CH-3-4 Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability – Strategic Management: Theory: An Integrated Approach : Book Guide

This Document Contains Chapters 3 to 4 CHAPTER 3 Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability Synopsis of Chapter The goal of this chapter is to explore the basis of competitive advantage at the level of the individual company through internal analysis. The central question this chapter deals is why, within a given industry, some companies do better than others. Internal analysis gives managers the information they need to choose the business model and strategies that will enable their company to attain a sustained competitive advantage. This is a very important chapter because it introduces a framework for understanding competitive advantage that will be used throughout the rest of the book. Chapter 3 opens with the roots of competitive advantage. This chapter asserts that, to gain a competitive advantage the firm must adopt an effective strategy which will lead to the formation of distinctive competencies, or firm-specific strengths. Distinctive competencies arise from a firm’s resources and capabilities. Successful firms adopt strategies that build upon existing competencies or develop new competencies. Next, this chapter explains that companies use their competencies to produce competitive advantage which should offer value to customers and lead to superior profitability. The relationship between company products, pricing, and the costs of creating those products are explored, as they are related to the creation of superior value. The financial utility calculation of superior value (profitability) is explored in detail. The discussion of the value chain aims to show students how the different value creation activities of a company fit together. A point strongly emphasized here is that each of the value chain activities whether primary or supporting is a potential source of value creation. This chapter then examines the role of distinctive competencies in helping to achieve the four generic building blocks of competitive advantage—superior efficiency, quality, innovation, and customer responsiveness. Companies that have superior performance in one or more of these areas are able to differentiate their products and/or reduce costs, which leads to value creation and higher profitability. The next section, then, discusses how the business model represents the way in which managers configure the value chain, through strategy, as well as investments to support the configuration, so that they can build the distinctive competencies necessary to attain the efficiency, quality, innovation, and customer responsiveness required to support the firm’s low cost or differentiated position to achieve competitive advantage and superior profitability. The next section analyzes a firm’s competitive advantage for profitability. The financial calculation of superior value (profitability) is explored in detail. The durability of competitive advantage is the focus of the next section, which argues that the durability of a company’s competitive advantage is a function of three factors—barriers to imitation, the capability of competitors, and the general dynamism of the industry environment. Finally, the chapter addresses why companies fail, focusing on organizational inertia, past strategic commitments, and the Icarus paradox. The concluding section of the text mentions ways that companies can avoid competitive failure and sustain a competitive advantage. Learning Objectives 1. Discuss the source of competitive advantage. 2. Identify and explain the role of efficiency, quality, innovation, and customer responsiveness in building and maintaining a competitive advantage. 3. Explain the concept of the value chain. 4. Understand the link between competitive advantage and profitability. 5. Explain what impacts the durability of a company’s competitive advantage. Opening Case Verizon Wireless One of the most significant facts about Verizon is that it has the lowest churn rate in the industry. Customer churn refers to the number of subscribers who leave a service within a given time period. The risk of churn increased significantly in the United States after November 2003, when the Federal Communications Commission (FCC) allowed wireless subscribers to take their numbers with them when they switched to a new service provider. By mid-2006, Verizon’s churn rate was 0.87% a month, implying that 10.4% of the company’s customers were leaving the service each year. This was lower than the churn rate at its competitors. The low customer churn at Verizon is due to a number of factors. First, it has the most extensive network in the United States, blanketing 95% of the nation. Second, the company has invested aggressively in high-speed wireless networks, including 3G and now 4G LTE, enabling fast download rates on smartphones. To further reduce customer churn, Verizon has invested heavily in its customer care function. Surveys by J.D. Power have repeatedly confirmed Verizon’s advantages. Teaching Note: This case illustrates a number of ways in which Verizon Wireless’ utilizes the four main building blocks of competitive advantage—efficiency, customer responsiveness, innovation, and reliable quality. Classroom discussion of the case could center on the following questions: • What is the link between Verizon Wireless’ business model, strategy, competitive advantage, and profitability? • What are Verizon Wireless’ distinctive competencies and resources and capabilities to make it happen? • What does the value chain look like within Verizon Wireless? • How will the Verizon Wireless’ competitive advantage be maintained in the future? Lecture Outline I. Overview Internal analysis is concerned with identifying the strengths and weaknesses of a company. Internal analysis, coupled with an analysis of the company’s external environment, gives managers the information they need to choose the strategy and business model that will enable their company to attain a sustained competitive advantage. Internal analysis is a three-step process: • Managers must understand the process by which companies create value for customers and profit for the company. They must also understand the role of its resources, capabilities, and distinctive competencies. • Managers need to understand the importance of superior efficiency, innovation, quality, and customer responsiveness when creating value and generating high profitability. • Managers must be able to analyze the sources of their company’s competitive advantage to identify what drives the profitability of their enterprise, and where opportunities for improvement might lie. Three more critical issues in internal analysis are: • What factors influence the durability of competitive advantage? • Why do successful companies sometimes lose their competitive advantage? • How can companies avoid competitive failure and sustain their competitive advantage over time? II. The Roots of Competitive Advantage A company has a competitive advantage over its rivals when its profitability is greater than the average profitability of all companies in its industry. It has a sustained competitive advantage when it is able to maintain above-average profitability over a number of years. A. Distinctive Competencies Competitive advantage is based upon distinctive competencies. Distinctive competencies are firm-specific strengths that allow a company to differentiate its products from those offered by rivals, and/or achieve substantially lower costs than its rivals. Distinctive competencies arise from two complementary sources—resources and capabilities. 1. Resources Resources refer to the assets of a company. A company’s resources can be divided into two types: • Tangible resources—physical entities, such as land, buildings, manufacturing plants, inventory, money, and equipment • Intangible resources—nonphysical entities that are created by managers and other employees, such as brand names, the reputation of the company, the knowledge that employees have gained through experience, and the intellectual property of the company, including patents, copyrights, and trademarks Resources are particularly valuable when they enable a company to create strong demand for its products, and/or to lower its costs. Valuable resources are more likely to lead to a sustainable competitive advantage if they are rare, in the sense that competitors do not possess them, and difficult for rivals to imitate; that is, if there are barriers to imitation. 2. Capabilities Capabilities refer to a company’s resource-coordinating skills and productive use. These skills reside in an organization’s rules, routines, and procedures, that is, the style or manner through which it makes decisions and manages its internal processes to achieve organizational objectives. Capabilities are, intangible. They reside not in individuals, but in the way individuals interact, cooperate, and make decisions within the context of an organization. 3. Resources, Capabilities, and Competencies The distinction between resources and capabilities is critical to understanding what generates a distinctive competency. A company may have firm-specific and valuable resources, but unless it also has the capability to use those resources effectively, it may not be able to create a distinctive competency. Additionally, it is important to recognize that a company may not need firm-specific and valuable resources to establish a distinctive competency so long as it has capabilities that no other competitor possesses. 4. The Role of Strategy Figure 3.1 illustrates the relationship of a company’s strategies, distinctive competencies, and competitive advantage. Distinctive competencies shape the strategies that the company pursues, which lead to competitive advantage and superior profitability. However, it is also very important to realize that the strategies a company adopts can build new resources and capabilities or strengthen the existing resources and capabilities of the company, thereby enhancing the distinctive competencies of the enterprise. Figure 3.1: Strategy, Resources, Capabilities, and Competencies B. Competitive Advantage, Value Creation, and Profitability Competitive advantage leads to superior profitability. At the most basic level, a company’s profitability depends on three factors: • The value customers place on the company’s products • The price that a company charges for its products • The costs of creating those products The value customers place on a product reflects the utility they get from a product, or, the happiness or satisfaction gained from consuming or owning the product. Value is a function of the attributes of the product, such as its performance, design, quality and point-of-sale and after-sale service. A company that strengthens the value of its products in the eyes of customers has more pricing options—it can raise prices to reflect that value or hold prices lower to induce more customers to purchase its products, thereby expanding unit sales volume. Regardless of the pricing option a company may choose, that price is typically less than the value placed upon the good or service by the consumer. This is because the customer captures some of that utility in the form of what economists call a consumer surplus. The customer is able to do this because it is normally impossible to segment the market to such a degree that the company can charge each customer a price that reflects that individual’s unique assessment of the value of a product—what economist’s refer to as a customer’s reservation price. In addition, because the company is competing against rivals for the customer’s business, it frequently has to charge a lower price than it could were it a monopoly supplier. The basic principle is that the more value that consumers get from a company’s products or services, the more pricing options it has. Figure 3.2: Value Creation per Unit V is the average value per unit of a product to a customer, P is the average price per unit that the company decides to charge for that product, and C is the average unit cost of producing that product (including actual production costs and the cost of capital investments in production systems). The company’s average profit per unit is equal to P − C, and the consumer surplus is equal to V – P. The company makes a profit so long as P is more than C, and its profitability will be greater the lower C is relative to P. Bear in mind that the difference between V and P is in part determined by the intensity of competitive pressure in the marketplace; the lower the competitive pressure’s intensity, the higher the price that can be charged relative to V, but the difference between V and P is also determined by the company’s pricing choice. Figure 3.3: Value Creation and Pricing Options A company’s pricing options are captured in Figure 3.3. There are two different pricing options that the company can pursue: • Option 1 is to raise prices to reflect the higher value—the company raises prices more than its costs increase, and profit per unit (P − C) increases. • Option 2 involves a very different set of choices—the company lowers prices in order to expand unit volume. o Generally, customers recognize that they are getting a great bargain because the price is now much lower than the value (the consumer surplus has increased), so they rush out to buy more (demand has increased). o As unit volume expands due to increased demand, the company is able to realize scale economies and reduce its average unit costs. Figure 3.4: Comparing Toyota and General Motors At the heart of any company’s business model is the combination of congruent strategies aimed at creating distinctive competencies that (1) differentiate its products in some way so that its consumers derive more value from them, which gives the company more pricing options, and (2) result in a lower cost structure, which also gives it a broader range of pricing choices. Achieving superior profitability and a sustained competitive advantage requires the right choices regarding utility through differentiation and pricing (given the demand conditions in the company’s market), and the company’s cost structure at different levels of output. III. The Value Chain The term value chain refers to the idea that a company is a chain of activities that transforms inputs into outputs that customers’ value. The transformation process involves both primary activities and support activities that add value to the product. A. Primary activities Primary activities include the design, creation, and delivery of the product, the product’s marketing, and its support and after-sales service. In the value chain illustrated in Figure 3.5, the primary activities are broken down into four functions—research and development, production, marketing and sales, and customer service. Figure 3.5: The Value Chain 1. Research and Development Research and Development (R&D) refers to the design of products and production processes. Although people think of R&D as being associated with the design of physical products and production processes in manufacturing enterprises, many service companies also undertake R&D. By creating superior product design, R&D can increase the functionality of products, making them more attractive to customers, and thereby adding value. Alternatively, the work of R&D may result in more efficient production processes, thereby lowering production costs. 