Directions

 After reading the course materials, including Mukerjee  (2016) (a good overview of the factors for competitive advantage!), apply the most relevant two elements of a value chain analysis to an organization of your choice. Justify your choice of elements as to why they are important for that organization.

Describe one or two strategic tactics the organization might try (or already uses) based on the value chain analysis and justify why the tactic is useful as a competitive advantage tool. 

Strategic Management

Jeff Dyer

Third Edition

Chapter 3

Internal Analysis: Strengths, Weaknesses, and Competitive Advantage

Professor’s Goals for this Lecture 

There are many types of problems that can be solved for a company by doing a cost analysis. A cost analysis can be used to solve problems as diverse as marketing (e.g., how much to spend to acquire additional customers) or HR (how much labor costs go down per unit with increases in volume). The principle tools to be learned in this chapter are designed to help the student examine the relationship between a company’s size (measured in volumes produced or market share) and cost per unit. This is primarily reinforced by teaching students how to create a scale/experience curve (both done in the same way with “cost per unit” on the “Y” axis but the scale curve uses volume for a given year on the “X” axis whereas the experience curve uses cumulative volume on the “X” axis. The students will have the opportunity to examine the relationship between scale/experience in the following assignments:  

– the homework assignment involving calculating an experience curve in semiconductors  

– Fry’s Credit Card Mini-case (in lecture); considers the relationship between total number of subscribers (X axis) and cost per subscriber (Y axis)  

– the Southwest Case (after lecture); considers the relationship between total passengers flown (or market share) and performance (profitability) in the industry  

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Technical innovations

Flowers and Trees—the first cartoon to use 3 color Technicolor technology, 1932

Snow white—the first full length feature in 1937

Fantasia—1940, the first film in stereophonic sound

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The following are more technical innovations that Disney pioneered. Students will be familiar with Snow White and Fantasia (both from their own childhood viewing and the opening vignette), and so these slides can provide a quick quiz and test of student retention.

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Huge innovation, huge risk

Disneyland

The Happiest Place on Earth

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1957—Disneyland opens. Disneyland is not only a great technical innovation (lots of new technology from the imagineers in developing really cool rides and attractions).

Disneyland was also a huge business innovation, and a huge risk. First, to finance Disneyland, Walt began producing weekly TV programs, when it was not at all clear that TV would become a major medium of communication.

Second, in the 1950s theme parks were all local, and many were shabby and poorly run. Remember, the U.S. Interstate system is in the early days of its construction, having been funded only a year earlier, and jet air travel only began in 1954. It was not at all clear that a theme park could become a national draw and attraction.

It was a huge success, from the day that it opened. Walt made one huge mistake in setting up Disneyland, however, in that he only bought 160 Acres of land for the park. They avoided that mistake with their next purchase, buying more that 27,000 acres.

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The Value Chain

Value Chain- A visual description of the steps required to turn raw materials into finished products and/or services. The value chain also describes key functions of

the firm linked to each stage and functions that span the productive activities of the firm.

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The Resource-Based View

Resources- All assets, capabilities, organizational processes, firm attributes, information, knowledge, and so on, controlled by a firm that enable the firm to conceive of and implement strategies that improve its efficiency and effectiveness.

Assets- Tangible or intangible resources or factors of production that create economic value for the firm when employed.

Four categories of resources are important contributors to competitive advantage:

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Physical resources, such as plant or equipment

2. Financial resources, such as free cash flow

3. Human resources, including employee and management skills and talents

4. Intangible resources, the intangible assets held by firms, such as brands and patents.

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Physical Resources

Financial Resources

Human Resources

Intangible Resources

The Resource-Based View (continued)

Capabilities- The procedures, processes, and routines firms employ in their activities.

Operating Capabilities- Procedures, processes, or routines for delivering value to customers, employees, suppliers, or investors.

Dynamic Capabilities- Procedures, processes, and routines that continuously expand existing resources or improve operating capabilities.

Priorities- A firm’s values and rankings of what is most important.

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CREATING A SUSTAINABLE COMPETITIVE ADVANTAGE: VRIO MODEL

Value- Worth or utility.

Rarity- To be uncommon, or not available to other competitors.

Inimitability- An attribute of a resource that describes the degree of difficulty a competitor would face in copying, imitating, or mimicking the value of that resource

Positive Network Externalities- When the value of a product increases with the number of users.

Virtuous Circle- When more sellers attract more buyers, who, in turn, attract more sellers.

Organized to Exploit- The degree to which the legal, administrative, and operating structure of the firm allows it to capture the rents generated by resources.

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Competitive advantages arise when resources or capabilities possess two attributes: Value and rarity. Two other principles determine the durability, or sustainability, of competitive advantage: Inimitability, the characteristics that make a resource or capability difficult to imitate, and an organization’s ability to exploit profit returns generated by its unique and valuable resources. Together, these four characteristics—value, rarity, inimitability, and organization to exploit profits—are often abbreviated as VRIO.

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Example: Inimitable Resources

Unique History—Coke

Path Dependence—Boeing

Complex Systems—Merck

Tacit Knowledge—Apple

Property Rights—Chevron

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Coke’s historical advantage comes from WWII, when the US military subsidized bottling plants all over the world so that soldiers could have “a coke within arm’s reach”

Boeing’s path dependence has a military origin as well. During WWII, the British focused on building fighters and the US on bombers (like the B-17). Those bombers gave Boeing the technical know how to build commercial aircraft and a lead over the British in creating safe jet travel.

The complex regulatory approval process that Merck has to endure to bring drugs to market mean that the company needs to develop and maintain a set of very complex organizational systems and routines.

Apple’s design capabilities (think of the innovations that Steve Jobs came up with) represent tacit, difficult to transfer, knowledge and skill.

Property rights, mainly land ownership and drilling rights, provide companies like Chevron with a legally protected resource base.

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Assessing Competitive Advantage with VRIO

Competitive Failure- When firms that can’t create value for their stakeholders don’t survive.

Competitive Parity- When a company survives but has no real competitive advantage over rivals.

Sustained Competitive Advantage- When firms combine the legal elements, intellectual property rights, administrative elements, and cultural elements,

allowing them to capture high profits that come from their valuable, rare, and inimitable resources, capabilities, or priorities.

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VRIO

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I’ll spend a few minutes here. The chart can easily apply to resources and capabilities. The important thing to reinforce is the last column—because this is the essence of the Diamond. Unless companies are organized to both create and exploit their resources and capabilities, their sources of competitive advantages will fade over time.

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Disney’s competitive advantage

Create content that drives repeat business

Managers can easily forget resources

Growth and expansion will always threaten the core

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It’s useful before moving on to summarize the key points of the Disney discussion. While these bullet points apply to Disney, the instructor can ask students if they can think of other companies where this has happened.

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Today’s Activity Map?

Miramax ESPN
Lucas Film Pixar Walt Disney ESPN Zone ESPN Deportes
Disneyland Disney Cruise Line 710am ESPN
Walt Disney World Resorts ABC Disney Channel
The History Channel

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What would an activity map of the Disney company look like today? Is there anything at the Center? What does this imply for long term competitive advantage?

The launch of the Disney+ streaming service is a new activity. How do you think Disney analyzed this new service?

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The Company Diamond

Capabilities

Priorities

Resources

Strengths & Weaknesses

(Activities)

&

The things we do to compete

The assets we employ

The processes we use

The values that guide us

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I’m going to spend about 10 minutes here outlining and building out this slide. It’s useful to move from top to bottom. I use ESPN—one of Disney’s most successful units—to illustrate the different elements of the diamond. The purpose of this slide, and the arrows that connect all the different elements, is to help students see that competitive advantage is a complex, deliberate thing that executives construct. The text on the slide is helpful to remind students of the progression from easily observable activities, through assets and processes, and down to deep, abstract values.

For ESPN

Activities—they make movies and creative content, produce products (televise games), run theme parks, restaurants, etc.

Resources—The brands, the personalities, the contracts,

Capabilities—sports center (cutting edge, fun, engaging), seeking new venues, innovation

Values—”sports fans serving sports fans”. ESPN is pretty diligent about hiring sports fans to work for the company, and puts a lot of emphasis on finding new and creative ways to deliver sports content to their fan base.

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Gathering Data for Company Diamond Analysis

Data to complete a diamond profile come from a number of sources. You can use three main types of data:

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Data to complete a diamond profile come from a number of sources. You can use three main types of data:

Archival data: Written or numeric information can be found in the library or on the Internet.

Interviews: Interviews can range from personal questions to impersonal Surveys.

Observation: Your own experiences, such as visits or use of products or services, are also valuable.

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Archival Data

Interviews

Observations

Using the Diamond Model

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Class Activity: Creating a Company Diamond

Capabilities

Priorities

Resources

Strengths & Weaknesses

(Activities)

&

The things we do to compete

The assets we employ

The processes we use

The values that guide us

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This is where I’ll have the students spend about 20 minutes. The text provides a nice reminder of the elements of the Diamond. Again, students can either develop a diamond model for the company that they are using for a semester length project, one assigned by the instructor, or they can spend 20 minutes thinking about their own competitive advantages, and how they might build a sustainable advantage over the first few years of their careers.

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Copyright

Copyright © 2020 John Wiley & Sons, Inc.

All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

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17

Copyright

Copyright © 2020 John Wiley & Sons, Canada, Ltd.

All rights reserved.  Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.

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Strategic Management

Jeff Dyer

Third Edition

Chapter 4

Cost Advantage

Professor’s Goals for this Lecture 

There are many types of problems that can be solved for a company by doing a cost analysis. A cost analysis can be used to solve problems as diverse as marketing (e.g., how much to spend to acquire additional customers) or HR (how much labor costs go down per unit with increases in volume). The principle tools to be learned in this chapter are designed to help the student examine the relationship between a company’s size (measured in volumes produced or market share) and cost per unit. This is primarily reinforced by teaching students how to create a scale/experience curve (both done in the same way with “cost per unit” on the “Y” axis but the scale curve uses volume for a given year on the “X” axis whereas the experience curve uses cumulative volume on the “X” axis. The students will have the opportunity to examine the relationship between scale/experience in the following assignments:  

– the homework assignment involving calculating an experience curve in semiconductors  

– Fry’s Credit Card Mini-case (in lecture); considers the relationship between total number of subscribers (X axis) and cost per subscriber (Y axis)  

– the Southwest Case (after lecture); considers the relationship between total passengers flown (or market share) and performance (profitability) in the industry  

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Two Generic Strategies

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Companies typically choose between one of two “generic” strategies for offering unique value to customers: cost advantage or differentiation advantage. By designing cars

to be manufactured at the lowest cost possible, and by designing a distribution system to get the cars to customers at the lowest cost possible, Tata has a cost advantage over every other carmaker in India, which allows it to sell the Nano at the lowest price.

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Cost advantage

Differentiation advantage

The Cost Advantage Strategy

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Cost Advantage Strategy

A firm reduces its prices below all of its competitors, thereby allowing it to gain market share.

