Strategy Formulation

Strategy Formulation HCAD 5390

Managerial Scope of SBU vs Corporate Executives • Managerial responsibilities and decision-making concerns at corporate and SBU levels • At SBU level, trade-off between operational and strategic responsibilities • Within SBUs, strategic role of functional areas • Consolidation trend in health care means more multi-SBU corporations • New freestanding ventures constantly emerging

Strategies Duties of SBU Management (I) • Define strategic direction • Conduct internal/external environmental assessments • Negotiate strategy with corporate parent • Adopt a generic strategy • Formulate action strategies

Strategies Duties of SBU Management (II) • Develop needed resources and competencies • Negotiate with functional area managers for strategy implementation • Appoint and evaluate functional area managers • Monitor and control strategy implementation

Role of Corporate Center in SBU Strategy • Hold SBU managers to strategic standards, goals and criteria • Support SBU strategic initiatives with financial and other resources • Facilitate sharing of knowledge and other resources among SBUs

Formulating Strategy in SBUs Broad strategic objectives of SBUs and independent businesses: • Grow revenues and profits as rapidly as possible • Build a sustainable competitive advantage

Ways to Grow Revenues and Profits • Sell more units to existing customers • Sell more units to new customers • Sell same number of units at higher prices, leading to higher revenues and perhaps profits • Sell same number of units at same price, with lower production costs, leading to higher profits

Types of SBU Growth Strategies • Increase market share • Enter new markets • Identify new uses • Create new products • Acquire new businesses • Collaborate with others

Building Sustainable Competitive Advantage • Competition in most markets is a zero-sum game • One business grows at the expense of another • It does that by positioning itself more positively and distinctively to its customers • When it does that, it has a competitive advantage • When it does that for a long time, it has a sustainable competitive advantage

Thinking About Generic Business Strategies – á la Michael Porter Businesses gain competitive advantage by giving their customers value unavailable from their competitors. There are three variables in pursuing this goal: • Cost of producing the goods/services to be sold • Features of the goods/services to be sold • Range of customers to whom the goods/services are marketed

Types of Business-Level Strategies • Business-level strategies are intended to create differences between the firm’s position relative to those of its rivals • To position itself, the firm must decide whether it intends to perform activities differently or to perform different activities as compared to its rivals

Porter’s Generic Business Strategies Combine the three variables into four generic business strategies: • Full market low-cost leadership • Full market differentiation • Segment low-cost leadership • Segment differentiation

Five Generic Strategies Competitive Advantage Cost Uniqueness Cost Leadership Differentiation Broad target Integrated Cost Leadership/ Differentiation Competitive Scope Narrow target Focused Cost Leadership Focused Differentiation

Cost Leadership Strategy An integrated set of actions designed to produce or deliver goods or services at the lowest cost, relative to competitors with features that are acceptable to customers • relatively standardized products • features acceptable to many customers • lowest competitive price

Low-Cost Leadership Strategy • Goal is to have the lowest production costs of any competitor in the market • Not just “lower” costs, but “lowest” costs • Does the business have the resources and competencies to create goods and services at very low costs?

Achieving Low-Cost Leadership • Define and analyze the internal value chain • Look for points where modifications might produce cost savings • Fully utilize fixed cost resources • Expand volume to achieve economies of scale • Utilize new cost-saving production technologies • Perform every chain activity at optimal location – insourcing vs outsourcing • Take advantage of learning and experience curves

Internal Value Chain Modifications • Current chain configuration is not the only one possible: • Existing activities could be performed better • Activity sequence could be rearranged • Activities could be moved or performed simultaneously • Interface between activities could be improved • In-house activities could be outsourced

Exploiting Low-Cost Leadership • Lower prices to reflect lower costs – leading to increased sales and revenues • Leave prices at same level – earn higher profits • Leave prices at same level – use greater margin to add differentiating features

Downside to Low-Cost Leadership • In fixation on costs, business may ignore changing customer value preferences • New preferences may require different production technologies and cost structure • Competitors may be able to imitate the cost-cutting innovations • If preferences do not change and innovations cannot be imitated --- sustainable competitive advantage results