2. Production Production refers to the creation process of a good or service. For physical products, this generally means manufacturing. For services, production typically takes place while the service is delivered to the customer. By performing its activities efficiently, the production function of a company helps to lower its cost structure. The production function can also perform its activities in a way that is consistent with high product quality which leads to differentiation and lower costs. 3. Marketing and Sales Through brand positioning and advertising, the marketing function can increase the value that customers perceive to be contained in a company’s product (and thus the utility they attribute to the product). Marketing and sales can also create value by discovering customer needs and communicating them back to the R&D function of the company, which can then design products that better match those needs. 4. Customer Service The role of the service function of an enterprise is to provide after-sales service and support. This function can create superior utility by solving customer problems and supporting customers after they have purchased the product. 3.1 Strategy in Action: Value Creation at Burberry In 1997, Rose Marie Bravo took over the ailing British fashion house, Burberry. By 2006, when she stepped down, the company had become one of the most valuable luxury fashion brands in the world. This was the result of unleashing creativity and innovation throughout the value chain. New designers were brought in to lead the design team. The marketing department created hip new advertising using fashion icons such as Kate Moss. Bravo emphasized teamwork throughout the company, encouraging innovation at all levels. Teaching Note: This case describes Burberry’s ability to create value for customers through innovation throughout the value chain. The case notes several specific actions taken by the firm to differentiate their products from those of their competitors. The actions included hiring new designers, upgrading advertising and protecting the brand. One good discussion point would be to ask students whether these actions might be expensive or difficult for other firms to imitate. Students can then predict whether these actions would be likely to lead to a sustained competitive advantage for Burberry. B. Support Activities The support activities of the value chain provide inputs that allow the primary activities to take place. These activities are broken down into four functions—materials management (or logistics), human resources, information systems, and company infrastructure. 1. Materials Management (Logistics) The materials-management (or logistics) function controls the transmission of physical materials through the value chain, from procurement through production and into distribution. The efficiency with which this is carried out can significantly lower cost, thereby creating more profit. 3.2 Strategy in Action: Competitive Advantage at Zara The Spanish fashion retailer Zara is one of the country’s fastest growing and most successful companies. The basis for this success is the company’s speed in going from design to merchandise in stores. Zara can have products in stores in just five weeks as opposed to the nine months of other fashion companies; this speed to market is achieved through competencies in design, information systems and logistics management. Zara owns its own factories, designers and stores. Their designers are in close contact with the stores and can respond to changing trends very quickly. The company purchases basic textiles from global suppliers but performs the final production activities in its own facilities using computer controlled machinery to cut the fabric. Zara has excess production capacity to respond to trends quickly. At the same time, Zara under-produces products to create scarcity value which means that customers snap up items when they are offered. This lowers Zara’s inventory costs and leaves fewer products to be marked down. Teaching Note: This case illustrates how Zara has built a competitive advantage over other fashion retailers by using competencies in design, information systems, and logistics management. The speed at which this retailer is able to introduce new products is a major advantage in a trend driven market. 2. Human Resources Human resource function ensures that the company has the right combination of skilled people to perform its value creation activities effectively. It is also the job of the human resource function to ensure that people are adequately trained, motivated, and compensated to perform their value creation tasks. 3. Information Systems Information systems are, primarily, the electronic systems for managing inventory, tracking sales, pricing products, selling products, dealing with customer service inquiries, and so on. Information systems, when coupled with the communications features of the Internet, are holding out the promise of being able to improve the efficiency and effectiveness with which a company manages its other value chain activities. 4. Company Infrastructure Company infrastructure is the company-wide context within which all the other value creation activities take place—the organizational structure, control systems, and company culture. Because top management can exert considerable influence upon shaping these aspects of a company, top management should also be viewed as part of the infrastructure of a company. Through strong leadership, top management can shape the infrastructure of a company and, through that, the performance of all other value creation activities that take place within it. IV. The Building Blocks of Competitive Advantage Four factors help a company to build and sustain competitive advantage—superior efficiency, quality, innovation, and customer responsiveness. Each of these factors is the product of a company’s distinctive competencies. In a very real sense they are “generic” distinctive competencies. These generic competencies allow a company to: • Differentiate its product offering, and hence offer more utility to its customers • Lower its cost structure These factors are all highly interrelated. Figure 3.6: Building Blocks of Competitive Advantage A. Efficiency The simplest measure of efficiency is the quantity of inputs that it takes to produce a given output, that is, efficiency 5 outputs/inputs. The more efficient a company is, the fewer inputs required to produce a particular output, and the lower its costs will be. One common measure of efficiency is employee productivity. Employee productivity refers to the output produced per employee. It helps a company attain a competitive advantage through a lower cost structure. B. Quality as Excellence and Reliability A product can be thought of as a bundle of attributes. The attributes of many physical products include their form, features, performance, durability, reliability, style, and design. A product is said to have superior quality when customers perceive that its attributes provide them with higher utility than the attributes of products sold by rivals. When customers evaluate the quality of a product, they measure it against two kinds of attributes—those related to quality as excellence and those related to quality as reliability. As with excellence, reliability increases the value (utility) a consumer gets from a product, and thus the price the company can charge for that product and/or demand for the product. Figure 3.7: A Quality Map for Wireless Service The impact of high product quality on competitive advantage is twofold: • Providing high-quality products increases the value (utility) those products provide to customers, which gives the company the option of charging a higher price for the products. • Greater efficiency and lower unit costs associated with reliable products of high quality impact competitive advantage. o When products are reliable, less employee time is wasted making defective products, or providing substandard services, and less time has to be spent fixing mistakes—which means higher employee productivity and lower unit costs. C. Innovation Innovation refers to the act of creating new products or processes. There are two main types of innovation: • Product innovation is the development of products that are new to the world or have superior attributes to existing products. • Process innovation is the development of a new process for producing products and delivering them to customers. Product innovation creates value by creating new products, or enhanced versions of existing products, that customers perceive as having more value, thus increasing the company’s pricing options. Process innovation often allows a company to create more value by lowering production costs. In the long run, innovation of products and processes is perhaps the most important building block of competitive advantage. Competition can be viewed as a process driven by innovations. Although not all innovations succeed, those that do can be a major source of competitive advantage because, by definition, they give a company something unique—something its competitors lack (at least until they imitate the innovation). Uniqueness can allow a company to differentiate itself from its rivals and charge a premium price for its product, or, in the case of many process innovations, reduce its unit costs far below those of competitors. D. Customer Responsiveness To achieve superior responsiveness to customers, a company must be able to do a better job than competitors of identifying and satisfying its customers’ needs. Customers will then attribute more value to its products, creating a competitive advantage based on differentiation. Improving the quality of a company’s product offering is consistent with achieving responsiveness, as is developing new products with features that existing products lack. Another factor that stands out in any discussion of responsiveness to customers is the need to customize goods and services to the unique demands of individual customers or customer groups. An aspect of responsiveness to customers that has drawn increasing attention is customer response time—the time that it takes for a good to be delivered or a service to be performed. Other sources of enhanced responsiveness to customers are superior design, superior service, and superior after-sales service and support. V. Business Models, the Value Chain, and Generic Distinctive Competencies A business model is a manager’s conception, or gestalt, of how the various strategies that a firm pursues fit together into a congruent whole, enabling the firm to achieve a competitive advantage. A business model represents the way in which managers configure the value chain of the firm through their choice of strategy. It includes the investments they make to support that configuration, so that they can build the distinctive competencies necessary to attain the efficiency, quality, innovation, and customer responsiveness required to support the firm’s low-cost or differentiated position, thereby achieving a competitive advantage and generating superior profitability. Figure 3.8: Competitive Advantage and the Value Creation Cycle VI. Analyzing Competitive Advantage and Profitability If a company’s managers are to perform a good internal analysis, they must be able to analyze the financial performance of their company, identifying how its strategies contribute (or not) to profitability. To identify strengths and weaknesses effectively, they must be able to compare, or benchmark, the performance of their company against competitors, as well as against the historic performance of the company itself. The key measure of a company’s financial performance is its profitability, which captures the return that a company is generating on its investments. Although several different measures of profitability exist, such as return on assets and return on equity, many authorities on the measurement of profitability argue that return on invested capital (ROIC) is the best measure because “it focuses on the true operating performance of the company.” ROIC is defined as net profit over invested capital, or ROIC = net profit/invested capital. Net profit is calculated by subtracting the total costs of operating the company from its total revenues (total revenues − total costs). Net profit is what is left over after the government takes its share in taxes. Invested capital is the amount that is invested in the operations of a company—property, plant, equipment, inventories, and other assets. Invested capital comes from two main sources: Interest-bearing debt—money the company borrows from banks and those who purchase its bonds. Shareholders’ equity—money raised from selling shares to the public, plus earnings that the company has retained in prior years (and that are available to fund current investments). A company’s ROIC can be algebraically divided into two major components: • Return on sales—ROIC = net profits/invested capital = net profits/revenues × revenues/invested