers

  • Telecom lines

  • Media

  • Shipping services

  • Inbound shipment of top titles

  • Server operations

  • Billing

  • Collections

  • Picking and shipment of top titles from warehouse

  • Shipment of other titles from third- party distributors

  • Pricing

  • Promotions

  • Advertising

  • Product information and reviews

  • Affiliations with other websites

  • Returned items

  • Customer feedback

  • Warehousing

  • Primary

  • activities

Inbound

Logistics

Operations

Outbound

Logistics

Marketing

& Sales

After-Sales Service

Primary Activities


Cost vs differentiation

Cost vs Differentiation

  • Focus on both cost and differentiation

  • Porter proposes that there are only three kinds of strategies:

    • Differentiation

    • Overall cost leadership

    • Focus

  • This suggests that costs and differentiation are mutually exclusive.

  • Dual advantages are rare.


Porter s generic strategies

Porter’s Generic Strategies

STRATEGIC ADVANTAGE

Uniqueness Perceived

by the Customer

Low Cost Position

OVERALL

COST LEADERSHIP

Industry wide

DIFFERENTIATION

STRATEGIC TARGET

Particular

Segment only

FOCUS

Source: Michael Porter, Competitive Strategy, 1980


Interplay between cost and differentiation

Interplay between Cost and Differentiation

$

Industry

average

competitor

Successful

differentiated

competitor

Successful

low-cost

competitor

Competitor with

dual advantage


Costs and willingness to pay for aspartame

Costs and Willingness to Pay for Aspartame

Willingness to Pay

100

( NS )

90

( HSC )

80

70

60

50

40

30

$ per Lb.

20

10

0

0

2000

4000

6000

8000

( HSC )

Cost

( NS )

Tons


Hostess s cost components

Hostess’s Cost Components

80

Profit

70

Marketing: Promotions

60

Marketing: Advertising

50

Outbound logistics

Cents per unit

40

Operations: Manufacturing

30

Operations: Packaging

Operations: Ingredients

20

10

0


Relative cost analysis

Relative Cost Analysis

90

80

Profit

Marketing: Promotions

70

60

Marketing: Advertising

50

Outbound logistics

40

Operations: Manufacturing

30

Operations: Packaging

20

Operations: Ingredients

10

0

Cents per unit

Hostess

Little Debbie

Ontario Baking

Savory Pastries


Relative success in satisfying customer needs

Relative Success in Satisfying Customer Needs

4

3

Hostess

Rating

Little Debbie

2

Ontario Baking

Savory Pastries

1

0

Price

(****)

Brand

Image

(****)

Freshness

(***)

Variety

(**)

Size

(*)

Customer Need (and Importance ****)


Chapter 3 text related slides

Chapter 3 Text Related Slides

from

Strategy and the Business Landscape


Calibrating profit drivers

Calibrating Profit Drivers

Residual

Industry

Corporate

Positioning

Source: Richard P. Rumelt, “How Much Does Industry Matter?,”

Strategic Management Journal, 1991; 12:167-185


Added value

Added Value

  • Under unrestricted bargaining, a firm cannot capture more than its added value

    • If you (in your relationships with customers and suppliers) create no value, you can capture no value

  • More generally, if a firm (in its relationships) creates no new value, it had better have some clever way of claiming value

Added value =total value created with the firm in the game

- total value created without the firm in the game

OR EQUIVALENTLY

the value that would be lost to the world if the firm disappeared


Value creation

Value Creation

  • Value is created by a business operating together with its customers and its suppliers

    • A firm does not create value in isolation

  • Willingness to pay = the most that a customer will pay for a firm’s product

  • Supplier opportunity cost = willingness to receive = the least that a supplier will accept for the resources required to make a product

  • The value created by a transaction is the difference between the customer’s willingness to pay and the opportunity cost of the resources

Customer

Firm

Supplier


Value creation cont

Value Creation (cont.)

Customer

Firm

Supplier

Willingness to pay

Total value created

Supplier opportunity cost


Value division

Value Division

Customer

Firm

Supplier

Willingness to pay

Value captured by customer

Price

Value captured by firm

Cost

Value captured by supplier

Supplier opportunity cost


Activity analysis of competitive advantage

Activity Analysis of Competitive Advantage

  • Added value => goal is to drive a wedge between willingness to pay and (supplier opportunity) cost

    • Indeed, a wider wedge than competitors achieve

  • Problem: a firm must often incur higher costs to deliver a better product or service

  • Partial solution: use activity analysis to spot opportunities to widen the wedge


