strategy and sustaining competitive advantage -- february 18, 2006 dr. theodore h. k. clark...

Strategy and Sustaining Competitive Advantage --

February 18, 2006

Dr. Theodore H. K. ClarkAssociate Professor, Deputy Head (IS), and Academic Director of

MSc in IS Management and MSc in E-Commerce Management ProgramsDepartment of Information & Systems Management

The Hong Kong University of Science & Technologyand Adjunct Associate Professor of Operations & Information Management

(Information Economics and Strategy Group) 1998 - 2001

The Wharton School of the University of Pennsylvania

2HKUST Business School

What is Strategy? Strategy versus Tactics

Strategy is when you have time to plan Time is a luxury many firms may not have Planning helps firms avoid failures or inefficiency

Doing the right things, not just solving the urgent crisis

Goal of Strategy is to Gain Advantage Faster growth, higher margins, or both

Alternative is More Work, Resources, or Luck But, a good strategy can beat superior forces


What is Competitive Advantage? Comparable Advantage - Something you are

better at than almost everyone else Circular slide rule example Swedish language example

Competitive Advantage - A comparable advantage that MATTERS in your market Circular slide rule skills irrelevant; use calculator! Swedish MIGHT matter in some environments Would Cantonese be a competitive advantage?


Porter’s Five Competitive Forces that Drive Industry Profitability

Potentialnew entrants

Industrycompetitors

Threats of substituteproducts or services

Bargaining powerof suppliers

Bargaining powerof buyers


Why is Industry Structure Important for Strategy? Implications of new investments or changes

in environment can affect all firms Decisions on entry or exit of an industry Decisions on investments in new capabilities Understanding how technology affects firms

Useful tool to examine how these forces act differently upon different firms in an industry

Benchmark for understanding expected profits in an industry given these forces

HKUST Business School

Lessons from Five Forces Industry structure has a strong influence on

profitability Firms position in industry is endogenous (chosen) We used to believe industry structure was exogenous

(given)... now we’re not really sure “Excessive” profits threatened by new entrants and

substitute products and competitive actions Retention of value determined by relative

bargaining power of suppliers and customers Market imperfections determine ability to keep

value that is created


Three generic strategies

Overall CostLeadership

Differentiation

Focus

StrategicTarget

Industry

SegmentOnly

Strategic Advantage

Uniqueness Low cost position

“Determining the cost/value tradeoff you wish to offer consumers is themost critical decision” - Porter


Porter’s Generic Strategy # 1: Leadership Based on Lower Cost Become low-cost producer in the industry

Lowest total cost, not just low variable cost Often driven by economies of scale Must have parity quality or have lowest cost

AFTER adjusting for quality differences Leveraging scale is common source of

advantage in many industries Information goods may have difficulties with

this strategy as costs of duplication are low


Porter’s Generic Strategy # 2: Differentiation and Segmentation Differentiation means to make your product

unique and (hopefully) more valuable Becoming hard to copy is critically important Avoid commodity competition based on price

Differentiation must be worth more to customers than it costs to create

Horizontal differentiation (segmentation) versus vertical differentiation (quality) Less competition with horizontal differentiation


Porter’s Generic Strategy # 3: Focus or Niche Target Market Can be based on cost, differentiation or both

By targeting a narrow market segment, you may be able to provide targeted products and services to that segment that are both low-cost and differentiated relative to less targeted firms

Strategy is by design differentiated based on segment, as target market segment needs must be unique for focus strategy to work

May be only option open for new entrants


Rethinking and Updating Porter’s Generic Strategies Today Cost leadership and differentiation are

often hard to separate or clearly distinguish Cost leadership adjusted for quality differences Differentiation relative to differentiation costs Market leaders generally achieve BOTH

Information goods total cost leadership means highest volumes (or copying) Differentiation critical to achieving scale Pricing not uniform, so a new key variable


Attackers’ Advantage Large Business Operations Focus on

Meeting the Needs of Traditional Customers New Products and Services Offer Small

Revenues Cost of Redesigning Existing Processes is High

New Entrants can Focus on Niche Markets Fast Growing Niche / New Customer Segments New Products with Higher Initial Cost and Value Rapid Growth Replaces Traditional Markets

Ignoring New Markets can be VERY Costly!