capital where net profits/revenues is the return on sales, and revenues/invested capital is capital turnover. • Capital turnover—measures how effectively the company employs its invested capital to generate revenues. Figure 3.9: Drivers of Profitability Table 3.1 Definitions of Basic Accounting Terms A company’s managers can boost the profitability of their company by obtaining greater sales revenues from their invested capital, thereby increasing capital turnover. They do this by pursuing strategies that reduce the amount of working capital, such as the amount of capital invested in inventories, needed to generate a given level of sales (working capital/sales) and then pursuing strategies that reduce the amount of fixed capital that they have to invest in plant, property, and equipment (PPE) to generate a given level of sales (PPE/sales). FOCUS ON WAL-MART Wal-Mart and Target Wal-Mart and Target are very close in size. In 2012, Wal-Mart earned a ROIC of 13.61%, and Target earned a respectable 10.01% but the expenses on sales, general and administrative expenses for Wal-Mart are lesser than Target. Wal-Mart also has a significantly lower PPE/sales ratio than Target. Wal-Mart’s high profitability is a function of its strategy, and the distinctive competencies that strategic investments have built over the years, particularly in the area of information systems and logistics. Figure 3.10: Comparing Wal-Mart and Target, 2012 Teaching Note: Wal-Mart’s methodology of internal analysis can be a very useful tool for analyzing why and how well accompany is achieving and sustaining a competitive advantage. It highlights a company’s strengths and weaknesses, showing where there is room for improvement and where a company is excelling. You can ask students to consider whether Target will be able to successfully reposition themselves to compete more effectively with Wal-Mart. They are likely to decide that they cannot. Next, ask students whether that implies that these competitors will ultimately fail, or whether they could succeed by adopting a different strategy. Classroom discussion could include ideas for alternative strategies that might be useful for Target to improve its ongoing performance. This case has an important but veiled message about the impact of strategy on performance. You should make sure that students understand this point—strategies can give firms a powerful, sustained advantage; however, there are always other strategies that could also lead to success. Managers must seek out alternate strategies if they want their firms to succeed against powerful rivals. VII. The Durability of Competitive Advantage The durability of competitive advantage, given that other companies are also seeking to develop distinctive competencies that will give them a competitive advantage, depends on three factors: • Barriers to imitation • The capability of competitors • The general dynamism of the industry environment A. Barriers to Imitation A company with a competitive advantage will earn higher-than-average profits. These profits send a signal to rivals that the company has valuable, distinctive competencies allowing it to create superior value. How quickly rivals will imitate a company’s distinctive competencies is an important issue, because the speed of imitation has a bearing on the durability of a company’s competitive advantage. The longer it takes competitors to imitate a distinctive competency, the greater the opportunity for the imitated company to improve on its competency or build other competencies, thereby remaining one step ahead of the competition. Barriers to imitation are a primary determinant of the speed of imitation. Barriers to imitation are factors that make it difficult for a competitor to copy a company’s distinctive competencies; the greater the barriers to imitation, the more sustainable a company’s competitive advantage. 1. Imitating Resources In general, the easiest distinctive competencies for prospective rivals to imitate tend to be those based on possession of firm-specific and valuable tangible resources, such as buildings, manufacturing plants, and equipment. Such resources are visible to competitors and can often be purchased on the open market. Intangible resources can be more difficult to imitate. This is particularly true of brand names, which are important because they symbolize a company’s reputation. Marketing and technological knowhow are also important intangible resources and can be relatively easy to imitate. Successful marketing strategies are relatively easy to imitate because they are so visible to competitors. With regard to technological knowhow, the patent system in theory should make technological knowhow relatively immune to imitation. However, this is not always the case. In electrical and computer engineering, for example, it is often possible to invent and circumnavigate the patent process—that is, produce a product that is functionally equivalent but does not rely on the patented technology. 2. Imitating Capabilities Imitating a company’s capabilities tends to be more difficult than imitating its tangible and intangible resources, chiefly because capabilities are based on the way in which decisions are made and processes are managed deep within a company. The invisible nature of capabilities would not be enough to halt imitation; competitors could still gain insights into how a company operates by hiring people away from that company. However, a company’s capabilities rarely reside in a single individual. Rather, they are the product of how numerous individuals interact within a unique organizational setting. B. Capability of Competitors A major determinant of the capability of competitors to rapidly imitate a company’s competitive advantage is the nature of the competitors’ prior strategic commitments. Strategic commitment means a company’s commitment to a particular way of doing business—that is, to developing a particular set of resources and capabilities. Once a company has made a strategic commitment, it will have difficulty responding to new competition if doing so requires a break with this commitment. Another determinant of the ability of competitors to respond to a company’s competitive advantage is the absorptive capacity of competitors. Absorptive capacity refers to the ability of an enterprise to identify value, assimilate, and use new knowledge. Internal forces of inertia can make it difficult for established competitors to respond to rivals whose competitive advantage is based on new products or internal processes—that is, on innovation. C. Industry Dynamism A dynamic industry environment is one that changes rapidly. The most dynamic industries tend to be those with a very high rate of product innovation. In dynamic industries, the rapid rate of innovation means that product life cycles are shortening and that competitive advantage can be fleeting. A company that has a competitive advantage today may find its market position outflanked tomorrow by a rival’s innovation. D. Summary The durability of a company’s competitive advantage depends upon the height of barriers to imitation, the capability of competitors to imitate its innovation, and the general level of dynamism in the industry environment. When barriers to imitation are low, capable competitors abound, and innovations are rapidly being developed within a dynamic environment, then competitive advantage is likely to be transitory. VIII. Avoiding Failure and Sustaining Competitive Advantage A. Why Companies Fail When a company loses its competitive advantage, its profitability falls. The company does not necessarily fail; it may just have average or below-average profitability and can remain in this mode for a considerable time, although its resource and capital base is shrinking. Failure implies something more drastic. A failing company is one whose profitability is substantially lower than the average profitability of its competitors; it has lost the ability to attract and generate resources and its profit margins and invested capital are rapidly shrinking Three related reasons for failure are inertia, prior strategic commitments, and the Icarus paradox. 1. Inertia The inertia argument states that companies find it difficult to change their strategies and structures in order to adapt to changing competitive conditions. One reason companies find it so difficult to adapt to new environmental conditions is the role of capabilities in causing inertia. Organizational capabilities—the way a company makes decisions and manages its processes—can be a source of competitive advantage, but they are often difficult to change. Capabilities are difficult to change because distribution of power and influence is embedded within the established decision-making and management processes of an organization. Those who play key roles in a decision-making process clearly have more power. 2. Prior Strategic Commitments A company’s prior strategic commitments not only limit its ability to imitate rivals but may also cause competitive disadvantage. 3. The Icarus Paradox Danny Miller has postulated that the roots of competitive failure can be found in what he termed the “Icarus paradox.” Icarus is a figure in Greek mythology who used a pair of wings, made for him by his father, to escape from an island where he was being held prisoner He flew so well that he climbed higher and higher, ever closer to the sun, until the heat of the sun melted the wax that held his wings together, and he plunged to his death in the Aegean sea. The paradox is that his greatest asset, his ability to fly, gave rise to his demise. Miller argues that the same paradox applies to many once-successful companies. According to Miller, many companies become so dazzled by their early success that they believe more of the same type of effort is the way to future success. As a result they can become so specialized and myopic that they lose sight of market realities and the fundamental requirements for achieving a competitive advantage. Sooner or later, this leads to failure. B. Steps to Avoid Failure Given that so many pitfalls await companies, the question arises as to how strategic managers can use internal analysis to find and escape them. 1. Focusing on the Building Blocks of Competitive Advantage Maintaining a competitive advantage requires a company to continue focusing on all four generic building blocks of competitive advantage—efficiency, quality, innovation, and responsiveness to customers—and to develop distinctive competencies that contribute to superior performance in these areas. Miller’s Icarus paradox promotes the message that many successful companies become unbalanced in their pursuit of distinctive competencies. 3.3 Strategy in Action: The Road to Ruin at DEC By 1990, Digital Equipment Corporation’s (DEC) superiority in producing high quality VAX minicomputers made it one of the largest corporations in the world. However, the company’s success carried the seeds of its destruction. An increasingly narrow focus on engineering capability led to a neglect of other functions, and the firm became dangerously out of touch with changing customer needs and industry conditions. DEC went through a terrible change of fortune in the early 1990s, returning to profitability only with the ouster of CEO Ken Olsen and a drastic change in strategy. DEC was acquired by Compaq in 1998. (Compaq was acquired by Hewlett Packard in 2001.) Teaching Note: This case provides a striking example of how successful firms can lose their competitive advantage through strategic missteps. To facilitate classroom discussion, students could be asked to describe the causes of DEC’s failure. Students will see that DEC suffered from all three of the major causes of failure. The firm’s large size led to inertia, making it more difficult for DEC to adapt, and CEO Olsen was one of the worst offenders in terms of protecting his “turf” from changes proposed by others. DEC also had prior strategic commitments in the form of specialized engineering know-how, which made change less likely. Finally, DEC suffered from the Icarus paradox. Dazzled by its early success, it became so specialized and inner-directed that it lost sight of customers and competitors, leading to strategic failure. 2. Institute Continuous Improvement and Learning In a dynamic, fast-paced environment, the only way that a company can maintain a competitive advantage over time is to continually improve its efficiency, quality, innovation, and responsiveness to customers. The way to do this is to recognize the importance of learning within the organization. Learning from prior mistakes and seeking out ways to improve processes over time is the primary objective. 3. Track Best Industrial Practice and Use Benchmarking Identifying and adopting best industrial practice is one of the best ways to develop distinctive competencies that contribute to superior efficiency, quality, innovation, and responsiveness to customers. Only in this way will a company be capable of building and maintaining the resources and capabilities that underpin excellence in efficiency, quality, innovation, and responsiveness to customers. 4. Overcome Inertia Overcoming the internal forces that are a barrier to change within an organization is one of the key requirements for maintaining a competitive advantage. Identifying barriers to change is an important first step. Once barriers are identified, implementing change to overcome these barriers requires good leadership, the judicious use of power, and appropriate subsequent changes in organizational structure and control systems. 