Keys to Success of a Low-Cost Leadership Strategy (I) • Start with sufficient working capital to survive until low-cost leadership achieved • Possess the resources and competencies to carry out necessary value chain modifications • Exercise tight control of all processes and personnel

Keys to Success of a Low-Cost Leadership Strategy (II) • Align performance incentives with a low-cost operational strategy • Leaders experienced in managing low-cost operations • Corporate culture that is comfortable with a low-cost operating model

Five Forces of Competition Rivalry Among Competing Firms Threat of Substitute Products Threat of New Entrants Bargaining Power of Buyers Bargaining Power of Suppliers Cost Leadership Strategy and the Five Forces of Competition • Rivalry Among Competing Firms Can use cost leadership strategy to advantage since: • competitors avoid price wars with cost leaders, creating higher profits for the entire industry

Five Forces of Competition Rivalry Among Competing Firms Threat of Substitute Products Threat of New Entrants Bargaining Power of Buyers Bargaining Power of Suppliers Cost Leadership Strategy and the Five Forces of Competition • Bargaining Power of Buyers Can mitigate buyers’ power by: • driving prices far below competitors, causing them to exit and shifting power with buyers back to the firm

Five Forces of Competition Rivalry Among Competing Firms Threat of Substitute Products Threat of New Entrants Bargaining Power of Buyers Bargaining Power of Suppliers Cost Leadership Strategy and the Five Forces of Competition • Bargaining Power of Suppliers Can mitigate suppliers’ power by: • being able to absorb cost increases due to low cost position • being able to make very large purchases, reducing chance of supplier using power

Five Forces of Competition Rivalry Among Competing Firms Threat of Substitute Products Threat of New Entrants Bargaining Power of Buyers Bargaining Power of Suppliers Cost Leadership Strategy and the Five Forces of Competition • Threat of New Entrants Can frighten off new entrants due to: • their need to enter on a large scale in order to be cost competitive • the time it takes to move down the learning curve

Five Forces of Competition Rivalry Among Competing Firms Threat of Substitute Products Threat of New Entrants Bargaining Power of Buyers Bargaining Power of Suppliers Cost Leadership Strategy and the Five Forces of Competition • Threat of Substitute Products Cost leader is well positioned to: • make investments to be first to create substitutes • buy patents developed by potential substitutes • lower prices in order to maintain value position

Differentiation Strategy An integrated set of actions designed by a firm to produce or deliver goods or services (at an acceptable cost) that customers perceive as being different in ways that are important to them • price for product can exceed what the firm’s target customers are willing to pay • nonstandardized products • customers value differentiated features more than they value low cost

Differentiation Strategy • Value provided by unique features and value characteristics • Command premium price • High customer service • Superior quality • Prestige or exclusivity • Rapid innovation

Differentiation Strategy (I) • Sell products with added value that customers want and competitors do not offer • Added value justifies a higher price • Higher price covers cost of creating the value (or the business will lose money creating it) • Higher price is not more than the customer is willing to pay for the added value (or the customer will not buy it)

Differentiation Strategy (II) • Create differentiation as economically as possible, while … • Also keeping other costs as low as possible • What kinds of differentiation should be created?

Bases for Creating Differentiation • Depends on what the business is capable of creating and delivering • Scrutinize the value chain to see what activities can be performed differently to add new value • Differentiation opportunities can be found at almost any point in the chain

Generic Forms of Differentiation (I) • More product features • New, appealing product features • Product features tailored to individual customer preferences • Better produce performance • Easier to use and operate • Costs the customer less to use and operate • More reliable, durable, and long-lasting

Generic Forms of Differentiation (II) • More attractive in appearance • More convenient purchase locations • Speedier delivery • Friendlier customer service at all stages • More prompt after-purchase repair and maintenance service • Heightened reputation and image • In any way at all, the customer perceives added value

Criteria for Choosing a Differentiation Feature (I) • Customer will notice it and want it more than a product without the feature • Customer will pay more for a product with the feature than it cost to create it

