Kamis, 30 Juli 2009

Porter's Generic Strategies

Michael Porter has described a category scheme consisting of three general types of strategies that are commonly used by businesses to achieve and maintain competitive advantage. These three generic strategies are defined along two dimensions: strategic scope and strategic strength. Strategic scope is a demand-side dimension (Porter was originally an engineer, then an economist before he specialized in strategy) and looks at the size and composition of the market you intend to target. Strategic strength is a supply-side dimension and looks at the strength or core competency of the firm. In particular he identified two competencies that he felt were most important: product differentiation and product cost (efficiency).

He originally ranked each of the three dimensions (level of differentiation, relative product cost, and scope of target market) as either low, medium, or high, and juxtaposed them in a three dimensional matrix. That is, the category scheme was displayed as a 3 by 3 by 3 cube. But most of the 27 combinations were not viable.

In his 1980 classic Competitive Strategy: Techniques for Analysing Industries and Competitors, Porter simplifies the scheme by reducing it down to the three best strategies. They are cost leadership, differentiation, and market segmentation (or focus). Market segmentation is narrow in scope while both cost leadership and differentiation are relatively broad in market scope.

Empirical research on the profit impact of marketing strategy indicated that firms with a high market share were often quite profitable, but so were many firms with low market share. The least profitable firms were those with moderate market share. This was sometimes referred to as the hole in the middle problem. Porter’s explanation of this is that firms with high market share were successful because they pursued a cost leadership strategy and firms with low market share were successful because they used market segmentation to focus on a small but profitable market niche. Firms in the middle were less profitable because they did not have a viable generic strategy.

Combining multiple strategies is successful in only one case. Combining a market segmentation strategy with a product differentiation strategy is an effective way of matching your firm’s product strategy (supply side) to the characteristics of your target market segments (demand side). But combinations like cost leadership with product differentiation are hard (but not impossible) to implement due to the potential for conflict between cost minimization and the additional cost of value-added differentiation.

Since that time, some commentators have made a distinction between cost leadership, that is, low cost strategies, and best cost strategies. They claim that a low cost strategy is rarely able to provide a sustainable competitive advantage. In most cases firms end up in price wars. Instead, they claim a best cost strategy is preferred. This involves providing the best value for a relatively low price.

Cost Leadership Strategy
This strategy emphasizes efficiency. By producing high volumes of standardized products, the firm hopes to take advantage of economies of scale and experience curve effects. The product is often a basic no-frills product that is produced at a relatively low cost and made available to a very large customer base. Maintaining this strategy requires a continuous search for cost reductions in all aspects of the business. The associated distribution strategy is to obtain the most extensive distribution possible. Promotional strategy often involves trying to make a virtue out of low cost product features.

To be successful, this strategy usually requires a considerable market share advantage or preferential access to raw materials, components, labour, or some other important input. Without one or more of these advantages, the strategy can easily be mimicked by competitors.

Successful implementation also benefits from:
  • process engineering skills
  • products designed for ease of manufacture
  • sustained access to inexpensive capital
  • close supervision of labour
  • tight cost control
  • incentives based on quantitative targets.
always ensure that the costs are kept at the minimum possible level.

When a firm designs, produces and markets a product more efficiently than competitors such firm has implemented a cost leadership strategy. Cost reduction strategies across the activity cost chain will represent low cost leadership. Attempts to reduce costs will spread through the whole business process from manufacturing to the final stage of selling the product. Any processes that do not contribute towards minimization of cost base should be outsourced to other organisations with the view of maintaining a low cost base. Low costs will permit a firm to sell relatively standardised products that offer features acceptable to many customers at the lowest competitive price and such low prices will gain competitive advantage and increase market share. These writings explain that cost efficiency gained in the whole process will enable a firm to mark up a price lower than competition which ultimately results in high sales since competition could not match such a low cost base. If the low cost base could be maintained for longer periods of time it will ensure consistent increase in market share and stable profits hence consequent in superior performance. However all writings direct us to the understanding that sustainability of the competitive advantage reached through low cost strategy will depend on the ability of a competitor to match or develop a lower cost base than the existing cost leader in the market.