5. The Role of Luck Some scholars have argued that luck plays a critical role in determining competitive success and failure. Although luck may be the reason for a company’s success in particular cases, it is an unconvincing explanation for the persistent success of a company. It is difficult to imagine how sustained excellence within any of these four dimensions could be produced by anything other than conscious effort—that is, by strategy. Luck may indeed play a role in success, and managers must always exploit a lucky break. Teaching Note: Ethical Dilemma Most of the students will say that the friend’s approach to doing business is not ethical because not giving benefits to the workers and not allowing them to form unions is a way of cheating the workers from exercising their rights. Most of them will counsel their friend to use an alternative approach. Answers to Discussion Questions 1. What are the primary implications of the material discussed in this chapter for strategy formulation? The material discussed in this chapter has several key implications for strategy formulation. First, it indicates the critical role played by efficiency, quality, innovation, and customer responsiveness in building a competitive advantage. A company should direct its strategies toward achieving excellence in each of these areas, and it should do so not just with functional-level strategies, but also with business, global, and corporate strategies. In addition, the key role assigned to capabilities in maintaining a competitive advantage suggests that barriers to imitation are higher and competitive advantage is more durable when that advantage is based on organizational capabilities. Thus, companies should pay close attention to strategies that help build a high-performance culture. A further implication concerns the durability of competitive advantage. Ultimately, all competitive advantages can be imitated or could become obsolete due to changing environmental conditions. To be continually successful, companies need to continually improve their efficiency, quality, innovation, and customer responsiveness, and they need to constantly adapt to new situations. Consequently, a premium should be placed on strategies and structures that encourage organizational flexibility and adaptiveness. 2. When is a company’s competitive advantage most likely to endure over time? The durability of competitive advantage is a function of three main factors—the height of barriers to imitation, the capability of competitors, and the dynamism of the environment. It follows that a competitive advantage is more durable when barriers to imitation are high, the company lacks capable competitors, and the dynamic environment in which it is based is not very. One should also note that barriers to imitation will be higher when a company’s distinctive competencies, and hence competitive advantage, are based on capabilities as opposed to resources. Barriers to imitation will be lowest, and competitive advantage most fleeting, when distinctive competencies are based on tangible resources. However, nothing lasts forever. Therefore, to maintain its advantage over the long run, a company must embrace the concept of continuous improvement, constantly upgrading its efficiency, quality, and customer responsiveness and constantly seeking innovations, in order to stay one step ahead of its competitors. 3. Is it possible for a company to be the lowest cost producer in its industry and simultaneously have an output that is most valued by customers? Discuss this statement. Yes, it is possible for a company to be the lowest cost production in its industry and simultaneously have an output that is most valued by customers. This can happen as the result of features of the product itself, or as a result of the low cost of the production process. For example, Swatch watches are made of inexpensive plastic components, but command premium prices as compared to watches made of more durable, traditional materials. Consumers are paying for features of the product other than quality including styling, fashion, trendiness, etc. Other products that are valued by customers but are relatively low cost to produce include the Volkswagen Beetle and designer clothing such as Ralph Lauren’s expensive cotton shirts. Other companies are able to offer low costs and still be valued by customers due to having a low-cost production process. Walmart is a good example. They have a very low-cost operation, and yet, because of the variety of items they sell in one location, are also preferred by customers. Another example is a maker of above-ground pools, whose products are cheaper to produce than are in-ground pools, yet are preferred by many customers due to the ease and speed of installation. 4. Why is it important to understand the drivers of profitability, as measured by the return on invested capital? The success or failure of a profit-making corporation will hinge upon its ability to provide adequate returns to shareholders (adequate as compared to other investments of similar risk). All other measures of success, such as motivated employees, innovative products, or satisfied customers, are secondary because they are not absolutely vital to the firm’s survival, as profits are. This is so because, when a company achieves profits and is able to make adequate returns to shareholders in the form of dividends or enhanced share value, the firm will continue to attract financing, enabling it to continue its operations. When returns are inadequate for an extended period of time, funds will become unavailable, and the firm will be forced out of business. 5. Which is more important in explaining the success and failure of companies: strategizing or luck? Both strategy and luck are undoubtedly important in explaining success and failure. However, although luck may explain a company’s success in particular cases, it is an unconvincing explanation for a company’s persistent success. Recall our argument that the generic building blocks of competitive advantage are superior productivity, quality, innovation, and customer responsiveness. Keep in mind also that competition is a process in which companies are continually trying to outdo one another in their ability to achieve high productivity, quality, innovation, and customer responsiveness. Given this, although one may imagine a company getting lucky and coming into possession of resources that allow it to achieve excellence in one or more of these dimensions, it is difficult to conceive how sustained excellence in any of these four dimensions could be the product of anything other than conscious effort—that is, of strategy. Luck may play a role in success, (have your students research the lucky beginnings of Microsoft Corporation), but to argue that success is entirely a matter of luck is to strain credibility. Also, it is clear that lucky opportunities do come along, but only the firms that are prepared to adapt are able to fully exploit those opportunities. Practicing Strategic Management Small-Group Exercise: Analyzing Competitive Advantage The students are asked to break up into groups of three to five people. Drawing on the concepts introduced in this chapter, they are asked to analyze the competitive position of their business school in the market for business education. Then they are asked to answer the following questions: 1. Does your business school have a competitive advantage? 2. If so, upon what is this advantage based, and is this advantage sustainable? 3. If your business school does not have a competitive advantage in the market for business education, identify the inhibiting factors that are holding it back. 4. How might the Internet change the way in which business education is delivered? 5. Does the Internet pose a threat to the competitive position of your school in the market for business education, or is it an opportunity for your school to enhance its competitive position? Teaching Note: These questions should solicit an interesting debate and in particular allow the students to apply the concepts learned in this chapter. You can guide students to publications such as U.S. News and World Report or Business Week that publish annual rankings of business schools, which can also be accessed via the Internet on the respective magazine’s web site. Students’ answers will vary, depending on their school and the students’ perception of its competitive position. The questions can be used as a written assignment, either alone or with small groups, or can be the basis of classroom discussion. You should monitor students’ answers, especially to questions 1–3, to ensure that they have understood the concepts of this chapter and are applying them correctly to this problem. Questions 4 and 5 present a chance for you to discuss the dual nature of many environmental changes—virtually every development and trend can pose a threat to an organization, as well as provide opportunities. Emphasize to students that each development or trend must be carefully considered to see both its good and bad aspects. Strategy Sign-On Article File 3 Find a company that has sustained its competitive advantage for more than ten years. Identify the source of its competitive advantage and describe why it has lasted so long. Teaching Note: Students should be able to identify successful firms with ease, but if they experience difficulties, you might suggest such companies as CNN, Applebee’s, Trader Joe’s, Kashi, Apple Computers, etc. Students should identify reasons such as barriers to imitation, the capability of competitors, and industry dynamism as reasons for sustained competitive advantage. In order to describe these factors, students may need to reference library materials or a web site that provides information about competition and industry factors. One site that provides a general industry overview is Hoover’s Online, at http://www.hoovers.com/. Strategic Management Project: Module 3 This module deals with the competitive position of your company. With the information you have available, perform the following tasks and answer the listed questions: 1. Identify whether your company has a competitive advantage or disadvantage in its primary industry. (Its primary industry is the one in which it has the most sales.) 2. Evaluate your company against the four generic building blocks of competitive advantage: efficiency, quality, innovation, and responsiveness to customers. How does this exercise help you understand the performance of your company relative to its competitors? 3. What are the distinctive competencies of your company? 4. What roles have prior strategies played in shaping the distinctive competencies of your company? What has been the role of luck? 5 Do the strategies your company is currently pursuing build on its distinctive competencies? Are they an attempt to build new competencies? 6. What are the barriers to imitating the distinctive competencies of your company? 7. Is there any evidence that your company finds it difficult to adapt to changing industry conditions? If so, why do you think this is the case? Teaching Note: This portion of the strategic management project will likely require a great deal of both research and thought for the students. They will need to find data about the firm’s history, internal operations, industry conditions, and future strategies, as well as finding similar data for their firm’s major competitors. They will then need to evaluate and interpret all of that data. Allow plenty of time for completion of this portion, and encourage them to start early. This portion of the project will emphasize the related nature of building blocks including, distinctive competencies, competitive advantage, and strategy. In addition, it will illustrate how strategic choices lead to consequences, which can be beneficial or harmful to the firm. Most students will readily find that strategy has had a far greater impact on their firm than has luck, but if they fail to understand this point, be sure to clarify. You can remind them that, even if luck has played some part in their firm’s success, preparedness and competency enable the firm to fully exploit its lucky opportunity. Encourage students to make comparisons to competitors as they answer items related to the difficulty in adaptation and the extent of luck in influencing success. In other words, every firm has some difficulty in adaptation, or is lucky to some extent, but it is more helpful to think of the extent of the difficulty or the extent of the luck in relative terms. Closing Case Competitive Advantage at Starbucks Originally, Starbucks was formed in 1980s to offer customers a coffee house “experience” which allowed them to charge a premium price for coffee. The “experience” was created through the atmosphere of the stores and superior customer service. Between 1995 and 2005, Starbucks added U.S. stores at an annual rate of 27%, reaching almost 12,000 total locations. However, in 2008, with Starbucks still adding stores and competition becoming stronger, ROIC tumbled from 21% to 8.6% along with stock price. Taking back the reigns, Howard Shultz has returned the company to its roots of creating value by having a great customer experience through efficiency and store redesign. The resulting higher customer satisfaction has returned Starbucks’ ROIC to 26.13% in 2012. Teaching Note: This case illustrates a number of ways in which Starbucks’s utilizes the four main building blocks of competitive advantage: efficiency, customer responsiveness, innovation, and reliable quality. Classroom discussion of the case could center on the following questions: • What is the link between strategy, competitive advantage, and profitability? • What are Starbucks’ distinctive competencies and resources and capabilities to make it happen? • What does the value chain look like within Starbucks’s? • How will the Starbucks’s competitive advantage be maintained in the future? Answers to Case Discussion Questions 1. What is the value that Starbucks creates for its customers? How does the company create this value? Starbucks strategy was to sell the company’s own premium roasted coffee and freshly brewed espresso-style coffee beverages, along with a variety of pastries, coffee accessories, and other products, in a tastefully designed coffeehouse setting. The idea was to transform the act of buying and drinking coffee into a social experience. They planned to create value for their customers through the experience they provided to their customers. 