1207-Strategy

Nova SBE Bachelor Program

Fall Semester, 2018/19

Session 8
Value creation and competitive advantage

Professor Afonso Almeida Costa

 1. Competitive strategy – “How should we play?”

1207-Strategy - Afonso Almeida Costa 2

Competitive success (economic profitability) in a market/industry…

• I.e., firm value creation and ability to appropriate/capture value in a market/industry

“Market economics”/
Market size “Industry
Sessions 5-7:
attractiveness”
1.2. Market size,
industry structure, and
Economic competition
Industry
profitability
structure
= Intensity of
Value creation competition Sessions 2-4:
and Dynamics of 1.1. Microeconomic
appropriation competition models of strategic
interaction

Competitive Relative cost

(dis)advantage position Sessions 8-14:
(i.e., value 1.3. Creating and
created Relative sustaining competitive
relative to benefit advantage
competitors) position
(Adapted with permission from Luís Almeida Costa’s slides, and from Besanko D, Dranove D,
1207-Strategy - Afonso Almeida Costa Shanley M, Schaefer S. 2017. Economics of Strategy, 7th ed. John Wiley & Sons Inc: Hoboken, 3
NJ.)
 1.3. Creating and sustaining competitive advantage

1207-Strategy - Afonso Almeida Costa 4

Let’s bring back our scheme…
Internal Analysis

STRATEGY
FIRM ENVIRONMENT
(Where/how to
- Resources and - Industry
play)
Capabilities (Competitors,
(People, Brands, Customers,
Technology, Suppliers,
Know-how) Complementors,
- Structure, Government etc.)
systems, and REALIZED - Broad (Political,
processes PERFORMANCE Economic, Social,
- Shared values and Technological,
culture Legal,
Environmental)

1207-Strategy - Afonso Almeida Costa 5

Recall: “How should we play?” is an important decision… (Airlines) (i)
Average spread (1988-2007): ROE – Cost of equity capital = “Economic returns”

(Source: Ghemawat P. 2017. Strategy and the Business Landscape, 4th ed. Ghemawat Publishing.)

1207-Strategy - Afonso Almeida Costa 6

Recall: “How should we play?” is an important decision… (Pharmaceuticals)
(ii)
Average spread (1988-2007): ROE – Cost of equity capital = “Economic returns”

(Source: Ghemawat P. 2017. Strategy and the Business Landscape, 4th ed. Ghemawat Publishing.)

1207-Strategy - Afonso Almeida Costa 7

 Value creation and competitive advantage

1207-Strategy - Afonso Almeida Costa 8

How is value created anyway?

• Let’s start with a market for a specific product/service…

Benefit
Price,
WTP Supply
(costs)

Demand (WTP)
Cost

Quantity
Firm X

• … And select a potential transaction in which a representative customer

is supplied by some firm X

1207-Strategy - Afonso Almeida Costa 9

The “value stick” = value creation - Decreasing
marginal utility
- Situation-driven
• Taking a potential transaction for a representative
customer….
Benefit
→ "𝑽𝒂𝒍𝒖𝒆 𝒔𝒕𝒊𝒄𝒌" = 𝑩𝒆𝒏𝒆𝒇𝒊𝒕 − 𝑪𝒐𝒔𝒕
– 𝑪𝒐𝒔𝒕 = 𝑼𝒏𝒊𝒕 𝑪𝒐𝒔𝒕 𝒐𝒇 𝒔𝒆𝒓𝒗𝒊𝒏𝒈 𝒕𝒉𝒆 𝒄𝒖𝒔𝒕𝒐𝒎𝒆𝒓

Value creation
“Value stick”=
→ The value stick represents a firm’s ability to
create value for a representative customer in
a specific target customer segment

Cost
• A (useful) simplification…
– Representative customer
– Representative transaction
Firm X

1207-Strategy - Afonso Almeida Costa 10

Value creation vs. value appropriation/capture

• Typically firms do not capture all the value they

create for customers… Why?
→ 𝑉𝑎𝑙𝑢𝑒 𝑐𝑎𝑝𝑡𝑢𝑟𝑒 = 𝑃𝑟𝑖𝑐𝑒 − 𝐶𝑜𝑠𝑡 Benefit
→ 𝐵𝑒𝑛𝑒𝑓𝑖𝑡 ≥ 𝑃𝑟𝑖𝑐𝑒
Customer