A firm attempts to maintain a low cost base by controlling production costs, increasing their capacity utilization, controlling material supply or product distribution and minimizing other costs including R&D and advertising. Mass production, mass distribution, economies of scale, technology, product design, learning curve benefit, work force dedicated for low cost production, reduced sales force, less spending on marketing will further help a firm to main a low cost base. Decision makers in a cost leadership firm will be compelled to closely scrutinise the cost efficiency of the processes of the firm. Maintaining the low cost base will become the primary determinant of the cost leadership strategy. For low cost leadership to be effective a firm should have a large market share. New entrants or firms with a smaller market share may not benefit from such strategy since mass production, mass distribution and economies of scale will not make an impact on such firms. Low cost leadership becomes a viable strategy only for larger firms. Market leaders may strengthen their positioning by advantages attained through scale and experience in a low cost leadership strategy. But is their any superiority in low cost strategy than other strategic typologies? Can a firm that adopts a low cost strategy out perform another firm with a different competitive strategy? If firms costs are low enough it may be profitable even in a highly competitive scenario hence it becomes a defensive mechanism against competitors. Further they mention that such low cost may act as entry barriers since new entrants require huge capital to produce goods or services at the same or lesser price than a cost leader. As discussed in the academic frame work of competitive advantage raising barriers for competition will consequent in sustainable competitive advantage and in consolidation with the above writings we may establish the fact that low cost competitive strategy may generate a sustainable competitive advantage. However, this is not true in all cases.

Further in consideration of factors mentioned above that facilitate a firm in maintaining a low cost base; some factors such as technology which may be developed through innovation (mentioned as creative accumulation in Schumpeterian innovation) and some may even be resources developed by a firm such as long term healthy relationships build with distributors to maintain cost effective distribution channels or supply chains (inimitable, unique, valuable non transferable resource mentioned in RBV). Similarly economies of scale may be an ultimate result of a commitment made by a firm such as capital investments for expansions (as discussed in the commitment approach). Also raising barriers for competition by virtue of the low cost base that enables the low prices will result in strong strategic positioning in the market (discussed in the IO structural approach). These significant strengths align with the four perspectives of sustainable competitive advantage mentioned in the early parts of this literature review. Low cost leadership could be considered as a competitive strategy that will create a sustainable competitive advantage.



However, low cost leadership is attached to a disadvantage which is less customer loyalty. Relatively low prices will result in creating a negative attitude towards the quality of the product in the mindset of the customers. Customer’s impression regarding such products will enhance the tendency to shift towards a product which might be higher in price but projects an image of quality. Considering analytical in depth view regarding the low cost strategy, it reflects capability to generate a competitive advantage but development and maintenance of a low cost base becomes a vital, decisive task.

Differentiation Strategy
Differentiation is aimed at the broad market that involves the creation of a product or services that is perceived throughout its industry as unique. The company or business unit may then charge a premium for its product. This specialty can be associated with design, brand image, technology, features, dealers, network, or customers service. Differentiation is a viable strategy for earning above average returns in a specific business because the resulting brand loyalty lowers customers' sensitivity to price. Increased costs can usually be passed on to the buyers. Buyers loyalty can also serve as an entry barrier-new firms must develop their own distinctive competence to differentiate their products in some way in order to compete successfully. Examples of the successful use of a differentiation strategy are Hero Honda, Asian Paints, HLL, Nike athletic shoes, Perstorp BioProducts, Apple Computer, and Mercedes-Benz automobiles. Research does suggest that a differentiation strategy is more likely to generate higher profits than is a low cost strategy because differentiation creates a better entry barrier. A low-cost strategy is more likely, however, to generate increases in market share. This may or may not be true.

Variants on the Differentiation Strategy
The shareholder value model holds that the timing of the use of specialized knowledge can create a differentiation advantage as long as the knowledge remains unique [1]. This model suggests that customers buy products or services from an organization to have access to its unique knowledge. The advantage is static, rather than dynamic, because the purchase is a one-time event.

The unlimited resources model utilizes a large base of resources that allows an organization to outlast competitors by practicing a differentiation strategy. An organization with greater resources can manage risk and sustain losses more easily than one with fewer resources. This deep-pocket strategy provides a short-term advantage only. If a firm lacks the capacity for continual innovation, it will not sustain its competitive position over time.

Focus Strategy
In this strategy the firm concentrates on a select few target markets. It is also called a segmentation strategy or niche strategy. It is hoped that by focusing your marketing efforts on one or two narrow market segments and tailoring your marketing mix to these specialized markets, you can better meet the needs of that target market. The firm typically looks to gain a competitive advantage through product innovation and/or brand marketing rather than efficiency. It is most suitable for relatively small firms but can be used by any company. A focus strategy should target market segments that are less vulnerable to substitutes or where a competition is weakest to earn above-average return on investment.

