Lecture 5: The Nature and

Sources of Competitive
Advantage
Dr Kevin Masters
Strategic Management
February 2015

Strategy

The essence of strategy lies in

creating tomorrows competitive
advantages faster than your
competitors can mimic the ones
that you possess today (Hamel and
Prahalad)

What is competitive advantage?

When two or more firms compete within the

same market, one firm possesses a
competitive advantage over its rival when it
earns (or has the potential to earn) a
persistently higher rate of profit (Grant
2010)
But competitive advantage may not translate
into higher profitability immediately, a firm
may forgo current profits in order to build
market share, create customer loyalty, etc.

The Emergence of Competitive

Advantage
How does competitive
advantage emerge?

External sources of change:

Changing customer demand
Changing prices
Technological change

Different resource and

capabilities
among firms means
different impacts

Internal sources
of change

Some firms are faster

and more effective
in anticipating and exploiting
change

Some firms
have greater creative
and innovative
capability

Sources of Competitive Advantage

COMPETITIVE
COMPETITIVE
ADVANTAGE
ADVANTAGE

ct
u
d
ro
p
r
st
la
o
i
c
m
r
Si
we
o
l
at

Pri
ce
fro
pre
m
mi
un
um
iqu
ep
rod
uc
t

COST
COST
ADVANTAGE
ADVANTAGE

DIFFERENTIATION
DIFFERENTIATION
ADVANTAGE
ADVANTAGE

Porters Generic Strategies

SOURCE OF COMPETITIVE ADVANTAGE

Low cost
Differentiation
Industry-wide
COMPETITIVE

COST

DIFFERENTIATION

LEADERSHIP

SCOPE
Single Segment

FOCUS

Activity 1

Turn to your neighbour and discuss

the following question
Should managers focus more on
cost or quality when deciding on
competitive strategy? Why?
10 minutes then feedback

Features of Cost Leadership and

Differentiation Strategies

Generic strategy
COST
LEADERSHIP

DIFFERENTIATION

Key strategy elements

Scale-efficient plants.
Design for manufacture.
Control of overheads &
R&D. Avoidance of
marginal customer
accounts.
Emphasis on branding
and brand advertising,
design, service, and
quality.

Resource & organizational

requirements
Access to capital. Process
engineering skills. Frequent
reports. Tight cost control.
Specialization of jobs and
functions. Incentives for
quantitative targets.
Marketing. Product
engineering. Creativity.
Product R&D
Qualitative measurement
and incentives. Strong
cross-functional
coordination.

Cost-leadership

Cost-leadership strategy involves becoming

the lowest-cost organisation in a domain of
activity.
Finding and exploiting all sources of cost advantage
and selling a standard no-frills product
Traditionally about deriving economies of scale and
scope through in investment in mass production and
mass distribution
More recently extended to out-sourcing, off-shoring,
process reengineering, lean production,
organisational delayering, etc.

Drivers of Cost Advantage

Seven principal determinants of a firms

unit costs relative to its competitors (see
next slide)
Their relative importance varies across
industries, between firms, and between
activities within firms
By examining each cost driver we can
analyse a firms cost position relative to its
competitors and make recommendations
for improvement

Drivers of Cost Advantage

Indivisiblities
Specialization and division of labour

ECONOMIES OF SCALE

ECONOMIES OF LEARNING

Increased dexterity
Improved organizational routines
Process innovation
Reengineering business processes

PRODUCTION TECHNIQUES
PRODUCT DESIGN

Standardizing designs & components

Design for manufacture

Location advantages
Ownership of low-cost inputs
Non-union labor
Bargaining power

INPUT COSTS

CAPACITY UTILIZATION

Ratio of fixed to variable costs

Speed of capacity adjustment

RESIDUAL EFFICIENCY

Organizational slack; motivation &

culture; managerial efficiency

Example
Economies of Scale and the Long-Run
Cost Curve for a Manufacturing Plant
Sources of scale economies:
- Volume related economies of scale
- Indivisibilities (many resources and activities are lumpy
and small scale does not bring reduced costs, e.g. TV
advertising campaigns)
- Specialization (economies through greater division of
labour)
Cost per
unit of
output

Minimum
Efficient Plant
Size: the point at
which most scale
economies are
exhausted

Units of output
per period

Scale Economies in Advertising: U.S. Soft

Drinks

Advertising Expenditure ($ per case)

0.02
0.05
0.10
0.15
0.20

Soft drinks brands with the greatest sales volumes tend to have the lowest
advertising costs per unit of sales.