2. How important have innovation, efficiency, quality, and customer responsiveness been to Starbucks’ competitive position? Efficiency, quality, customer responsiveness, innovation are of great importance to Starbucks’s competitive position For decades, Starbucks’s experience in success was grounded in a simple formula, which it believed would make consumers return time and time again: • To give consumers a great coffee experience • Good quick service • Consistent quality in a clean environment 3. Does Starbucks have any distinctive competencies? If so, how do they impact the business? When Howard Schultz took the reins of Starbucks back in hand, his strategy was to return Starbucks to its roots, which was to provide customers with an ultimate coffeehouse experience. He wanted the company to reemphasize the creation of value through great customer experiences, and he wanted the company to do that as efficiently as possible. 4. Why do you think the performance of Starbucks started to decline after 2005? What was Schultz trying to do with the changes he made after 2008? Students’ answers may vary. Some of them may say that competitors from small boutique coffee houses to chains like Tully’s and Pete’s Coffee, and even McDonald’s, were beginning to erode Starbucks’ competitive advantage. Although the company was still adding stores at a break-neck pace, same-store sales started to fall. It might have been because Starbucks was not able to keep up with the speed that it was growing. With the many stores that it was adding, may be employees started neglecting the quality that Starbucks stood for because of the pressure of performance they were exerted do. Schultz tried to return Starbucks to its roots, reemphasize the creation of value through great customer experiences efficiently. CHAPTER 4 Building Competitive Advantage Through Functional-Level Strategies Synopsis of Chapter 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 production systems and mass customization, marketing strategy, and materials management and just in time. The contributions of R&D strategy, the human resource strategy, information systems, and company infrastructure are then examined. Next, the chapter addresses how functional strategies can achieve superior quality of a company’s goods and services through the dimensions of reliability and excellence. The principal tool used by most managers today is Six Sigma for increasing reliability. However, total quality management (TQM) is an ancestor for improving reliability. Methods of implementing reliability methodologies are provided. Improving quality through excellence may be done through different attributes that include form, features, performance, durability, and styling. 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 list of ways to reduce innovation failures along with 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 and, better ways to satisfy those needs. Learning Objectives 1. Explain how an enterprise can use functional level strategies to increase its efficiency. 2. Explain how an enterprise can use functional level strategies to increase its quality. 3. Explain how an enterprise can use functional level strategies to increase its innovation. 4. Explain how an enterprise can use functional level strategies to increase customer responsiveness. Opening Case Amazon.Com When Jeff Bezos started Amazon.com back in 1995, the online retailer focused just on selling books. Music and videos were soon added to the mix. Today, people can purchase a wide range of media and general-merchandise products from Amazon, which is now the world’s largest online retailer, with over $60 billion in annual sales. According to Bezos, Amazon’s success is based on three main factors—a relentless focus on delivering value to customers, operating efficiencies, and a willingness to innovate. Amazon offers customers a much wider selection of merchandise than they can find in a physical store, and does so at a low price. Online shopping and purchasing is made easy with a user-friendly interface, product recommendations, customers wish lists, and a one-click purchasing option for repeat customers. To deliver products to customers quickly and accurately, Amazon has been investing heavily in a network of distribution centers. In the United States alone there are now over 40 such centers. To make its distribution centers work more efficiently, Amazon is embracing automation. In 2012, Amazon purchased Kiva, a leading manufacturer of robots that service warehouses. On the innovation front, Amazon has been a leader in pushing the digitization of media. Its invention of the Kindle digital reader, and the ability of customers to use that reader either on a dedicated Kindle device or on a general-purpose device such as an iPad, turbo charged the digital distribution of books, a market segment where Amazon is the clear leader. Teaching Note: This case indicates how a company can improve its performance through the use of improvements at the functional level. Create a discussion of how Amazon.com increased efficiency, quality, and, in turn, responsiveness to customers. Lecture Outline I. Overview This chapter takes a close look at functional-level strategies—those aimed at improving the effectiveness of a company’s operations and its ability to attain superior efficiency, quality, innovation, and customer responsiveness. It is important to keep in mind the relationships between functional strategies, distinctive competencies, differentiation, low cost, value creation, and profitability (Figure 4.1). Distinctive competencies shape the functional-level strategies that a company can pursue. Managers, through their choices related to functional-level strategies, can build resources and capabilities that enhance a company’s distinctive competencies. Companies that increase the value (utility) consumers get from their products through differentiation, while simultaneously lowering their cost structure, create more value than their rivals—and this leads to a competitive advantage, superior profitability, and profit growth. Figure 4.1: The Roots of Competitive Advantage II. Achieving Superior Efficiency A company is a device for transforming inputs (labor, land, capital, management, and technological knowhow) into outputs (the goods and services produced). The simplest measure of efficiency is the quantity of inputs that it takes to produce a given output; that is, efficiency = outputs/inputs. An efficient company has higher productivity, and therefore lower costs, than its rivals. A. Efficiency and Economies of Scale Economies of scale are unit-cost reductions associated with a large scale of output. One source of economies of scale is the ability to spread fixed costs over a large production volume. Fixed costs are costs that must be incurred to produce a product regardless of the level of output; examples are the costs of purchasing machinery, setting up machinery for individual production runs, etc. Another source of scale economies is the ability of companies producing in large volumes to achieve a greater division of labor and specialization. Specialization is said to have a favorable impact on productivity, primarily because it enables employees to become very skilled at performing a particular task. The concept of scale economies is depicted in Figure 4.2, which illustrates that as a company increases its output, unit costs decrease. Figure 4.2: Economies and Diseconomies of Scale When all scale economies are exhausted, the company may encounter diseconomies of scale, which are the unit cost increases associated with a large scale of output. Diseconomies of scale occur primarily because of the increased bureaucracy associated with large-scale enterprises and the managerial inefficiencies that can result. Managers must know the extent of economies of scale, and where diseconomies of scale begin to occur. B. Efficiency and Learning Effects Learning effects are cost savings that come from learning by doing. Labor productivity increases over time, and unit costs decrease as individuals learn the most efficient way to perform a particular task. and managers learn how best to run the new operation. Learning effects tend to be more significant when a technologically complex task is repeated because there is more to learn. In terms of the unit cost curve of a company, economies of scale imply a movement along the curve. The realization of learning effects implies a downward shift of the entire curve as both labor and management become more efficient over time at performing their tasks at every level of output. Figure 4.3: The Impact of Learning and Scale Economies on Unit Costs No matter how complex the task is, learning effects typically diminish in importance after a period of time. They are most important only during the start-up period of a new process, and become trivial after two or three years. 4.1 Strategy in Action: Learning Effects in Cardiac Surgery Researchers from Harvard Business School studied learning effects in a new surgical procedure. In a study of 16 hospitals and 660 patients they found that one hospital was significantly better than the others. At that hospital the time for an operation decreased from 500 minutes for case #1 to 132 minutes by case #50. This meant that the surgeons were able to perform an extra operation per day leading to significant cost savings and additional revenue. The researchers studied what distinguished this hospital from others doing the same operation. The difference was that the core team was selected and managed to maximize learning. The team worked together for multiple operations and briefed and debriefed each other extensively during the initial operations. Teaching Note: This case shows students how implementation can make a significant impact on the success of new procedures. The hospitals were largely identical in terms of equipment and training yet one hospital was considerably better in terms of learning and productivity than the others. Ask students for personal stories where implementation techniques increased or decreased learning effects. C. Efficiency and the Experience Curve The experience curve refers to the systematic lowering of the cost structure, and consequent unit cost reductions, that have been observed to occur over the life of a product. According to the experience-curve concept, per unit-manufacturing costs for a product typically decline by some characteristic amount each time accumulated output of the product is doubled (accumulated output is the total output of a product since its introduction). The outcome of the process is a relationship between unit manufacturing costs and accumulated output (Figure 4.4). Economies 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 realize both economies of scale (as volume increases) and learning effects. Consequently, unit costs and cost structure fall with increases in accumulated output. Figure 4.4: The Experience Curve The strategic significance of the experience curve is that increasing a company’s product volume and market share will lower its cost structure relative to its rivals. This concept is very important in industries that mass-produce a standardized output, for example, the manufacture of semiconductor chips. A company that wishes to become more efficient and lower its cost structure must try to move down the experience curve as quickly as possible. This means constructing efficient scale manufacturing facilities, and aggressively pursuing cost reductions from learning effects. It might also need to adopt an aggressive marketing strategy, cutting prices drastically, and stressing heavy sales promotions and extensive advertising, in order to build up demand and accumulated volume as quickly as possible. Managers should not become complacent about efficiency-based cost advantages derived from experience effects for the following reasons: •Neither learning effects nor economies of scale are sustained forever, the experience curve is likely to bottom out at some point. •Cost advantages gained from experience effects can be made obsolete by the development of new technologies. D. Efficiency, Flexible Production Systems, and Mass Customization Central to the concept of economies of scale is the idea that a lower cost structure, through the mass production of a standardized output, is the best way to achieve high efficiency. The tradeoff implicit in this idea is between unit costs and product variety. This view of production efficiency has been challenged by the rise of flexible production technologies. The term flexible production technology covers a range of technologies designed to reduce setup times for complex equipment, increase the use of individual machines through better scheduling, and improve quality control at all stages of the manufacturing process. Research suggests that the adoption of flexible production technologies may increase efficiency and lower unit costs relative to what can be achieved by the mass production of a standardized output, while at the same time enabling the company to customize its product offering to a much greater extent than was once thought possible. The term mass customization has been coined to describe the company’s ability to use flexible manufacturing technology to reconcile two goals that were once thought to be incompatible—low cost and differentiation through product customization. The effects of installing flexible production technology on a company’s cost structure can be dramatic. Figure 4.5: Tradeoff between Costs and Product Variety 4.2 Strategy in Action Pandora: Mass Customizing Internet Radio Pandora has adopted mass customization for providing customers with music by allowing them to stream it to their PCs and mobile devices. The customers start by typing in the kind of music that they want to listen to. With a database of over 100,000 artists, there is a good chance that Pandora has something for everyone, however obscure their tastes. Customers can then rate the music that Pandora plays for them (thumbs up or down). Pandora takes this feedback and refines the music it streams to a customer. The company also uses sophisticated predictive statistical analysis and product analysis (what Pandora calls its Music Genome, which analyzes songs and identifies similar songs) to further customize the experience for the individual listener. The Music Genome even introduces customer to new songs they might like based on an analysis of their listening habits. The result is a radio station that is uniquely tuned into each individual’s unique listening preferences. This is mass customization at its most