A firm may choose the same price as competitors, which results in greater profits rather than higher market share.

Sources of Cost Advantage: Economies of Scale

Economies of Scale

1

Learning and Experience Effects

2

Lower Costs due to Proprietary Knowledge

3

Lower Input Costs

4

Different Business Model

5

Copyright ©2020 John Wiley & Sons, Inc.

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Summary of the sources of cost advantage. If we were going to do a logic tree and what drives cost advantage, there are these five things that I would point to as one way to organize that logic tree as to why companies have cost advantage. It’s because of economies of scale, it’s because of learning and experience effects, lower cost due to prior knowledge, lower input cost or a different business model.

One of the first things to appreciate is how you solve various different kinds of problems for a company or how you help them by understanding how to do cost analysis.

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First electronic bank (FEB) provides a store credit card to Frys electronics.

After 3 years, 25% of Frys customers have a Frys credit card but growth has slowed

Should FEB:

A) Spend more on marketing to increase penetration of the card at Frys

B) Spend money on marketing to get other store client customers to adopt a store credit card provided by FEB

What analysis would you recommend to FEB to determine what, if any, they should spend on marketing to get new customers?

Additional Mini-Case

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Q: Fry’s Electronic Bank does store credit cards for First Electronic Bank. After a number of years, 25 percent of Fry’s customer base have a Fry’s credit card, but growth is slow. So, should First Electronic Bank spend more money on marketing to increase penetration of the Fry’s card, should they spend money on marketing to get other store client customers to adopt the credit card provided by First Electronic Bank, and what analysis would you give FEB to determine what, if any, they should spend to get new customers?

A: as we think about this, this is sort of the cost per card or per subscriber. This is our cost per customer, per subscriber, per card, or you might even think about it as a cost per transaction. If you wanted to take it down to the individual transaction, some customers or subscribers may have more transactions than others, so you can look at how your cost per transaction is changing over time. And then you look at the total number or subscribers. So now I’ve got my total number of subscribers and then I can just start plotting years.

So, I start 1995 or whatever, and I plot the first year. What was my cost per subscriber, and what was the total number of subscribers? And to get my cost per subscriber all I have to do is take my total costs, divide it by the total number of subscribers, and I’ve got my cost per subscriber. And I can do that each year! You can usually get that data off of an annual report. That’s part of the reason why I wanted you to do that assignment for today. To get a sense for this data and actually analyze it from publicly available data.

Alright so you look, you plot your one, you plot your two, and you see what this looks like. It usually doesn’t look that plain, but let’s assume that it does. You plot the best fit line, your regression line, and then that will tell you how much our cost decreases if we double our number of subscribers. We can now do a skill curve against an experience curve. So then this now tells us how much our cost will decrease. Well let’s say I am here and I am trying to figure out whether or not to invest to grow my subscribers. Now, I’m actually, if I think I can grow my subscribers, the question is how much I can grow my subscribers, but I think I can get down here. What that means is I can now look at my cost going, dropping from this to this per subscriber, I take that across all my subscribers, and I know, that’s the value of this many more customers here because I’ve now been able to drop my cost per subscriber, I’ve added a certain number of additional subscribers, if it costs me more than that in marketing, then it probably doesn’t make sense to do it. But if it costs me less than that in marketing, then it probably makes sense for me to make the investment. And the other thing you have to realize is that the marketing expense may be a one year expense, or it may be a multiple year expense if you keep them. If it’s only a one year expense, you may want to keep the money to get the additional customers, but the nice thing is now this gets built in because you have more subscribers, and your cost per subscriber is lower for everybody.

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How important is size/volume as a driver of costs (and thus profitability) in my industry?

Scale/Experience Curve analysis

Market-share/profitability analysis

Overview

Additional Mini-Case:
Analyzing Cost Advantage

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If we think about this case with First Electronic Bank what you’re trying to understand is how important is increased volume as the driver of my costs. The more increased volume as the driver of my costs the more I can invest, the more I should be willing to invest in order to increase my volume. Right, so then, if Frist Electronic Bank finds that if they could double their number of subscribers, and their cost dropped by 20 percent, then they now can sort of estimate here’s how much it is worth to spend on marketing to get new customers.

And the goal is just to make sure that you’re smart about your business. That you know what happens when we increase customers, how much more money are we likely to make. If we lose customers, in an economic downturn, let’s say we lose customers, how much is that going to affect our cost per customer, or our cost per unit. So that then you can hopefully make smart decisions about how to make sure…this is one of the reasons why Southwest wanted to grow slowly, and in a controlled way. Because what they learned was that when you have lots of planes and you have an economic downturn, this actually hurts your profitability, and they didn’t want to have to lay people off, they wanted to maintain this certain kind of culture, where people felt like they had stable employment, which was very unlike many of the other airlines that had lots of layoffs. And, so, these influence the choices that you make around how quickly that you grow and how much investment we make to try and get new customers.

So you’re trying to answer this question, how important is size and volume as a driver of profitability to do, to understand that you have to be able to know how to do experience curve analysis, and scale curve analysis, or a market share profitability analysis.

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Economies of Scale

Economies of scale- A reduction in costs per unit due to increases in efficiency of production as the number of goods being produced increases.

Economies of scale arise from four principle sources:

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Economies of scale- A reduction in costs per unit due to increases in efficiency of production as the number of goods being produced increases.

Economies of scale arise from four principle sources: the ability to spread fixed costs of production, the ability to spread nonproduction costs, specialization of equipment, and specialization of people.

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Ability to Spread Fixed Costs of Production

Ability to Spread Nonproduction Costs

Specialization of Equipment

Specialization of People

Why Economies of Scale Lower Costs

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Why do economies of scale lower costs, ok. Well, two main reasons. One is the ability to spread fixed costs, property, plant, and equipment, but also you have non-production costs like research and development. Once you’ve made that investment to develop that new drug, if you only sell in the United States you could only spread your R&D costs over a U.S. population, whereas you’d rather spread it across a global population. A lot of times those costs really become fixed costs. And then the second reason that your costs go down with economies of scale is specialization. So, you now can have specialized machines and equipment that are designed for a specific task instead of maybe using labor, uh, or you can have people who now specialize on how to do a particular task and they get really good at it, and it’s just the whole notion of practice makes perfect, and more people can do the same task over and over, the better they will get. And that’s why costs go down with economies of scale. We see this in a lot of different industries.

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Specialization

Specialization of machines and equipment.

A firm with high volumes is able to purchase and use specialized equipment or tools that small firms simply cannot afford.

Specialization of tasks and people.

Small firms do not have the volume to create high levels of employee specialization.

When do hire specialized may not be enough work to keep them busy

Ability to Spread Fixed Costs

ProduScale is particularly valuable when investments in PPE are indivisible or “lumpy”—unavailable in small sizes.

Property, plant and equipment.

Non-Production: R&D, advertising, distribution, finance, G&A.

Economies of Scale and Scope

Scale Curve- A graphic representation of the relationship between cost per unit and scale (volume) of production in a given time period.

Minimum Efficient Scale- The smallest level of output (unit volume) that a plant or firm can produce to minimize its long run average costs. In a graphic

presentation of output/unit volume (x-axis) and cost per unit (y-axis), it is the output level where costs per unit flatten and no longer continue going down with increased output.

Diseconomies of Scale- An increase in marginal cost when output is increased.

Economies of Scope- The average total cost of production decreases as a result of increasing the number of different goods produced.

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Figure 4.1: Economies of scale

Q1

Low

High

Dis-economies of

Scale

Economies of Scale

Minimum Efficient Scale (optimal quantity)

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Economies of scale is taking, for given years, cost per unit of production and volume of production for a given year. And what we tend to find is that over time it drops, but at some point manufacturing plants become so large it’s so complex, that actually the costs start to go back up. They become very hard to manage. You have to draw workers from a larger and larger area, you have to pay more wages that in fact at some point you’re plant can become too big, and you’re costs will actually start to go up. The place where this curve starts to flatten out is what we often think of as the “minimum efficient scale”. So this is the minimum volume that we need to produce in order to be, pretty much, at the lowest cost possible. And that is where you typically want to produce. Is wherever you’re minimum efficient scale is or, any sort of production facility. Alright, so, you’re getting economies of scale, here is your minimum efficient scale where it’s flattening out, and that’s where you tend to want to, produce and then you can get to this economies of scale.

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Cost per Unit of Production 1 3 5 7 9 11 13 15 17 19 21 100 69 49 36 28 22 19 17.5 19 22 26

Volume of Production

Cost per Unit of Production

Source: Boston Consulting Group

Example: Scale Economies in Advertising: U.S. Soft Drinks

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I just wanted to note that what you can do is, you can actually do this for specific kinds of costs in a company. So you could do it for advertising, you could do it for marketing, let’s see how it works for research and development. We could pick a variety of different costs, and look at how the costs per, in this case, per case of soft drinks sold goes down as we increase the annual sales volume of cases. And what you see here with Pepsi and Coke is that, yeah, they’re spending a lot of time and money. It looks like 230 million looks like a lot of money. It is a lot of money, but when you actually look at the cost per case relative to some of the competitors, they’re actually spending less per case because of the volumes that they’re turning. So, they’re able to get that brand awareness but they’re able to get it at a relatively low cost per unit.

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Schweppes 15 0.2 Diet Dr. Pepper 20 0.18 Tab 100 0.17 Diet Pepsi 150 0.15 Diet 7-UP 25 0.15 Diet Rite 40 0.13 Fresca 55 0.1 Sprite 75 0.04 Dr. Pepper 200 0.05 7-Up 400 0.09 Pepsi 500 0.03 Coke 950 0.04

Annual Sales Volume (millions of cases)

Advertising Expenditure ($ per case)

75.5 % Scale Curve

y = 32534x

-0.4052

$-

$5.00

$10.00

$15.00

$20.00

$25.00

$30.00

$35.00

30,000,000

35,000,000

40,000,000

45,000,000

50,000,000

55,000,000

Number of Subscribers

Average Cost per Subscriber

(Constant Dollars)

Example: Credit Card Company Scale Curve

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This is an example of a credit card company scale curve, so what you see on this one, I’m going to show this on another one, with the Intel case. What you often actually see is a rolling pattern with the scale or experience curves. Why do you think that happens?

(also evident in next slide and similar to Intel case)

At some point along the way, you usually have to make some larger fixed costs investments to service, to serve that next group of customers. It’s often related to plant equipment that are needed for production, so you see it more in manufacturing industries than other industries. But, not necessarily, maybe there’s just a big marketing push, that needs to occur every once in a while to pull in more customers. Or maybe you invest more in R&D for certain periods.

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Sources of Cost Advantage: Learning and Experience Effects

Economies of Scale

1

Learning and Experience Effects

2

Lower Costs due to Proprietary Knowledge

3

Lower Input Costs

4

Different Business Model

5

Copyright ©2020 John Wiley & Sons, Inc.

