RSM392 Exam Article Readings

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Rotman Commerce
Professor Chris Liu

RSM392 Readings What is Strategy – By: Porter Strategy is not operational effectiveness  Key to outperforming is to establish a difference that delivers greater value  Differentiation arises from both choice of activities and how they are preformed  Activities are basic units of competitive advantage  OE = performing similar activities better than rivals – included but not limited to efficiency *for superior profitability* o Sources of differences in profitability among competitors b/c they directly affect relative cost positions and levels of differentiations o When improves OE moves towards frontier cost capital to improve performance o Issue: easily copied as technology increases and companies catch up o OE competition shifts curve outwards o More benchmarking the more companies look alike – copy each other‟s improvements which becomes a cycle and a race down same path (ie no one can win) o This is mutually destructive  leads to diminishing returns  Strategic positioning = performing different activities from rivals‟ of performing similar activities in different ways  Performed Activity + Efficiency = Cost Advantage o Performed Activity = Cost = Basic unit of competitive advantage o Efficiency = choice of activity = differentiation Strategy Rests on Unique Activities  Choosing a different set of activities to deliver a unique mix of value  Ex. Southwest air caters to price and convenience sensitive customers  Strategic positions emerges form 3 distinct sources 1. Variety Based Positioning = can be based on producing a subset of industry‟s product/services 2. Needs-based Positioning = that of serving most overall the needs of a particular group of customers 3. Access-based Positioning = segmenting customer who are accessible in different ways (ex. Old school theaters for towns)  Positioning not only about carving out a niche A Sustainable Strategic Position Requires Trade-offs  Strategic position not sustainable w/o tradeoffs  Trade-off arise b/c: o Inconsistences in image or reputation o Arise form activities themselves o Limit on internal coordination and control Fit Drives Both Competitive Advantage & Sustainability  Types of Fit o First-order fit = simple consistency between each activity and overall strategy o Second-order fit = activities are reinforcing o Third-order fit = goes beyond activity reinforcement to optimization of effect  Fit & Sustainability o Position built on systems of activities more sustainable than an activity o Fit of activities creates pressure and incentive to improve operational effectiveness o When activities complement each other, rivals get little benefit unless copy whole system  The inevitable result of frequent shifts in strategy, or of failure to choose a distinct position in the first place, is “me- too” or hedged activity configurations, inconsistencies across functions, and organizational dissonance Rediscovering Strategy  Failure to choose o External changes o Sound strategy, is undermined by a misguided view of competition, by organization failures, and especially by desire to grow o Management thinker that do not have to make tradeoffs 1 | P a g e RSM392 Readings o Unnerved by forecasts of hypercompetition, managers more likely to likelihood of imitating everything about competition o Chase every new competition o Pursuit of OE appealing b/c concrete and actionable o Customer focus mistaken as serve all needs and wants from customers  The Growth Trap o Compromise and inconsistencies in the pursuit of growth will erode the competitive advantage a company had with its original varieties or target customers o Attempts to compete in several ways creates confusion and undermine organizational motivation and focus o Manager unable to make choice so broaden and compromise o Cycle of OE and copying results in downsizing/merging  Profitable Growth o Create stand-alone units each with its own brand name and tailored activities o Company‟s activities more distinctive, strengthening fits, and communicating strategy better  The Role of Leadership o Core strategy of management: defining and communicating the company‟s unique position making trade- offs, and forgoing fit among activities o Leader must provide the discipline to decide which industry changes and customer needs the company will respond to, while avoiding organizational distraction and maintaining the company‟s distinctiveness  Company‟s choice of a new position must be driven by the ability to find new trade-offs and leverage a new system of complementary activities into a sustainable advantage The 5 Competitive Forces that Shape Strategy – By: Porter 1. Barriers to Entry  Economies of Scale = larger firms can produce at lower cost per unit o Lower number of firms and reduce competition  Proprietary Product Differences = characteristics that make a product appeal to a large market segment o Only those characteristics that cannot be copied at low cost by competitors will be a barrier to entry  Brand Identity = extent to which buyers will take the brand name into account when making purchase decisions  Capital Requirements = total cost of acquiring the plant and equipment necessary to begin operating in the industry 2. Bargaining Power of Suppliers  Differentiation of Inputs = different suppliers provide different inputs characteristic for input that basically do the same job o Greater degree of differentiation among suppliers the more bargaining power suppliers have  Presence & Availability of Substitute Inputs = extent to which it is possible to switch to another supplier for an input o Greater number and closeness of substitute input the lower the bargaining power of supplier  Supplier Concentration = degree of competitor among suppliers o More concentrated the industry, fewer supplier and more control suppliers have over prices they charge o Greater supplier concentration means greater supplier bargaining power  Cost Relative to Total Purchase in Industry = amount you firm spends on inputs from a particular supplier compare to the total revenue of all firms in the supplier industry o Lowe expenditure implies more bargaining power for supplier o Buyer‟s bargaining power falls as spending with a particular firm falls 3. Threat of Substitutes  Relative Price Performance of Substitutes = price of substitutes for your output compared to the price you are charging o If the price of substitutes is lower, the competitive threat increases as the price differential increases o Switching costs = cost to the buyer of switching from one seller to another 2 | P a g e RSM392 Readings o The greater the switching costs the lower the threat of substitutes because buyers have a stronger incentive to stick with a single supplier  Buyer Propensity to Substitute = the extent to which buyers are willing to consider other suppliers 4. Bargaining Power of Buyers  Buyer Concentration Versus Firm