Sustainable Advantage: Part 1 Economies of Scale and Network Externalities

Economies of scale important for E-commerce (e.g., advertising, software development, etc.)

However, network externalities can be even more powerful forces in online business (Metcalf’s Law)

Value of network of relationships increases as a function of the number of people or systems in the network

Fax machines, Telephones, VCRs, VCD, E-mail, Internet Learning effects of scale can also be hard to copy


Achieving and Sustaining Competitive Advantage Firms need a COMPETITIVE ADVANTAGE to

be able to PROFIT from this REVOLUTION Sustaining an Online Advantage can be Difficult

Key Challenge is Becoming Hard to Copy Economies of scale and network externalities Access to key skills, resources, or suppliers Customer switching costs and brand preference Government policy (patents, antitrust, etc.)

Fast (not First) Mover Advantage also Matters


Sustainable Advantage versus Competitive Necessity Information goods have relatively low costs

of reproduction and distribution Lower distribution costs are good, but Lower reproduction costs can be a problem

It is frequently one-third less expensive to copy an innovation (even without violating patent rights) and takes one-third less time

IT innovations often become competitive necessities instead of strategic advantages


Competitive Necessity Today: Challenge for the Future The more we spend on IT, the more we lose

Why don’t we all just stop investing in systems? Why don’t you start first and show us how well

it works for you, and then we will follow? No firm can afford NOT to have advanced

IT-based trading systems in market today How long is long enough for sustainable

advantage in our fast paced world? Long enough to keep a venture capitalist happy


Copying Innovations and Competitive Necessity Many new IT enabled innovations are easy to

copy or can not be maintained by one firm Bank ATMs - only HSBC has sufficient market

share to go it alone, so others collaborate Competitive advantage initially, then copied Unsustainable advantage may become necessity

An innovation is a competitive necessity if: Must do it to be competitive in the market Easy to copy and many firms doing it Not clear benefits as “stand-alone” investment


Innovations, Investments, and Competitive Necessity An investment should only be justified as

competitive necessity as a LAST RESORT Many investments are just smart business, like

investing in factory automation to reduce costs Competitive necessity LOOKS like a bad

investment versus STATUS QUO, but is essential A competitive necessity must be valued by

customers MORE than the cost of investment Some market innovations are not worth copying Alternative strategies could enable differentiation


Economies of Scale versus Economies of Networks Economies of scale resulted in larger firms

winning, limited by minimum efficient scale Any firm with efficient scale could survive Minimum scale sufficient for moderate success Stability achieved by declining returns to scale

Economies of networks result in single firm or at least standard becoming dominant

Value increases based on number of users Positive feedback leads to single firm dominance Sometimes referred to as a “natural” monopoly


Lower Cost Distribution: Scale Advantages from Technology Giving away samples to increase sales

Mrs. Fields cookies and new food products Free newspapers for high-class hotels Free “samples” of information online

Information products are EXPERIENCE goods Need to try it to know if it worth buying later

Free samples as “Infomercials” (free version) Need attractive upgrade path for customers Create component based products online


Strategy, Technology, Timing, and Competitive Advantage Technology changes so fast, that strategy is

highly dependent on implementation timing Good strategy, wrong timing leads to failure

Many new technologies failed to achieve market success at first, and many eventual successes require multiple failed attempts for learning

Failure of a strategy may be error in timing Banking ATMs, disposable diapers, ziplock bags,

PC banking, and many more examples


Sustainable Advantage: Part 2 Access to Resources as Source of Advantage

Access to either suppliers or channels of distribution can be a sustainable advantage

Customer switching costs can provide a first mover advantage and can favor established firms

Part of IBM’s continuing advantage is due to cost of software conversion which makes switching difficult

Brand can be viewed as a form of switching cost, but may be overcome with intensive promotion

Scarce expertise may provide lasting advantage


Targeting the New Battleground Pricing and Versioning can create NEW

strategic options that can enable firms to overcome SIZE advantages of dominant firms

Alternative to “Winner Takes All” is smartest firm using customer information most effectively gains competitive advantage.

How can firm with higher operating costs (due to lower scale) WIN with lower prices?