Examples of firm using a focus strategy include Southwest Airlines, with provides short-haul point-to-point flights in contrast to the hub-and-spoke model of mainstream carriers, and Family Dollar, which targets poor urban American families who can not drive to Wal-Marts in the suburbs because they do not own a car.

Recent developments
Michael Treacy and Fred Wiersema and tarun (1993) have modified Porter's three strategies to describe three basic "value disciplines" that can create customer value and provide a competitive advantage. They are operational excellence, product leadership, and customer intimacy.

Criticisms of generic strategies
Several commentators have questioned the use of generic strategies claiming they lack specificity, lack flexibility, and are limiting.
In particular, Miller (1992) questions the notion of being "caught in the middle". He claims that there is a viable middle ground between strategies. Many companies, for example, have entered a market as a niche player and gradually expanded. According to Baden-Fuller and Stopford (1992) the most successful companies are the ones that can resolve what they call "the dilemma of opposites".< A popular post-Porter model was presented by W. Chan Kim and Renée Mauborgne in their 1999 Harvard Business Review article "Creating New Market Space". In this article they described a "value innovation" model in which companies must look outside their present paradigms to find new value propositions. Their approach fundamentally goes against Porter's concept that a firm must focus either on cost leadership or on differentiation. They later went on to publish their ideas in the book Blue Ocean Strategy.

An up-to-date critique of generic strategies and their limitations, including Porter, appears in Bowman, C. (2008) Generic strategies: a substitute for thinking? [1]

If the primary determinant of a firm's profitability is the attractiveness of the industry in which it operates, an important secondary determinant is its position within that industry. Even though an industry may have below-average profitability, a firm that is optimally positioned can generate superior returns.

A firm positions itself by leveraging its strengths. Michael Porter has argued that a firm's strengths ultimately fall into one of two headings: cost advantage and differentiation. By applying these strengths in either a broad or narrow scope, three generic strategies result: cost leadership, differentiation, and focus. These strategies are applied at the business unit level. They are called generic strategies because they are not firm or industry dependent.

The following table illustrates Porter's generic strategies:

Porter's Generic Strategies
Target ScopeAdvantage
Low CostProduct Uniqueness

Broad (Industry Wide)
Cost Leadership
Strategy
Differentiation
Strategy

Narrow
(Market Segment)
Focus
Strategy

(low cost)
Focus
Strategy

(differentiation)


Cost Leadership Strategy

This generic strategy calls for being the low cost producer in an industry for a given level of quality. The firm sells its products either at average industry prices to earn a profit higher than that of rivals, or below the average industry prices to gain market share. In the event of a price war, the firm can maintain some profitability while the competition suffers losses. Even without a price war, as the industry matures and prices decline, the firms that can produce more cheaply will remain profitable for a longer period of time. The cost leadership strategy usually targets a broad market.

Some of the ways that firms acquire cost advantages are by improving process efficiencies, gaining unique access to a large source of lower cost materials, making optimal outsourcing and vertical integration decisions, or avoiding some costs altogether. If competing firms are unable to lower their costs by a similar amount, the firm may be able to sustain a competitive advantage based on cost leadership.

Firms that succeed in cost leadership often have the following internal strengths:

  • Access to the capital required to make a significant investment in production assets; this investment represents a barrier to entry that many firms may not overcome.

  • Skill in designing products for efficient manufacturing, for example, having a small component count to shorten the assembly process.

  • High level of expertise in manufacturing process engineering.

  • Efficient distribution channels.

Each generic strategy has its risks, including the low-cost strategy. For example, other firms may be able to lower their costs as well. As technology improves, the competition may be able to leapfrog the production capabilities, thus eliminating the competitive advantage. Additionally, several firms following a focus strategy and targeting various narrow markets may be able to achieve an even lower cost within their segments and as a group gain significant market share.

Differentiation Strategy

A differentiation strategy calls for the development of a product or service that offers unique attributes that are valued by customers and that customers perceive to be better than or different from the products of the competition. The value added by the uniqueness of the product may allow the firm to charge a premium price for it. The firm hopes that the higher price will more than cover the extra costs incurred in offering the unique product. Because of the product's unique attributes, if suppliers increase their prices the firm may be able to pass along the costs to its customers who cannot find substitute products easily.