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Summary of the sources of cost advantage. If we were going to do a logic tree and what drives cost advantage, there are these five things that I would point to as one way to organize that logic tree as to why companies have cost advantage. It’s because of economies of scale, it’s because of learning and experience effects, lower cost due to prior knowledge, lower input cost or a different business model.

One of the first things to appreciate is how you solve various different kinds of problems for a company or how you help them by understanding how to do cost analysis.

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Learning and Experience

Cost Advantage Strategy- A strategy in which the unique value offered to customers is lower-priced products or services.

Learning Curve- The concept that labor costs per unit decrease with increases in volume due to learning. New skills or knowledge can be quickly acquired initially,

but subsequent learning becomes much slower.

Experience Curve- A representation of the relationship between cumulative volume and product cost.

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Figure 4.3: Semiconductor Experience Curve

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SEMICONDUCTOR INDUSTRY

y = 3693.8x-0.3261

438736.47930000001 885648.17249999847 1226790.7649759999 1551455.759658 1855493.7813132 2196025.9578180001 2529945.2946347999 2867843.2355495999 3258643.8939684001 3625256.8195284 3975955.3286963999 4294788.6707963999 4580223.539 0435997 50 44.160231660231617 38.030888030888043 31.901544401544399 32.818532818532809 34.507722007722002 33.928571428571431 32.239382239382238 31.177606177606179 27.075289575289581 26.496138996138999 20.945945945945919 22.007722007722009

Cumulative Volume (Units)

Cost Per Unit ($)

A

B

C

Industry Price

Best Fit Line

Cost Per Unit of Output*

Cumulative Output/Experience

The Law of Experience

Variable and average (variable + fixed) costs per unit decline by a constant percentage (typically 10-30%) each time cumulative output doubles

The Experience Curve

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So when you think about an experience curve, the general notion is that companies are out selling similar kinds of products, and there’s an industry price, and if they’re producing the product in a similar way, they’re all coming down an experience curve, and you’ve got curves A, B, and C, and we would expect that over time C is probably going to be the most profitable company because they have the lowest cost per unit. And the law of experience means that the variable and average, or variable plus fixed cost per unit declined by a constant percentage, typically somewhere between 15 and 30 percent each time doubles. That’s what you would expect to have happen in most industries.

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Decreasing Variable Costs Per Unit Due to Learning

Human Learning (Efficiency)

Design and Process Technology Learning

Decreasing Fixed Costs Per Unit due to Scale

Economies of Scale increase ability to spread fixed costs

Why the Experience Curve Works

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Why does it work? Well you get decreasing variable cost per unit because of things like bargaining power as you get bigger. But you also get increased learning, human learning in regards to increased dexterity and improved coordination of work tasks. You have design and process improvements that you get, and you also get decreased fixed cost per unit because you can spread those fixed costs

Design and Process Technology Learning (Effectiveness)

Mechanization and automation

Efficient utilization of materials

Designs to economize on materials

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Relative market share (RMS) is a reasonable proxy for relative cumulative experience:

Of leader relative to next largest follower

Of all followers relative to leader

There will be a relationship between market share and profitability in industries where experience/volume drives lower costs per unit of experience.

Profitability

Relative Cumulative Experience (Market Share)

But Market Share is not always the cause of high profitability

Companies with higher market share tend to have higher profitability if size/volume drives profitability

The Importance of Relative Market Share

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The other way you can think about looking at the value volume or market share you can do what I have described as this sort of market share profitability. So we expect that relative market share to be a proxy for experience or for volume. The more market share we have, the more volume we have. So we may not be able to do a cost per unit, but we would typically expect there to be a relationship so that profitability is going to go up as experience, or relative cumulative experience or market share goes up. However, market share is not always the cause of high profitability. So, I think we talked about that like the second or third day. It could be for example that Toyota has emerged over the last 20 to 30 years as the leader of automobiles, not because of market share profitability, but because quality drove both market share and profitability at the same time. Sometimes there’s a third variable, something that isn’t on this chart that could be driving both. So just be aware of that. But at least it gives you a sense of whether not being big is likely to be an important factor for success in an industry. That’s why I wanted to have you do it for the airline industry, because once you do that graphic you realize, “Oh, okay. Being big isn’t critical for being successful.” That’s helpful to know. Yes?

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Ensuring Causality

Sometimes a third variable (e.g., quality, features) may be causing both profitability and market share to increase simultaneously. Even if a relationship seems clear within your model, it may be only correlated and not actually causal.

Market Share

Profitability

10%

15%

20%

25%

Market leader

Quality

Copyright ©2020 John Wiley & Sons, Inc.

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Note: Market share figures are for 2004; profit figures are avg. of 2000-2005

Figure 4.4: The Market Share-Profit Relationship: Home Improvement

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So let me give you an example. This is actually from the home improvement, we think about the home improvement in retailing. We’ve got Home Depot, Lowe’s, and this is an estimate for Walmart, that was based upon some data, but we don’t know for sure how costs are allocated at Walmart, so this could be quite a bit higher… and then you’ve got Sears, True Value, and Ace. And clearly what you see here, so just that if you’re going to succeed in home improvement, you’re better off if you’re Home Depot or Lowe’s, that you’re a big player. Although, you can see that Home Depot is a lot bigger at the time, but not a lot more profitable. But at least, if you do this kind of chart, it gives you a sense of whether or not being big really makes a difference to success and to a particular industry.

This is net profit margin which is a percentage of sales. So the way you typically do these as a percentage of sales, the best measure is operating income divided by your revenues because that’s what you’re generating. Your operating income is the profit you’re getting from your operations, and you’re dividing that by your revenue. And then sometimes you’ll have funny things with financing and your taxation stuff that comes to your net income.

So, typically in strategy we like to look at operating income divided by revenues as the profit of measurability. So you’re always going to see this as a percentage basis over here. Because it’s right, Walmart because of lower prices may only make one percent on margins but when you divide that by the assets they have employed or the remnants that are really that much more profitable than their competition. You typically prefer to do a return on assets.

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Wal-Mart

0.04 3.2000000000000001E-2 Sears

3.7999999999999999E-2 1.4E-2 Tru Value

Tru Value

8.0000000000000002E-3 1.0999999999999999E-2 Ace Hardware

0.01 1E-3 Lowes

8.5000000000000006E-2 6.0999999999999999E-2 Home Depot

0.17 6.8000000000000005E-2

Market Share in Revenues

Net Profit Margin

First movers in a fast growing market will secure a widening cost advantage. Firm’s must grow as fast, or faster, than rivals or be at a cost disadvantage. This is behind the “be #1 or #2 or exit” philosophy.

Growth/Investment Strategy

As a basis for market share based pricing strategy

As a basis for planning future prices

As a basis for pricing a production run or contract

Pricing Strategy

Scale/X-curves can be plotted for a company and its competitors to assess how well each company is managing its costs. Companies that fall above the regression line may not be managing costs well.

Benchmarking/Cost Analysis

Scale/X-curves provide data on how much costs will likely decrease (cost synergies) if two firms combine their volume/scale.

Acquisition Strategy

Strategic Implications of the Scale/Experience Curve

Copyright ©2020 John Wiley & Sons, Inc.

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So what do we learn from this? There are some strategic implications for managing business from doing this kind of analysis, experience curve and scale curve analysis. Number one, it helps you put growth in investment strategy.

The slogan or the saying to be number one or number two in your industry which came from General Electric years ago. Jack Welch said, “Well, we’re just going to be number one or number two, or we’re just not going to be in there.” It comes from GE competing in a lot of businesses that have some experience curves. Because if you are not number one or number two in a steep experience curve business, you are not going to make much money. You’re not a leader in micro processers, you’re not going to make a lot of money. Now, that’s not true in airlines. But in micro processers, it’s true. In GE, in the engine business, it’s true, in their appliance business, it’s true, in their lighting business, it’s true. So in the businesses that they were in with relatively steep experience curves, it’s like, “It’s a steep experience curve, you better get big fast, or get out.” That’s sort of the implication.

Number 2: It also helps you with pricing strategy. If you know how fast cost comes down as units increase, you can now price for future profits because you can say, “Oh, well we can price maybe even at our cost today because we know that if we price at our cost then we drive more volume then our cost will be 20 percent lower than this.” Let’s say if we can double our volume over the next year or whatever time frame. You may not choose to do that, but at least if you understand how your costs are going down then you can using it for pricing contract or just use it for pricing decisions in the marketplace.

Three: it can also help you with benchmarking or cost analysis. So, scale curves can be plotted for your company, you could plot it for a competitor, and then you can say, “Are we doing a good job in terms of our managing costs, or are we doing a bad job?” When you look at the auto industry, General Motors for example, we had all the car companies going through bankruptcy, you know, three, four, five years ago, well what happened is GM had high market share but they didn’t have high profits. Their costs were high, and a lot of it had to do with their union labor, the fact that they had very high medical costs and pensions, and they had spent a lot of money on plant equipment over the past. And they weren’t able to keep the volumes going because people weren’t buying cars as much as they needed them to. And so they ended up needing to restructure and pulling back their volumes, their total volumes, because they simply weren’t able to sell them in the marketplace. They just had too much plant equipment and too many workers and the benchmarking analysis can help you figure that out.

The last thing that can help you out with is acquisition strategy. So, you’ve all heard about synergies right? You acquire a company, and there are going to be synergies. Who can tell me what is a synergy? Yes?

It’s this notion that 1+1=3. That’s a synergy. But where does that actually come from? How do you get it?

There may be synergy on the marketing side perhaps with sort of cross-selling customers. There can also be synergies on the cost side. Like, “Well, we don’t need two customer service areas, we can cut one of them back by 50 percent” let’s say, or, “We don’t need as many plants we can actually close one of the plants because now we have, um, sort of redundancy.” So it eliminates some of the redundancies.

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Guest-Tek costs fall by an average of 29 percent with every doubling of room count1

Acquisition of Golden-Tree (200K rooms)

Power function (based on trend-fit) is C = 154.13 Q ^ (-.4955). Doubling volume (2^-0.4955) delivers a cost that is 71 percent of previous level.

Number of Rooms (Installed Base)

Figure 4.5: The Value of Scale in Delivering Internet Service to Hotel Rooms

Copyright ©2020 John Wiley & Sons, Inc.

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Let me give you an example. So here we have total operating room costs per room per day is the cost per unit in the Internet service provider business. So we’ve got, Guess Tech which is coming down this experience curve, this is their data right here, then they acquire Golden Tree which has 200 thousand rooms. So they jump from here out to here. Now the question is, is there any way they can predict what their costs will be after the acquisition? And the answer is, yeah. If you look at an experience curve and you calculate how much your costs are coming down per unit, and then you say, “Okay, now if we jump from here to here, how much will our costs come down?” Then when we do an acquisition we can estimate what the synergies will come on the cost side per unit by putting our two operations together. Of course what you tend to find because of the integration costs, you tend to find you usually are going to have, you’ll actually see, you’ll usually see a bump then this sort of goes sort of flat, but usually you’ll see it’s going to jump up for a while before it goes back down because now you’re trying to figure out how to put these together, and there’s often costs associated with integration.