pure. Teaching Note: This case describes Pandora’s use of mass customization in the sharing and streaming of music. The process of mass customization is initially time consuming and expensive but it increases customer satisfaction. You could discuss the pros and cons of customization with your students. Further, you could ask them if they support or are against Pandora’s way of functioning. E. Marketing and Efficiency The marketing strategy that a company adopts can have a major impact on efficiency and cost structure. Marketing strategy refers to the position that a company takes with regard to market segmentation, pricing, promotion, advertising, product design, and distribution. Some of the steps leading to greater efficiency are fairly obvious. For example, moving down the experience curve to achieve a lower cost structure can be facilitated by aggressive pricing, promotions, and advertising—all of which are the task of the marketing function. Other aspects of marketing strategy have a less obvious—but no less important impact—on efficiency. One important aspect is the relationship of customer defection rates, cost structure, and unit costs. Customer defection (or “churn rates”) are the percentage of a company’s customers who defect every year to competitors. Defection rates are determined by customer loyalty, which in turn is a function of the ability of a company to satisfy its customers. Because acquiring a new customer often entails one-time fixed costs, there is a direct relationship between defection rates and costs. The longer a company retains a customer, the greater 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. One consequence of the defection–cost relationship depicted is illustrated in Figure 4.6. Because of the relatively high fixed costs of acquiring new customers, serving customers who stay with the company only for a short time before switching to competitors often leads to a loss on the investment made to acquire those customers. Figure 4.6: The Relationship Between Customer Loyalty and Profit per Customer One economic benefit of long-time customer loyalty is the free advertising that customers provide for a company. Loyal customers can dramatically increase the volume of business through referrals. A central component of developing a strategy to reduce defection rates is to identify customers who have defected, find out why they defected, and act on that information so that other customers do not defect for similar reasons in the future. To take these measures, the marketing function must have information systems capable of tracking customer defections III. Materials Management, Just-In-Time, and Efficiency The contribution of materials management (logistics) to boosting the efficiency of a company can be just as dramatic as the contribution of production and marketing. Materials management encompasses the activities necessary to get inputs and components to a production facility (including the costs of purchasing inputs), through the production process, and through a distribution system to the end user. For a typical manufacturing company, materials and transportation costs account for 50 to 70% of its revenues, so even a small reduction in these costs can have a substantial impact on profitability. Improving the efficiency of the materials management function typically requires the adoption of just-in-time (JIT) inventory systems, which is designed to economize on inventory holding costs by scheduling components to arrive at a manufacturing plant just in time to enter the production process, or to have goods arrive at a retail store only when stock is almost depleted. The drawback of JIT 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, and can help a company respond quickly to increases in demand. The efficient management of materials and inventory has been recast in terms of supply-chain management—the task of managing the flow of inputs and components from suppliers into the company’s production processes to minimize inventory holding and maximize inventory turnover. A. R&D Strategy and Efficiency The role of superior research and development (R&D) in helping a company achieve a greater efficiency and a lower cost structure is twofold: •The R&D function can boost efficiency by designing products that are easy to manufacture. By cutting down on the number of parts that make up a product, R&D can dramatically decrease the required assembly time, which results in higher employee productivity, lower costs, and higher profitability. •Pioneering process innovations is the second way in which the R&D function can help a company achieve a lower cost structure. A process innovation is a new, unique way that production processes can operate to improve their efficiency. B. Human Resource Strategy and Efficiency Productive employees lower the costs of generating revenues, increase the return on sales, and, by extension, boost the company’s return on invested capital. The challenge for a company’s human resource function is to devise ways to increase employee productivity. Among its choices are using certain hiring strategies, training employees, organizing the workforce into self-managing teams, and linking pay to performance. 1. A Hiring Strategy Many companies that are well known for their productive employees devote considerable attention to hiring. It is important to be sure that the hiring strategy of the company is consistent with its own internal organization, culture, and strategic priorities. 2. Employee Training Employees who are highly skilled can perform tasks faster and more accurately, and are more likely to learn the complex tasks associated with many modern production methods than individuals with lesser skills. Training upgrades employee skill levels, bringing the company productivity-related efficiency gains from learning and experimentation. 3. Self-Managing Teams The use of self-managing teams, whose members coordinate their own activities and make their own hiring, training, work, and reward decisions, has been spreading rapidly. Team members learn all team tasks and rotate from job to job. Because a more flexible workforce is one result, team members can fill in for absent coworkers and take over managerial duties such as scheduling work and vacation, ordering materials, and hiring new members. The greater responsibility thrust on team members and the empowerment it implies are seen as motivators. (Empowerment is the process of giving lower-level employees decision-making power.) The effect of introducing self-managing teams is reportedly an increase in productivity of 30% or more and a substantial increase in product quality. Further cost savings arise from eliminating supervisors and creating a flatter organizational hierarchy, which also lowers the cost structure of the company. Still, teams are no panacea; in manufacturing companies, self-managing teams may fail to live up to their potential unless they are integrated with flexible manufacturing technology. Also, teams place a lot of management responsibilities upon team members, and helping team members to cope with these responsibilities often requires substantial training—a fact that many companies often forget in their rush to drive down costs. 4. Pay for Performance Linking pay to performance can help increase employee productivity. But, it is also important to define what kind of job performance is to be rewarded and how. Some of the most efficient companies in the world, mindful that cooperation among employees is necessary to realize productivity gains, link pay to group or team (rather than individual) performance. this link creates a strong incentive for individuals to cooperate with each other in pursuit of team goals; that is, it facilitates teamwork. Focus On: Wal-Mart Human Resource and Productivity at Wal-Mart Wal-Mart has one of the most productive workforces of any retailer. The roots of Wal-Mart’s high productivity go back to the company’s early days and the business philosophy of the company’s founder, Sam Walton. He believed that if you treat people well, they will return the favor by working hard, and that if you empower them, then ordinary people can work together to achieve extraordinary things. These beliefs formed the basis for a decentralized organization that operated with an open-door policy and open books. Walton opposed unionization, fearing that it would lead to higher pay and restrictive work rules that would sap productivity. The key to getting extraordinary effort out of employees, while paying them meager salaries, was to reward them with profit-sharing plans and stock-ownership schemes. This worked for Wal-Mart for a long period of time, but then started creating problems for it. The company has come under attack for paying its associates low wages and pressuring them to work long hours without overtime pay. Labor unions have made a concerted but so far unsuccessful attempt to unionize stores, and the company itself is the target of lawsuits from employees alleging sexual discrimination. Wal-Mart claims that the negative publicity is based on faulty data, and perhaps that is right, but if the company has indeed become too big to put Walton’s principles into practice, the glory days may be over. Teaching Note: This case describes Wal-Mart’s success and problems in getting its employees to work extraordinarily for meager wages. To start the discussion, you could ask students what Wal-Mart could’ve done to avoid the problems it faced. C. Information Systems and Efficiency With the rapid growth of computer use, the explosive growth of the Internet, corporate intranets (internal corporate computer networks based on Internet standards), and the spread of high-bandwidth fiber-optics communications, and digital wireless technology, the information systems function has moved to center stage in the quest for operating efficiencies and a lower cost structure. The impact of information systems on productivity is wide ranging and potentially affects all other activities of a company. By using Web-based programs to automate customer and supplier interactions, companies can substantially reduce the number of people required to manage different interfaces, thereby reducing costs. Cost savings can also be realized by using Web-based information systems to automate many internal company activities, from managing expense reimbursements to benefits planning and hiring processes, thereby reducing the need for internal support personnel. D. Infrastructure and Efficiency A company’s infrastructure—that is, its structure, culture, style of strategic leadership, and control system—determines the context within which all other value creation activities take place. Improving infrastructure can help increase efficiency and lower its cost structure. Strategic leadership is especially important in building a companywide commitment to efficiency. One of the leadership tasks is to facilitate the cross-functional cooperation needed to achieve superior efficiency. E. Summary Table 4.1 summarizes the primary roles of various functions in achieving superior efficiency. Achieving superior efficiency requires an organization-wide commitment and an ability to ensure close cooperation among functions. Table 4.1 Primary Roles of Value Creation Functions in Achieving Superior Efficiency IV. Achieving Superior Quality Quality can be thought of in terms of two dimensions: •Quality as reliability •Quality as excellence Superior quality provides a company with two advantages: •First, a strong reputation for quality allows the company to differentiate its products from those offered by rivals, thereby creating more value in the eyes of customers, and giving the company the option of charging a premium price for its products. •Second, eliminating defects or errors from the production process reduces waste, increases efficiency, lowers the cost structure of the company, and increases its profitability. A. Attaining Superior Reliability The principal tool that most managers now use to increase the reliability of their product offering is the Six Sigma quality improvement methodology. The Six Sigma methodology is a direct descendant of the total quality management (TQM) philosophy that was widely adopted, first by Japanese companies and then by American companies, during the 1980s and early 1990s. The TQM concept was developed by a number of American management consultants, including W. Edwards Deming, Joseph Juran, and A. V. Feigenbaum. The philosophy underlying TQM, as articulated by Deming, is based on the following five-step chain reaction: •Improved 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. •Better quality leads to higher market share and allows the company to raise prices. •Higher prices increase the company’s profitability and allow it to stay in business. •Thus, the company creates more jobs. Deming identified a number of steps that should be part of any quality improvement program: •Management should embrace the philosophy that mistakes, defects, and poor-quality materials are not acceptable and should be eliminated. •Quality of supervision should be improved by allowing more time for supervisors to work with employees, and giving employees appropriate skills for the job. •Management should create an environment in which employees will not fear reporting problems or recommending improvements. •Work standards should not only be defined as numbers or quotas, but should also include some notion of quality to promote the production of defect-free output. •Management is responsible for training employees in new skills to keep pace with changes in the workplace. •Achieving better quality requires the commitment of everyone in the company. Western businesses were blind to the importance of the TQM concept until Japan rose to the top rank of economic powers in the 1980s. Since that time, quality improvement programs have spread rapidly throughout Western industry. 4.3 Strategy in Action: General Electric’s Six Sigma Quality Improvement Process Six Sigma is a quality and efficiency program that aims to reduce defects, boost productivity, eliminate waste, and cut costs throughout a company. “Sigma” comes from the Greek letter that statisticians use to represent a standard deviation from a mean—the higher the number of sigmas, the smaller the number of errors. At Six Sigma, a production process would be 99.99966% accurate, creating just 3.4 defects per million units. General electric (GE) is perhaps the most fervent adopter of Six Sigma programs, which can be used as part of Total Quality Management. 