42 Chapter 4: Building Competitive Advantage Through Functional-Level Strategy

CHAPTER 4
Building Competitive Advantage Through
Functional-Level Strategy
SYNOPSIS OF CAPT!"
This chapter explains how functional-level strategies can help a company achieve superior efficiency, quality,
innovation, and customer responsiveness, leading to competitive advantage.
Functional strategies consistent with attaining superior efficiency are considered first. This section reviews the
contributions that each of the different functional areas of a company can make toward increasing efficiency.
Among the topics discussed with regard to their impact on efficiency are economies of scale, learning effects, the
experience curve, flexible manufacturing technologies, marketing strategy, and materials management. The
contributions of the !" function, the human resource function, the information systems function, and company
infrastructure are then examined.
#ext, the chapter addresses how functional strategies can improve quality of a company$s goods and services. %ne
aspect of quality is reliability, and total quality management &T'() is proposed as a methodology for improving
reliability. %ther aspects of quality, such as form, features, durability and styling are also discussed.
The third section focuses on the means of achieving superior innovation through functional strategies. A
discussion of the reasons for the high failure rate of innovations is followed by a detailed examination of the ways
in which a company can build a distinctive competency in innovation.
The final section of the chapter concentrates on the contribution of functional strategies to improved
responsiveness to customers. Achieving superior customer responsiveness requires superior efficiency, quality,
and innovation. Also, the chapter describes steps that companies can take to better understand the needs of their
customers, better satisfy those needs, and satisfy those needs more quickly.
T!ACIN# OB$!CTI%!S
*. "iscuss how a company can build and maintain a competitive advantage through its choice of functional
strategies.
+. ,dentify the different steps that can be taken at the functional level to improve a company$s efficiency.
-. ,dentify the different steps that can be taken at the functional level to improve the quality of the company$s
product.
.. ,dentify the different steps that can be taken at the functional level to improve a company$s ability to
innovate.
/. ,dentify the different steps that can be taken at the functional level to improve a company$s responsiveness
to its customers.
OP!NIN# CAS!& CS'(#!TTIN# T! T"AINS TO ")N ON TI*!
012 0orporation, a freight transporter, merged with 0onrail in *334, creating one of the largest railroad firms in
the 5.1. The expected costs savings due to economies of scale did not result, due to a host of problems in merging
the two firms. Among the post-merger difficulties were poor quality, unsafe tracks, low employee morale, and
poor customer service. ,n +666, an efficiency campaign was launched, focused around the use of *. critical
operating efficiency metrics. 012 made tremendous improvement over the next year in those *. areas,
empowering local employees to make decisions, fixing defective tracks, and building a web-based customer
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43 Chapter 4: Building Competitive Advantage Through Functional-Level Strategy
interface for service. These actions led to better quality, higher customer satisfaction, greater efficiency, and
ultimately, higher profits.
Teaching Note: This case provides a vivid demonstration of how a company suffering from poor performance and
numerous internal problems could achieve successful outcomes, through the use of improvements at the
functional level. The details of the case clearly relate to many of the topics introduced in this chapter, focusing on
ways to improve efficiency, quality, and responsiveness to customers. This case provides an excellent introduction
to an idea that may at first be difficult for students to grasp. That is, that the basis of competitive advantage is
always found at the lowest levels of the organi7ation &the functions). 1tudents may erroneously assume that large,
diversified companies should be turned around primarily by the actions of top managers. 8ou can use this case as
an opportunity to demonstrate that real, lasting, important changes are in fact, most often due to many small
improvements at the functional level. Thus, functional level managers play a key role in organi7ational success.
L!CT)"! O)TLIN!
,. %verview
A. This chapter addresses the role that functional-level strategies play in improving the effectiveness of
functional operations within a company, such as manufacturing, marketing, materials management,
research and development, and human resources. Functional strategies may also cut across two or
more functions to attain a common goal.
9. Functional-level strategies can improve effectiveness by helping an organi7ation to achieve
efficiency, quality, innovation, and customer responsiveness.
0. Functional strategies are responsible for building the resources and capabilities that lead to distinctive
competencies, allowing a firm to pursue a differentiation and:or low cost strategy.
Show Transparency 22
Figure 4.1: The Roots of Competitive Advantage
,,. Achieving 1uperior ;fficiency
A. ;fficiency is measured by the cost of inputs &labor, capital, equipment, know-how, and so on) required
to produce a given output &the good or service produced by the company). The more efficient a
company, the lower the cost of inputs is required to produce a given output. An efficient company has
higher productivity than its rivals, and, therefore, lower costs.
9. Economies of scale are unit-cost reductions associated with a large scale of output. 9oth
manufacturing and service companies can benefit from economies of scale.
*. %ne source of economies of scale is the ability to spread fixed costs over a large production
volume.
+. Another source is the ability of companies producing in large volumes to achieve a greater
division of labor and speciali7ation. 1peciali7ation improves employee productivity because it
enables individuals to become very skilled at performing a particular task.
-. ;conomies of scale raise %,0 in two ways. They reduce spending on 0%<1, 1<!A, and
!" as a percentage of sales, improving return on sales. They also make more intensive use of
existing ==;, increasing capital turnover.
.. ;conomies of scale do not continue indefinitely. Typically, diseconomies of scale are reached
at very high volumes, due to increased bureaucracy and the resulting inefficiencies.
Show Transparency 2
Figure 4.2: !conomies and "iseconomies of Sca#e
0. Learning effects refer to cost savings that come from learning by doing. >abor productivity increases
as individuals learn the most efficient way to perform a particular task and managers learn how best to
run the operation.
*. >earning effects are most important in a technologically complex task that is repeated, and are
really important only during the start-up period of a new process. The importance of learning
effects tends to cease after two or three years.