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Guest-Tek 520201 492913 472809 435000 390000 205000 205000 196650 202618 194643 166190 190546 141788 187819 124263 107000 83900 171204 176227 180440 183514 0.22 0.26 0.22 0.23 0.3 0.34 0.4 0.42 0.43 0.5 0.61

Total Operating Cost Per Room Per Day

GUEST-TEK ANNOUNCES RECORD REVENUE AND CASH FLOW FOR THE THREE MONTHS ENDED JUNE

August 10, 2005 – Guest-Tek announced today that the Company achieved record positive EBITDA of $1.8 million. Guest-Tek CEO Arnon Levy commented, “The contribution of the acquisition of Golden-Tree in the quarter substantially increased … cash flow, and EBITDA, as well as improved margins. We believe there are opportunities for further margin improvement once the full integration of the two organizations is completed.”

Guest-tek Result

Copyright ©2020 John Wiley & Sons, Inc.

23

What we actually saw from Guess Tech when they acquired Golden Tree is that because they were able to bring, because they were in the same business they were direct competitors, one benefit from acquiring a direct competitor is now you don’t have to compete with them. So now there is less pressure on the pricing side, but also now you get to, to bring your costs together, and you can eliminate redundancies in the costs and hopefully it still allows you to keep going on the experience curve, and that’s why Guess Tech were able to have record profits after that acquisition and after they integrated it.

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Market share does not guarantee substantial cost advantages

What is the cost of market share?

Learning curve flattens with high experience

“Spillovers” of knowledge to rivals lower their costs of learning

Aging equipment can impede continued learning and cost advantages (e.g., airlines).

Limitations of the Experience Curve

Copyright ©2020 John Wiley & Sons, Inc.

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I want to highlight some limitations of the experience curve. Market share does not guarantee substantial cost advantages because there’s this question, “What’s the cost of market share? What are we going to have to spend to get it?” And the learning curve flattens with high experience. So the next thing is spillovers of knowledge to rivals to lower their costs of learning and aging equipment can also impede and you can continue to get lower cost reduction. Sometimes your equipment can become obsolete, and a new entrant can come in with newer, more advanced equipment and lower their costs.

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Firms with scale have an advantage in economic upturns but may be at a disadvantage during downturns.

They have more difficulty spreading fixed costs when demand declines.

Firms with heavy fixed assets can respond to this concern by:

Shifting more of their cost structure from fixed cost to variable cost (e.g., outsourcing to make costs more variable; using labor instead of capital).

Diversifying into businesses that are countercyclical

Disadvantages of Scale

Copyright ©2020 John Wiley & Sons, Inc.

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There are disadvantages of scale when you get a downturn. Now you’ve got a lot of fixed assets that you can’t spread across as many customers. So firms with heavy fixed assets can respond to this by one, you try and shift more of your cost structure from a fixed cost to a variable cost. That means there’s less leverage, so it’s less good in an upturn, but it’s better in a downturn. A variable cost means let’s outsource it to another company. That way if our costs go down, we just don’t buy as much. Whereas if we have our own plant and equipment and labor, and our volumes go down, we still have to pay for that regardless. So that’s what I mean by shifting it to variable cost.

Another way is to try and be in different kinds of businesses that might have different cyclicality. And that’s one of the benefits to General Electric because they’re in a lot of different businesses. Some, like lighting goes with the economy, and financial services sort of goes with the economy. Medical equipment, people sort of need medical equipment in good and bad times, when you have those sort of businesses in your portfolio it helps smooth the ups and the downs, so you’re much more predictable and that moves your cost to capital.

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Example: Disadvantages of Scale in an Economic Downturn

Copyright ©2020 John Wiley & Sons, Inc.

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We saw this in the airline industry, as you may recall, that from the 2002 to 2006 time period if you were bigger, if you had greater market share or more airline seat miles flown, you actually were less profitable during that downturn time period.

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SouthWest

7.2217647943753099E-2 8.6 JetBlue

1.40159447744566E-2 12.512 America West

2.8701807418892299E-2 -4.8679999999999897 US Air

7.6419935875753395E-2 -9.4880000000000013 Alaska Air

2.3511226388342601E-2 -4.2120000000000006 Delta

0.15828444864784999 -20.423999999999999 Northwest

0.11425238801012901 -11.006 Continental

0.100742667589807 -3.7180000000000009 American

0.19961459588611499 -16.97 United

0.167044188825579 -28.771999999999991

Average Market share for each Airline

(2002-2006)

Operating Profit/Sales

(2002-2006)

Sources of Cost Advantage: Lower Costs due to Proprietary Knowledge

Economies of Scale

1

Learning and Experience Effects

2

Lower Costs due to Proprietary Knowledge

3

Lower Input Costs

4

Different Business Model

5

Copyright ©2020 John Wiley & Sons, Inc.

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Summary of the sources of cost advantage. If we were going to do a logic tree and what drives cost advantage, there are these five things that I would point to as one way to organize that logic tree as to why companies have cost advantage. It’s because of economies of scale, it’s because of learning and experience effects, lower cost due to prior knowledge, lower input cost or a different business model.

One of the first things to appreciate is how you solve various different kinds of problems for a company or how you help them by understanding how to do cost analysis.

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Proprietary Knowledge

Proprietary Knowledge- Information that is not public and that is viewed as the property of the holder.

Copyright ©2020 John Wiley & Sons, Inc.

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Some Key Principles of TPS:

Use a “pull” system: to avoid overproduction

Just-in-time delivery: to reduce inventories

Level out the workload: to smooth production

Use visual controls: to illuminate problems and reduce defects

Find the bottleneck: to increase productivity

TPS is a very successful, but very difficult to imitate,

production system.

Lower Costs Due to Proprietary Knowledge

Copyright ©2020 John Wiley & Sons, Inc.

29

Another way to have low costs is that you develop some proprietary knowledge about how to produce a product or a service that others just can’t figure out very easily. We mentioned this last time with Southwest, and I showed you that graph about the Toyota production system. And they just have a variety of key principles, and it’s been really successful over time because it’s really hard to imitate. It’s hard for somebody to understand how the whole thing works and be able to put it together and make it work, and make it work with your suppliers as well. So the more you can learn something that’s valuable and keep it proprietary, the better off you are. So you don’t want others to know how you do it.

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Sources of Cost Advantage: Lower Input Costs

Economies of Scale

1

Learning and Experience Effects

2

Lower Costs due to Proprietary Knowledge

3

Lower Input Costs

4

Different Business Model

5

Copyright ©2020 John Wiley & Sons, Inc.

30

Summary of the sources of cost advantage. If we were going to do a logic tree and what drives cost advantage, there are these five things that I would point to as one way to organize that logic tree as to why companies have cost advantage. It’s because of economies of scale, it’s because of learning and experience effects, lower cost due to prior knowledge, lower input cost or a different business model.

One of the first things to appreciate is how you solve various different kinds of problems for a company or how you help them by understanding how to do cost analysis.

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Lower Input Costs

Inputs- Resources such as people, raw materials, energy, information, or financing that are put into a system to obtain a desired output.

There are four primary ways that companies achieve cost advantage through lower-cost inputs:

Copyright ©2020 John Wiley & Sons, Inc.

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Exercising Strong Bargaining Power Over Suppliers

Cooperating Especially Well With Suppliers

Getting Inputs From Low-Cost Locations

Arranging Better Access to Inputs than Other Companies Have

Walmart: Greater bargaining power over suppliers

Honda: Superior cooperation with suppliers

(including lower transaction costs)

Nike: Sourcing from low cost locations

(e.g., country comparative advantage)

De Beers: Preferred access to inputs

(e.g., DeBeers owns diamond mines)

Lower Input Costs

Copyright ©2020 John Wiley & Sons, Inc.

32

If we think about why we get lower input costs, there tend to be three or four main reasons. Number one is it’s a bargaining story. It’s a volume story. Volume really does matter. Or it could be not a volume story if you look at, for example, Toyota’s costs of their inputs from suppliers or Honda’s, they have historically been lower than those at GM or Ford even though GM and Ford were bigger, and they really had more bargaining power over their suppliers. But it was because of the way they worked with their suppliers in a cooperative fashion that they figured out ways that they could mutually lower costs together. So I think I mentioned a supplier that built the conveyor belt, they took the seats from their plant into the Toyota plant. Well that really saves a lot of costs in terms of inventory instead of building your seats 500 miles away, putting them in a truck and shipping them there. That’s one way that you lower costs through better cooperation. And then, you could just be sourcing from low cost locations. We’ll do a Nike case in not too long where we will look at how, their sourcing strategy has been an important part of their success by being the first to really aggressively source their shoes in Asia, and, try and get the lowest cost of labor possible. And then finally, you might have lower costs because you just have preferred access to those inputs, and that’s what De Beers does by owning the diamond mines, as they find raw materials, the diamond mines as they buy them that they own them and then get them at a lower cost.

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Sources of Cost Advantage: Different Business Model

Economies of Scale

1

Learning and Experience Effects

2

Lower Costs due to Proprietary Knowledge

3

Lower Input Costs

4

Different Business Model

5

Copyright ©2020 John Wiley & Sons, Inc.

33

Summary of the sources of cost advantage. If we were going to do a logic tree and what drives cost advantage, there are these five things that I would point to as one way to organize that logic tree as to why companies have cost advantage. It’s because of economies of scale, it’s because of learning and experience effects, lower cost due to prior knowledge, lower input cost or a different business model.

One of the first things to appreciate is how you solve various different kinds of problems for a company or how you help them by understanding how to do cost analysis.

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Business Model and Value Chain

Business Model- The plan and set of activities implemented by a company to offer unique value and generate revenue and make a profit from operations.

Value Chain- The sequence of all activities that are performed by a firm to turn raw materials into the finished product that is sold to a buyer.

Copyright ©2020 John Wiley & Sons, Inc.

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Different Business Model

Copyright ©2020 John Wiley & Sons, Inc.

35

Finally, different business models. But it could be reconfiguring the value chain, it’s often to reconfigure or eliminate steps in the value chain, in some cases it might be to eliminate stores. So if we think about Amazon versus Barnes & Noble and Borders in the way they have been successful in books, it was really a very different business model, selling over the internet as opposed to in stores. And Dell for years didn’t sell through stores either, it was all ordered and customized, delivered to your doorstep.

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Reconfigure the Value Chain

Eliminate Activities/Steps in the Value Chain

Example: Eliminate Retail Stores

i.e., Netflix and Amazon.com

Sources of Cost Advantage

Economies of Scale

Greater unit volume allows firms to have lower costs by spreading fixed costs across more units.

Learning and Experience Effects

Greater cumulative volume drives cost differences due to greater learning and experience within companies with more cumulative experience in production.

Proprietary Knowledge

Cost advantage from developing proprietary knowledge in the production of their product or service

Lower Input Costs

Some companies may have lower input costs than others due to bargaining power, superior cooperation, low cost locations.