Value chain

Value Chain

Firm

Infrastructure

Human Resource

Management

Technology Development

Procurement

Support

Activities

M

a

r

g

i

n

Inbound

Logistics

Operations

Outbound

Logistics

Marketing

& Sales

After-Sales Service

Primary Activities


Types of competitive advantage

Types of Competitive Advantage

Lower Cost

Differentiation

Competitive

Advantage


Cost leadership strategy

Cost Leadership Strategy

  • Deliver a GOOD product or service at the lowest possible cost

  • Open a significant and sustainable cost gap over all competitors

  • Create advantage through superior management of key cost drivers

  • Translates into above-average profits with industry-average prices

    BUT

  • Cost leaders must maintain parity or proximity in satisfying buyer needs

  • Cost leadership often requires trade-offs with differentiation


Successful cost leadership strategy gallo wines

Successful Cost Leadership Strategy:Gallo Wines

Firm

Infrastructure

Human Resource

Management

Technology Development

Procurement

Support

Activities

  • Blending technology

M

  • National advertising

a

  • Grape purchasing

r

g

i

n

Inbound

Logistics

Operations

Outbound

Logistics

Marketing

& Sales

After-Sales Service

Primary Activities


Cost drivers

Scale

Learning

Pattern of capacity utilization

Linkages

Interrelationships

Integration

Timing

Policies

Location

Institutional factors

Cost Drivers

Source: Michael E. Porter, Competitive Advantage

(New York: Free Press, 1985)


Common pitfalls in cost leadership

Common Pitfalls in Cost Leadership

  • Misunderstanding of actual costs

  • False perception of cost drivers

  • Focus on manufacturing

  • Failure to exploit linkages

  • Inadequate proximity to differentiators

  • Ignoring competitor behavior

  • Poor implementation

  • Acting incrementally

  • No cost management program


The differentiation strategy

The Differentiation Strategy

  • Select one or more needs that are valued by buyer

  • Achieve and sustain superior performance by meeting these needs uniquely

  • Selectively add costs if necessary to do so

  • Successful differentiation leads to premium prices

  • Differentiators must pick cost-effective forms of differentiation

  • Differentiation leads to above-average profitability provided the firm maintains cost parity or proximity to competitors


Successful differentiation strategy stouffer s frozen foods

Successful Differentiation Strategy:Stouffer’s Frozen Foods

Support

Activities

Firm

Infrastructure

Human Resource

Management

Technology Development

Procurement

  • Innovative menus

  • Sauce technology

M

a

  • High quality inputs

r

g

i

High quality, consistent packaging

Brokers

Highest advertising levels

Advertising content

n

Inbound

Logistics

Operations

Outbound

Logistics

Marketing

& Sales

Service

Primary Activities


Common pitfalls in differentiation

Common Pitfalls in Differentiation

  • Creating differentiation that buyers do not value

  • Over-fulfilling buyer needs

  • Looking too narrowly at the sources of differentiation

  • Charging an excessive price premium

  • Failing to understand costs of differentiation

  • Ignoring signals of value

  • Failing to recognize buyer segments

  • Creating differentiation that competitors can emulate quickly or cheaply


Focus strategy

Focus Strategy

  • Exploits the same fundamental types of competitive advantage

  • Selects narrow target segment(s) with unusual needs

  • Creates optimal strategy for the target

Narrowing of scope creates cost or

differentiation advantage


Can business do more than one

Overall Cost

Leadership

+

Differentiation

Focus

Can business do more than one?

OR

  • Sometimes consistent

  • But requires defense against a competitor achieving one or the other

  • Can have multiply-focused entities in one company


Types of competitive advantage1

Types of Competitive Advantage

Lower Cost

Differentiation

Competitive

Advantage


1 catalog activities the value chain

1. Catalog Activities (The Value Chain)

Firm

Infrastructure

Human Resource

Management

Technology Development

Procurement

  • Frugal culture (sharing hotel rooms, calling collect

  • No regional offices

  • Lots of management visits

  • Saturday meetings

  • Fun working environment

  • Associates, not employees

  • Not unionized

  • Store manager autonomy

  • Manager compensation tied to store

  • Stock ownership plan

  • Decentralized training in DC

  • Promotion from within

  • Associate compensation tied to company

  • Shrink incentive plan

Support

Activities

  • POS

  • Satellite system

  • Store performance tracking

  • UPC

  • Real-time market research

M

  • Hard-nosed negotiating

  • Centralized buying

  • No-frills meeting rooms

  • Partnerships with some vendors

  • EFT, electronic invoicing

  • Planning packets

a

r

g

  • Frequent replenishment

  • Automated DCs, cross docking, pick-to-light

  • EDI

  • Hub and spoke system

  • Big stores in small towns => local monopolies, low rental costs

  • Pricing that reflects local monopoly

  • Concentric expansion

  • Brand-name merchandise

  • Private labels

  • Little space for inventory

  • Suggestion program

  • Store within a store

  • Traiting: tailoring merchandise to locale

  • EDLP

  • Low prices

  • Store manager latitude on pricing

  • Little advertising

  • Merchandise meeting

  • Easy returns

i

n

Inbound

Logistics

Operations

Outbound

Logistics

Marketing

& Sales

After-Sales Service

Primary Activities


2 use activities to analyze relative costs

2. Use Activities to Analyze Relative Costs


3 use activities to analyze relative wtp

3. Use Activities to Analyze Relative WTP

(****)