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Chapter 4: Building Competitive Advantage Through Functional-Level Strategy 44
+. Although economies of scale move a firm downward along the unit cost curve, learning effects
shift the entire curve downwards.
Show Transparency 24
Figure 4.: The $mpact of %earning and Sca#e !conomies on &nit Cost
". The experience curve refers to systematic unit-cost reductions that have been observed to occur over
the life of a product. According to the experience-curve concept, unit manufacturing costs for a
product typically decline by some characteristic amount each time accumulated output of the product
is doubled.
Show Transparency 2'
Figure 4.4: The !(perience Curve
*. ;conomies of scale and learning effects underlie the experience-curve phenomenon. As a
company increases the accumulated volume of its output over time, it is able to reali7e both
economies of scale &as volume increases) and learning effects. As a consequence, unit costs fall
with increases in accumulated output.
+. The experience curve suggests that increasing a company$s product volume and market share
will bring cost advantages over the competition. The concept is perhaps most important in those
industries where the production process involves the mass production of a standardi7ed output
&for instance, the manufacture of semiconductor chips).
-. ,f a company wishes to attain a low-cost position, it must ride down the experience curve as
quickly as possible. This involves building an efficient scale plant ahead of demand and
aggressively pursuing learning effects. ,t also involves aggressive price cutting and marketing
in order to expand sales and get down the experience curve ahead of competitors.
ST"AT!#Y IN ACTION +,-& TOO *)C !'P!"I!NC! AT T!'AS INST")*!NTS
Texas ,nstruments &T,) was one of the first companies to exploit the experience curve concept. ?hen T, first
produced a new product, it would slash the price to stimulate demand, driving up the accumulated volume of
production and driving down costs. As a result, during the *346s and *3@6s T, hammered its competitors in
transistors, semiconductors, hand-held calculators, and digital watches. 5ltimately, however, T,$s single-minded
focus on cost reductions left the company with a poor understanding of consumer needs and market trends.
0ompetitors such as 0asio, Aewlett-=ackard, (otorola, and ,ntel made maBor inroads into T,$s markets by
focusing on additional features that consumers demanded, rather than on cost and price. T, was slow to react to
this trend and lost substantial market share as a result.
Teaching Note: The case shows students how increasing experience and expertise can be both an advantage and a
disadvantage. The case demonstrates an example of a firm that rode down the experience curve, benefiting from
the efficiency and know-how improvements, but then became over-reliant on further improvements in efficiency,
ignoring changing conditions. 1tudents can use this case to understand how organi7ations must balance their quest
for efficiency with an equally important search for innovations. 1ome have called this need for balance, Clearning
vs. efficiency.D 8ou can use this case for classroom discussion by asking students to suggest actions that T, could
have taken to avoid the loss of market share. 1tudents will reali7e that T, needed to innovate, making changes and
risking the possibility of error. That is not efficient, but it would have allowed T, to stay in touch with customers
and improve their products$ functionality.
.. Aowever, the company furthest down the experience curve must not become complacent about
its position for three reasons.
a. The experience curve bottoms out at some point, which implies that other companies can
catch up.
b. 0ost advantages gained from experience effects can be made obsolete by the
development of new technologies that require new methods of production.
c. The experience curve suggests that high volume leads to a cost advantage, but this does
not always happen. ,n some industries, there are two or more different production
technologies, one of which is cost-efficient at high volumes, and the other at low
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45 Chapter 4: Building Competitive Advantage Through Functional-Level Strategy
volumes. A company using low-volume technology may be able to operate with a cost
structure similar to that of companies using a high-volume technology.
;. ,t seems then, that the best way to reduce costs is to produce high volumes of a standard product.
Aowever, this view has been challenged by the rise of flexible manufacturing technologies, also
called lean production.
*. Flexible manufacturing technologies allow firms to produce a wider variety of product while
still achieving the efficiencies of high volume production. 0ost efficiencies are achieved by
reducing setup times for complex equipment, increasing the utili7ation of individual machines
through better scheduling, and improving quality control at all stages of the manufacturing
process.
+. (ass customi7ation refers to the use of flexible manufacturing technologies to achieve low cost
and differentiation through product customi7ation.
Show Transparency 2)
Figure 4.): Tradeoff *etween Costs and +roduct ,ariety
ST"AT!#Y IN ACTION +,.& TOYOTA/S L!AN P"O0)CTION SYST!*
Toyota is the most efficient auto company in the global industry, thanks to its lean production system, developed
in response to problems Toyota$s engineers saw with the long production runs of a mass production system. The
problems included the creation of large and expensive inventories, the production of a large number of defective
products if the initial machine settings were wrong, and the system$s inability to accommodate diverse consumer
preferences. Toyota then developed a number of techniques designed to reduce equipment setup timesEa maBor
source of fixed costs. This made small production runs economical, which eliminated large inventories, fewer
defective products, and better responsiveness to consumer demands for product diversity. =rocess innovations
enabled Toyota to produce a more diverse product range at a lower unit cost than was possible with conventional
mass production.
Teaching Note: This case describes Toyota$s disenchantment with mass production, and their subsequent
development of a flexible manufacturing system, to overcome mass production$s disadvantages. The case also
focuses attention on the interrelatedness of efficiency, quality, innovation, and responsiveness to customers, as
Toyota$s new system improved all four at the same time. 8ou can point out to students that virtually every
manufacturing industry has adopted flexible manufacturing to some extent, and that the explosion in technologies
such as 0A":0A( software, robotics, and artificial intelligence has enabled lean production techniques.
