Differentiation Advantage

1. Differentiation Advantage OUTLINE • The nature of differentiation • Differentiation and segmentation • Analyzing differentiation: the demand side • Analyzing differentiation: the supply side • Bringing it all together: value chain analysis

2. The Nature of Differentiation DEFINITION: “Providing something unique that is valuable to the buyer beyond simply offering a low price.” (M. Porter) THE KEY IS TO CREATE VALUE FOR THE CUSTOMER Potentially more durable than cost leadership! • TANGIBLE DIFFERENTATION • Observable product characteristics: • size, color, materials, etc. • performance • packaging • complementary services INTANGIBLE DIFFERENTATION Unobservable and subjective characteristics that appeal to customer’s image, status, identity, and desire for exclusivity TOTAL CUSTOMER RESPONSIVENESS Differentiation not just about the product, it embraces the whole relationship between the supplier and the customer.

3. Differentiation and Segmentation DIFFERENTIATION: is concerned with how a firm distinguishes its offerings from those of its competitors (i.e. How the firm competes) SEGMENTATION: is concerned with which customers, needs, localities a firm targets (i.e. Where the firm competes) DOES DIFFERENTIATION IMPLY SEGMENTATION? —Not necessarily, depends upon the differentiation strategy: BROAD SCOPE DIFFERENTIATION Appealing to what is common between different customers (McDonalds, Honda, Gillette) FOCUSED DIFFERENTIATION Appealing to what distinguishes different customer groups (MTV Harley-Davidson, Ralph Lauren)

4. Differentiation and the Product Life Cycle New packages of hardware and software introduced Augmentation: repackaging of hardware and software SYSTEM Desystematization: some packages unbundled PRODUCTS & SERVICES PRODUCTS & SERVICES Decommoditization Commoditization COMMODITY

5. Analyzing the Demand Side Techniques for analyzing product attributes and positioning: • Multidimensional Scaling (implied preferences) • Conjoint Analysis (stated preferences) • Hedonic Price Analysis (revealed preferences) • Value Curve Analysis (Chan & Mauborgne)

6. Differentiation in Pain Relievers: Multidimensional Scaling of Competing Products in the U.S. High Tylenol Low High Bufferin EFFECTIVENESS Bayer Private label aspirin Anacin Excedrin Low GENTLENESS

7. Expensive wines Yellow tail Cheap wines VALUE CURVE for U.S. WINE INDUSTRY – YELLOW TAIL High Low Price Above-the-linemarketing Vineyardprestige Winerange Ease ofselection Use of technicalwine terminology Agingquality Winecomplexity Easydrinkability Fun andadventure

8. Identifying Differentiation Potential: The Demand Side What needs does it satisfy? THE PRODUCT What are key attributes? • FORMULATE DIFFERENTIATION STRATEGY • Select product positioning in relation to product attributes • Select target customer group • Ensure customer / product compatibility • Evaluate costs and benefits of differentiation Relate patterns of customer preferences to product attributes By what criteria do they choose? THE CUSTOMER What price premiums do product attributes command? What motivates them? What are demographic, sociological, psychological correlates of customer behavior?

9. Supply Side: Product Integrity Key to successful differentiation is consistency of all aspects of the firm’s relationship with its customers. Product Integrity: the total balance of product features • Internal integrity: consistency between function and structure • External integrity: fit between the product and the customers’ objectives, values, lifestyle etc. • Examples?

10. Signaling and Reputation • Akerlof: The market for lemons • A form of prisoner’s dilemma • Especially problematic with “experience” and “credence” goods (as opposed to “search” goods) • Vitamin supplements • Education • Car repairs • Many forms of medical treatment • Home maintenance services, such as plumbing and electricity. • Estate agents • Solutions • Warranties, money back guarantees, brand advertising, sponsorship, retail environment • Premium pricing and advertising are complementary • Are brands more a signal of reliability or identity/lifestyle?