Firms that succeed in a differentiation strategy often have the following internal strengths:

  • Access to leading scientific research.

  • Highly skilled and creative product development team.

  • Strong sales team with the ability to successfully communicate the perceived strengths of the product.

  • Corporate reputation for quality and innovation.

The risks associated with a differentiation strategy include imitation by competitors and changes in customer tastes. Additionally, various firms pursuing focus strategies may be able to achieve even greater differentiation in their market segments.

Focus Strategy
The focus strategy concentrates on a narrow segment and within that segment attempts to achieve either a cost advantage or differentiation. The premise is that the needs of the group can be better serviced by focusing entirely on it. A firm using a focus strategy often enjoys a high degree of customer loyalty, and this entrenched loyalty discourages other firms from competing directly.

Because of their narrow market focus, firms pursuing a focus strategy have lower volumes and therefore less bargaining power with their suppliers. However, firms pursuing a differentiation-focused strategy may be able to pass higher costs on to customers since close substitute products do not exist.

Firms that succeed in a focus strategy are able to tailor a broad range of product development strengths to a relatively narrow market segment that they know very well.

Some risks of focus strategies include imitation and changes in the target segments. Furthermore, it may be fairly easy for a broad-market cost leader to adapt its product in order to compete directly. Finally, other focusers may be able to carve out sub-segments that they can serve even better.

A Combination of Generic Strategies

- Stuck in the Middle?

These generic strategies are not necessarily compatible with one another.
If a firm attempts to achieve an advantage on all fronts, in this attempt it may achieve no advantage at all.
For example, if a firm differentiates itself by supplying very high quality products, it risks undermining that quality if it seeks to become a cost leader.
Even if the quality did not suffer, the firm would risk projecting a confusing image.
For this reason, Michael Porter argued that to be successful over the long-term,
a firm must select only one of these three generic strategies.
Otherwise, with more than one single generic strategy the firm will be "stuck in the middle" and will not achieve a competitive advantage.

Porter argued that firms that are able to succeed at multiple strategies often do so by creating separate business units for each strategy. By separating the strategies into different units having different policies and even different cultures, a corporation is less likely to become "stuck in the middle."

However, there exists a viewpoint that a single generic strategy is not always best because within the same product customers often seek multi-dimensional satisfactions such as a combination of quality, style, convenience, and price.
There have been cases in which high quality producers faithfully followed a single strategy and then suffered greatly when another firm entered the market with a lower-quality product that better met the overall needs of the customers.

Generic Strategies and Industry Forces

These generic strategies each have attributes that can serve to defend against competitive forces.
The following table compares some characteristics of the generic strategies in the context of the Porter's five forces.

Generic Strategies and Industry Forces




















Industry
Force
Generic Strategies
Cost LeadershipDifferentiationFocus
Entry
Barriers
Ability to cut price in retaliation deters potential entrants.Customer loyalty can discourage potential entrants.Focusing develops core competencies that can act as an entry barrier.
Buyer
Power
Ability to offer lower price to powerful buyers.Large buyers have less power to negotiate because of few close alternatives.Large buyers have less power to negotiate because of few alternatives.
Supplier
Power
Better insulated from powerful suppliers.Better able to pass on supplier price increases to customers.Suppliers have power because of low volumes, but a differentiation-focused firm is better able to pass on supplier price increases.
Threat of
Substitutes
Can use low price to defend against substitutes.Customer's become attached to differentiating attributes, reducing threat of substitutes.Specialized products & core competency protect against substitutes.
RivalryBetter able to compete on price.Brand loyalty to keep customers from rivals.Rivals cannot meet differentiation-focused customer needs.

Recommended Reading

From the three generic business strategies Porter stress the idea that only one strategy should be adopted by a firm and failure to do so will result in “ stuck in the middle” scenario. He discuss the idea that practising more than one strategy will lose the entire focus of the organisation hence clear direction of the future trajectory could not be established. The argument is based on the fundamental that differentiation will incur costs to the firm which clearly contradicts with the basis of low cost strategy and in the other hand relatively standardised products with features acceptable to many customers will not carry any differentiation hence, cost leadership and differentiation strategy will be mutually exclusive. Two focal objectives of low cost leadership and differentiation clash with each other resulting in no proper direction for a firm.