-. %ne type of flexible manufacturing technology is flexible machine cells, which are groupings
of four to six various machines, a materials handler, and a central computer. The machines are
computer controlled, allowing each cell to switch quickly between the production of different
products.
a. Flexible machine cells allow for improved capacity utili7ation due to a reduction in setup
times and better coordination of production flow between machines.
b. Flexible machine cells reduce work in progress and waste because of the tight
coordination between machines and the ability of computer-controlled machinery to
identify how to transform inputs into outputs while producing a minimum of unusable
waste material.
F. Marketing strategy refers to the position that a company takes with regard to pricing, promotion,
advertising, product design, and distribution.
*. (arketing strategy can increase efficiency by using aggressive pricing, promotions, and
advertising to improve sales and help the organi7ation ride down the experience curve.
+. Another aspect of marketing strategy that can improve efficiency is the creation of customer
loyalty, through high customer satisfaction. >oyalty reduces customer defection rates, or the
percentage of a company$s customers that defect every year to competitors.
a. There is a direct relationship between defection rates and costs. Acquiring a new
customer entails one-time fixed costs for advertising, promotions, and the like.
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Chapter 4: Building Competitive Advantage Through Functional-Level Strategy 4
b. The longer a company retains a customer, the greater is the volume of customer-generated
unit sales that can be set against these fixed costs and the lower is the average unit cost of
each sale.
Show Transparency 2-
Figure 4.-: The Re#ationship *etween Customer %oya#ty and +rofit per Customer
<. ;fficiency can also be improved through the use of materials management, which encompasses the
activities necessary to get materials to a production facility, through the production process, and
through a distribution system to the end user. (aterials management is also called supply chain
management.
*. (aterials management typically accounts for /6 to @6 percent of a manufacturer$s costsEthus,
even a small reduction can have a great impact.
+. ,mproving the efficiency of the materials management function typically requires the adoption
of Bust-in-time &F,T) inventory systems. F,T reduces inventory-holding costs by having materials
arrive at a manufacturing plant Bust in time to enter the production process, and not before.
-. The drawback of F,T systems is that they leave a firm without a buffer stock of inventory.
Although buffer stocks of inventory are expensive to store, they can help tide a firm over
shortages on inputs brought about by disruption among suppliers.
ST"AT!#Y IN ACTION +,1& S)PPLY CAIN *ANA#!*!NT AT OFFIC!
S)P!"STO"!S
Three companies, %ffice "epot, 1taples, and %ffice (ax are the maBor competitors in the competitive office
superstore industry, which retails office supplies, earning thin profit margins. All are examining their supply chain
management, looking for ways to cut costs. %ffice "epot succeeds by having a high inventory turn rate, and the
firm also has reduced the number of items it stocks, with a focus on carrying only items that turn over rapidly or
earn a high profit margin. This allows %ffice "epot to use stores that are one-sixth smaller than its competitors$
stores, which further reduces costs. 1taples is concentrating on developing closer, cooperative relationships with
suppliers, which has led to lower inventory held at the stores. 1taples has also eliminated in-store displays of
computers, freeing up floor space, and now sells =0s through a web-based ordering system offering customi7ed
design to customers. %ffice (ax too is reducing the number of items and scaling down the si7e of stores.
Teaching Note: This case provides students with examples of a number of possible improvements in materials
management, including reduction in the number of items stocked, focus on high-margin items, cooperation with
suppliers, F,T inventory, and use of the ,nternet for product display. The case also demonstrates the benefits that
superior materials management can provide. This case could be used as the basis for class discussion, by asking
students to describe how the materials management practices listed in the case could be used by other retailers.
For example, ask students, C?hich of the practices in the case could be successfully employed at a retail clothing
storeG At a bookstoreG At a grocery storeG ?hich could not, and whyGD
A. The !" function can boost efficiency by designing products that are easy to manufacture, cutting
down on the number of parts and reducing assembly time. !" can also pioneer process innovations
to improve efficiency.
,. The human resource function can aid in improving efficiency by raising employee productivity.
*. ecruiting is one area where human resources can help. 0arefully hiring individuals with the
right attitudes and values can raise employee productivity. 1killed employees can also interact
with customers in ways that improve customer loyalty.
+. Another way to raise employee productivity is through training. 1killed individuals perform
tasks more quickly and accurately, and are better able to learn complex tasks. A company can
upgrade the skill level of its employees through training.
-. Self-managing teams, where members are responsible for coordinating their own activities, are
another source of efficiency gain. Team members learn all team tasks and rotate from Bob to Bob,
creating a more flexible workforce in which members can fill in for absent coworkers. Teams
also take over managerial duties, and the resulting empowerment is a motivator.
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4! Chapter 4: Building Competitive Advantage Through Functional-Level Strategy
.. Another boost to productivity comes from linking pay to performance. 1uccessful companies
are careful to specify the quality, as well as the quantity, of production. 1uccessful firms also
tend to reward group, rather than individual, performance, in order to improve cooperation
among employees.
F. ?ith the rapid growth of computers, the ,nternet, corporate intranets, and high bandwidth
communications, the information systems function contributes to operational efficiencies.
*. ,nformation systems can improve labor efficiency by automating tasks that were previously
performed manually.
")NNIN# CAS!& 0!LL/S )TILI2ATION OF T! INT!"N!T
"ell began selling =0s by phone, and was one of the first companies to implement online selling of computers.
Founder and 0;% (ichael "ell says that the ,nternet gives more information to customers, permits them to
customi7e their computers, and provides timely and easy-to-use customer support, leading to differentiation. At
the same time, "ell$s use of the ,nternet allows them to reduce their sales and customer support personnel, and
eliminate physical stores, which reduces the company$s costs. ,n addition, "ell uses the ,nternet to manage its
supply chain, using the web to communicate with suppliers and call for components on a Bust-in-time basis. This
reduces inventory costs to very low levels, and also synchroni7es demand and supply of components. Thus,
customers get the latest-and-greatest products, and obsolete inventory write-offs are virtually eliminated.