Value creation
surplus
• The intensity of competition will influence the
ability of a firm to set prices (and capture value) Price
– E.g.: Number and diversity of competitors; Value
differentiation/segmentation of customers; captured
buyer power of customers; etc.
by the firm
Cost (Producer
→ ... But generally, the more value a firm creates
surplus/
(𝐵𝑒𝑛𝑒𝑓𝑖𝑡 − 𝐶𝑜𝑠𝑡)…
– … The greater its ability to offer a better
~Profit)
deal to a customer (a larger 𝐵𝑒𝑛𝑒𝑓𝑖𝑡 −
𝑃𝑟𝑖𝑐𝑒) Firm X
– … And the greater its ability to capture
value (a larger Price − 𝐶𝑜𝑠𝑡)

1207-Strategy - Afonso Almeida Costa 11

 Competitive advantage = Longest “value stick”

• Definition: Unique, firm-specific value creation relative to competitors

→ Formally, firm X with a competitive advantage over competitors if:
𝑪𝒐𝒎𝒑𝒆𝒕𝒊𝒕𝒊𝒗𝒆 𝒂𝒅𝒗𝒂𝒏𝒕𝒂𝒈𝒆𝑿 = 𝑩𝒆𝒏𝒆𝒇𝒊𝒕 − 𝑪𝒐𝒔𝒕 𝑿 − 𝑩𝒆𝒏𝒆𝒇𝒊𝒕 − 𝑪𝒐𝒔𝒕 𝑩𝒆𝒔𝒕 𝑪𝒐𝒎𝒑𝒆𝒕𝒊𝒕𝒐𝒓 >𝟎

Benefit Benefit drivers: -Brand reputation

Benefit
-Technology -Geography
advantage
Benefit -Quality -Risk
-Delivery -Network externalities
-Breadth of line -Environmental policy
-Service -Complements
-Customization -Few substitutes
-Etc.
Cost Cost drivers:
Cost -Economies of scale
Cost advantage -Economies of scope
-Economies of learning
-Low cost of key inputs
-Efficient production processes
-Organizational practices and culture
Competitor Y Firm X -Favorable government policies
-Etc.
1207-Strategy - Afonso Almeida Costa 12
 An example: School choice (Student ≈ Customer)

• Does Nova SBE have a competitive advantage over an average business or

economics school? Benefit drivers:
Benefit Benefit -Quality of education
-Faculty (☺)
advantage
Benefit -Quality of peers (network
? externality)
-Reputation
Price -Connections to employers
Price -Location
-Etc.
Cost
Cost
Cost Cost drivers:
advantage -Economies of scale
? -Relatively lower cost of staff
(cost-of-living, reputation of
the school)
Average -Budget controls
-(Some) Government support
business or
economics Vs. -Etc.

school
1207-Strategy - Afonso Almeida Costa 13
Competitive advantage: Winning in two ways

• A firm that creates more value for customers than competitors (larger 𝑩𝒆𝒏𝒆𝒇𝒊𝒕 −
𝑪𝒐𝒔𝒕)…
– … Can offer more value to customers (larger 𝑩𝒆𝒏𝒆𝒇𝒊𝒕 − 𝑷𝒓𝒊𝒄𝒆)
– … And can capture more value (larger 𝑷𝒓𝒊𝒄𝒆 − 𝑪𝒐𝒔𝒕)

Benefit
• E.g.: Firm X and Competitor Y
Benefit
Price
Price
→ What will happen to firms that offer
generally less value to customers
(lower 𝑩𝒆𝒏𝒆𝒇𝒊𝒕 − 𝑷𝒓𝒊𝒄𝒆)? Cost
→ …They will lose market share! Cost
→ Need to lower prices, raise
benefit, or both

Competitor Y Firm X
1207-Strategy - Afonso Almeida Costa 14
 Three roads to competitive advantage (or types of value creation)

• Firm X relative to a competitor Y:

Benefit

Cost

Competitor Y
(e.g.: Blue
Ocean)