11. The Impact of Quality on Profitability ROI (%) Relative Price Relative Direct Cost 19 28 38 107 107 108 104 103 101 Relative product quality Low 33% 67% High Relative product quality Low 33% 67% High Relative product quality Low 33% 67% High 14 20 28 103 104 104 104 102 100 7 16 23 101 101 102 104 102 100 Low 25% 60% High Relative market share Low 25% 60% High Relative market share Low 25% 60% High Relative market share Conclusion: Increases in quality typically add more to price than they do to cost.

12. Using the Value Chain to Identify Differentiation Potential on the Supply Side MIS that supports fast response capabilities Training to support customer service excellence Unique product features. Fast new product development FIRM INFRASTRUCTURE HUMAN RESOURCE MANAGEMENT TECHNOLOGY DEVELOPMENT INBOUND OPERATIONS OUTBOUND MARKETING SERVICE LOGISTICS LOGISTICS & SALES Customer technical support. Consumer credit. Availability of spares Quality of components & materials Defect free products. Wide variety Fast delivery. Efficient order processing Building brand reputation

13. Identifying Differentiation Opportunities through Linking the Value Chains of the Firm and its Customers: Can Manufacture 1 Service & technical support Sales Distribution Inventory holding Manufacturing Design Engineering Inventory holding Purchasing 5 2 3 4 Distribution Marketing Canning Processing Inventory holding Purchasing Supplies of steel & aluminum CAN MAKER CANNER 1. Distinctive can design can assist canners’ marketing activities. 2. High manufacturing tolerances can avoid breakdowns in customer’s canning lines. 3. Frequent, reliable delivery can permit canner to adopt JIT can supply. 4. Efficient order processing system can reduce customers’ ordering costs. 5. Competent technical support can increase canner’s efficiency of plant utilization.

14. Industry Evolution OUTLINE • The industry life cycle • Industry structure, competition, and success factors over the life cycle. • Anticipating and shaping the future.

15. The Industry Life Cycle Drivers of industry evolution : • demand growth • creation and diffusion of knowledge • emergence of a dominant design and common technical standards Industry Sales Introduction Growth Maturity Decline Time

16. Product and Process Innovation Over Time Product Innovation Process Innovation Rate of innovation Time

17. Standardization of Product Features in Cars FEATURE INTRODUCTION GENERAL ADOPTION Speedometer 1901 by Oldsmobile Circa 1915 Automatic transmission1st installed 1904 Introduced by Packard as an option, 1938. Standard onCadillacs early 1950 Electric headlamps GM introduces 1908 Standard equipment by 1916 All-steel body GM adoptes 1912 Standard by early 1920s All-steel enclosed body Dodge 1923 Becomes standard late 1920s Radio Optional extra 1923 Standard equipment, 1946 Four-wheel drive Appeared 1924 Only limited availability by 1994 Hydraulic brakes Introduced 1924 Became standard 1939 Shatterproof glass 1st used 1927 Standard features in Fords 1938 Power steering Introduced 1952 Standard equipment by 1969 Antilock brakes Introduced 1972 Standard on GM cars in 1991 Air bags GM introduces 1974 By 1994 most new cars equipped with air bags

18. How Typical is the Life Cycle Pattern? • Technology-intensive industries (e.g. pharmaceuticals, semiconductors, computers) may retain features of emerging industries. • Other industries (especially those providing basic necessities, e.g. food processing, construction, apparel) reach maturity, but not decline. • Industries may experience life cycle regeneration. Sales Sales 1900 50 90 07 1930 50 70 90 07 MOTORCYCLES TV’s • Life cycle model can help us to anticipate industry evolution—but dangerous to assume any common, pre-determined pattern of industry development • Life cycles may be shortening Color Portable B&W HDTV ?