Different Business Model

Eliminating steps in the value chain or using a different activity set may offer lower costs

Walmart

intel

Toyota

Nike

Netflix

Copyright ©2020 John Wiley & Sons, Inc.

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Now you have this high level summary of different ways that a company can generate cost advantage. It can come from a variety of different sources, sometimes it is from scale and experience, but sometimes it’s from lower cost inputs or proprietary knowledge of how to do something. The key is of course, once you have figured out a way to do something as you’re trying to figure out, “How do we make sure others can’t figure out how to do it like we do,” Because ultimately you’re trying to create barriers.

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Copyright

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All rights reserved.  Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.

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38

Strategic Management

Jeff Dyer

Third Edition

Chapter 5

Differentiation Advantage

Professor’s Goals for this Lecture 

There are many types of problems that can be solved for a company by doing a cost analysis. A cost analysis can be used to solve problems as diverse as marketing (e.g., how much to spend to acquire additional customers) or HR (how much labor costs go down per unit with increases in volume). The principle tools to be learned in this chapter are designed to help the student examine the relationship between a company’s size (measured in volumes produced or market share) and cost per unit. This is primarily reinforced by teaching students how to create a scale/experience curve (both done in the same way with “cost per unit” on the “Y” axis but the scale curve uses volume for a given year on the “X” axis whereas the experience curve uses cumulative volume on the “X” axis. The students will have the opportunity to examine the relationship between scale/experience in the following assignments:  

– the homework assignment involving calculating an experience curve in semiconductors  

– Fry’s Credit Card Mini-case (in lecture); considers the relationship between total number of subscribers (X axis) and cost per subscriber (Y axis)  

– the Southwest Case (after lecture); considers the relationship between total passengers flown (or market share) and performance (profitability) in the industry  

1

Differentiation means providing unique value that allows a firm to command a premium price for its product or service (relies on the consumers’ willingness to pay more).

There are four primary ways that companies differentiate their products from competitors:

2

Copyright ©2020 John Wiley & Sons, Inc.

Differentiation

Professor: Today we are going to talk about differentiation. And I think that it’s probably not surprising that differentiation is all about understanding the customer in a much deeper way than you have to if you’re pursuing a cost based advantage. But it’s really getting into the customer’s willingness to pay. And that’s really what you are trying to understand with differentiation is what are the pain points that the customers are experiencing and what are they willing to pay in order to make those pain points go away. Or you could think about it as pleasure or pain depending on how you wanted to define pain broadly you could define pleasure as part of that. There are four primary ways that you can differentiate that are described in the text. So Sam do you remember any of those?

Sam: Yes. Brand.

Professor: Brand.

Sam: Is one. Cost. Having low cost.

Professor: Ok. Cost would be a separate. So you’ve got differentiation and cost and under differentiation there are different ways you can…

Sam: Maybe a more generic one, a lower cost strategy.

Professor: So you could have…a lower cost strategy, we think of that as a completely separate category. So you’ve got differentiation…so they all fall under the value proposition of unique value. Then you’ve got two branches, you’ve got differentiation and you’ve got cost. Under differentiation, one way is brand that you can differentiate.

Student: Premium services as part of the product.

Professor: Ok, so somehow premium services are features.

Student: Right. Like the vacuum, if it sucks really well.

Professor: Ok, if it sucks really well. Cause vacuums suck really well. So brand, features

Student: Convenience.

Professor: Convenience would be a third.

Students: Quality.

Professor: And quality would be the fourth. So quality reliability would be the fourth. So, it’s often hard to group these, but at sort of a very high level, what I found in the work that I do is if you’re trying to differentiate your product, it’s usually, you’ve got a feature, and there are different dimensions of features, but you’ve got a feature that either does an existing job better than any other product out there, it does more jobs, or it does a unique job. And we will sort of dig into that. And maybe it’s just, this just lasts longer, more reliable, better quality. It’s more convenient to access, to buy, to use in one way or another or it’s got a brand or image that you want to identify with, or that somehow you trust this brand more than the other brands that are out there.

2

Superior Product

Features

Better Reliability

Convenience

Brand/Image

Nordstrom

Apple dyson

Apple FujiFilm

Disney

Build-A-Bear

Toyota Honda

Starbucks Coca-Cola

Harley Jell-o Prius

Sources of Differentiation Advantage

3

Copyright ©2020 John Wiley & Sons, Inc.

Figure 5.1: Sources of Differentiation Advantage

I usually spend about 20 minutes talking through this slide.

Alright, so let’s put this in a logic tree or you think of it as a problem tree. So what is the source of the differentiation advantages? So we’ve got product features, quality reliability, more convenient to find, purchase, use, and brand image. Alright, so it does a better job on existing features, more jobs, or does a unique job. So I’m going to go up here. Michael, up in, that’s why I was looking, at your hand today. So tell me, what does it mean, give me example of each of these three. Does a better job on existing features, does more jobs than other products, or does a unique job that nothing else does. What would you say would be an example of a product does a better job on existing features?

Student: On existing features, well that was like the example of the vacuum.

Professor: Ok, the vacuum, sucking better. Ok, so we know we expect that vacuums to suck. So what about does more jobs?

Student: The iPhone. So with all the apps.

Professor: The iPhone. Ok good. So the iPhone succeeded early on because it could do more things than a traditional phone, all though the majority of iPhone users actually admitted they thought it was a worse phone than the other phones on the market place. That’s just the phone, but they liked it because it could do so many other things. Ok. And what about a unique job?

Student: It does something that other products or services just don’t do. How about like a touch screen computer.

Professor: If you were the very first that had the touch screen computer, that would be unique. What else?

Student: I just saw this commercial for…in a few years a car is going to come out that can fly too. It’s like an airplane. It’s a nasty looking car, but it can fly. I would say that’s a unique job.

Professor: You would say that’s pretty unique.

Student: Yeah, the car that can fly.

Student: I think an example is like Disneyland. There’s not really a substitute for the park.

Professor: Yeah, it is unique. You’re experience at Disneyland is a completely unique experience. You can’t go anywhere else and have lunch with the Disney princesses. Cause I’m sure most of you really want to. But I took my daughter, eight year old daughter, and we had a good time having lunch with the Disney princesses. And I learned two things from that experience. Number one, that they can charge you 25 bucks for a hamburger if you want to have a lunch with Disney princesses. And the second thing, is that at the time my sons, I think were 13 and 17, and they liked having lunch with the Disney princesses as much as my 8 year old. So I think they were ok with that too. Alright, do you have another?

Student: I was just going to say, that I have heard about this new app which is going to make it so people can create stocks directly with no broker fees.

Professor: So it is going to be a new app, free?

Student: Yeah.

Professor: It will be completely unique?

Student: Exactly.

Professor: Yeah, and if you think about a lot of…this is the way pharmaceutical companies make their living. They create a unique drug, a unique product, they get a patent on it, and then they are the only product of their kind until the patent runs out. So there are products like that that will do something that’s completely unique, they often are protected by patents. And the examples we talked about the, or at least that are described in the book or text are the iPod, originally did a much better job of portability than the Discman. So most of you are probably too young to remember the joys of jogging with the Discman, but it was not the best portable music experience because it wasn’t really small and portable. So on that feature of being portable, iPods are stronger. And then of course we talked about Dyson. And you think about every company needs to provide service, but Nordstrom somehow differentiates on service. And there are these legendary stories that they tell, that actually, if you go look it up, they actually, they are true about, like the guy in Anchorage, Alaska that took his tires back to Nordstrom, and Nordstrom doesn’t sell tires, but the manager, to keep the man happy, he took the tires back. That’s some pretty good service, when you’re taking back a product that you don’t even sell. Then this gets known. And then, apparently, if you dig deeper in the story, I guess there was a tire store that was there before, and he knew where it had moved, so I think they just took the tires back for the guy and got reimbursed. But that’s the kind the kind of service you were talking about earlier. So another time where a customer left a bag of clothes and things that had been purchased at Nordstrom was near the store, an employee found it, it had an airline ticket in it. It was in the New York area, and so they actually jumped on their system to try and find the customers phone number, call the number, couldn’t get it, but the employee then jumped in a vehicle and went to, cause they saw what time the flight was going to leave from the ticket, took the bags, paged the person at the airport and delivered the bags to them. And that’s what you call customer service. That’s the way you get written up in Business Week and other places. And that’s the kind of thing they do training about, is we want you to do things that are unexpected. And as we get into today’s class a little bit more, I want you to think about a product that you think of as awesome. That the first time you experienced this product or service, you just thought, “Oh this is really awesome”. And I want to get at what makes…what is it that makes a product or service really awesome in the minds of the customer because that is what’s going to help get you a high net promoter score.

Student: It seems that in the case that a lot of times people that are doing a better job, it seems like that is also fairly unique. Like I feel like Nordstrom offering that customer service is also unique in that sense. And the same with Disneyland, you could argue that there are other people who offer that theme park fun experience, like Universal Studios or Six Flags, but Disneyland, not only do they have the unique one, but they are also better at doing it, them, than other people.

Professor: Yeah, so this is where…the only way you can differentiate the two, is that there is something protecting someone doing something that’s unique that it’s trademark, it’s patented, it’s something that means nobody else can do it the same way because of some sort of trademark or patent. So everybody could do what, it’s not like you couldn’t do what Nordstrom do. It’s not like they have a trademark or a patent or something that prevents it. They just do it because of great training and culture. The others could potentially do it, but nobody can actually put Mickey Mouse in their parks.

Student: So that’s the unique part.

Professor. That is the unique part. Is there is something about it that’s protected by intellectual property or others that makes it, sort of, impossible for someone else to actually imitate it. And that’s the only way you can distinguish the two because otherwise it is unique, it’s just not that it necessarily has to be, others could do it, but they just don’t. Yes?

Student: When we are talking about service, customer service. Does that part fall more into better quality or like a ____, or does that fall into _____(securing a process??).

Professor: Yeah, so when you think about, well if we move to quality and reliability. And actually why don’t we, let’s go through here and then we can talk about distinction because what you are asking and you are trying to get this sort of careful sense of this is a categorization, a taxonomy, and the question is, are these really mutually exclusive and exhaustive and how does that work. Because there really aren’t a lot of taxonomies out there around differentiation. And we have tried to create one that we think works, but a lot of times there are these areas that sort of overlap and it seems like they are pretty similar, but we will tell you how they are different. So what does more jobs is the iPhone, film digital cameras, the reason that they beat 35 millimeter wasn’t because of better picture quality. At the beginning picture quality was worse, but it was the ease of being able to take a picture and see it. You didn’t have to have the old Polaroid anymore to see your picture and know if it was good, and then it was just the ease with which you could send digital files, so it did more jobs. Eventually it did catch up in terms of picture quality as well. And then the unique job, I’ve got here Disney does a fairly unique job. I think, in many ways, Build-A-Bear, the way you build certain bears that are unique to Build-A-Bear Workshop is also fairly unique. Now let’s move to quality. Better reliability. So there are slightly different definitions of quality. The way we are using it here is that you create a product or service, it’s really a product that lasts longer. In other words it doesn’t do anything different, necessarily in terms of having a feature that it does something that another product doesn’t do, or doesn’t do more jobs, it doesn’t necessarily do anything unique. It just lasts longer. So you could have a company that could clone, have the same body style as a Honda Civic, let’s say, but if you had the two vehicles the Civic would probably just last longer. And that’s what we mean by quality and reliability, is it’s not really that it differentiates on any particular feature or job to be done. It does the same job, but it just lasts longer. It does it for longer. So you may be a subtle distinction, but we are trying to distinguish between features that actually do something different for the customer, do a different job for the customer, and those that simply where it’s just a reliability factor.