Competitive Strategy and Information Goods Pricing Pricing of information goods is complex, as

there is no clear cost basis for comparison Most traditional products have some cost based

component in the pricing of products Information goods pricing can be very different

from comparable physical goods Encyclopedia for $1600 USD or $89.99 USD? Costly to produce, but cheap to reproduce

Generic competition means all firms lose


Critical Role of Information Differentiation in E-Commerce For any online business, ask yourself if this

product or service can easily be copied? If yes, then it is a commodity and competition will

drive prices (and profits) towards zero over time If no, business MAY generate sustainable profits

Cost of copying: barrier to entry CD-based US telephone books example FREE information online (marginal cost = zero)

Advertising and “free” services - challenges


Sustainable Market Structures for Information Goods Dominant firm model: Winner Take All

Microsoft example - cost leadership via scale What is the cost per copy for competitors?

10 million to develop and 10 customers 10 million to develop and 10 million customers

Not the best product, but size and scale win Differentiated product market

Needs differ by segment, so focus wins Publishing (low cost author?), TV, Movies


Even if Dominant, Pricing Important for Maximizing Value Customer willingness to pay different for

different groups of customers (segments) DON’T BE GREEDY - limit incentives for entry PLAY TOUGH - Attack entrants aggressively

Not optimal in each case individually, but powerful signal to the market that entry is not profitable

Personalized products and pricing strategies Use information to determine pricing Value-based pricing by segment


Maximizing Value: Creative Product Pricing Strategies Personalized pricing: Sell unique product to

each customer at a different price Consulting or legal services Grocery products: coupons and electronic

rewards Value of information in services and pricing

Versioning: Portfolio of products and prices Discussed in depth in Session #7

Group pricing: Price sensitivity (students), Network effect, Lock-in, and Sharing


Power of Profitability Gradient New Entrants Exploit Profitability Gradient

Profitability of all customers is not the same Historical pricing is not adequately

differentiated Information advantage can yield high profits

Percentageof TotalCustomers

Percentage of Total Profits-20 0 20 40 60 80 100

10

0

80

60

40

20

0


Datamining: A Powerful Segmentation Tool, But … Datamining can only tell you about possible

correlation, not drivers of behavior Driven by past data; future might be different Correlation not same as causality (coincidence)

Need to look for plausible justification for findings from datamining processes For example, datamining shows that CEOs are

bad customers for credit card companies - WHY?


Information-Based Pricing Strategy: Summary Information about customers behavior,

preferences, cost-to-serve, and ability to pay can be extremely valuable for ALL products

Datamining is ONE powerful tool that can be used to understand potential opportunities Correlation but not causality

Data collection in online businesses can be much lower cost than for traditional firms

Valuable and unused data as free byproducts


Sustainable Advantage: Part 3 Government, Politics, and Options Advantages

Patents, copyright, and trademarks are Government granted Monopoly rights (potentially hard to copy)

Franchises and Licenses, granted by Governments or by Large and Successful Firm, can be hard to copy

Value of owning McDonald’s franchise right can be high Right to operate Star Ferry may valuable and hard to copy

Government policies on antitrust or prohibitions of monopoly can be source of advantage or disadvantage

Government “grants” may be source of advantage


Information Alliances, Outsourcing, and Strategy Information outsourcing is becoming

increasingly common and popular Information alliances are becoming essential

for competitive advantage, especially for network goods to achieve scale for success

Vertical integration initially projected for the new economy is becoming virtual integration No firm can afford to own all elements of the

value chain in today’s complex, global economy Virtual integration is both efficient and flexible


Information Based Organizational Transformation Implementation Implementing Transformation Strategy

Objective are often unclear or evolving over time Industry transformation is hard to do top down Risks and failures can be costly for innovators

Radical Goals, Incremental Change Process Harvard study of successful Reengineering P&G channel transformation success case study

Process R&D and Process Prototyping Needed Infrastructure more than systems; need skills too.


Risks and Benefits of Sharing Information Sharing information even once can result in

power shifts that last for years in a relationship (proceed with caution)

However, successful partnerships based on shared information can yield strong mutual benefits and reduce channel inefficiencies P&G now selling more than 50% of volume

using channel information sharing processes Intel and customers both benefit from shared

information to improve efficiency and service


Developing Relationships of Trust Establishing inter-organizational

relationships based on trust requires management time and attention

But, management time is one of the most scare assets any firm possesses, especially for senior management

Thus, any firm has a limit on the number of close relationships based on trust which can be sustained


Evolution of Trust and Consolidation of Relationships Limited number of relationships at a high

level of trust results consolidation of vendor and customer relationships

Tight partnerships for critical jointly interdependent activities (e.g., JIT) GM and other firms reducing suppliers Strategic supply networks and alliances

Leaders in developing trust can gain sustainable competitive advantage


Reengineering: What is it and Why is it Needed Anyway? Business as usual won’t work

Legacy of past failures - creeping inefficient and tolerance for under-performance.