(***)

(**)

(*)

(****)


4 explore options and make choices

4. Explore Options and Make Choices


Complementarities and landscapes

Complementarities and Landscapes

No Complementarities

Complementarities


Nk modeling

NK Modeling

  • N is the number of activities about which choices have to be made

  • K is the degree of interactivity in the payoffs to them

  • Each of the N activities makes a randomly assigned contribution to overall value that depends on how that activity and K other activities are performed


Activities interactivity and peaks

Activities, Interactivity and Peaks

Source: Jan W. Rivkin


How far can a competitive advantage travel

How Far Can a Competitive Advantage Travel?

  • Is the destination market structurally attractive?

    • After considering the effects of entry

  • Does the advantage apply in the destination market?

    • A formula for success in one market can be a recipe for disaster in another

    • Strategy is highly dependent on context

  • Can the advantage be transferred?

    • The very factors that block imitation at home may prevent transfer to the destination (e.g., resources or capabilities build up over a long period)

    • Transfer may take a long time

  • Do the benefits of transfer outweigh the costs?

    • Including benefits and costs to home business


The importance of uniqueness

The Importance Of Uniqueness

  • Uniqueness is essential to adding value in both competitive and complementary situations

  • The kind of strategy that is uniquely valuable tends to involve

    • External consistency, with the environment

    • Internal consistency

    • Dynamic consistency, in the sense of deliberate upgrading


The limits of positioning analysis

The Limits of Positioning Analysis

  • Evaluates competitive positions under simplifying assumptions

  • Ignores differential reactions

    • sustainability analysis recognizes that superior positions are like honey to flies

  • Ignores uncertainty

    • flexibility analysis recognizes that revision possibilities are valuable in an uncertain world


Ethylene positioning analysis

Ethylene Positioning Analysis

  • Relative costs of new plants

  • New plants vs. old plants

  • Average industry margin


Profits from a new ethylene plant

Profits from a New Ethylene Plant

Client’s cost advantage at adding a new plant

  • Cost advantage of new plants vs. “average” capacity

  • Average industry profit margin

  • Profit margin attainable from plant addition


Analytical components

Analytical Components


Average industry margin 1990s vs 1960s

Potential Volatility

OPEC

Politicization

Exchange Rates

Greater Number

Less Chemical Co. Control

Greater Asymmetry

oil companies

foreigners

cos. from mature industries

History of losses

Average Industry Margin1990s vs. 1960s

Feedstock Suppliers

Competitors

Buyers

  • Maturing Demand

  • Better Info About Price Dispersions


New plants vs old plants

New Plants vs. Old Plants

Cost

Capital

Cost

Old Plants

Cash Cost

Cumulative Capacity


Relative costs of new plants

Relative Costs of New Plants

[

]

Competitor’s Capital Cost

Competitor’s Capacity Util.

Client’s Capital Cost

Client’s Capacity Util.

x ROR

  • Client had traditionally maintained higher-than-average capacity utilization

  • The scale it was planning to build at was only one-half to one-third of likely competitive expansions

  • Plant scale had big impact on capital costs

  • =-


Impact of client s capacity utilization

Impact of Client’s Capacity Utilization

0

100%

(Cents/lb.)

90%

80%

80

90

100

Competitor’s Capacity Utilization


The rest of the ethylene analysis

The Rest of the Ethylene Analysis

  • Bandwagon implications of expansion by client

  • Uncertainty about competitive behavior, demand


Chapter 3 case related slides

Chapter 3 Case Related Slides

Wal*Mart


Wal mart

Wal*Mart

Price

Other Costs

FOB Cost

Wal*Mart

Industry


Wal mart s activities

Wal*Mart’s Activities

Limited Advertising

Everyday Low Prices

Focus on Hard Goods

Real-time Market Research at HQ

Price Discretion

Bursting at Seams Appearance

Point of Sale Information System

Incentive Systems

In-store Warehouses

Satellite Communications

Exhaustive Selection Within Target Categories

Saturation of Markets with Stores

Computerized Ordering & Inventory Management

Automation of Distribution Centers

EDI With Suppliers


Changes in wal mart s market valuation since 1993

Changes in Wal*Mart’s Market Valuation Since 1993


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