Differentiation, Cost Leadership, and Integration Answer Key Part 6

105. Discuss the important differences between economies of scale and learning effects. There are some important differences between economies of scale and learning effects: • Learning effects occur over time as output is accumulated, while economies of scale are captured at one point in time when output is increased. Although learning declines at some point, there are no diseconomies to learning (unlike diseconomies to scale). • In some production processes (e.g., a simple one-step process in the manufacture of steel rods), effects from economies of scale can be quite significant, while learning effects are minimal. In contrast, in some professions (brain surgery or the practice of estate law), learning effects can be substantial, while economies of scale are minimal. 106. How do experience-curve and learning-curve effects help a business gain competitive advantage? Learning by doing can drive down cost. As individuals and teams engage repeatedly in an activity, whether writing computer code, developing new medicines, or building submarines, they learn from their cumulative experience. The concept of an experience curve attempts to capture both learning effects and process improvements. In this perspective, economies of learning allow movement down a given learning curve based on current production technology. By moving further down a given learning curve than competitors, a firm can gain a competitive advantage. Taken together, learning by doing allows a firm to lower its per-unit costs by moving down a given learning curve, while combining experience based learning and process innovation allows the firm to leapfrog to a steeper learning curve, thereby further driving down its per-unit costs. 107. How does process innovation benefit a firm? Process innovation is a new method or technology to produce an existing product that may initiate a new and steeper learning curve. If a firm is able to implement a new production process (such as lean manufacturing), it initiates an entirely new and steeper learning curve. 108. How are the benefits different for cost leadership and differentiation strategies when analyzing the power of suppliers in an industry? A cost leader is fairly well isolated from threats of powerful suppliers to increase input prices, because it is more able to absorb price increases through accepting lower profit margins. If the differentiator is able to create a significant difference between perceived value and current market prices, the differentiator will not be so threatened by increases in input prices due to powerful suppliers. 109. How are cost leaders and differentiators protected against powerful buyers? A cost leader can absorb price reductions easily when demanded by powerful buyers. Since a successful differentiator creates perceived value in the minds of consumers and builds customer loyalty, powerful buyers demanding price decreases are unlikely to emerge. 110. How are the benefits different for cost leadership versus differentiation when analyzing the threats of substitutes in an industry? Should substitutes emerge, a low-cost leader can try to fend them off by further lowering its prices to reinstall relative value with the substitute. A strong differentiated position reduces the threat of substitutes, because the unique features of the product have been created to appeal to customer preferences, keeping them loyal to the product. 111. Discuss the threats a cost leader faces when there are new entrants into the market. Although a cost-leadership strategy provides some protection against the five forces, it also carries some risks. If a new entrant with new and relevant expertise enters the market, the low-cost leader's margins may erode due to loss in market share while it attempts to learn new capabilities. 112. Why is keeping its costs the lowest in the industry not the only focus of a firm pursuing cost-leadership strategy? The low-cost leader needs to stay vigilant to keep its cost the lowest in the industry. Over time, competitors can beat the cost leader by implementing the same business strategy, but more effectively. Although keeping its cost the lowest in the industry is imperative, the cost leader must not forget that it needs to create an acceptable level of value. If continuously lowering costs leads to a value proposition that falls below an acceptable threshold, the low-cost leader's market share will evaporate. 113. Discuss the threats firms face when they pursue a differentiation strategy. The viability of a differentiation strategy is severely undermined when the focus of competition shifts to price rather than value-creating features. This can happen when differentiated products become commoditized and an acceptable standard of quality has emerged across rival firms. A differentiator also needs to be careful not to overshoot its differentiated appeal by adding product features that raise costs but not the perceived value in the minds of consumers. Finally, a differentiator needs to be vigilant that its costs of providing uniqueness do not rise above the customer's willingness to pay. 114. What does the success of business-level strategies depend on? It is important to note that none of the business-level strategies (cost leadership, differentiation, and focused variations thereof) is inherently superior. The success of each is context-dependent and relies on two factors: • How well the strategy leverages the firm's internal strengths while mitigating its weaknesses; and • How well it helps the firm exploit external opportunities while avoiding external threats. There is no single correct generic strategy for a specific industry. The deciding factor is that the chosen business strategy provides a strong position that attempts to maximize economic value creation and is effectively implemented. 115. What is an integration strategy? An integration strategy allows a firm to offer a differentiated product or service at low cost. A successful integration strategy requires that trade-offs between differentiation and low cost are reconciled. This is often difficult because differentiation and low cost are distinct strategic positions that require the firm to effectively manage internal value chain activities that are fundamentally different from one another. For example, a cost leader would focus research and development on process technologies in order to improve efficiency, but a differentiator would focus research and development on product technologies in order to add uniqueness. When successful, investments in differentiation and low cost are not substitutes but are complements, providing important spill-over effects. 