However, contrarily to the rationalisation of Porter, contemporary research has shown evidence of firms practising such a “hybrid strategy”. Hambrick identified successful organisations that adopt a mixture of low cost and differentiation strategy. Research writings of Davis state that firms employing the hybrid business strategy (Low cost and differentiation strategy) outperform the ones adopting one generic strategy. Sharing the same view point, Hill challenged Porter’s concept regarding mutual exclusivity of low cost and differentiation strategy and further argued that successful combination of those two strategies will result in sustainable competitive advantage. As to Wright and other multiple business strategies are required to respond effectively to any environment condition. In the mid to late 1980’s where the environments were relatively stable there was no requirement for flexibility in business strategies but survival in the rapidly changing, highly unpredictable present market contexts will require flexibility to face any contingency. After eleven years Porter revised his thinking and accepted the fact that hybrid business strategy could exist and writes in the following manner.

Competitive advantage can be divided into two basic types: lower costs than rivals, or the ability to differentiate and command a premium price that exceeds the extra costs of doing so. Any superior performing firm has achieved one type of advantage, the other or both.

Though Porter had a fundamental rationalisation in his concept about the invalidity of hybrid business strategy, the highly volatile and turbulent market conditions will not permit survival of rigid business strategies since long term establishment will depend on the agility and the quick responsiveness towards market and environmental conditions. Market and environmental turbulence will make drastic implications on the root establishment of a firm. If a firm’s business strategy could not cope with the environmental and market contingencies, long term survival becomes unrealistic. Diverging the strategy into different avenues with the view to exploit opportunities and avoid threats created by market conditions will be a pragmatic approach for a firm.

Critical analysis done separately for cost leadership strategy and differentiation strategy identifies elementary value in both strategies in creating and sustaining a competitive advantage. Consistent and superior performance than competition could be reached with stronger foundations in the event “hybrid strategy” is adopted. Depending on the market and competitive conditions hybrid strategy should be adjusted regarding the extent which each generic strategy (cost leadership or differentiation) should be given priority in practise.

References
  1. William E. Fruhan, Jr., "The NPV Model of Strategy—The Shareholder Value Model," 1979.
  2. Porter, Michael E., Competitive Strategy:Techniques for Analyzing Industries and Competitors

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Rabu, 29 Juli 2009

Value Chain

The value chain, also known as value chain analysis, is a concept from business management that was first described and popularized by Michael Porter in his 1985 best-seller, Competitive Advantage: Creating and Sustaining Superior Performance.
A value chain is a chain of activities. Products pass through all activities of the chain in order and at each activity the product gains some value. The chain of activities gives the products more added value than the sum of added values of all activities. It is important not to mix the concept of the value chain with the costs occurring throughout the activities. A diamond cutter can be used as an example of the difference. The cutting activity may have a low cost, but the activity adds much of the value to the end product, since a rough diamond is significantly less valuable than a cut diamond.
The value chain categorizes the generic value-adding activities of an organization. The "primary activities" include: inbound logistics, operations (production), outbound logistics, marketing and sales (demand), and services (maintenance). The "support activities" include: administrative infrastructure management, human resource management, technology (R&D), and procurement. The costs and value drivers are identified for each value activity. The value chain framework quickly made its way to the forefront of management thought as a powerful analysis tool for strategic planning. The simpler concept of value streams, a cross-functional process which was developed over the next decade,[1] had some success in the early 1990s[2].

The value-chain concept has been extended beyond individual organizations. It can apply to whole supply chains and distribution networks. The delivery of a mix of products and services to the end customer will mobilize different economic factors, each managing its own value chain. The industry wide synchronized interactions of those local value chains create an extended value chain, sometimes global in extent. Porter terms this larger interconnected system of value chains the "value system." A value system includes the value chains of a firm's supplier (and their suppliers all the way back), the firm itself, the firm distribution channels, and the firm's buyers (and presumably extended to the buyers of their products, and so on).
Capturing the value generated along the chain is the new approach taken by many management strategists. For example, a manufacturer might require its parts suppliers to be located nearby its assembly plant to minimize the cost of transportation. By exploiting the upstream and downstream information flowing along the value chain, the firms may try to bypass the intermediaries creating new business models, or in other ways create improvements in its value system.
The Supply-Chain Council, a global trade consortium in operation with over 700 member companies, governmental, academic, and consulting groups participating in the last 10 years, manages the Supply-Chain Operations Reference (SCOR), the de facto universal reference model for Supply Chain including Planning, Procurement, Manufacturing, Order Management, Logistics, Returns, and Retail; Product and Service Design including Design Planning, Research, Prototyping, Integration, Launch and Revision, and Sales including CRM, Service Support, Sales, and Contract Management which are congruent to the Porter framework. The SCOR framework has been adopted by hundreds of companies as well as national entities as a standard for business excellence, and the US DOD has adopted the newly-launched Design-Chain Operations Reference (DCOR) framework for product design as a standard to use for managing their development processes. In addition to process elements, these reference frameworks also maintain a vast database of standard process metrics aligned to the Porter model, as well as a large and constantly researched database of prescriptive universal best practices for process execution.