Criteria for Choosing a Differentiation Feature (II) • Business is capable of creating the product at a cost less than the price the customer willing to pay for it • It is impossible for a competitor to create a product with the same feature at the same cost in the near future

Benefits of a Differentiation Strategy (I) • As long as it sustains the differentiation, the business is insulated from competition in its market • It effectively defines a new product in a new market segment where it is the only competitor • Once hooked on the differentiating feature, many customers will accept higher prices to keep enjoying it

Benefits of a Differentiation Strategy (II) • Attraction of the feature engenders customer loyalty leading to automatic repeat purchases • That customer loyalty makes it harder for new competitors to enter the market

Disadvantages of a Differentiation Strategy (I) • Competitor could differentiate the product even further • Competitors could carve out other narrower segments of the market • Customers may be confused by numerous differentiating products from many competitors • Customers eventually may lose interest in the differentiating features

Disadvantages of a Differentiation Strategy (II) • Differentiating features often required specialized, expensive processes and equipment that may be obsoleted by lower-cost competitive versions • If enough competitors copy the differentiating features, customers may take them for granted and view the product as a commodity • To stay ahead of imitative competitors, a business must continuously create new innovative differentiating features

Five Forces of Competition Rivalry Among Competing Firms Threat of Substitute Products Threat of New Entrants Bargaining Power of Buyers Bargaining Power of Suppliers Differentiation Strategy and the Five Forces of Competition • Rivalry Among Competing Firms Can defend against competition because: • brand loyalty to differentiated product offsets price competition

Five Forces of Competition Rivalry Among Competing Firms Threat of Substitute Products Threat of New Entrants Bargaining Power of Buyers Bargaining Power of Suppliers Differentiation Strategy and the Five Forces of Competition • Bargaining Power of Buyers Can mitigate buyer power because: • well differentiated products reduce customer sensitivity to price increases

Five Forces of Competition Rivalry Among Competing Firms Threat of Substitute Products Threat of New Entrants Bargaining Power of Buyers Bargaining Power of Suppliers Differentiation Strategy and the Five Forces of Competition • Bargaining Power of Suppliers Can mitigate suppliers’ power by: • absorbing price increases due to higher margins • passing along higher supplier prices because buyers are loyal to differentiated brand

Five Forces of Competition Rivalry Among Competing Firms Threat of Substitute Products Threat of New Entrants Bargaining Power of Buyers Bargaining Power of Suppliers Differentiation Strategy and the Five Forces of Competition • Threat of New Entrants Can defend against new entrants because: • new products must surpass proven products or, • new products must be at least equal to performance of proven products, but offered at lower prices

Five Forces of Competition Rivalry Among Competing Firms Threat of Substitute Products Threat of New Entrants Bargaining Power of Buyers Bargaining Power of Suppliers Differentiation Strategy and the Five Forces of Competition • Threat of Substitute Products Well positioned relative to substitutes because: • brand loyalty to a differentiated product tends to reduce customers’ testing of new products or switching brands

Focus Strategy • Not selling to the entire potential market, but … • Selling to a subset of customers, or • Operating in a particular section of the industrial value chain, or • Selling only a few of all product possible in the market or industry, or • Selling to a narrow geographic market

Focus Strategy Principles • Goal is to earn greater profits while accepting lower sales revenues • Identify a subset of customers with more specific preferences that are not being met • Might pay a premium to have them satisfied • Business has resources and competencies to create the desired products • At a cost that returns it above-average profits

When Focus Strategy Makes Sense • Total market composed of numerous segments with distinctive feature preferences that can be satisfied profitably - YES • Homogenous total market – NO • Segment differences too subtle – NO • Too few customers in the segments – NO • Competitor operating in the segment – NO

Focus Strategy Success Factors (I) • At least one definable segment of total market • Product or value preferences are substantially different • Enough customers to generate sales/profits worth trying to serve them • Clear understanding of unique product features the customers seek

Focus Strategy Success Factors (II) • Capable of manufacturing such a product • Customers willing to pay a price that allows business to earn an acceptable profit • Low enough competitive intensity that business can establish a competitive advantage • Resist impulse to broaden the segment served or to serve more segments to increase revenues

Strategy Formulation