116. Discuss the pricing options a firm has when it follows an integration strategy. A successfully implemented integration strategy allows firms two pricing options: First, the firm can charge a higher price than the cost leader, reflecting its higher value creation and thus generating greater profit margins. Second, the firm can lower its price below that of the differentiator because of its lower-cost structure. If the firm offers lower prices than the differentiator, it can gain market share and make up the loss in margin through increased sales. 117. When pursuing an integration strategy, what does a firm's competitive advantage depend on? Being successful at an integration strategy doesn't imply that the firm must be the highest value creator and the lowest-cost producer in its respective industry. Whether an integration strategy can lead to competitive advantage depends on the difference between value creation (V) and cost (C), and on the resulting magnitude of economic value created (V - C). What matters in gaining competitive advantage is the relative difference in economic value creation in comparison to industry rivals. The goal of an integration strategy is therefore to achieve a larger economic value created than that of rivals pursuing a differentiation or low-costleadership strategy. 118. List the value and cost drivers that managers can use to pursue an integration strategy. The most salient value and cost drivers that managers can use to pursue an integration strategy are: • Quality • Economies of scope • Customization • Innovation • Structure, culture, and routines 119. How does quality act as a value and cost driver in integration strategy? The quality of a product denotes its durability and reliability. Quality not only can increase a product's perceived value, but also can lower its cost. Through techniques like total quality management, companies design and build products with quality in mind, while increasing their differentiated appeal. By building in better quality, companies lower the cost of both production and after-sale service requirements. From the customer's perspective, the product has increased value because it reduces the total cost of ownership. Quality is a two-pronged activity: It raises economic value creation (V - C) by simultaneously increasing value and lowering cost. 120. Explain economies of scope. The concept economies of scope describes the savings that come from producing two (or more) outputs at less cost than producing each output individually, even though using the same resources and technology. In economies of scope, a firm lowers its cost structure by sharing its production assets over multiple outputs, while increasing its menu and thus its differentiated appeal. 121. Discuss mass customization. Customization allows firms to go beyond merely adding differentiating features to tailoring products and services for specific customers. Advances in manufacturing and information technology have made feasible mass customization—the manufacture of a large variety of customized products or services done at a relatively low unit cost. 122. Briefly describe an ambidextrous organization. An ambidextrous organization is one that enables managers to balance and harness different activities in trade-off situations. The trade-offs to be addressed involve the simultaneous pursuit of low-cost and differentiation strategies. Ambidexterity describes a firm's ability to address trade-offs not only at one point but also over time. It encourages managers to balance exploitation (applying current knowledge to enhance firm performance in the short term) with exploration (searching for new knowledge that may enhance a firm's future performance). 123. Briefly explain the difficulties in pursuing an integration strategy. An integration strategy is difficult to implement because it requires the reconciliation of fundamentally different strategic positions—differentiation and low cost—which in turn require distinct internal value chain activities in order to allow the firm to increase value and lower cost at the same time. Many firms that attempt to pursue an integration strategy fail because they end up being stuck in the middle: They succeed at neither a differentiation nor a costleadership strategy. In a world of strategic trade-offs, increasing value and lowering cost have opposite effects. Improved product features, customer services, and customization all result in higher cost, while offering a no-frills product reduces perceived value. It happens quite often that a firm can't do both but must choose to be either a differentiator or a cost leader. 124. How does productivity frontier help a firm attain competitive advantage? Productivity frontier is the value-cost relationship that captures the result of performing best practices at any given time. Firms that exhibit effectiveness and efficiency reach the productivity frontier; others are left behind. Moreover, the productivity frontier represents a set of best-in-class strategic positions the firm can take relating to value creation and low cost at a given point in time. A firm's business strategy determines which strategic position it aspires to along the productivity frontier. Reaching the productivity frontier at a given point in time increases the likelihood of achieving a competitive advantage. Falling behind the productivity frontier, in contrast, results in a competitive disadvantage. 125. Why is it important for managers to understand the dynamics of competitive positioning? Strategic positions are not fixed, but can—and need to—change as the environment changes. It is critical for managers, therefore, to understand the dynamics of competitive positioning—or how strategy shapes a firm's position over time. Changes in the industry environment allow firms to stake out more valuable positions and turn inferior performance into a competitive advantage. By the same token, as industries change, once-leading companies who held strategic positions along the productivity frontier may fall behind. Since competition is never static, understanding changes as the industry evolves is critical in staking out valuable competitive positions and to sustain a competitive advantage.