Value Reference Model

A Value Reference Model (VRM) developed by the global not for profit Value Chain Group offers an open source semantic dictionary for value chain management encompassing one unified reference framework representing the process domains of product development, customer relations and supply networks.

The integrated process framework guides the modeling, design, and measurement of business performance by uniquely encompassing the plan, govern and execute requirements for the design, product, and customer aspects of business.

The Value Chain Group claims VRM to be next generation Business Process Management that enables value reference modeling of all business processes and provides product excellence, operations excellence, and customer excellence.

Six business functions of the Value Chain:

  • Research and Development
  • Design of Products, Services, or Processes
  • Production
  • Marketing & Sales
  • Distribution
  • Customer Service

To analyze the specific activities through which firms can create a competitive advantage, it is useful to model the firm as a chain of value-creating activities. Michael Porter identified a set of interrelated generic activities common to a wide range of firms. The resulting model is known as the value chain and is depicted below:


Primary Value Chain Activities



Inbound
Logistics
>Operations>Outbound
Logistics
>Marketing
& Sales
>Service

The goal of these activities is to create value that exceeds the cost of providing the product or service, thus generating a profit margin.

  • Inbound logistics include the receiving, warehousing, and inventory control of input materials.

  • Operations are the value-creating activities that transform the inputs into the final product.

  • Outbound logistics are the activities required to get the finished product to the customer, including warehousing, order fulfillment, etc.

  • Marketing & Sales are those activities associated with getting buyers to purchase the product, including channel selection, advertising, pricing, etc.

  • Service activities are those that maintain and enhance the product's value including customer support, repair services, etc.

Any or all of these primary activities may be vital in developing a competitive advantage. For example, logistics activities are critical for a provider of distribution services, and service activities may be the key focus for a firm offering on-site maintenance contracts for office equipment.

These five categories are generic and portrayed here in a general manner. Each generic activity includes specific activities that vary by industry.

Support Activities

The primary value chain activities described above are facilitated by support activities. Porter identified four generic categories of support activities, the details of which are industry-specific.

  • Procurement - the function of purchasing the raw materials and other inputs used in the value-creating activities.

  • Technology Development - includes research and development, process automation, and other technology development used to support the value-chain activities.

  • Human Resource Management - the activities associated with recruiting, development, and compensation of employees.

  • Firm Infrastructure - includes activities such as finance, legal, quality management, etc.

Support activities often are viewed as "overhead", but some firms successfully have used them to develop a competitive advantage, for example, to develop a cost advantage through innovative management of information systems.

Value Chain Analysis

In order to better understand the activities leading to a competitive advantage, one can begin with the generic value chain and then identify the relevant firm-specific activities. Process flows can be mapped, and these flows used to isolate the individual value-creating activities.

Once the discrete activities are defined, linkages between activities should be identified. A linkage exists if the performance or cost of one activity affects that of another. Competitive advantage may be obtained by optimizing and coordinating linked activities.

The value chain also is useful in outsourcing decisions. Understanding the linkages between activities can lead to more optimal make-or-buy decisions that can result in either a cost advantage or a differentiation advantage.

The Value System

The firm's value chain links to the value chains of upstream suppliers and downstream buyers. The result is a larger stream of activities known as the value system. The development of a competitive advantage depends not only on the firm-specific value chain, but also on the value system of which the firm is a part.

Recommended Reading

Porter, Michael E., Competitive Advantage:Creating and Sustaining Superior Performance

In Competitive Advantage, Michael Porter introduces the value chain as a tool for developing a competitive advantage. Topics include:

  • Sharing of value chain activities among business units.

  • Using value chain analysis to develop low-cost and differentiation strategies.

  • Interrelationships between value chains of different industry segments.