Teaching Note: This case describes "ell$s success in utili7ing the ,nternet to improve efficiency, and how the firm
reali7ed all three benefitsH lower labor costs, easier coordination of the supply chain, and less reliance on physical
facilities. To spark discussion, ask students why "ell$s competitors, such as <ateway, Apple, or Aewlett-=ackard
&owner of 0ompaq) have not imitated "ell$s strategy yet. ,s it because they are unable to imitate the strategy, or is
it because they have chosen a different strategyG ?hichever answer students give, ask them to explain whyEwhy
the strategy cannot be imitated, or why they chose a different strategy, that is, what benefits did they expect to
receive from a different strategyG 8ou can also ask students whether "ell$s competitors could use some of the
actions that "ell is using. ,n other words, ask students whether this strategy can be adopted a piece at a time. ?hy
or why notG
*. ?eb-based information systems can reduce the costs of supply chain coordination, including
the relationships between the company and its customers, and the company and its suppliers.
+. %n-line sellers can replace their capital-intensive physical locations with a much less costly
web site.
I. ,nfrastructure can also improve efficiency, as a companywide commitment to low costs can be built
through top management leadership. >eaders can also facilitate cooperation among functions in the
pursuit of efficiency goals.
,,,. Achieving 1uperior 'uality
A. Achieving superior quality gives a company two advantages. First, the enhanced reputation for
quality allows the company to differentiate and thus charge a premium price for its products. 1econd,
by eliminating defects or errors from the production process, superior quality can result in greater
efficiency and hence lower costs.
9. %ne aspect of quality is reliability. Total Quality Management TQM! is a technique to improve
reliability. T'( stresses that quality should be a main concern of the company, and that all of a
company$s operations should be oriented toward this end.
*. The T'( philosophy, as articulated by "eming and others, is based on a five-step chain
reaction. &*) ,mproved quality means that costs decrease because of less rework, fewer
mistakes, fewer delays, and better use of time and materials. &+) As a result, productivity
improves. &-) 9etter quality leads to higher market share and allows the company to raise
prices. &.) This increases the company$s profitability and enables it to stay in business. &/) Thus
the company creates more Bobs.
+. American firms are increasing their focus on quality, but still do not give it the same attention
as overseas competitors. (any firms do not fully understand or have not yet fully embraced
T'(, and therefore are not reali7ing the full benefits of it.
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Chapter 4: Building Competitive Advantage Through Functional-Level Strategy 4"
ST"AT!#Y IN ACTION +,+& #!N!"AL !L!CT"IC/S SI'-SI#*A 3)ALITY
I*P"O%!*!NT P"OC!SS
1ix 1igma is a quality and efficiency program that aims to reduce defects, boost productivity, eliminate waste, and
cut costs throughout a company. &The term comes from the <reek letter, sigma, which is used to represent a
standard deviation. Thus, six-sigma quality is six standard deviations above the mean or average, which translates
into about -.. defects per million units produced.) <; is perhaps the most fervent adopter of six-sigma programs,
which are can be used as part of Total 'uality (anagement. The company uses six-sigma analysis to improve the
reliability of each component of their products, which translates to lower manufacturing costs. The attention to
detail workedE<;$s products are known for their reliability. Although improvements led to a higher cost for
customers, improved performance and decreased down time far outweigh the increased price.
Teaching Note: This case can be used to provide a specific example of a quality improvement process, as it was
applied to the production of one product. The case also outlines the benefits that derived from the quality
improvement, including better product performance, reliability, and durabilityJ lower costs of reworkJ the ability
to charge higher pricesJ and higher profits. The case also emphasi7es two important points about quality
improvement. First, the process is often timely, detailed, and painstakingEalthough it can also yield significant
benefits. 1econd, customers are paying for value, and companies can charge more for a product that better serves
customers$ needs.
-. Table ..+ summari7es the contribution that each functional area can make to a T'( program.
a. ,nfrastructure &firm leadership) can build an organi7ational commitment to quality. T'(
must be embraced by all, and top managers serve as role models. Also, the human
resource function must take on responsibility for companywide training in T'(
techniques.
b. A focus on the customer is the starting point of the whole quality philosophy. The
marketing function, because it provides the primary point of contact with the customer,
should play a maBor role here. The role of marketing is to identify customer needs, to
identify how the company meets those needs, to identify the quality gap that exists
between what customers want and what they actually getJ and, in conBunction with other
functional areas, to formulate a plan for closing the quality gap.
c. T'( requires obBective measures of quality, including identification of the customer$s
perspective on quality, and development of a metric to capture this. Top management,
with input from other functional areas, should formulate various metrics to measure
quality.
d. Top management and human resources should set goals and create performance
incentives, to motivate workers to reach quality targets.
e. ;mployees can be an important source of information regarding the sources of poor
quality. Therefore, some framework must be established for soliciting employee
suggestions as to the improvements that can be made &for example, quality circles). Top
managers should establish a communication mechanism.
f. A maBor source of product defects is the production process. T'( preaches the need to
identify defects in the work process, trace them to the source, find out why they occurred,
and make appropriate corrections. (anufacturing and materials management typically
have primary responsibility for this task.
g. =oor-quality raw materials and components are a maBor source of poor-quality finished
goods. =ersonnel in the materials management function can improve quality by reducing
the number of suppliers and then building cooperative relationships with those that
remain.
h. !" and manufacturing need to be involved in designing products that are easy to
manufacture, in order to reduce mistakes and defects.
i. Top management must ensure that there is close cooperation among functions.