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 worked—GE’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 derived from the quality improvement, including better product performance, reliability, and durability; lower costs of rework; the ability to charge higher prices; and higher profits. The case also emphasizes two important points about quality improvement: •First, the process is often timely, detailed, and painstaking—although it can also yield significant benefits. •Second, customers are paying for value, and companies can charge more for a product that better serves customers’ needs. B. Implementing Reliability Improvement Methodologies Among companies that have successfully adopted quality improvement methodologies, certain imperatives stand out. Improvement in product reliability is a cross-functional process. Its implementation requires close cooperation among all functions in the pursuit of the common goal of improving quality; it is a process that works across functions. The roles played by the different functions in implementing reliability improvement methodologies are summarized in Table 4.2: •It is important that senior managers agree to a quality improvement program and communicate its importance to the organization. •If a quality improvement program is to be successful, individuals must be identified to lead the program. •Quality improvement methodologies preach the need to identify defects that arise from processes, trace them to their source, find out what caused the defects, and make corrections so that they do not recur. •Another key to any quality improvement program is to create a metric that can be used to measure quality. •Once a metric has been devised, the next step is to set a challenging quality goal and create incentives for reaching it. •Shop floor employees can be a major source of ideas for improving product quality, so these employees must participate and must be incorporated into a quality improvement program. •A major source of poor-quality finished goods is poor-quality component parts. To decrease defects, a company must work with its suppliers to improve the quality of the parts they supply. •Designing products with fewer parts is often major component of any quality improvement program. •Implementing quality improvement methodologies requires organization-wide commitment and substantial cooperation among functions. Table 4.2 Roles Played by Different Functions in Implementing Reliability Improvement Methodologies C. Improving Quality as Excellence A product is comprised of different attributes, and reliability is just one attribute, albeit an important one. Products can also be differentiated by attributes that include form, features, performance, durability, and styling of a product. In addition, a company can create quality as excellence by emphasizing attributes of the service associated with the product, such as ordering ease, prompt delivery, easy installation, the availability of customer training and consulting, and maintenance services. Table 4.3 Attributes Associated with a Product Offering For a product to be regarded as high in the excellence dimension, a company’s product offering must be seen as superior to that of rivals. Achieving a perception of high quality on any of these attributes requires specific actions by managers: •It is important for managers to collect marketing intelligence indicating which of these attributes are most important to customers. •Once the company had identified the attributes that are important to customers, it needs to design its products (and the associated services) in such a way that those attributes are embodied in the product. •The company must decide which of the significant attributes to promote and how best to position them in the minds of consumers, that is, how to tailor the marketing message so that it creates a consistent image in the minds of customers. Many marketing experts advocate promoting only one or two central attributes to customers. •It must be recognized that competition is not stationary, but instead continually produces improvement in product attributes, and often the development of new-product attributes. It is important to have a strong R&D function in the company that can work with marketing and manufacturing to continually upgrade the quality of the attributes that are designed into the company’s product offerings. V. Achieving Superior Innovation In many ways, innovation is the most important source of competitive advantage. This is because innovation can result in new products that better satisfy customer needs, can improve the quality (attributes) of existing products, or can reduce the costs of making products that customers want. The ability to develop innovative new products or processes gives a company a major competitive advantage that allows it to: •Differentiate its products and charge premium price •Lower its cost structure below that of its rivals Successful new-product launches are major drivers of superior profitability. A. The High Failure Rate of Innovation Research evidence suggests that only 10 to 20% of major R&D projects give rise to commercial products. Although many reasons have been advanced to explain why so many new products fail to generate an economic return, five explanations for failure repeatedly appear. •Many new products fail because the demand for innovations is inherently uncertain. Although good market research can minimize uncertainty about likely future demand, that uncertainty cannot be fully eradicated altogether; a certain failure rate is to be expected. •New products often fail because the technology is poorly commercialized. This occurs when there is definite customer demand for a new product, but the product is not well adapted to customer needs because of factors such as poor design and poor quality. •New products mail because of poor positioning strategy. Positioning strategy is the specific set of options a company adopts for a product based upon four main dimensions of marketing: price, distribution, promotion and advertising, and product features. •Many new product introductions fail because companies often make the mistake of marketing products based on a technology for which there is not enough consumer demand. A company can become blinded by the wizardry of a new technology and fail to examine whether there is consumer demand for the product. •Companies fail when products are slowly marketed. The more time that elapses between initial development and final marketing—the slower the “cycle time”—the more likely it is that a competitor will beat the company to market and gain a first-mover advantage. B. Reducing Innovation Failures One of the most important things that managers can do to reduce the high failure rate associated with innovation is to make sure that there is tight integration between R&D, production, and marketing. Tight cross-functional integration can help a company ensure that: •Product development projects are driven by customer needs. •New products are designed for ease of manufacture. •Development costs are not allowed to spiral out of control. •The time it takes to develop a product and bring it to market is minimized. •Close integration between R&D and marketing is achieved to ensure that product development projects are driven by the needs of customers. A company’s customers can be a primary source of new-product ideas. The identification of customer needs, and particularly unmet needs, can set the context within which successful product innovation takes place. Integration between R&D and production can help a company to ensure that new products are designed with manufacturing capabilities in mind. Design for manufacturing lowers manufacturing costs and leaves less room for mistakes; thus it can lower costs and increase product quality. One of the best ways to achieve cross-functional integration is to establish cross-functional product-development teams composed of representatives from R&D, marketing, and production. The objective of a team should be to oversee a product development project from initial concept development to market introduction. Specific attributes appear to be important in order for a product development team to function effectively and meet all its development milestones: •A project manager who has high status within the organization and the power and authority required to secure the financial and human resources that the team needs to succeed should lead the team and be dedicated primarily, if not entirely, to the project. •The team should be composed of at least one member from each key function or position. •The team members should be physically co-located to create a sense of camaraderie and facilitate communication. •The team should have a clear plan and clear goals, particularly with regard to critical development milestones and development budgets. •Each team needs to develop its own processes for communication, as well as conflict resolution. •There is sufficient evidence that developing competencies in innovation requires managers to proactively learn from their experience with product development, and to incorporate the lessons from past successes and failures into future new-product development processes. The primary role that the various functions play in achieving superior innovation is summarized in Table 4.4. The table makes two matters clear: •Top management must bear primary responsibility for overseeing the entire development process. •The effectiveness of R&D in developing new products and processes depends upon its ability to cooperate with marketing and production. Table 4.4 Functional Roles for Achieving Superior Innovation 4.4 Strategy in Action: Corning—Learning from Innovation Failures The case describes Corning’s attempt to enter the market for DNA microarrays (DNA chips). Corning was late to market because it used its long-established innovation processes in this new (to Corning) area. Corning insisted on higher quality standards than were considered necessary. The quality standards were difficult to achieve and delayed Corning’s entry into the market. In addition, Corning failed to consult users and, as a result, failed to incorporate some crucial features. As Corning was developing the new DNA chips, the incumbent in the market, Affymetrix, was consolidating its position. Users were accustomed to its products and loathe to switch to an unknown new product. Corning cancelled its project in 2001 after spending $100 million. As a result of the failure of the DNA chips, Corning reevaluated its innovation processes. Corning realized it needed to bring outsiders in early, especially when entering an unfamiliar area. The outsiders were both customers and experts. Corning was able to put this learning to good use when it initiated a project to develop drug testing equipment using light waves. This technology could result in significant savings for pharmaceutical companies. Corning had eighteen pharmaceutical companies testing the product before it was finalized. The company believes that Epic could result in $500 million annually. Teaching Note: Students could discuss the reasons for Corning’s failure in innovation—was it slowness to market, technological myopia, poor commercialization or all of the above? The case illustrates the principle that no experiment is a total failure, as it can always serve as a bad example. Corning evaluated the failure of the DNA chip project to improve its innovation processes. These adjustments led to success on a subsequent project. Students will see that companies can learn from their mistakes. VI. Achieving Superior Responsiveness to Customers To achieve superior responsiveness to customers, a company must give customers what they want, when they want it, and at a price they are willing to pay—so long as the company’s long-term profitability is not compromised in the process. Customer responsiveness is an important differentiating attribute that can help to build brand loyalty. Strong product differentiation and brand loyalty give a company more pricing options; it can charge a premium price for its products, or keep prices low to sell more goods and services to customers. Achieving superior responsiveness to customers means giving customers value for money, and steps taken to improve the efficiency of a company’s production process and the quality of its products should be consistent with this aim. In addition, giving customers what they want may require the development of new products with new features. A. Focusing on the Customer A company cannot be responsive to its customers’ needs unless it knows what those needs are. Thus, the first step to building superior responsiveness to customers is to motivate the entire company to focus on the customer. 1. Demonstrating Leadership Customer focus must begin at the top of the organization. A commitment to superior responsiveness to customers brings attitudinal changes throughout a company that can only be built through strong leadership. 2. Shaping Employee Attitudes Leadership alone is not enough to attain a superior customer focus. All employees must see the customer as the focus of their activity, and be trained to focus on the customer—whether their function is marketing, manufacturing, R&D, or accounting. The objective should be to make employees think of themselves as customers— to put themselves in the customers’ shoes. From that perspective, employees become better able to identify ways to improve the quality of a customer’s experience with the company. To reinforce this mindset, incentive systems within the company should reward employees for satisfying customers. 