  • Applying the value chain to understand the role of technology in competitive advantage.

The book concludes by considering the implications for offensive and defensive competitive strategy, including how to identify vulnerabilities and initiate an attack on the industry leader.


References
1. ^ Martin, James (1995). The Great Transition: Using the Seven Disciplines of Enterprise Engineering. New York: AMACOM. ISBN 978-0814403150., particularly the Con Edison example.
2. ^ "The Horizontal Corporation". Business Week. 1993-12-20.

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Minggu, 26 Juli 2009

Competitive Advantage

When a firm sustains profits that exceed the average for its industry, the firm is said to possess a competitive advantage over its rivals. The goal of much of business strategy is to achieve a sustainable competitive advantage.
Michael Porter identified two basic types of competitive advantage:
  • cost advantage
  • differentiation advantage
A competitive advantage exists when the firm is able to deliver the same benefits as competitors but at a lower cost (cost advantage), or deliver benefits that exceed those of competing products (differentiation advantage). Thus, a competitive advantage enables the firm to create superior value for its customers and superior profits for itself.

Cost and differentiation advantages are known as positional advantages since they describe the firm's position in the industry as a leader in either cost or differentiation. A resource-based view emphasizes that a firm utilizes its resources and capabilities to create a competitive advantage that ultimately results in superior value creation. The following diagram combines the resource-based and positioning views to illustrate the concept of competitive advantage:
A Model of Competitive Advantage



Resources




Distinctive
Competencies

Cost Advantage
or
Differentiation Advantage


Value
Creation


Capabilities





Resources and Capabilities

According to the resource-based view, in order to develop a competitive advantage the firm must have resources and capabilities that are superior to those of its competitors. Without this superiority, the competitors simply could replicate what the firm was doing and any advantage quickly would disappear.

Resources are the firm-specific assets useful for creating a cost or differentiation advantage and that few competitors can acquire easily. The following are some examples of such resources:

  • Patents and trademarks
  • Proprietary know-how
  • Installed customer base
  • Reputation of the firm
  • Brand equity

Capabilities refer to the firm's ability to utilize its resources effectively. An example of a capability is the ability to bring a product to market faster than competitors. Such capabilities are embedded in the routines of the organization and are not easily documented as procedures and thus are difficult for competitors to replicate.

The firm's resources and capabilities together form its distinctive competencies. These competencies enable innovation, efficiency, quality, and customer responsiveness, all of which can be leveraged to create a cost advantage or a differentiation advantage.

Cost Advantage and Differentiation Advantage

Competitive advantage is created by using resources and capabilities to achieve either a lower cost structure or a differentiated product. A firm positions itself in its industry through its choice of low cost or differentiation. This decision is a central component of the firm's competitive strategy.

Another important decision is how broad or narrow a market segment to target. Porter formed a matrix using cost advantage, differentiation advantage, and a broad or narrow focus to identify a set of generic strategies that the firm can pursue to create and sustain a competitive advantage.

Value Creation

The firm creates value by performing a series of activities that Porter identified as the value chain. In addition to the firm's own value-creating activities, the firm operates in a value system of vertical activities including those of upstream suppliers and downstream channel members.

To achieve a competitive advantage, the firm must perform one or more value creating activities in a way that creates more overall value than do competitors. Superior value is created through lower costs or superior benefits to the consumer (differentiation).


In Competitive Advantage, Michael Porter analyzes the basis of competitive advantage and presents the value chain as a framework for diagnosing and enhancing it. This landmark work covers:

  • The 10 major drivers of the firm's cost position
  • Differentiation with the buyer's value chain in mind
  • Buyer perception of value and signals of value
  • How to defend against substitute products
  • The role of technology in competitive advantage
  • Competitive scope and its impact on competitive advantage
  • Implications for offensive and defensive competitive strategy

Competitive Advantage makes these concepts concrete and actionable. It rightfully has earned its place in the business strategist's core collection of strategy books


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Jumat, 17 Juli 2009

More About Business Model

A business model is a framework for creating economic, social, and/or other forms of value. The term business model is thus used for a broad range of informal and formal descriptions to represent core aspects of a business, including purpose, offerings, strategies, infrastructure, organizational structures, trading practices, and operational processes and policies.