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4# Chapter 4: Building Competitive Advantage Through Functional-Level Strategy
ST"AT!#Y IN ACTION +,4& I*P"O%IN# 3)ALITY IN !ALT CA"!
Aealth care organi7ations are adopting the six-sigma approach to improve quality. (ount 0armel Aealth, an %hio
provider, discovered that profits were low, due to large write-offs of uncollectible (edicare reimbursements. A
careful investigation showed that the problem began with incorrect coding of procedures on patients$ records.
?hen coders were trained to ensure that correct codes were used, the firm$s net income increased dramatically.
Another example is ,ntermountain Aealth 0are, which operates +. ?estern hospitals. Administrators there
identified variations in practice across physicians, particularly with regard to the cost and success rate of
treatments. These data were then shared among physicians, who used the data to eliminate poor practices and
upgrade quality. The results have been a sharp drop in the rate of postoperative infections to 6.. percent,
compared with the current national average of + percent. 9ecause the average postoperative infection adds
K*.,666 to a hospital bill, this constitutes a big cost saving.
Teaching Note: This case is interesting to consider as a comparison to the 1trategy in Action ... case about
<eneral ;lectric. 1tudents often mistakenly believe that quality improvement applies primarily to manufacturing
firms, and this case points out the importance of quality for service firms also. Ask students to compare the
similarities and differences between this case and the preceding case about <eneral ;lectric. 1tudents will find
many similarities, such as the painstaking nature of the process of uncovering the roots of poor quality. Also, this
case, like the <; case, shows that the result of improved quality is not Bust higher profitsJ higher quality creates
value for customers too.
0. ,n addition to reliability, superior quality depends upon the development of other attributes, such as
form, features, performance, durability, and styling, which contribute to differentiation.
*. Table ..- summari7es attributes of products, services, and personnel that may be valued by
customers.
+. A company$s products and services must be superior to competitors$ offerings in order to be
regarded as high quality.
a. To accomplish this, marketing intelligence is used to identify the attributes that customers
value.
b. Then, products must be designed and personnel trained to deliver that attribute.
c. #ext, the company$s marketers must decide which attributes to promote and how to
position them for consumers. 5sually, firms focus on Bust one or two critical attributes.
d. Finally, a strong !" function can help the firm continual improve its offerings to stay
ahead of competitors.
,L. Achieving 1uperior ,nnovation
A. ,n many ways, innovation is the single most important building block of competitive advantage.
*. ,nnovation is what gives a company something unique. 5niqueness allows a company to charge
a premium price or to lower its cost structure below that of its rivals.
+. 1tudies in several industries have shown that innovation is a maBor driver of superior
profitability.
9. Aowever, the failure rate of innovations is high, due to a variety of causes. %nly about *+ percent of
!" proBects result in a product for which the profits exceed the company$s cost of capital.
*. ,nvestment in !" is a high-risk, high-return strategy. The high risk comes from the high
failure rate of most new-product innovations. The high return comes from the quasi-monopoly
revenues that a successful innovation can earn for a company.
+. 5ncertainty about the future is one reason for the high failure rate of innovation. #ew-product
development requires asking a question whose answer is impossible to know prior to market
introductionJ namely, is there sufficient market demandG Although good market research can
minimi7e uncertainty about demand, the uncertainty cannot be eradicated altogether.
a. Quantum innovations represent a radical departure from current technology, whereas
incremental innovations represent an extension of existing technology.
b. 'uantum innovations are accompanied by higher uncertainty, and thus are more likely to
fail than are incremental innovations.
-. Another reason for the high failure rate of new-product introductions is poor
commerciali"ation, which occurs when there is demand for a new product, but the company$s
offering is not well adapted to consumer needs because of poor design or poor quality.
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Chapter 4: Building Competitive Advantage Through Functional-Level Strategy 5$
.. Another cause of innovation failure is the poor positioning strategy that arises when an
attractive new product garners low sales because it is poorly positioned in the marketplace.
#ositioning strategy is the position a company adopts for a product on four main dimensions
of marketingEprice, distribution, promotion and advertising, and product features.
/. Another reason why many new product introductions fail is that companies often make the
mistake of marketing product based on a technology for which there is not enough consumer
demand. Technological myopia occurs when a company gets blinded by the wi7ardry of a new
technology and fails to examine whether there is consumer demand for the product.
4. #ew products fail when companies are slow to get their products to market. The longer the time
between initial development and final marketing, the more likely that someone will beat the
firm to market. Also, slow innovators tend to update their products less frequently than fast
innovators and therefore, can be perceived as technical laggards relative to the fast innovators.
0. There are a number of actions that firms can take to build competencies in innovation and reduce the
chances of failure.
*. 9uilding skills in basic and applied research requires the employment of research scientists and
engineers and the establishment of a work environment that fosters creativity. A number of top
companies try to achieve this by setting up university-style research facilities, where scientists
and engineers are given time to work on their own research proBects, in addition to proBects that
are linked directly to ongoing company research.
+. =roBect management is the overall management of the innovation process, and it requires three
important skillsH the ability to encourage idea generation, the ability to select the most
promising proBects at an early stage of development, and the ability to minimi7e time to market.
Show Transparency 2.
Figure 4..: The "eve#opment Funne#
a. ;ffective proBect management can be facilitated by using a three-phase development
funnel. The obBective in =hase , of the development funnel is to widen the mouth of the
funnel to encourage as much idea generation as possible. To do so, a company should
solicit input from all functions of the company, as well as from customers, competitors,
and suppliers.
b. At <ate *, the funnel is narrowed. Aere ideas are reviewed by a cross-functional team of
managers that were not involved in the original concept development. The concepts that
are ready to proceed then move on to =hase ,, of the funnel, which is where the details of
the proBect proposal are worked out.
c. <ate + is a go, no-go evaluation point. 1enior managers are brought in to review the
various proBects and to select those that seem likely winners. Any proBect selected to go
forward at this stage will be funded and staffed with the expectation that it will be carried
through to market introduction.
d. ,n =hase ,,,, the proBect development proposal is executed by a cross-functional team in
order to ensure that time to market is minimi7ed.
