Introducing Competitive Strategy

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Tobias Hunter
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1 Introducing Competitive Strategy Econ 466 Spring, 2010

2 Concepts and vocabulary in strategy Competition is a driving force in market economies How do firms compete? What determines a firm s competitive strategy? How is strategy related to firm performance and success? Use competitive strategy as a way to discuss Financial management Financial intermediation Market for financial services Based on Besanko et.al. Chapters 6,10,11,12,13

How is strategy related to firm performance and success?

3 US Total Farm Debt Market Share by Lender 1961 to Market Share Percent Year Comm. Banks FCS FSA Life Ins. Cos. Ind & Others CCC Loans

71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07

5 Competitive advantage The ability of the firm to outperform its industry to earn a higher rate of return than the industry norm A competitive advantage is sustainable if superior performance persists despite the actions of competitors

than the industry norm A competitive advantage is

6 How does a firm create a sustainable competitive advantage? By creating more value than its competitors.

7 Created value The difference between the perceived or determined value of a finished good, service or input And the value that is sacrificed to produce it

8 Framework for competitive advantage Market Conditions Benefit position relative to competitors Cost position relative to competitors Value added Profitability

9 Industry and business unit effects in explaining productivity Effect 4% 32% 19% 24% 43% Unexplained Year Industry Parent Business Unit

10 How does the firm create value? Michael Porter s value chain

12 TTYN SKETCH OUT A VALUE CHAIN #2 YELLOW CORN AGRICULTURAL LENDING

13 How does the firm create value? Michael Porter s value chain Firm-specific assets Resources (Have) Capabilities (Do) Change the value chain (business model) Improve the value chain

14 Examples of firm-specific assets Resources Patents or trademarks Brand name reputation Organizational culture Capabilities Worker s expertise and knowhow Operational processes Recruit and reward employees

culture Capabilities Worker s expertise and

15 TTYN EXAMPLES OF FIRM-SPECIFIC RESOURCES, FARMING AND LENDING

16 Generic value creation strategies Cost Advantage maintain B and reduce C Benefit Advantage maintain C and increase B

17 Concepts and terms we have mastered, thus far. Competitive advantage Value creation Value chain Firm-specific assets Resources Capabilities Cost advantage Benefit advantage Value map

18 Cost advantage is best if: Economies of scale or learning exist but rival firms are not exploiting them Product or service does not lend itself to benefit enhancement Consumers are very price sensitive Search good

them Product or service does not lend itself to

19 Benefit advantage is best if: Consumer is value conscious Most economies of scale or learning have been exploited Experience good

20 TTYN SKETCH OUT AN EXAMPLE OF A COST LEADERSHIP STRATEGY THAT COULD BE PURSUED BY A FARM BUSINESS

21 TTYN NOW TRY A BENEFIT LEADERSHIP STRATEGY AGAIN FOR A FARM BUSINESS

22 Firm-level price elasticity of demand Assumes imperfect competition Differentiated products or services Incorporates perceived behavior of rivals Percent change in demand resulting from a percent change in the firm s price

23 Vertical differentiation Attributes of a product that makes it clearly superior to those of competitors Examples? Attributes Products or services

24 Horizontal differentiation Attributes of a product or service that are valued by some consumers and not by others Examples? Attributes Products or services

25 Horizontal differentiation and firmlevel price elasticity of demand Weak horizontal differentiation High elasticity of demand Strong horizontal differentiation Low elasticity of demand

26 TTYN LIST SOME EXAMPLES OF AGRICULTURAL PRODUCTS WITH WEAK AND STRONG HORIZONTAL DIFFERENTIATION

27 Pricing strategy and horizontal differentiation Margin strategy Widen margin Share strategy Increase market share

28 Pricing strategy and horizontal differentiation Horizontal Differentiation Weak (High price elasticity) Strong (Low price elasticity) Cost Advantage Share Underprice competitors to gain share Margin Maintain price parity Benefit Advantage Share Maintain price parity, gain share Margin Charge price premium

29 So who is my competitor? Substitute products or services? Product performance characteristics Occasions for use Geographic market Empirically measure cross-price elasticity of demand Q y / P x (P x /Q y )> 0?

30 TTYN HOW IMPORTANT IS GEOGRAPHY IN FINANCIAL SERVICES MARKETS?

31 And how will the industry impact the competitive strategy of the firm? Michael Porter (again) and his Five Forces Analysis framework

33 Concepts and terms we have mastered Competitive advantage Value creation Value chain Firm-specific assets Resources Capabilities Cost advantage Benefit advantage Value map Cost leadership Benefit leadership Firm-level demand elasticity Vertical differentiation Horizontal differentiation Search good Experience good Margin strategy Share strategy Five-Forces analysis

34 OK NOW LETS TRY THEM OUT!

Competitive Advantage

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