Does BPR work? Sometimes ... As many as 70% of BPR projects failed. But there are many dramatic successes as well.

Ford - Accounts payable department reduced by 75%. Bell Atlantic - Cycle time reduced from 15 to 3 days. IBM Credit - Loan application turn-around time

reduced from 6 days to 4 hours with 100 times (not 100%) increase in volume using same staff!


Value Chain - Activities

InboundLogistics

Operations OutboundLogistics

Marketing &Sales

Service

Organization

Human resources

Technology

Purchasing

SupportActivities

PrimaryActivities

Idea: Break firm down into manageable pieces for analysis

From: Porter & Miller, 1985


Value System

Identify where value is created outside the firm Can a firm use IT to appropriate this value? Are there additional opportunities to create gains

from trade?

Supplier Firm Channel Buyer

From: Porter & Miller, 1985


Continuous Replenishment: A Continuous Channel Process

Timely, accurate, paperless information flow

Smooth, continual product flow matched to consumption

Supplier Distributor Retail Store

Supplier receives daily demand information and ships based on actual sales demand from distributor warehouse to retail store

Supplier Distributor Retail Store

Traditional Grocery Channel Product and Information Flows using EDI

Weekly or less frequent order received based on price promotions or actual demand, with product shipments based on orders placed by stores and distributors up the value chain.

Orders

Actual Sales Data Actual Sales Data

JIT Shipments JIT Shipments

Orders

Products Products

Traditional and Continuous Replenishment Processes


Manualdelivery(fax, mail)

Direct datalink (EDI)

Discrete &Variable

Continuous &Consistent

ORDERING PROCESS INNOVATIONS

TECHNOLOGICALINNOVATIONS

Traditional

TechnologyInnovation

ProcessInnovation

BusinessProcessRedesign




Discrete &Variable



TECHNOLOGICALINNOVATIONS

EDI CRP

Traditional EDLCManual

CRP




Discrete &Variable



TE

CH

NO

LO

GIC

AL

INN

OV

AT

ION

S

EDI

Traditional EDLC

CRP

Manual CRP*

0-10% 0-10%

50-100% <0%

50-200%

50-200%

50-100%

Figure 12 - Performance Improvements from Innovations

* Manual CRP refers to using CRP processes and policies without using EDI for data transmission. Although technically possible, all attempts at using CRP without EDI have been terminated due to the high costs involved.


Redefining Interorganizational Linkages

BEFORE PROCESS CHANGE AFTER PROCESS CHANGE

Seller

Buyer

Customer Service Team

Category Manager


Increasing Interdependencies: IT, Strategy, and Organizational Design

IT Infrastructure

and Applications

OrganizationalStructure and

Incentives

Business Strategy(and Resources)

Limits or Enables

Requires

Limits or Enables

Drives

Facilitate or Discourage

Redesign andEnhance


Evolutionary versus Revolutionary Change: Conflicting Views Hammer & Champy advocated radical change

“Obliterate, don’t automate!” was their slogan BUT, P&G example most cited is EVOLUTIONARY!

Harvard Business School study of successful reengineering found that evolution dominated Study was REJECTED initially for publication This view has become more accepted as

reengineering itself has lost its zealots Punctuated Equilibrium Model of Change


Success in Value Chain Transformation Value Chain Transformation is even harder

than BPR One factor associated with successful BPR is strong

support from CEO and top management However, a value chain involves several firms and

has NO SINGLE DECISION MAKER IN CHARGE! Thus, changing value-chain operations can be as

difficult as doing business within a JV in China. Value chain transformation requires new

business models and visionary leaders

strategy and sustaining competitive advantage -- february 18, 2006 dr. theodore h. k. clark...

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strategy group

good strategy

comparable advantage

industry decisions

urgent crisisgoal of

industry structure important

competitive forces

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