-. Tight cross-functional integration between !", production, and marketing can help a
company to ensure that &*) product development proBects are driven by customer needs, &+) new
products are designed for ease of manufacture, &-) development costs are kept in check, and &.)
time to market is minimi7ed.
a. 0lose integration between !" and marketing is required to ensure that product
development proBects are driven by the unmet needs of customers.
b. ,ntegration between !" and production can help a company to ensure that new
products are designed with existing manufacturing capabilities in mind.
.. %ne of the best ways to achieve cross-functional integration is to establish cross-functional
product-development teams. These are teams composed of representatives from !",
marketing, and production. The obBective of a team should be to take a product development
proBect through from the initial concept development to market introduction.
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5% Chapter 4: Building Competitive Advantage Through Functional-Level Strategy
a. The team should be led by a CheavyweightD proBect manager who has high status within
the organi7ation and who has the power and authority required to get the financial and
human resources that the team needs to succeed.
b. The team should be composed of at least one member from each key function.
c. The team members should be physically co-located to create a sense of camaraderie and
to facilitate communication.
d. The team should have a clear plan and clear goals, particularly with regard to critical
development milestones and development budgets.
e. ;ach team needs to develop its own processes for communication and conflict resolution.
/. %ne way in which a product development team can speed time to market is to use a partly
parallel development process. Traditionally, product development processes are sequential. ,n a
partly parallel development process, stages overlap so that work can be done in more than one
stage simultaneously, shortening time to market.
Show Transparency 2/
Figure 4./: Se0uentia# and +art#y +ara##e# "eve#opment +rocesses
4. Table ... summaries the roles that various functional areas play in achieving superior
innovation.
L. Achieving 1uperior 0ustomer esponsiveness
A. Achieving superior customer responsiveness requires that a company give customers what they want
when they want it and at a price they are willing to payEso long as the company$s long-term
profitability is not compromised in the process.
*. The more responsive a company is to the needs of its customers, the greater the brand loyalty
that the company can command. ,n turn, strong brand loyalty may enable a company to charge
a premium price for its products or sell more goods and services to customers.
+. Achieving superior efficiency, quality, and innovation are all part of achieving superior
customer responsiveness.
9. A company must know its customers$ needs in order to respond to them. Thus the first step in building
superior customer responsiveness is to get the whole company to focus on the customer.
*. 0ustomer focus must start at the top of the organi7ation with leadership. A commitment to
superior customer responsiveness involves attitudinal changes throughout a company that can
only be affected through strong leadership.
+. Achieving a superior customer focus requires the right employee attitudesEleadership alone is
not enough. ;mployees need to be trained to put themselves in the customers$ shoes, to identify
ways of improving the quality of a customer$s experience with the company. To reinforce this
mindset, incentive systems should reward employees for satisfying customers.
-. Another aspect of knowing the customer is listening to what customers say and bringing them
into the company. This may mean soliciting feedback from customers and building information
systems that communicate the feedback to the relevant people.
0. The next task is to satisfy customer needs, with efficiency, quality, and innovation all playing a part.
*. ,n addition to efficiency, quality, and innovation, companies can satisfy customer needs through
customi7ation. This involves varying the features of a good or service to tailor it to the unique
needs of groups of customers, or in the extreme case, individual customers. Traditionally,
customi7ation raises costs, however, flexible manufacturing allows a company to produce a
greater variety of products without raising costs.
+. 0ustomi7ation has fragmented many markets into ever-smaller niches, allowing firms to cater
to the particular needs of a small segment of customers.
". <iving customers what they want when they want it requires speed of response to customer demands.
To gain a competitive advantage, a company often needs to be fast at responding to consumer
demands. ,ncreased speed allows a company to charge a significant premium.
*. educing response time requires a marketing function that can quickly communicate customer
requests to manufacturing.
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Chapter 4: Building Competitive Advantage Through Functional-Level Strategy 52
+. The manufacturing and materials management functions that can quickly adBust production
schedules in response to unanticipated customer demands also enable the firm to respond more
rapidly.
-. apid responses also relies on information systems that can help manufacturing and marketing
in this process.
.. Table ../ summari7es the roles that various functional areas play in achieving superior
responsiveness to customers.
ANS5!"S TO 0ISC)SSION 3)!STIONS
*. Aow are the four generic building blocks of competitive advantage related to each otherG
The four building blocks are closely related to one another. 9ecause it reduces waste, the time spent fixing
defects, and the cost of after-sales service and support, achieving superior quality has an important positive
impact on efficiency. (oreover, insofar as superior quality is valued by consumers, it increases the
company$s customer responsiveness. 9esides, innovation in both products and processes can enhance
efficiency, quality, and customer responsiveness. For example, process innovations, such as Toyota$s lean
production system, can simultaneously increase efficiency and quality. 1imilarly, the ability to rapidly
develop innovative new products increases a company$s ability to serve its customers. Finally, it is
important to keep in mind that achieving superior efficiency, quality, and innovation are all part of achieving
superior customer responsiveness.
+. ?hat role can top management play in helping a company achieve superior efficiency, quality, innovation,
and responsiveness to customersG
The role of top management is absolutely critical in achieving each of these goals. ,t is top management$s
task to set challenging efficiency, quality, innovation, and responsiveness goals and to communicate the
importance of these goals to others in the organi7ation. Top management must also demonstrate
commitment to the attainment of these goals by modeling the desired behavior and by using the internal
incentive systems of the organi7ation to reinforce behavior that is consistent with each of the goals.