Student: And that would be ______ (the beginning??) of a company’s life, so that’s just establishing the time. They didn’t establish themselves and say, “Hey we are going to last longer _____.

Professor: That’s right. It wasn’t until Toyota and Honda had been in the US car business for 20 years that people started realizing that they lasted longer, they went more miles. In fact I just saw an advertisement last night, Volkswagen’s advertisement or are now advertising they have more cars on the road with more than 100,000 miles trying to pitch this idea, our cars are more reliable, they will last longer, as a way to differentiate their product. And because companies will sometimes do that as a way to differentiate, it’s not like they are trying to do something like, our car does this or this or this that’s different. It just lasts longer. Alright, more convenient to find, purchase, or use. So this is thinking of convenience very broadly as an issue. We think of Starbucks and Coke as differentiating mainly on brand. When you think about Starbucks or Coke, we did the coke case, it’s mainly brand. And I think that is true. However, think about when, we are going to do a case on Starbucks on Wednesday, but Starbucks. If you’re in downtown San Francisco or downtown Seattle, you have to have a pretty poor arm to not be able to pick up a rock and throw it to the next Starbucks if you were standing at a Starbucks. They are so close, there are so many. They are so convenient that if you need a coffee, you don’t have to go hunt. There is a Starbucks that is really close within probably two blocks that you could walk to. And the convenience of being able to get it, also, is a differentiator, in addition to the brand. And that is true for Coke and Pepsi. Their vending machine network is so extensive that a lot of times we will go grab something that’s at the vending machine because that’s what is convenient. And if it happens to be a Coke machine, then we will take a Coke, or if it’s a Pepsi machine, then we will take a Pepsi or one of their Pepsi beverages. But it’s just more convenient to find. Or it’s more convenient to purchase. So that could be another difference. It is just easier to buy. One-click shopping at Amazon has made it easier for people to buy. They keep all your credit card information on file, so you just one-click and you’re done. You don’t have to reenter things in. That’s just more convenient. So there are a variety of ways that a product could be more convenient either to buy, to find, or to use. It could be more convenient to use. Yes?

Student: What’s the logic on Starbucks having stores across the street from each other?

Professor: Let’s save that, and I’ll ask you that on Wednesday.

Student: OK.

Professor: Alright. So think about that. Remind me to ask Samuel about what the answer would be because the answer to that is on Wednesday.

Student: Kind of referring back to his question about Nordstrom and how we categorize it. Is convenience to return the product?

Professor: Making it easy to return?

Student: Yeah. Does it matter how we categorize it as whether it is superior, better quality, or convenience.

Professor: So convenience, this is where you could argue that Nordstrom is more convenient. That is part of their better service, so they do a better job on that existing feature of convenience. So I think you could argue that there is some overlap there in terms of, well they do a better job on that existing feature by just being convenient. But because there are so many different ways you can be convenient, I think it is important. A lot of times, when you are thinking about how do we, the reason I want to give you this typology, this way of thinking about it is, let’s say you are sitting down, whether it is software or something else. You are working in Product Development and you are asking yourself how can we differentiate this product? What could we do that’s different? And then what you could do, is you can lay out and you say, “Ok. What are the things we think customers are looking for today? How do we do a better job on any of those?” Are there other things we could add to our product so that it could do more jobs than competing projects, or are there things that our product could do that others can’t do? Let’s look at that as an option. Is there something that we could trademark, or we could patent to do something that is unique relative to everybody else? Is there some way we could make our product more reliable than anybody else. The Energizer Bunny, it’s all about reliability. It’s not like the battery…It’s just that it lasts longer, right? But you could go through this and then you get to convenience and you say, “Is there any way we could make it more convenient to find, purchase, to use. Or is there any way we could create brand. So it gives you a way to systematically go through, and think of ways that you could differentiate a product or service. Does that make sense? That’s why it is nice to have this kind of taxonomy or set of categories because it gives you ways to sort of systematically go through and look for opportunities to differentiate a product or service. Finally, there is brand image. And we normally think about brand as a prestige or luxury. A lot of people think of, you hire Gucci, or Brosacci, or Prada, or whatever it might be because you want to be identifying yourself with that exclusive club. The job to be done is much more emotional than it is functional. Now there are Prada diaper bags, but I don’t know that there are. Usually young couples with young kids are looking more for diaper bags that are functional, that meet certain functional requirements as opposed to, maybe, the social or emotional, although I’m sure there probably are…

Student: Yeah, there are.

Professor: So I’m sure there are all types, but people maybe tend to move towards the functional for some kinds of products and others will move towards more the emotional. So we tend to think of it as luxury, but it doesn’t have to be luxury. Harley Davidson is kind of luxury, but as we talked about it, it really has more to do with personal identity that has to do with individualism, and a little bit of rebelliousness, and American’s, and so on. Jell-O, if you think about that brand, most of us…because certain products pioneer a product category they have their name associated with the product category. So technically it is gelatin. We don’t buy Jell-O. We buy gelatin. Jell-O is just the brand, and you can buy other kinds of gelatin, but because they were first, and they pioneered it. The same is true with Kleenex. We think about buying Kleenex instead of tissues. So sometimes you’ll see that. And then, Prius, I don’t think you’d see as a prestige brand necessarily, but would some people want to identify themselves with Prius. Why?

Student: Because they find the Prius environmentally conscious.

Professor: Yeah. It’s like, I want to demonstrate that I’m environmentally conscious and so I want to identify with that brand. So it could be a variety of different ways that you could connect with people. It doesn’t have to be necessarily prestige. And those tend to be the primary ways that you differentiate.

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What is the source of differentiation advantage?

Superior Product Features

Does a better job on existing features

Does more “jobs” than other products

Better Quality/Reliability

More convenient to find, purchase, use

Brand/Image

Does a “unique” job that nothing else does

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Copyright ©2020 John Wiley & Sons, Inc.

Differentiation Advantages

Differentiation strategies require a deeper understanding of the customer’s needs than cost-based strategies.

This typically requires:

Customer segmentation analysis

Consumption chain analysis

In order to be good at it, you typically have to understand customer’s needs better than cost based strategies. This typically requires doing customer segmentation analysis, or doing consumption chain analysis. What are three different ways that you can segment customers? And this was described in the chapter. There are three different ways that you can segment customers. There are probably more than that, but yeah.

Student: Was it by behavioral.

Professor: Ok. So you could think of it as behavioral, but I’m going to put that into the category of you’re trying to understand the circumstances they are in and they job that they have to get done.

Student: Yeah, ok. Those are by demographic.

Professor: Demographics would be a second. Think about what we did on the board with Honda and Harley Davidson. We were segmenting by? What were the things along the bottom?

Student: Product Features.

Professor: Features. Product Features. So a third way is product features. If you did it by demographics, you might take 50-70 year olds, and you are going to have some 50-70 year olds that really might want to have very different features than other 50-70 year olds. They might want some of the same features as a 20 year old. Although directionally speaking, we expect 50-70 year olds to behave more similarly to each other than we expect them to behave like 20-30 year olds. So demographics is an easy way to do it.

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Customer Segmentation

Definition

Customer segmentation is the analysis of customer needs to identify groups of buyers who are similar in the way they discriminate among (and value) product or service offerings

Objective

To identify a profit and market share maximizing strategy for each need-based customer segment to minimize:

Over-satisfying some customer segment needs (excess financial cost)

Under-satisfying others (market share cost)

But when we think about different ways of segmenting, what we are trying to do is we are trying to group customers together who are similar in terms of what they want. And if we can group them together, then we can design products or services to meet the needs of that customer group, or that segment. And that is the way to be successful. You don’t have to be successful with every segment out there, but basically you are trying to identify a profit and maximize a profit and market share maximizing strategy. What you don’t want to do is if you add features that people don’t care about then you essentially over satisfied needs and there is a financial cost. You have put in things in there like maybe certain segments that don’t want that product, so you may want to have a bare bones product for a particular segment, and then you maybe want to have a more feature rich product for a different segment. And you may have a different set of features all together for a third different segment of the market. You don’t want to over satisfy needs because there is a financial cost, but you also don’t want to under satisfy needs because then there is a market share cost, you’ll have many customers who won’t choose your product or service.

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Segmentation Opportunities

So three different ways, 1) features of a product, 2) customer demographics, and 3) the attributes of the circumstance and job to be done. My experience as I have looked at what we tend to teach in marketing, and I think it’s generally true of BYU, but around the country we tend to teach mostly about segmenting based upon customer features and customer demographics. Job to be done is a little bit different and it is a little bit newer as a way to think about it. This is a language that was described by Clayton Christensen and if you think about a product like a drill, you don’t really want a drill. What do you want?

Students: A hole.

Professor: You want a hole, right? Of a certain size and type. You don’t want an iron and an ironing board. What do you want?

Students: An ironed shirt.

Professor: Wrinkle-free clothing, right? That’s what you want. One of the nice things about defining something as a job to be done is that if you are going in to try and innovate and you are trying to come up with a better way to get wrinkle-free clothing, if you think you’re trying to improve an iron and an ironing board, then you’ll focus only on the features of an iron and an ironing board, but there may be very different ways to create wrinkle-free clothing, and it could be much more innovative and better. I think that is one of the helpful things about defining this broadly as job to be done.

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Product Attributes

Features of the product

Customer Demographics

Attributes of the customer

Job-to-be Done

Attributes of the circumstance and job to be done

Different Ways to Segment the Market

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Copyright ©2020 John Wiley & Sons, Inc.

Identify key “jobs-to-be-done” through customer empathy and discovery

Understand customer functional, social, and emotional

jobs-to-be-done

Empathy

Solution

Job

What?

Why?

“People don’t want to buy
a quarter-inch drill…

…they want a quarter-inch hole!”

– Theodore Levitt

Get the job done by providing a solution that offers greater simplicity, convenience, cost, and access

Discovery

Look for jobs that are important, unmet, and widely-held

Key Message

A systematic JOBS process can illuminate difficult-to-articulate customer needs, pinpointing opportunities for innovation.

Talking Points

JOBS (Jobs, Objectives, Barriers, Solutions) is a market research technique that makes innovation effective, efficient, and predictable by systematically illuminating difficult-to-articulate customer needs and pinpointing corresponding solution attributes.