19. Evolution of Industry Structure over the Life Cycle INTRODUCTION GROWTH MATURITY DECLINE DEMAND Affluent buyers Increasing Mass market Knowledgeable, penetration replacement customers, resi- demand dual segments TECHNOLOGY Rapid product Product and Incremental Well-diffused innovation process innovation innovation technology PRODUCTS Wide variety, Standardization Commoditiz- Continued rapid design change ation commoditization MANUFACT- Short-runs, skill Capacity shortage, Deskilling Overcapacity URING intensive mass-production TRADE -----Production shifts from advanced to developing countries----- COMPETITION Technology- Entry & exit Shakeout & Price wars, consolidation exit KSFs Product innovation Process techno- Cost efficiency Overhead red- logy. Design. uction, ration- alization, low cost sourcing

20. The Driving Forces of Industry Evolution BASIC CONDITIONS INDUSTRY STRUCTURE COMPETITION Customers become more knowledgeable & experienced Customers become more price conscious Quest for new sources of differentiation Products become more standardized Diffusion of technology Price competition intensifies Production becomes less R&D & skill-intensive Production shifts to low-wage countries Excess capacity increases Bargaining power of distributors increases Demand growth slows as market saturation approaches Distribution channels consolidate

21. Strategy and Performance across the Industry Life Cycle Note: The figure shows standardized means for each variable for businesses at each stage of the life cycle.

22. ROI at Different Stages of the Industry Life Cycle

23. Changes in the Population of Firms over the Industry Life Cycle: US Auto Industry 1885-1961 “Organizational Ecology” Source: S. Klepper, Industrial & Corporate Change, August 2002, p. 654.

24. The World’s Biggest Companies, 1912 and 2006 (by market capitalization)

25. Adaptation and Change • Sources of Inertia • Routines: Core capabilities become core rigidities • Social and political structures • Conformity: institutional isomorphism and legitimacy-seeking • Complementarities between strategy, structure, and systems • Tendency for punctuated equilibrium • Limited search and blinkered perceptions

26. Preparing for the Future : The Role of Scenario Analysis in Adapting to Industry Change Stages in undertaking multiple Scenario Analysis: • Identify major forces driving industry change • Predict possible impacts of each force on the industry environment • Identify interactions between different external forces • Among range of outcomes, identify 2-4 most likely/ most interesting scenarios: configurations of changes and outcomes • Consider implications of each scenario for the company • Identify key signposts pointing toward the emergence of each scenario • Prepare contingency plan

27. Change strategies • Problem of disruptive technologies (Christensen) • Create separate units • ambidextrous organizations • Plan to cross the chasm (Moore) • Fundamental change in product and distribution – work backwards

28. Innovation & Renewal over the Industry Life Cycle: Retailing Warehouse Clubs e.g. Price Club Sam’s Club Internet Retailers e.g. Amazon; Expedia Discount Stores e.g. K-Mart Wal-Mart “Category Killers” e.g. Toys-R-Us, Home Depot Mail order, catalogue retailing e.g. Sears Roebuck ? Chain Stores e.g. A&P 1880s 1920s 1960s 2000

29. OLD BRICK NEW BRICK Top management is responsible for setting strategy Everyone is responsible for setting strategy Gary Hamel: Shaking the Foundations Getting better, getting faster is the way to win Rule-busting innovation is the way to win Unconventional business concepts create competitive advantage IT creates competitive advantage Being revolutionary is high risk More of the same is high risk We can merge our way to competitiveness There’s no correlation between size and competitiveness Innovation equals new products and new technology Innovation equals entirely new business concepts Strategy is the easy only if you’re content to be an imitator Strategy is the easy part, Implementation the hard part Change starts with activists Change starts at the top Our real problem is execution Our real problem is execution Big companies can become gray-haired revolutionaries Big companies can’t innovate

30. Case: Video Games • Which companies have been most successful in each generation? What were the key success factors? • Are the key success factors changing for the next generation? • What strategy should your company (Microsoft, Sony, Nintendo) pursue for the next generation?