Competitive Advantage

Author: Michael Porter

Instructor: Wesley Shu

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How a firm can actually create
and sustain a competitive
advantage in its industry

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 Two Basic Types
• Cost leadership
• Differentiation

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 Value Chain
• Identify which activities contributing to
cost leadership and differentiation
• Analyze the source of competitive
advantage

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 Value Chain
Firm Infrastructure

Human Resource Management

Supporting
Activities
Technology Development

Procurement

Margin
Operations

and Sales
Outbound

Marketing
Logistics

Logistics
Inbound

Service
Primary
Activities

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 Primary Activities
• Inbound Logistics
Receiving, storing, and disseminating
inputs. E.g., warehousing, inventory
control
• Operations
Transforming inputs into the final
product form

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 Primary Activities
• Outbound Logistics
Collecting, storing and distributing the
product to buyers
• Marketing and Sales
Providing a means and incentive which
allow buyers to purchase the product
• Service
Providing service to enhance or maintain
the value of the product

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 Primary Activity Focus by Industry

Industry Inbound Operations Outbound Marketing & Service

Logistics Logistics Sales
Distributor X X
Restaurant X NA
Corporate X
Lending
Xerox X

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 Support Activities
• Procurement
Function of purchasing inputs used in
the value chain
• Technology Development

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 Support Activities
• Human Resource Management
• Firm Infrastructure
planning, finance, accounting, legal,
etc.

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 Competitive Scope
• Four scopes may affect value chain
• Ex. The value chain serves
minicomputer requires extensive
sales assistance, less hardware
performance – different from what
serves small business

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 Competitive Scope
• Segment Scope
Differences required to serve different
product or buyer segment
• Vertical Scope
Division of activities between a firm
and its suppliers, channels, and buyers

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 Competitive Scope
• Geographic Scope
Different geographic areas
• Industry Scope
Interrelationships among business
units

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“Generic” Competitive Advantage
• Cost Leadership
• Differentiation
• Focus

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 Competitive Strategies
Competitive Advantage
Lower Cost Differentiation
Broad Cost Differentiation
Competitive Scope

Target Leadership
Narrow Cost Focus Differentiation
Target Focus

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 Cost Leadership Strategy
Steps to achieve cost leadership
• Make cost assignment
• Identify cost drivers
• Understand cost dynamics
• Control cost drivers
• Reconfigure the value chain

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 Operating Cost Assignment
Firm Infrastructure (9%)
Human Resources Management (2%)

Technology Development(9%)
Procurement (1%)

Margin (5%)
(40%)
Inbound Logistics (3%)

Marketing & Sales (6%)

Purchased Operating Inputs

Human Resource Costs

Service (1%)
(27%)

Operations (67%) Outbound

Logistics (1%)

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 Asset Assignment
Human Resources Firm Infrastructure (16%)
Management (1%)

Technology Development(2%)
Procurement (2%)

(8%)

Liquid Assets (6%) (15%)

Service (2%)
Fixed Assets
(38%)

(2%) (5%)

Inbound Logistics Operations (67%) Outbound

Logistics (1%)
Marketing & Sales (1%)

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 Why cost assignment
• Understand the firm’s cost structure
• Find cost drivers of each cost segment
• Match cost structure to buyer’s value
chain
• Configure and reconfigure the cost
structure

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 Cost Leadership – Cost Drivers
Factors affect costs.

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 Cost Leadership – Cost Drivers
• Economies or diseconomies of scale
• Learning and spillover
• Pattern of capacity utilization
– When fixed cost high, capacity utilization is
important
• Linkages
How other activities are performed
– Linkages within the Value Chain
– Vertical Linkages

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 Cost Leadership – Cost Drivers
• Interrelationships
With other business units within a firm
• Integration
Vertical integration in a value activity
• Timing

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 Cost Leadership – Cost Drivers
• Discretionary policies
Policies that reflect a firm’s strategy
• Location
• Institutional factors
e.g., government regulations, financial
incentives, unionization, etc.

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Identify Cost Drivers

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 Cost Dynamics
• What cause the change of cost drivers

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 Cost Dynamics
• Industry real growth
• Differential scale sensitivity
• Different learning rates
• Differential technological change
• Relative inflation of costs
• Aging
• Market adjustment

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 How to Achieve Cost Advantage
Cost Position
composition of a
Reconfigure the
firm’s value
value chain
chain versus
competitors’
achieve Cost Advantage
a firm’s relative
position vis-à-vis
the cost drivers Control cost
of each activity drivers

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 Analyze Cost Advantage
Firm Infrastructure
Human Resource Management
Technology Development

Margin
Procurement

Your cost
Advantage

Logistics
Inbound

Operations

Service
and Sales
Outbound

Marketing
Logistics

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 Control Cost Drivers
• E.g., control scale – gain the
appropriate firm size

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 Reconfigure the Value Chain
• Reconfiguration of the value chain
presents the opportunity to fundamentally
restructure a firm’s cost, compared to
settling for incremental improvements.
• By altering the basis of competition in a
way that favors a firm’s strengths, it may
change the important cost drivers in a way
that favors a firm.

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 Steps in Strategic Cost Analysis
1. Identify the appropriate value chain and
assign costs and assets to it.
2. Diagnose the cost drivers of each value
activity and how they interact.
3. Identify competitor value chains, and
determine the relative cost of competitors
and the sources of cost differences.
4. Develop a strategy to lower relative cost
position through controlling cost drivers or
reconfiguring the value chain and/or
downstream value.

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 Cost Focus
A firm dedicates its efforts to a well-
chosen segment of an industry can often
lower its costs significantly.

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 Differentiation
• Emphasize on a unique source of
differentiation in the Value Chain, rather
than on products or markets only
• Differentiation base on buyers’ value,
not only difference that buyers do not
value
• Should consider the cost of
differentiation

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Uniqueness Differentiation Buyers’ Value

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Identify Sources of Differentiation

Margin
Your strength which can
lead to differentiation and
then improve buyers’ value

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 Drivers of Uniqueness
• Policy Choices
• Linkages
– Linkages within the value chain
– Supplier linkages
– Channel linkages
• Timing
Be the first
• Location

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 Drivers of Uniqueness
• Interrelationship
Sharing a value activity with sister business units.
E.g., sharing a sales force for both insurance and
other financial products
• Proprietary learning
• Integration – e.g., integrating online systems
to current ordering systems
• Scale
• Institutional factors – e.g., “Madame’s route”

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 Why buyers purchase?
Purchasing Criteria
• User criteria – firms to meet them by
lowering cost or raising buyer
performance
• Signaling criteria – telling buyers what
benefits to get

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Differentiation for creating
Buyer Value by
• Lowering buyer cost
• Raising buyer performance
• Signaling the value
Through
• Linking the firm’s value chain to the
buyer’s value chain

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 Steps in Differentiation
1. Determine who the real buyer is
2. Identify the buyer’s value chain and
the firm’s impact on it
3. Determine ranked buyer purchasing
criteria
4. Assess the existing and potential
sources of uniqueness in a firm’s
value chain

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 Steps in Differentiation
5. Identify the cost of existing and potential
sources of differentiation
6. Choose the configuration of value activities
that creates the most valuable differentiation
for the buyer relative to cost of differentiating
7. Test the chosen differentiation strategy for
sustainability
8. Reduce cost in activities that do not affect
the chosen forms of differentiation

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 Discussion:
Red Ocean to Blue Ocean
Porter’s
BPR BOS
Strategy

Porter’s
BOS
Strategy

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 Other Discussion
• Creative Industries
• Supply Chain Management
• What is “Buyer’s Value Chain”?

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