Schweppe
s
SF Dr. Pepper
Diet 7-Up

Tab
Diet Pepsi

Diet Rite
Fresca
Seven Up
Dr. Pepper

Sprite

Pepsi
10

20

50

100

200

500

Annual sales volume (millions of cases)

Coke
1,000

Cost Advantage in Short-Haul

Passenger Air Transport
Costs per Available Seat-Mile
Southwest Airlines
(cents)
Wages and benefits
2.4
Fuel and oil
1.1
Aircraft ownership
0.7
Aircraft maintenance
0.6
Commissions on ticket sales 0.5
Advertising
0.2
Food and beverage
0.0
Other
1.7

Total

7.2

United Airlines
(cents)
3.5
1.1
0.8
0.3
1.0
0.2
0.5
3.1

10.5

So how do small and medium-size

companies survive? By

Exploiting superior flexibility

Outsourcing activities where scale is
critical to efficiency
Avoiding the adverse motivation
and co-ordination problems that
affect large firms

Using the Value Chain to Analyse Costs

The Case of Automobile Manufacture
A Five-stage Process:
STAGE 1. IDENTIFY THE FIRMS PRINCIPAL ACTIVITIES
EACH ACTIVITY TENDS TO BE SUBJECT TO A DIFFERENT SET OF COST DRIVERS

PURCHASING

PARTS
INVENTORIES

R&D
TESTING,
COMPONENT
ASSEMBLY
DESIGN
QUALITY
MFR
ENGNRNG
CONTROL

GOODS
INVENTORIES

SALES DISTRI- DEALER &

&
BUTION CUSTOMER
MKITG
SUPPORT

STAGE 2. ALLOCATE TOTAL COSTS ACROSS THE PRINCIPAL ACTIVITIES

For each activity, what factors determine

the level of cost relative to other firms?
STAGE 3.
IDENTIFY
THE
COST
DRIVERS
PURCHASING

PARTS
INVENTORIES

--Plant scale for each

component
-- Process technology
-- Plant location
-- Run length
-- Capacity utilization

-- Level of quality targets

-- Frequency of defects

R&D
COMPONENT ASSEMBLY TESTING,
DESIGN
QUALITY
MFR
ENGNRNG
CONTROL

Prices paid
--Size of r&d commitment
depend on:
--Productivity of
-- Order size
R&D/design
-- Purchases per --No. & frequency of new
supplier
models
-- Bargaining power
-- Supplier location

GOODS
INVENTORIES

-- No. of dealers
-- Sales / dealer
-- Level of dealer
support
-- Frequency of defects
under warranty

SALES
&
MKITG

DISTRI- DEALER &

BUTION CUSTOMER
SUPPORT

-- Plant scale
--Cyclicality &
-- Flexibility of production predictability of sales
-- No. of models per plant --Customers
-- Degree of automation
willingness to wait
-- Sales / model
-- Wage levels
-- Capacity utilization

THE COSTS OF ONE ACTIVITY MAY BE DETERMINED IN PART

BY THE WAY THAT OTHER ACTIVITIES ARE PERFORMED,
SO
STAGE 4. IDENTIFY LINKAGES

Consolidation of orders to increase

discounts, increases inventories

PRCHSNG

PARTS
INVNTRS

R&D
DESIGN

Designing different models around

common components and platforms
reduces manufacturing costs

COMPONENT
MFR

Higher quality parts and materials

reduces costs of defects
at later stages

ASSEMBLY

TESTING
QUALITY

GOODS
INV

SALES
MKTG

DSTRBTN

Higher quality in manufacturing

reduces warranty costs

DLR
CTMR

Stage 5. Recommendations for cost

reductions (1)

Identify opportunities for reducing

costs
Areas

of comparative inefficiency?
Can volumes be increased to release
scale efficiencies?
Can productivity be improved, relocated
or outsourced?

Stage 5. Recommendations for

cost reductions (2)

Purchasing
Use fewer suppliers to increase volumes?
Use JIT component supply systems?

R&D Design

Fewer models and fewer changes?

Components
Seek economies of scale?
Out-source production if volumes are suboptimal?

Differentiation strategies

Differentiation
Involves uniqueness along some
dimension that is sufficiently valued by
customers to allow a price premium
Encompasses everything about a product
or service that influences the value that
the customer derives from it
Includes every aspect of the way in which
a company relates to its customers (e.g.
the Starbucks Experience)

The
The Nature
Nature of
of Differentiation:
Differentiation:
Tangible
Tangible and
and Intangible
Intangible Dimensions
Dimensions
DEFINITION: Providing something unique that is valuable to the
buyer beyond simply offering a low price. (M. Porter)
THE KEY IS TO CREATE VALUE FOR THE CUSTOMER

TANGIBLE DIFFERENTATION
Observable product characteristics:
size, color, materials, etc.
performance attributes
packaging
complementary services

Delivery, after-sales, accessories

INTANGIBLE
DIFFERENTATION
Unobservable and subjective
characteristics that appeal to
customers image, status, identity,
and desire for exclusivity

TOTAL CUSTOMER RESPONSIVENESS

Differentiation not just about the product, it embraces the whole
relationship between the supplier and the customer.