The tenets of JOBS-driven innovation are:

customers buy products and services to help them get “jobs” done, e.g., fundamental goals they are trying to accomplish as they go about their daily lives. Jobs anchor the overall approach. When markets are new or in flux due to disruptive opportunities, research can be framed around jobs. When incremental improvements are sought in an existing procedure, the job is likely clear and outcomes are the primary focus.

customers use metrics to define the successful execution of a specific job – these are their desired “objectives”.

Objectives are limited by “barriers” that inhibit consumption; designing a solution that removes or circumvents barriers will improve value or grow the market.

“Solutions” include any product, service, method, technology, and compensating behavior users can choose from to get the job done.

Discussion

A very relatable example of a job-to-be-done is that of an energy company that needs to satisfy peak demand. The job would be “Provide customers reliable energy during peak demand.” Some objectives for this job would be: low-cost, reliable, and environmentally responsible. A barrier might be the cost of building a large power plant. Solutions might include a new supply management system (Enernoc is a disruptive example) or a distributed set of smaller power plants.

And here are a few more examples of jobs-to-be-done:

Manager in an office: Give me fresh fruit that tastes good when I make a salad for lunch

Shop operator: I need to increase plant capacity by 60% within six months

HR manager: I need to “E-enable” (put on the Web) some of our HR processes for demanding constituents without setting myself up for failure!

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Example: Sometimes a Milkshake…
…isn’t just a milkshake

Functional Job: Yummy treat

Social Job:

Appease my kids

Emotional Job:

Commute companion

Milkshake

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How many people here like milkshakes?

Let’s say this half of the room is from a market research firm and who has been hired to help a quick-service restaurant chain increase sales of milkshakes. Your client is trying to understand why their sales aren’t higher when so many people out there like, like you, like milkshakes

What questions would you like to ask people?

Write these questions on a flip chart

Now let’s pretend the other half of the room is our customers. Answer the market researcher’s questions about what you’re looking for in a milkshake

Write these insights on a flipchart. You will likely hear more chocolaty, thicker, thinner, spill-proof, tastier, etc.

Is it clear how your client should innovate their milkshake business?

The client decided to hire a researcher to come in and understand what customers are trying to get done for themselves when they “hire” a milkshake

The researcher spent long days carefully observing who was buying milkshakes and they took very careful notes. What time did they buy? With a group or alone? Buy with a meal? Alone? Consume on the premises? Take it with them?

Do you know what time of day the majority of milkshakes are sold? Almost 50% are sold in the early morning

The researcher asked these customers: “job were you trying to get done for yourself” when you hired a milkshake? And when you don’t come here, what else do you buy/turn to. They all had a long and boring commuter. They needed something in their hand to make the long boring and commute more interesting and something that kept me full until lunch. Snickers? Gone fast, I feel guilty. Banana? Messy. Bagel? Dry, hard to swallow, make a mess, put jam on, gooey stuff on the steering wheel. Donuts? They’re gone fast. When I hire the milkshake, it is so viscous it takes 20 minutes to suck up the little straw. Not sure what in it, but stays in my stomach. The competition to solve the commuting companion is not just another company’s milkshake

Animate the slide to show the commuter

In the evening it was typically parents with their kids. They consumed their meals on the premises. The job for the parent is “I’ve been saying no all day long and my kid asks for one more thing and I want to yes to feel like a caring parent”. The kid asks “can I have a milkshake?” and the parent says yes. It takes the kid forever to suck that thick milkshake up the thin straw, the parent taps their foot and you throw it away half full

Animate the slide to show the child

You can imagine the implications for innovation. The morning Job you’d create a milkshake with a thinner straw, fruit, not so healthy but it’s a surprise, move machine in front of the counter, pre-paid swipe cards. Innovation becomes clear once you understand the job. If you do this, gain share, gain share against bananas, snickers. In the evening you’d make a thinner milkshake with a bigger straw.

Knowing what job a product gets hired to do, it can give innovators a much clearer roadmap for improving their products. Once you understand the job to be done, everything changes.

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Copyright ©2020 John Wiley & Sons, Inc.

Mapping the Consumption Chain

Another technique you could use to try and help figure out ways to differentiate is math and consumption chain. So we think about the supply chain or the value added chain is basically the series of steps that transform a product from raw materials into a final product that gets sold to the customer. So that is the value added chain or the supply chain. For cost advantage, you have to be really good at figuring out how do we make that as efficient as possible. For the customer chain it’s starting with the customer and you basically go through a series of questions that take you through the consumption chain. The first step is becoming aware that you might even need a product or service. That you have a job to be done. That you need to hire something to help you to get a job done. So the very first step is, how do they become aware? And then how will I find it? You might be able to differentiate on becoming just easier to find than the competition. Even if you’re not different on any particular features. It could be that you actually have a product that is differentiated on features, so this is how do they make their final selections, and what is the priority of attributes? How do they order or purchase your product? Can you make that more convenient and easier? How is your product serviced or delivered? Again, can we make that easier or more convenient, or less costly? Again, easier to pay for or easier to store or move around. Again, what is it actually used for? What do they want done? And what else do they use? Are there other things that they want to have with it that might be helpful? And then at the end of the day, how is the product repaired or serviced or disposed of? And you make that easier. So there are a whole variety of different ways that you could think of differentiating the product or service that actually has nothing to do with the product itself. It has to do with the steps that the consumer goes through to become aware of a product, to find it, to actually buy it, to take it to where it needs to get used, and then what else it needs to get used with and then even disposing it could be a differentiator. Yes?

Student: Quick question about the job to be done. Was there any sales revenue growth in that particular case? When he differentiated based on the of job to be done.

Professor: When they differentiated…yeah. They said that they were able to see growth on both sides, and for both segments of the market because the product was tailored. And that was the key. That you understood now there were two different segments and so instead of having one type of milkshake for everybody. You now tailor it for one type of product for the morning segment and a different type of product for the evening segment.

Student: Because it seems like a problem that could be there is that the customer themselves don’t even know the job that needs to be done. So I could be that morning person and now there could be a _____(tail??) of big shakes for me, but I wouldn’t even know the difference. I didn’t even know I wanted that.

Professor: Yeah. I think a lot of times that people don’t really quite realize. “Oh yeah. I’m buying this shake because it keeps me awake. I have this long boring commute. I don’t want to get hungry.” And they don’t quite fully recognize that this is what they are hiring it for, and what the other substitutes might be. So now that you know this, you could actually reach out to people that are doing commutes and advertise and try and let them know, here you can come in and quickly get a shake, something to take on that commute. You get through quickly. It’s a unique product. Come try it! And that will likely attract more customers.

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How do consumers become aware of a need for your product/service?

How do consumers find your offering?

How do consumers make their final selections (priority of attributes)

How do consumers order and purchase your product?

How is your product/service delivered?

How is your product/service paid for?

How is your product stored/moved around?

What is your product really used for (what “job” does the consumer want done)?

What do consumers need help with when they use the product?

How is your product repaired, service, disposed of?

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Copyright ©2020 John Wiley & Sons, Inc.

Differentiation

The essence of differentiation is to make choices that are different from those of rivals.

Successful differentiators create offerings that “delight” customers (“that was awesome”).

Delight and awesome products come from doing something unexpected or surprising….perceptively better than competitive offerings. (NPS helps here)

The essence of differentiation is to make choices that are different from those of rivals. So you’re not trying to get to one ideal position. You are actually trying to stake out a very different position than rivals, and offer a different value proposition. Successful differentiation create offerings that delight customers. Where they think, that was awesome!

(I combine this conversation with the NPS discussion on the next slide. All about “delighting” the customer)

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Implications from NPS Scores

So I wanted to ask you to think about, and I don’t know which products or services. If it was a product or service that you did for your net promoter score assignment, that’s great. If you didn’t, any particular product the first time you experienced it you thought this is pretty cool, or this is really awesome. Yeah?

Student: Five Guys.

Professor: Five Guys. So for the first time you thought, that’s a great burger.

Student: Yeah. It was awesome.

Professor: Ok.

Student: Friendlies has these waffle cheddar bacon fries that are like…

Professor: Is this the friendlies back east?

Student: Yeah.

Professor: Ok. I have never tried those.

Student: They are waffle cheddar bacon fries.

Professor: Waffle cheddar bacon fries. That is unique and it was like, this was awesome.

Student: Yeah. They are the best I have ever had.

Professor: Ok. Very good. Any other products that you just…

Student: Blendtec blender.

Professor: Blendtec blender. First time you threw in all of that metal and it blended it up, you thought that was pretty cool. Good. So Blendtec blender?

Professor: So what is it that fundamentally that makes a product or service come across to a customer as awesome? What do you think it is? Yeah?

Student: I find it that they tend to be more associated with the experience brands, like food sometimes. But I find that food always has an environment to it, or there is some type of, like it is a totally podunk place or a super glitzy place. For example, as a missionary I had some of the best tacos in the world in this podunk little place, and they were the best thing in the world. The experience of being next to the dog was so cool. I don’t know. It’s just the dog in itself.

Professor: You would take your bite and the dog takes his bite.

Student: It was awesome. It was a supply chain right there.

Professor: So you go in to this dive and you have this amazing food. And it is almost surprising. Yeah?

Student: It just exceeds expectation of the customer.

Professor: Yeah. Fundamentally we tend to think something is really awesome when it exceeds our expectations. When it does something that is unexpected. So this is for everybody in here, but mostly for the guys because we don’t tend to be as good at this. If you want to get an awesome reaction from a girlfriend or a spouse. If you want to give a gift, you have to give it when it is unexpected. That is when you get the real kudos. If you give a gift on the birthday, I mean, it has to be something special that is unexpected on the birthday for it to really draw that really strong response. Cause I expect to get stuff on my birthday. In fact, if you don’t get a gift on your birthday, if you don’t give a gift, then you are really in the dog house because you didn’t meet the expectations. To exceed the expectations you have to give the gift when they aren’t expecting it. And then it is out of the blue and just because. It’s just because you are so wonderful. I wanted to give you this gift. Then it is a surprise. I have noticed some of the girls in here, sort of nodding. Yes, they get that. It goes both ways. So it’s true with products and services. When it does something, I think, sometimes the dives actually, you go in and the food is so much better than you expected or it is so good. It’s like wow! That is really good. Or when it is something that you try that you haven’t tried before and it is really different and it’s really good. Then of course you get that same “Oh, it’s unexpectedly good.” It exceeded my expectations. That’s awesome. When something just meets your expectations, then we don’t tend to experience a product as really being awesome. If you want to turn your customers into sales people, you want them to have that awesome experience because that is when they will go tell somebody. It’s when you have had that great service experience that you’ll tell somebody, “Man! I had this really good experience. Anybody who wants this should go try this.” Or “If you want to try a great taco or a great bacon waffle fry thing, whatever that thing is.” You have someone out there who is now promoting your product and that is a great way to differentiate. So from my view, the underlying theory around how you really differentiate in a way that gets you a high net promoter’s score and really differentiates this, is you’re trying to do something that is unexpectedly good, and they go beyond expectations. Yes?