1207-Strategy - Afonso Almeida Costa (Adapted with permission from Fares Boulos’s slides) 15
V-A-RC framework: The multiple layers of competitive advantage
Product or service offerings that
create more Value than competing
Target Customers offerings for some target
customers or segments (i.e. longer
“value stick” than competitors for
target customers)
Value-
Different configuration of
creating Activities (i.e. different activities,
offerings or activities performed differently
– better or cheaper) that enable
superior value creation (activities
Activity
that connect to benefit or cost)
system
“Stocks” of Resources and
Capabilities that accumulate
Resources (and erode) over time and
& allow sustained superior
Capabilities performance in particular
activities relative to
Physical/tangible assets (plant and equipment,
key inputs) competitors and/or imitators
Intangible assets (technology (IP), brands,
(Adapted with permission from Javier
reputation, management talent etc.)
Gimeno’s slides)
Organizational capabilities (know-how, product
1207-Strategy - Afonso Almeida Costa development, market research, supply-chain 16
management, engineering etc.)
Looking into activities…

• Porter’s (1985) insight: Value creation stems from many discrete activities
performed by a firm
→ Firm value chain: Disaggregation of the firm (and its product or service offerings)
into strategically relevant activities
– Objective: Better understanding sources of value (costs, benefits)

FIRM INFRASTRUCTURE
Support
activities
HUMAN RESOURCE MANAGEMENT
TECHNOLOGY DEVELOPMENT
PROCUREMENT

INBOUND OUTBOUND MARKETING

OPERATIONS SERVICE
LOGISTICS LOGISTICS AND SALES Primary
activities
→ Providing a map to inquire about a firm’s activities
– E.g.: Which activities should a firm perform (integration vs. focus)?
– E.g.: Should the same activities be performed differently (better or cheaper)?

(Adapted from Porter ME. 1985. Competitive Advantage. The Free Press: New
1207-Strategy - Afonso Almeida Costa 17
York , NY.)
 Example: Firm value chain for an internet startup

FIRM
Financing, legal support, accounting Support
INFRASTRUCTURE
HR Recruiting, training, incentive system, employee feedback activities
MANAGEMENT
Inventory Site Pick and pack Site look and feel Return
TECHNOLOGY
system software procedure Customer procedure
DEVELOPMENT
research
PROCUREMENT CDs Computers Shipping Media
Shipping Telecom lines services
Inbound Server Picking and Pricing Returned
shipment operations shipment of Promotions items
of top titles Billing top titles from Advertising Customer
Warehou- collections warehouse Product feedback
sing Shipping of information
other titles Affiliations Primary
from third with other activities
parties web sites
INBOUND OPERATIONS OUTBOUND MARKETING SERVICE
LOGISTICS LOGISTICS AND SALES

(Source: Ghemawat P. 2017. Strategy and the Business Landscape, 4th ed.
1207-Strategy - Afonso Almeida Costa 18
Ghemawat Publishing.)
 What about resources and capabilities?

• Supporting and sustaining superior Examples (typically no financial resources):

performance in a firm’s activities
– … activities performed better or at a
lower cost than competitors/imitators
Resource or
Capability “stocks”
- Physical/tangible assets
- Plant and equipment
- Store locations
- Key inputs
- Intangible assets
- Technology (IP)
- Brands, reputation
- Management talent
- Access to channels
- Customer base (with network
externalities)
- Organizational capabilities
- Ryanair: Turnaround time
- Toyota: Supply chain management
- BMW: Engineering
- McDonald’s: Consistent execution

• Virtuous cycle: Resources and capabilities are “stocks”

… Their value can also that a firm uses to perform its activities, but also
erode/depreciate over accumulate over time by performing those activities
time
1207-Strategy - Afonso Almeida Costa 19
An example: IKEA

• What is (broadly) IKEA’s strategy?