Differentiation and segmentation (1)

o

DIFFERENTIATION: is concerned with how a firm

distinguishes its offerings from those of its
competitors (How the firm competes)

SEGMENTATION: is concerned with which

customers, needs, and localities a firm targets
(Where the firm competes)

Differentiation and segmentation (2)

o

Differentiation does not necessarily imply

segmentation, it depends upon the differentiation
strategy
o

Broad scope differentiation = appealing to what is common

between different customers (e.g. McDonalds, Honda, Gillette)

Focussed differentiation = appealing to what distinguishes

different customers (e.g. Harley-Davidson)

Differentiation is a more secure basis for

competitive advantage than low cost which is
vulnerable to the emergence of new competitors and
adverse movement of exchange rates

Differentiation in the US airline industry

Figure 6.5

Mapping differentiation in the US airline industry

Source: Simplified from Figure 1, in D. Gursoy, M. Chen and H. Kim (2005), The US airlines relative positioning, Tourism Management, 26, 5, 5767: p. 62

Identifying Differentiation Potential

What needs
does it satisfy?
THE PRODUCT

THE
CUSTOMER

By what
criteria do
they choose?

What are its key

attributes?
Relate patterns of
customer
preferences to
product attributes
What price
premiums do
product attributes
command?

What
motivates
them?

What are
demographic,
sociological,
psychological
correlates of
customer behavior?

FORMULATE
DIFFERENTIATION
STRATEGY
Select product
positioning in
relation to product
attributes

Select target
customer group

Ensure customer /
product
compatibility

Evaluate costs and

benefits of
differentiation

Consistency of Differentiation Strategy:

Product Integrity

Consistency is key to successful differentiation of all

aspects of the firms relationship with its customers.
Product Integrity is the total balance of product
features

Internal integrity: consistency between

function and
structure (well made)
External integrity: fit between the product and the customers
objectives, values, lifestyle

The key to successful differentiation is matching

the firms capacity for creating differentiation to the
attributes that customers value most.

Using the Value Chain to identify potential

drivers of uniqueness
MIS that supports
fast response
capabilities

Training to support
customer service
excellence

Unique product
features. Fast new
product development

FIRM INFRASTRUCTURE
HUMAN RESOURCE MANAGEMENT
TECHNOLOGY DEVELOPMENT

INBOUND

OPERATIONS

LOGISTICS

Quality of
components &
materials

Defect free
products.
Wide variety

OUTBOUND

MARKETING

LOGISTICS

& SALES

Fast delivery.
Efficient order
processing

Building brand
reputation

SERVICE

Customer technical
support. Consumer
credit. Availability
of spares

Identifying Differentiation Opportunities through

Linking the Value Chains of the Firm and its
Customers: Can Manufacture

5
2

2. High manufacturing tolerances can avoid breakdowns in customers canning lines.

3. Frequent, reliable delivery can permit canner to adopt JIT can supply.
4. Efficient order processing system can reduce customers ordering costs.
5. Competent technical support can increase canners efficiency of plant utilization.

Distribution

1. Distinctive can design can assist canners marketing activities.

Marketing

Canning

Processing

Inventory holding

Purchasing

Service &
technical support

Sales

Distribution

Inventory holding

Manufacturing

Design
Engineering

Inventory holding

Purchasing

Supplies of steel
& aluminum

CAN MAKER

CANNER

Back to Porters Generic Strategies

SOURCE OF COMPETITIVE ADVANTAGE

Low cost
Differentiation
Industry-wide
COMPETITIVE

COST

DIFFERENTIATION

LEADERSHIP

SCOPE
Single Segment

FOCUS

Stuck in the middle?

Porters argues:
That cost leadership and differentiation
strategies are mutually exclusive
It is best to choose which generic strategy to
adopt and then stick to it
Failure to do this carries the risk of being stuck
in the middle i.e. doing neither strategy well
The argument for pure generic strategies is
controversial, even Porter acknowledges that
the strategies can be combined (e.g. if being
unique costs nothing)

Activity 2
The argument for pure generic strategies
is controversial, even Porter acknowledges
that the strategies can be combined.
Turn

to your neighbour and discuss the

following question
Can you think of any firms where cost
leadership and differentiation strategies are:
1.
2.

Being combined successfully?

Being attempted unsuccessfully?

10 minutes then feedback

Reconciling differentiation with low cost

However, the argument for pure generic strategies is

controversial, even Porter acknowledges that the
strategies can be combined
Can you think of any firms where the two approaches
are:
Being combined successfully

TOYOTA IN CARS?
MCDONALDS IN FAST FOOD?
NIKE IN ATHLETIC SHOES?

Being attempted unsuccessfully

MORRISONS IN FOOD RETAIL?

M&S IN CLOTHING?

Combining generic strategies

may be OK if

A firm can create separate strategic

business units each pursuing different
generic strategies and with different cost
structures?
Being unique costs nothing?
Both cost efficiency and quality are
improved by technological or managerial
innovations?
Rivals are similarly stuck in the middle or if
there is no significant competition?

Activity 3

Turn to somebody different and

discuss the following question
To what extent do universities
compete by being different or the
same?

Reading about competitive

advantage

Essential reading:
Grant (2010) Chapters 7 and 10
Johnson, Whittington and Scholes (2011)
Chapter 6
Further reading:
Thompson et al. (2013) Crafting and
Executing Strategy: The Quest for
Competitive Advantage. London, McGraw Hill.
Porter (1985) Competitive Advantage. New
York, Free Press.

Preparing for Week 7

Johnson, Whittington and Scholes (2011)

Chapter 11 (Evaluating Strategies)

Chapter 12 (Strategy Development Process)

THE END
THANK YOU!