3. Knowing Customer Needs “Know thy customer” is one of the keys to achieving superior responsiveness to customers. Knowing the customer not only requires that employees think like customers themselves; it also demands that they listen to what customers have to say. This involves bringing in customers’ opinions by soliciting feedback from customers on the company’s goods and services, and by building information systems that communicate the feedback to the relevant people. B. Satisfying Customer Needs Efficiency, quality, and innovation are crucial competencies that help a company satisfy customer needs. Beyond that, companies can provide a higher level of satisfaction if they differentiate their products by: •Customizing them, where possible, to the requirements of individual customers •Reducing the time it takes to respond to or satisfy customer needs 1. Customization Customization means varying the features of a good or service to tailor it to the unique needs or tastes of groups of customers, or—in the extreme case—individual customers. Although extensive customization can raise costs, the development of flexible manufacturing technologies has made it possible to customize products to a greater extent than was feasible 10 to 15 years ago, without experiencing a prohibitive rise in cost structure (particularly when flexible manufacturing technologies are linked with Web-based information systems). The trend toward customization has fragmented many markets, particularly customer markets, into ever-smaller niches. 2. Response Time To gain a competitive advantage, a company must often respond to customer demands very quickly. Companies that can satisfy customer demands for rapid response build brand loyalty, differentiate their products, and can charge higher prices for products. Increased speed allows a company to choose a premium pricing option. Increased speed often lets a company choose a premium pricing option. In general, reducing response time requires: •A marketing function that can quickly communicate customer requests to production •Production and materials management functions that can quickly adjust production schedules in response to unanticipated customer demands •Information systems that can help production and marketing in the process Table 4.5 summarizes the steps different functions must take if a company is to achieve superior responsiveness to customers. Although marketing plays a critical role in helping a company attain this goal (primarily because it represents the point of contact with the customer), Table 4.5 shows that the other functions also have major roles. Table 4.5 Primary Roles of Different Functions in Achieving Superior Responsiveness to Customers Teaching Note: Ethical Dilemma The ability of Wal-Mart to be the low-cost leader and maintain competitive advantage depends on cost-savings throughout the company, so management defends its practices as necessary for the long-term success of the company. In addition, Wal-Mart is acting within the law to pay no more than the minimum wage and to vigorously oppose unions (as long as opposition tactics are not coercive). An argument could be made that it is the responsibility of lawmakers to affect change for all low-wage workers, so the breach of ethics (if there is one) occurs at the political level, not the company. There are several online communities that discuss Wal-Mart’s business practices, including the ethics of its wage and benefit policies. Have students visit and peruse http://makingchangeatwalmart.org. For a pro-Wal-Mart perspective, have students read the article at http://mises.org/story/2219. Answers to Discussion Questions 1. How are the four generic building blocks of competitive advantage related to each other? The four building blocks are closely related to one another. Because it reduces waste, the time spent fixing defects, the cost of after-sales service and support, and achieving superior quality, has an important positive impact on efficiency. Moreover, when superior quality is valued by consumers, it increases the company’s customer responsiveness. Besides, 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. Similarly, 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. 2. What role can top management play in helping a company achieve superior efficiency, quality, innovation, and responsiveness to customers? The role of top management is absolutely critical in achieving each of these goals. It 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 organization. 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 organization to reinforce behavior that is consistent with each of the goals. Furthermore, top management has to allocate resources within the organization so that others can attain these goals; it needs to facilitate cooperation between different functions within the organization in pursuit of superior efficiency, quality, innovation, and customer responsiveness. 3. Over time, will adoption of Six Sigma quality improvement processes give a company competitive advantage, or will it be required just to achieve parity with competitors? Like 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. Like any other valuable tool, it will be, and has been, rapidly imitated. Six Sigma 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 just for achieving competitive parity. In addition, customers are becoming accustomed to and demanding high quality, so Six Sigma and other quality improvement processes are becoming more and more essential, especially for multinational firms. 4. From what perspective might innovation be called the single most important building block of competitive advantage? In the business world, no advantage lasts forever. Valuable products and processes will always eventually be imitated by rivals, no matter how high the barriers to imitation are. It 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. Only 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. Having said this, one must add that innovation alone may not be enough to generate high returns. It is the joining together of innovation with superior efficiency, quality, and responsiveness to customers that is particularly valuable. Practicing Strategic Management Small-Group Exercise: Identifying Excellence The students are asked to break up into groups of three to five people and appoint one group member as a spokesperson who will communicate their findings to the class. You are the management team of a start-up company that will produce hard drives for the personal computer (PC) industry. You will sell your product to manufacturers of PCs (original equipment manufacturers [OEMs]). The disk drive market is characterized by rapid technological change, product life cycles of only 6 to 9 months, intense price competition, high fixed costs for manufacturing equipment, and substantial manufacturing economies of scale. Your customers, the OEMs, issue very demanding technological specifications that your product must comply with. They also pressure you to deliver your product on time so that it fits in within their company’s product introduction schedule. 1. In this industry, what functional competencies are the most important for you to build? 2. How will you design your internal processes to ensure that those competencies are built within the company? Teaching Note: This exercise should help students to synthesize the concepts taught in this chapter. Students should understand the role that R&D, flexible strategies, innovation, and pricing issues, play in the success of a company. Students should realize that achieving superior efficiency seems very attractive given substantial economies of scale. Other competencies that the students should identify include the need for a predictable, timely delivery schedule; low costs to enable them to keep prices low; and responsiveness to technologically demanding customers. However, the simultaneous achievement of all of the preferred functional competencies involves some tradeoffs. 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 likely be quite expensive (negating cost advantages, in the short run). Have students identify these tradeoffs 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. Strategy Sign-On Article File 4 Have students find an example of a company that is widely regarded as excellent. They should identify the source of its excellence and relate it to the material discussed in this chapter. Have them pay particular attention to the role played by the various functions in building excellence. Teaching Note: Students should readily find examples of excellent companies. If 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 may 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. Companies that are entering bankruptcy or that are struggling with low profits relative to their industry would make a useful lesson when contrasted with the excellent companies. You can ask students to consider and discuss the differences they see in the excellent and the failing firms. Strategic Management Project: Module 4 This module deals with the ability of the students’ company to achieve superior efficiency, quality, innovation, and responsiveness to customers. With the information the students have at their disposal, they are asked to perform the following tasks and answer the listed questions: 1. Is your company pursuing any of the efficiency-enhancing practices discussed in this chapter? 2. Is your company pursuing any of the quality-enhancing practices discussed in this chapter? 3. Is your company pursuing any of the practices designed to enhance innovation discussed in this chapter? 4. Is your company pursuing any of the practices designed to increase responsiveness to customers discussed in this chapter? 5. Evaluate the competitive position of your company with regard to your answers to questions 1–4. Explain what, if anything, the company must do to improve its competitive position. Teaching Note: This portion of the strategic management project will reinforce students’ understanding of how functional strategies form the basis of distinctive competencies, leading to competitive advantage. Students will identify a set of competencies spanning the four sources. The evaluation question will require students to consider their firm relative to those of their competitors. Students’ suggestions should focus on specific actions that functional area managers and employees can take to improve their operation. One lesson for students is that competitive advantage is usually based upon a whole set of related competencies, not just upon one or two. You can emphasize to students that well-managed firms build upon a competency in one area, developing more competencies over time. In making suggestions, students will obtain some sense of how difficult it is to suggest actions that are within the company’s capabilities and resources. For example, students might suggest changing the organization structure to empower employees and decentralize decision-making. However, you should point out to students that, although this suggestion sounds simple and easy, it would in fact take months of intensive effort to overcome habits, policies, attitudes, power shifts, and all of the other impediments to change. Closing Case Lean Production at Virginia Mason Gary Kaplan, CEO of Virginia Mason Hospital, was responsible for integrating lean production that transformed the efficiency of the hospital. By 2012, Virginia Mason had transformed into a more efficient, customer-responsive organization where medical errors during treatment has been significantly reduced. Among other gains, lean processes reduced annual inventory costs by more than $1 million, reduced the time it took to report lab tests to a patient by more than 85%, freed up the equivalent of 77 full-time employee positions through more efficient processes, and reduced staff walking distance by 60 miles a day, giving both doctors and nurses more time to spend with patients. These, and many other similar changes, lowered costs, increased the organization’s customer responsiveness, improved patient outcomes, and increased the financial performance of the hospital. Teaching Note: This case indicates how a company can improve its performance through the use of improvements at the functional level. You could involve your students in a discussion on how Virginia Mason increased efficiency, quality, and, in turn, responsiveness to customers. Answers to Case Discussion Questions 1. What do you think were the underlying reasons for the performance problems that Virginia Mason Hospital was encountering in the early 2000s? Students’ answers may vary. Some of the underlying reasons for the performance problems that Virginia Mason Hospital was encountering could be the lack of coordination between the staff at the hospital and the unnecessary workflow activities that delayed patient care. 2. Which of the four building blocks of competitive advantage did lean production techniques help improve at Virginia Mason? The four building blocks of competitive advantage that lean production technique helped improve at Virginia Mason were efficiency, quality, customer responsiveness, and employee satisfaction and morale. 3. What do you think was the key to the apparently successful implementation of lean production techniques at Virginia Mason? Students’ answers may vary. Some of them may say that teams, which included doctors as well as other employees, were freed from their normal duties for 5 days. They learned the methods of lean production, analyzed systems and processes, tested proposed changes, and were empowered to implement the chosen change the following week. Their dedication, willingness to learn and change, their eagerness for improvement and the cooperation of their management and their fellow colleagues helped in the apparently successful implementation of lean production at the Virginia Mason Hospital. 4. Lean production was developed at a manufacturing firm, Toyota, yet it is being applied in this case at a hospital. What does that tell you about the nature of the lean production philosophy for performance improvement? The fact that lean production can be implemented in hospitals tells us that this philosophy can be used in almost any field to trim the unwanted edges. Moreover, it also tells us that the philosophy is resourceful, functional, profitable, and effective. Solution Manual for Strategic Management: Theory: An Integrated Approach Charles W. L. Hill, Gareth R. Jones, Melissa A. Schilling 9781285184494