Concentration = the extent of concentration in the buyer‟s industry compared to the extent of concentration in your industry o More concentrated the buyer‟s industry relative to your industry the greater the bargaining power of buyers  Buyer Volume =number of units of your product the buyer purchases from all sources o Greater buyer volume compared to the quantity purchased from you, the greater the bargaining power of buyers  Buyer Information = state of information buyers have about your industry o More information buyers have about your industry the more bargaining power buyers have  Substitute Products = number and closeness of substitutes available for your product. o Greater the number of available substitutes the more bargaining power buyers have  Price of your Product Relative to Total Expenditures on all Products = the fraction of total expenditure buyers spend on your products o Greater the fraction of total expenditure the greater the price elasticity of demand and the more bargaining power buyers have  Product differences = degree of differentiation between your product and other products in the market. o Greater the differentiation of your product, the lower its price elasticity of demand and the less bargaining power buyers have  Brand identity is the extent to which your brand name is recognized and sought out by buyers o The stronger your brand identity the less bargaining power buyers have 5. Rivalry Determinates  Degree to which rivalry drives down an industry‟s profit potential depends on intensity and basis  Industry growth = speed at which the market is growing o Rapidly growing markets provide less incentive for firms to aggressively compete with each other  Intermittent overcapacity = amount demand fluctuates during a year (or over a business cycle) and the impact lower demand has on how efficiently the firm is able to use its plant and equipment o In some industries a decrease in demand leads to significant idle productive capacity, while other industries are not as susceptible to this factor o More intense rivalry is likely to be fostered in an industry in which firms face either large amounts of unused plant capacity or face frequent idle capacity  Concentration and balance is the number of firms in the industry and their relative size o An industry in which a few firms supply most of the output is likely to not be very competitive because the large firms will control the market Porter’s 5 Description of Industries 1. Fragmented (ex. Shore repairs, gift shops) 2. Emerging (ex. Space Travel) 3. Mature (ex. Automotive) 4. Declining (ex. Solid Fuels) 5. Global (ex. Microprocessors) Creating Competitive Advantage – By: Ghemawat & Rivkin  Difference in industry structure and customer affect profits  Ex. Pharmaceutical  little rivalry b/c patent, differentiation, large demand, little labour power from unions 3 | P a g e RSM392 Readings o Customer unwilling to switch brands b/c different products  Ex. Steel  rivalry high b/c little differentiation, slow growth, excess capacity o Union increase labour cost o Easy to switch between supplies  Large differentiation between companies in industries than industries  Industry-level effect appear to account for 10-20% of the variation in business profitability while stable within- industry effects account for 30-40%  Competitive advantage = driven a wide wedge between the willingness to pay it generates among buyers and the cost it incurs o Two Themes to have Competitive Advantage 1. Unique/valuable  added value & if were to disappear no one can replace perfectly 2. Firm‟s activity – harmony of all activities o Choices that establish a firm‟s advantage also influence whether the advantage can be sustained  Industry Analysis crucial to creating a competitive advantage 1. Use strategy to exploit attractable features 2. Industry structure – rules, constraints, conditions 3. Tension between managing industry structure and pursuing an advantage within that structure  Analysis and creativity guide entrepreneurial creativity and to set a batter of test for new business ideas  Value added o Ex. Industry create portal crane with NPV of $6.5million replaces each crane for cost of $2.5million to replace usual forklifts costing $1.0million (benefits - $6.5+1 and costs is $2.5)  WTP = maximum amount of money that a customer would be willing to with in order to obtain the product or service o Ex. Customer willing to pay $7.5million  Supplier opportunity cost = is precisely symmetrical to WTP, smallest amount that a supplier will accept for the service and resources required to produce a good or service  Value created = by transaction in the difference between the customer‟s willingness to pay and the supplier‟s opportunity cost  Added Value = firm is maximal value created by all participants in a transaction minus the maximal value that could be created without, it is the value that would be lost to the world if the firm disappeared  Unrestricted bargaining = amount of value of a firm can claim cannot exceed its added value 4 | P a g e RSM392 Readings  Increase gap between WTP and supplier OC increases amount of value it can potentially claim  greater competitive advantage which derives from scarcity  2 basic ways to establish advantage: 1. Increase WTP with small increase in costs  differentiation strategy 2. Increase supplier opportunity cost (reap large cost saving) with only slight decrease in customer willingness to pay  low-cost strategy  Opportunity Cost = least supplier will accept for the resources used to make a product  Competitive advantage can come from better management of supplier relations  Dual competitive advantage  Activity Analysis  ultimately incur costs and generate customer willingness to pay: managers can o Understand why a firm does or does not have a competitive advantage o Spot opportunities to increase a firm‟s competitive advantage o Foresee future shifts in competitive advantage  Steps to complete analysis of activities: 1. Catalog Activities (The Value Chain)  Value chain divides all activities into 2 classes: a) Primary activities that generate a good or services  broken down further into inbound logistics, operations, outbound logistics, marketing and sales b) Support activities that make the primary activities possible  procurement of inputs, development of technology and HR 2. Use Activities to Analyze Relative Costs  Pure commodity  customer refuse to pay premium  use low-cost position to add value  Non Pure Commodity  differences in cost often wield a large influences on difference in profitability  Cost drivers = factors that make the cost of an activity rise or fall o Allow managers to estimate competitors‟ cost position  General points about relative cost analysis o Focus on differences in individual activities, not just difference in total cost o Focus on all subsets of all of a firm‟s activities – break out in greatest detail and pay the most
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