Furthermore, top management has to allocate resources within the organi7ation so that others can attain
these goalsJ it needs to facilitate cooperation between different functions within the organi7ation in pursuit
of superior efficiency, quality, innovation, and customer responsiveness.
-. ,n the long run, will adoption of six-sigma quality improvement processes give a company a competitive
advantage, or will it be required Bust to achieve parity with competitorsG
>ike any other valuable management technique, six-sigma processes are tools that improve the competitive
position of those companies that adopt it, through their impact on efficiency, quality, innovation, and
responsiveness to customers. >ike any other valuable tool, it will be, and has been, rapidly imitated. 1ix
1igma has spread rapidly throughout firms headquartered in developed countries. Although many
companies still have some way to go in understanding and using six-sigma processes, they are becoming
less a source of competitive advantage &because they are no longer rare) than an absolute necessity Bust for
achieving competitive parity. ,n addition, customers are becoming accustomed to and demanding of high
quality, and so 1ix 1igma and other quality improvement processes are becoming more and more essential,
especially for multinational firms.
.. ,n what sense might innovation be called the single most important building block of competitive
advantageG
,n the business world, no advantage lasts forever. Laluable products and processes will always eventually be
imitated by rivals, no matter how high the barriers to imitation. ,t follows that in a world where imitation is
inevitable, the only way to stay ahead of the competition is through constant innovation in products and
processes. %nly through innovation can a company create something unique, and only unique and valuable
products and processes allow companies to earn high profits. Thus, in a very real sense, innovation is the
single most important building block of competitive advantage. Aaving said this, one must add that
innovation alone may not be enough to generate high returns. ,t is the Boining together of innovation with
superior efficiency, quality, and responsiveness to customers that is particularly valuable.
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53 Chapter 4: Building Competitive Advantage Through Functional-Level Strategy
S*ALL-#"O)P !'!"CIS!& I0!NTIFYIN# !'C!LL!NC!
The students are asked to break up into groups of three to five people and to identify important functional
competencies and to design the internal processes to build those competencies, given a scenario of rapid
technological change, short product life cycles, intense price competition, high fixed costs, and high economies of
scale. The scenario also includes demanding customers who want F,T delivery to fit in with their own production
schedule.
Teaching Note: This exercise should help students to synthesi7e the concepts taught in this chapter. For example,
achieving superior efficiency seems very attractive given substantial economies of scale. %ther competencies that
the students should identify include the need for a predictable, timely, delivery scheduleJ low costs to enable them
to keep prices lowJ and responsiveness to technologically demanding customers. Aowever, the simultaneous
achievement of all of the preferred functional competencies, involves some trade-offs. For example, moving
rapidly down the experience curve is desirable because the technology in this industry is changing quickly, and
yet building a manufacturing plant with high economies of scale will be likely to be quite expensive &negating
cost advantages, in the short run). Aave students identify these trade-offs and after they have decided on a
functional-level strategy, have them discuss the implementation and the potential difficulties in achieving
coordination and cooperation across functional areas.
This case provides an ideal example of the concept that every strategy presents some advantages, but also some
disadvantages. An open class discussion at the end to compare the positives and negatives of the various strategies
would be helpful.
A"TICL! FIL! +
Aave students find an example of a company that is widely regarded as an excellent company. They should
identify the source of its excellence and relate this to the material discussed in this chapter. Aave them pay
particular attention to the role played by the various functions in building excellence.
Teaching Note: 1tudents should readily find examples of excellent companies. ,f they experience difficulty, point
them towards the popular business press, such as Business Week, The Wall Street Journal, Fortune, Inc., and so
on.
The students will identify sources of excellence that include items related to superior efficiency, quality,
innovation, and responsiveness to customers. These competencies might include items such as efficient economies
of scale, the use of flexible manufacturing teams, close integration between functional areas, or quick speed to
market.
An interesting twist on this assignment would be to ask some students to identify examples of failing companies.
0ompanies that are entering bankruptcy or are struggling with low profits relative to their industry would make a
useful lesson when contrasted with the excellent companies. 8ou can ask students to consider and discuss the
differences they see in the excellent and the failing firms. Failing companies might include 5nited Airlines, Alcoa,
or Target &warningEthis list was current as of the time of publication of this manual).
ST"AT!#IC *ANA#!*!NT P"O$!CT& *O0)L! +
This module asks students to examine the ability of their company to achieve superior efficiency, quality,
innovation, and responsiveness to customers. They are asked to outline their firm$s functional area activities in
each of the four maBor sources of distinctive competencies. They are then asked to use this information to evaluate
their firm$s competitive position, and to suggest actions that might lead to improvement.
Teaching Note: This portion of the strategic management proBect will reinforce students$ understanding of how
functional strategies form the basis of distinctive competencies, leading to competitive advantage. 1tudents will
identify a set of competencies spanning the four sources. The evaluation question will require students to consider
their firm relative to competitors. 1tudents$ suggestions should focus on specific actions that functional area
managers and employees can take to improve their operation.
%ne lesson for students is that competitive advantage is usually based upon a whole set of related competencies,
not Bust upon one or two. 8ou can emphasi7e to students that well-managed firms build upon a competency in one
area, developing more competencies over time. ,n making suggestions, students will obtain some sense of how
Copyright Houghton Mifflin Company. All rights reserved.
Chapter 4: Building Competitive Advantage Through Functional-Level Strategy 54
difficult it is to suggest actions that are within the company$s capabilities and resources. For example, students
might suggest changing the organi7ation structure to empower employees and decentrali7e decision making.