Conceptualization of business models try to formalize informal descriptions into building blocks and their relationships. While many different conceptualizations exist, Osterwalder proposed[1] a synthesis of different conceptualizations into a single reference model based on the similarities of a large range of models, and constitutes a business model design template which allows enterprises to describe their business model:

Infrastructure
  • Core capabilities: The capabilities and competencies necessary to execute a company's business model.
  • Partner network: The business alliances which complement other aspects of the business model.
  • Value configuration: The rationale which makes a business mutually beneficial for a business and its customers.

Offering
  • Value proposition: The products and services a business offers. Quoting Osterwalder (2004), a value proposition "is an overall view of .. products and services that together represent value for a specific customer segment. It describes the way a firm differentiates itself from its competitors and is the reason why customers buy from a certain firm and not from another."

Customers
  • Target customer: The target audience for a business' products and services.
  • Distribution channel: The means by which a company delivers products and services to customers. This includes the company's marketing and distribution strategy.
  • Customer relationship: The links a company establishes between itself and its different customer segments. The process of managing customer relationships is referred to as customer relationship management.

Finances
  • Cost structure: The monetary consequences of the means employed in the business model. A company's DOC.
  • Revenue: The way a company makes money through a variety of revenue flows. A company's income.


To extract value from an innovation, a start-up (or any firm for that matter) needs an appropriate business model. Business models convert new technology to economic value. Business model is a method of doing business by which a company can generate revenue to sustain itself. Its also spells out where the company is positioned in the value chain.

For some start-ups, familiar business models cannot be applied, so a new model must be devised. Not only is the business model important, in some cases the innovation rests not in the product or service but in the business model itself.
Business models are a component of a business plan or a business case. In their paper, The Role of the Business Model in Capturing Value from Innovation, Henry Chesbrough and Richard S. Rosenbloom present a basic framework describing the elements of a business model.
Given the complexities of products, markets, and the environment in which the firm operates, very few individuals, if any, fully understand the organization's tasks in their entirety. The technical experts know their domain and the business experts know theirs. The business model serves to connect these two domains as shown in the following diagram:
Role of Business Model



Technical
Inputs



Business
Model



Economic
Outputs



A business model draws on a multitude of business subjects, including economics, entrepreneurship, finance, marketing, operations, and strategy. The business model itself is an important determinant of the profits to be made from an innovation. A mediocre innovation with a great business model may be more profitable than a great innovation with a mediocre business model.

In their research, Chesbrough and Rosenbloom searched literature from both the academic and the business press and identified some common themes. They list the following six components of the business model:

  1. Value proposition - a description the customer problem, the product that addresses the problem, and the value of the product from the customer's perspective.
  2. Market segment - the group of customers to target, recognizing that different market segments have different needs. Sometimes the potential of an innovation is unlocked only when a different market segment is targeted.
  3. Value chain structure - the firm's position and activities in the value chain and how the firm will capture part of the value that it creates in the chain.
  4. Revenue generation and margins - how revenue is generated (sales, leasing, subscription, support, etc.), the cost structure, and target profit margins.
  5. Position in value network - identification of competitors, complementors, and any network effects that can be utilized to deliver more value to the customer.
  6. Competitive strategy - how the company will attempt to develop a sustainable competitive advantage, for example, by means of a cost, differentiation, or niche strategy.


Business Model vs. Strategy
Chesbrough and Rosenbloom contrast the concept of the business model to that of strategy, identifying the following three differences:
  1. Creating value vs. capturing value - the business model focus is on value creation. While the business model also addresses how that value will be captured by the firm, strategy goes further by focusing on building a sustainable competitive advantage.
  2. Business value vs. shareholder value - the business model is an architecture for converting innovation to economic value for the business. However, the business model does not focus on delivering that business value to the shareholder. For example, financing methods are not considered by the business model but nonetheless impact shareholder value.
  3. Assumed knowledge levels - the business model assumes a limited environmental knowledge, whereas strategy depends on a more complex analysis that requires more certainty in the knowledge of the environment.


Structure of Business Models
All business models must specify their revenue model (the description of how the company or an E-Commerce project will earn revenue). Revenue sources are:
  • Transaction fees
  • Subscription fees
  • Advertisement fees
  • Affiliate fees
  • Sales
  • Other models
Value proposition is the description of the benefits a company can derive from using E-Commerce.

References
  1. Alexander Osterwalder, The Business Model Ontology - A Proposition In A Design Science Approach, Thesis, 2004.
  2. Malone et al., Do Some Business Models Perform Better than Others?, May 2006.

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