Student: Maybe you’re going to get _____. You need to go the opposite way too. If you go in with certain expectations and those aren’t met, like I’ll tell people not to go watch a movie or something if I had expectations and they weren’t met. Whereas, if I just went in there with no expectations, ______________.

Professor: Absolutely true. Yes?

Student: I was just going to ask if it is ever an effective strategy to instead of trying to make your product that much awesome, if you try to lower their expectations.

Professor: I haven’t really seen that used as a strategy. Don’t expect much and then when they come in, “Oh that’s pretty good. I wasn’t really expecting this.”

Student: Just kind of going along with that. We did our research on iPhones and Samsung Galaxy phones and the main reason that the tractors gave for not being happy with their iPhone was a lack of new innovation. So I just thought it was interesting that their expectation of innovation in future products was detracting from how they saw their current product.

Professor: So what was your net promoter score for iPhone?

Student: So our net promoter score for iPhone was 62 percent.

Professor: 62 percent net promoter score?

Student: Yeah.

Professor: What was your net promoter score for the Galaxy?

Student: It was a 48 percent.

Professor: 48 percent? So 62 to 48. So iPhone still had a higher net promoter score, but for those that weren’t as excited about iPhone, it’s like, you expect iPhone to still be the technological leader. And when Galaxy all of the sudden started having things that iPhone didn’t, it was disappointing for Apple lovers because they thought, “Our products are always supposed to have the coolest new things. It shouldn’t be coming from somewhere else. And we have seen iPhone dropping. What other products or services did you do net promoter scores on that someone would share what you learned? What were the other?

Professor: Cannon and Nikon cameras?

Professor: And what did you find? Which one had the better net promoter score?

Cannon camera to Nikon camera NPS was a 53 to 50? So that’s a statistical… basically, pretty similar. Not one nor the other is really differentiating relative to one versus the other. And that’s another thing a net promoter score can tell you. One is it tells you the level overall, but also relative to competition, are we really different or are we not? And in this case, Cannon people out there can like Nikon about the same. Yeah?

Student: We had one that had a pretty big difference. We did Pandora and Spotify. Spotify had a 70 percent net promoter score and Pandora had about 5 percent.

Professor: Really? And what was driving the big difference?

Student: Well it was interesting. The promoters of Pandora, the reason that they said they would recommend it is because it was free. It was because of the price. It was a lot higher than that was Spotify. So from that I kind of concluded that there weren’t a lot of good things about Pandora that made its users want to recommend it. Whereas with Spotify, their differentiator was the ability to pick your own songs instead of just having to listen to random songs.

Professor: This is where you can do early market research. So right now, if you had to buy stock in one of those two. You would probably say Spotify probably had more potential right now because they are turning more people into promoters of their product which is going to lead to more growth.

Student: Yeah. They had a huge growth percentage. In one year they had about a 3,000 percent growth.

Professor: Interesting. Is Spotify becoming pretty popular among…

Students: Yeah!!

Professor: Ok. What about Apple? So Apple has announced their old free music. What about Apple? Is Apple doing well in that space?

Students: iTunes Radio.

Professor: Yeah. Is it iTunes Radio?

Students: It’s pretty cool because they are lists. Like top 100 lists.

Professor: Even that would be an interesting one to compare too. Any other examples of what two products you looked at? Yeah?

Student: We looked at Apple and Microsoft.

Professor: Just as the companies?

Student: Companies, but I think you need to look at Operating Systems as well. What they provide and we got a net promoter score of 44 percent for Apple and then about 0 percent for Microsoft.

Professor: Yeah, because there are a lot of detractors. You have people that like it that there are a lot of detractors as well.

Student: We actually had the exact same, but ours was 34 percent for Apple and 27 percent for Microsoft.

Professor: So Apple wasn’t as far ahead.

Student: The interesting thing about that is that the main reason people use Windows is because it is familiar. It is what they grew up with. And that was the top one. Even though people liked Apple’s operating system better, Microsoft was the first mover. They were there and a lot of people know it.

Professor: So one of the things that we learn around differentiation is the _______(delight nosser products??) tend to come from doing something that is unexpected. It tends to be a pretty good picture of growth and net promoter score is used at a lot of companies today. So I would suspect that probably half of the larger companies today use net promoter score in some way or another to manage whether or not they are doing a good job of satisfying customers.

Students: I’m not sure if this is something that kind of ties into this, but one thing that I face when I go to work is Wells Fargo, Chase, Target, they all have scales that are usually on 1 to 5 or 1 to 10 and Gallop will call up Wells Fargo customers as they actually leave the bank and ask you “On a scale of 1 to 10 how did you think the employee met all these metrics. Because they did the same analysis, I don’t know what that is, but they basically you have to get a 10 out of 10 in order to get credit for it as a store, and if you get a 9 on any of those 5 metrics, you get a 0, and they basically look at the percentage inside the store and they say, “What was the customer satisfaction for the quarter and the bonus is based on that, but it looks like it’s almost the same idea as the scale of 1 to 10 that determines whether or not people are net promoters, like you gave them that which was awesome.

Professor: That’s a great experience. And you are only getting credit if you get 10’s not even 9’s.

Student: Not even 9’s. You have to get straight 10’s across the board.

Professor: This is grade inflation. They are expecting even more at some places.

Student: And the one “That we need to grow” article, it talked about how the net promoters offers a really simplistic, much cheaper, and more effective way to view customer satisfaction and here is how it’s impacting your growth. Is there any down sides that net promoter scores have when compared to the traditional customer satisfaction metrics.

Professor: I think net promoter score has caught on because it is easy to understand and pretty easy to implement. So I thing that’s why we are seeing it being use a lot in statistic. It’s like ok, I understand it. And it’s easy to gather that information and easy to use. I think we find it tends to be better, it’s more effective with consumer products than industrial products, and there are more sophisticated ways to try and get at the satisfaction of some industrial products.

The one thing I added to your assignment that you don’t see with the typical net promoter score is, now look at your detractors and your promoters and try and understand the primary reasons that they are promoters or detractors. You want to know more than just my net promoter score. I want to know why people are promoting and why people are detracting. Cause then it gives me an idea for where I want to continue to invest and what I need to fix. So my recommendation for you is to, if you are ever in a situation where you want to use the net promoter score, I would add that part to it because it’s going to give you more information around why people are detractors and why they are promoters.

By the way, differences of positioning are now necessary, but not sufficient to create competitive advantage. Why?

Student: Because, so you are talking about differences in positioning like there is net promoter score?

Professor: Yeah. Or differences in a different value proposition are maybe necessary to differentiate, but not sufficient for competitive advantage.

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Differentiation

The essence of differentiation is to make choices that are different from those of rivals.

Successful differentiators create offerings that “delight” customers (“that was awesome”).

Delight and awesome products come from doing something unexpected or surprising….perceptively better than competitive offerings. (NPS helps here)

Differences in positioning are necessary but not sufficient to create a competitive advantage

Sustainable advantage depends on barriers to imitation

(I finish up last bullet after NPS discussion)

4. The key is, you have to have a barrier limitation. If you differentiate on a feature and others can differentiate as well, if they can copy you, then it isn’t sustainable. So what you are trying to do is find the areas where it’s not only something that’s different but it’s sustainable because you have created a barrier limitation. It’s hard for others to imitate.

Student: Would an example be if we looked at Harley Davidsons. They have their various nature, but they are really bad at fashion producers of motorcycles. Would that be another example of positioning with cycles but not everything?

Professor: Yeah. In some ways at least their brand itself is quit unique. But if we think about Pandora. Pandora came out and it was different. It was something that was unique, something that was different, but now it has been imitated. Spotify has gone beyond in providing things that people like even better. The iTunes Radio. So you could do something different, but just remember, if others can imitate you pretty quickly, you lose your source of competitive advantage really fast.

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A

B

C

D

A

B

C

Barriers to Entry

Barriers to Imitation

Barriers to entry shared by all industry competitors; barriers to imitation are firm-specific.

Barriers to imitation are created by firms through developing unique resources and capabilities.

Barriers to imitation are primarily of two types:

Barriers to cost imitation (e.g., access to inputs, scale, experience)

Barriers to product/service imitation and accessing customers (e.g., features, patents, brands, convenience, etc.)

Barriers to imitation also act as barriers to entry.

7% ROA

5% ROA

15% ROA

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Some barriers to entry protect all of the companies in an industry for example large economies of scale or steep experience curves prevents new entrants and helps all in industry.

Barriers to imitation are specific to a firm. Meaning a Walmart in a small town creates a barrier to entry in a small market to that kind of store. Or a brand is a barrier to imitation at a firm level. Brands, Patents, preemptions of specific locations that are enjoyed by a specific firm.

Whereas barriers to entry are protecting all firms

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Copyright

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All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

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Copyright ©2020 John Wiley & Sons, Inc.

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Copyright

Copyright © 2020 John Wiley & Sons, Canada, Ltd.

All rights reserved.  Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.

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Unit 3: Overview – Evaluating the Internal Environment

Introduction

In traditional approaches to assessing an organization’s internal environment, a manager’s primary goal would be to determine the firm’s relative strengths and weaknesses.  These also are two elements of the SWOT analysis. There are many limitations of SWOT analysis, however, including its static perspective, the potential to overemphasize a single dimension of a firm’s strategy, and the likelihood that an organization’s strengths do not necessarily help the firm create value or competitive advantages.

There are two frameworks that serve to complement SWOT analysis in assessing a firm’s internal environment: Porter’s value chain analysis and the resource-based view of the firm. In conducting a value chain analysis, a manager first divides the firm into a set of value creating activities. These include primary activities such as inbound logistics, operations, and service as well as support activities that include procurement and human resources management. The manager then analyzes how each activity adds value as well as how interrelationships among value activities in the firm and among the firm and its customers and suppliers add value. Thus, instead of merely determining a firm’s strengths and weaknesses per se,  the manager has analyzed them in the overall context of the firm and its relationships with customers, suppliers, and the value system.

Part of the internal strategy development process is determining what strategies a company can use best based on their resources.  The company’s resources will help determine if it is best to differentiation based on a specific market segment (seniors), on cost (lowest price), or on a focused differentiation (always first with current technology).  Each of these strategies requires  different resources in personnel, material and speed of internal process.

Unit Learning Outcomes

At the conclusion of the unit, the learner will be able to:

1. Apply a value chain analysis and describe its value as an internal strategic tool. (CLO 3, 6)

2. Differentiate between the vision and mission of an organization and how they reflect an organization’s culture. (CLO 2)

3. Evaluate how organization’s business model, systems and culture affect the strategy and tactics the organization might use to meet goals and objectives. (CLO 2)

Unit 3: Discussion 1

Directions

After reading the course materials, including Mukerjee  (2016) (a good overview of the factors for competitive advantage!), apply the most relevant two elements of a value chain analysis to an organization of your choice. Justify your choice of elements as to why they are important for that organization.

Describe one or two strategic tactics the organization might try (or already uses) based on the value chain analysis and justify why the tactic is useful as a competitive advantage tool.