Aowever, you should point out to students that, although this suggestion sounds simple and easy, in fact, it would
take months of intensive effort to overcome habits, policies, attitudes, power shifts, and all of the other
impediments to change.
!'PLO"IN# T! 5!B& %ISITIN# APPLI!0 *AT!"IALS
1tudents are asked to visit the web site of Applied (aterials &www.appliedmaterials.com), focusing on their
mission statement, financial results, product descriptions, and press releases. This investigation should help
students to identify the competitive advantage of this market leader. Further, it will help them to understand how
important the concepts of efficiency, quality, innovation, and responsiveness to customers are in achieving and
maintaining this competitive advantage. ,n addition, the students are asked to evaluate whether Applied (aterials
is meeting the obBectives set forth in its mission and to determine which functional-level actions the company is
using to achieve its goals. ,n the <eneral Task, students are asked to search the web for a company whose home
page describes its approach to one of the functional-level strategies discussed in this chapter. After identifying the
functional-level strategy, the students are asked to evaluate itEgiven the concepts introduced in the book so far.
Teaching Note: 1tudents$ answers will identify several sources of competitive advantage that are present at
Applied (aterials. The company$s mission statement reads &in 1eptember, +66+)H C%ur (ission is to be the
leading supplier of semiconductor fabrication solutions worldwideEthrough innovation and enhancement of
customer productivity with systems, process modules and service solutions.D This mission points to company
goals regarding efficiency and quality &Cleading supplier,D implying a large si7e and high demand),
innovation, and responsiveness to customers &Cenhancement of customer productivityD). 1tudents will note
the inter-related nature of these four goals, and will be able to identify a number of specific actions the firm
has taken towards meeting those goals. Applied (aterials has been successful in meeting these goals, as
indicated by their high profitability.
The <eneral Task focuses on Bust one of the four sources of competency. 1tudents will discover that their
chosen firm$s goals are different from those of Applied (aterials, and the actions they take to ensure
achievement of those goals is also different.
CLOSIN# CAS!& "!IN%!NTIN# L!%I/S
,n the late *336s, >evi 1trauss was losing market share to competitors with better design and market skills, such
as The <ap. The company$s "ockers brand was looking stale, and the firm focused on sales to men, who were
reducing their clothing purchases. >evi$s had high prices, because of its 5.1. manufacturing facilities, and retailers
perceived the company as arrogant. >evi$s has begun to address these concerns with a three-fold strategy. First, it
closed most of its 5.1. plants and moved production to low-cost, foreign locations. 1econd, it is now paying
closer attention to fashion trends, while providing products to appeal to many segments of the market for women$s
Beans. Third, >evi$s has begun to offer customi7ed Beans through its %riginal 1pin program. Flexible
manufacturing allows the company to make the custom-si7ed and custom-featured Beans, including a Ctest fit,D in
Bust two to three weeks. The mass customi7ation allows the firm to increase the number of models of in-stock
Beans in a typical >evi$s store from *-6 to @/6. >evi$s plans to charge a +6 percent price premium and is
considering mass customi7ation of more than Bust Beans. ,n the long term, the company hopes to have a high-tech
body scanning system in each of its stores, to measure a customer for a custom fit in any item of clothing.
Teaching Note: This case re-caps many of the important concepts of this chapter, focusing once more on
efficiency, quality, innovation, and responsiveness to customers. This case provides yet another example of a
firm that used its functional area strategies to build competitive advantage.
An67er6 to Ca6e 0i6cu66ion 3ue6tion6
*. From a value creation perspective, what exactly is >evi$s trying to achieve by &a) moving manufacturing out
of the 5nited 1tates, &b) refocusing its design efforts on women, and &c) introducing the %riginal 1pin
programG
Copyright Houghton Mifflin Company. All rights reserved.
55 Chapter 4: Building Competitive Advantage Through Functional-Level Strategy
(oving manufacturing allowed >evi$s to reduce its costs of production by lowering labor expenses, which
lead to improved efficiency. %n the other hand, quality might be threatened by this move, and therefore
>evi$s must do a careful Bob of monitoring the quality of production from overseas factories.
efocusing design efforts of women improved responsiveness to customers and led to higher sales, as
women buy more clothes than do men. =roduct innovation was also improved, because women are more
demanding of trendy, high style clothing than are men. Aigher sales also allowed the company to reali7e
greater economies of scale, leading to greater efficiency.
The %riginal 1pin program allowed >evi$s to better respond to customers, by producing custom fit Beans.
The program also was an example of a process innovation, revolutioni7ing the way the company produced
its products. 0ustomers will also perceive higher quality from a product that is made to fit their exact
specifications. Aowever, %riginal 1pin has the possibility of reducing efficiency, requiring a high capital
investment. >evi$s must ensure that the cost of the program is not greater than its benefits.
+. Aow exactly might the %riginal 1pin program change the nature of the relationship between >evi 1trauss
and its customersG
0ustomer satisfaction is likely to be higher, because the products are customi7ed for each buyer. >oyalty is
also likely to be greater, as no other company can offer a similar level of service. Thus, customers should be
willing to pay premium prices. 0ustomers also should make more repeat purchases, reducing the need for
advertising and promotions aimed at attracting new customers.
-. "o you think that the strategic actions >evi$s is taking will allow it to reverse its six-year decline and build a
sustainable competitive advantageG
1tudents$ opinions about this issue will vary. (ost students will believe that moving manufacturing
overseas will, in fact, reduce expenses. A design refocus toward women customers is somewhat more risky,
but has a good chance of success. %n the other hand, the %riginal 1pin program is much more risky because
it is untried, and it may not be cost-effective due to its high start-up costs. Aowever, students who believe
that %riginal 1pin can be made cost-effective are likely to see it as beneficial in increasing sales.
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