– Target customer segment(s)
• Young singles/couples/families furnishing their (first) homes;
anyone looking for a piece of furniture or accessory for home
– Customer value offering/proposition ~ “How does
• Broad range of well-designed and low-cost home furnishings IKEA
– Scope of activities play?”/”Where
does IKEA
• Horizontal scope: Offering a broad range of products for every play?”
aspect of home living (over 9,500 in a given store)
• Geographic scope: Global presence in 50 countries with plans
to expand to 9 more (as of 2016)
• Vertical scope: Backward vertically-integrated into timber
operations
1207-Strategy - Afonso Almeida Costa (Adapted with permission from Fares Boulos’s slides) 20
Does IKEA have a competitive advantage? (i)

→ Which drivers contribute to increase or ↑ Drivers:

decrease benefits (and potentially influence -Furniture quality and durability
costs too) relative to average competitors’ (“good enough”), functionality
-Stylish and modular (“Made in
offerings?
Sweden”)
-1-stop shopping
Benefit -(Low) price guarantee
-Flat packs
-Instant gratification
-Website (catalogue and store
information)
-Amenities (Restaurants and kids
area, Swedish food store)

↓ Drivers:
-Difficult to find stuff
-Time-consuming to walk the “path”
-Inconvenient location
Average -Limited in-store service
competing Vs. -DIY delivery
furniture seller -DIY assembly

1207-Strategy - Afonso Almeida Costa 21

Does IKEA have a competitive advantage? (ii)

→ On balance, one could argue that the drivers

increase benefit for IKEA’s target customer
segments relative to competitors
IKEA’s benefit
advantage

Average
competing Vs.
furniture seller
1207-Strategy - Afonso Almeida Costa 22
Does IKEA have a competitive advantage? (iii)
→ Which drivers contribute to decrease or
increase costs (net of any increased
investments required) relative to average
competitors’ offerings?
Cost
↓ Drivers:
-Economies of scale in manufacturing
and in purchasing
- Streamlined warehousing/in-store
operations
-Access to key inputs ensured: long-
term contracts. backward vertical
integration into timber
-Motivated workforce at a low cost
(good career opportunities)
-Simplicity, informal culture
-Lowering costs of suppliers (and
IKEA’s costs, as a result):
• Paying on time; providing technical
assistance (operations and factory
design); extending financial
support; long-term contracts

↑ Drivers:
-Rigid processes/little flexibility
Average
competing Vs. -Difficult to work for? (Älmhult
culture)
furniture seller -Increasing costs of suppliers:
1207-Strategy - Afonso Almeida Costa -Too demanding? 23
Does IKEA have a competitive advantage? (iv)

→ On balance, one could argue that the drivers

decrease IKEA’s costs relative to competitors

IKEA’s benefit
advantage

Dual Longer “value

advantage stick”

IKEA’s cost
advantage

Average
competing Vs.
furniture seller
1207-Strategy - Afonso Almeida Costa 24
So, IKEA has a competitive advantage relative to competitors…

→ How does IKEA price its products relative to the

competition?

Relative to competitors, IKEA’s

(dual) competitive advantage
allows it to:
- Set lower prices…
- … Provide larger customer
Price surplus (𝐵𝑒𝑛𝑒𝑓𝑖𝑡 − 𝑃𝑟𝑖𝑐𝑒)
Price - … And arguably capture more
value (𝑃𝑟𝑖𝑐𝑒 − 𝐶𝑜𝑠𝑡) (+ also
through increased volumes)

→ No wonder IKEA is so
successful!
Average
competing Vs.
furniture seller
1207-Strategy - Afonso Almeida Costa 25
How are IKEA’s activities configured to allow for value creation?
i.e. Where does IKEA’s competitive advantage come from?
→ IKEA’s firm value chain (just a different representation):
Primary Benefit ↑ | Cost ↓ Support
activities Benefit -Supplier partnerships
activities
-Integrated supply chain -Process standardization:
management low cost/high volume
Logistics -Standardized processes (e.g. -Global sourcing
Procurement
small range of pallet sizes) -Stable access to key inputs:
-Stock on site L-T contracts, VI into timber
Store -Warehouse style Tech.
operations -Model rooms, displaying Development
“solutions”

-Advertising
-Frugality, Informality
-Catalogues
Marketing -Loyalty programs (IKEA
-Flat organization HR
Cost -Transfer of best practices
family)
-Delivery, assembly, and -In-house design (stylish, flat
packs, modular, standard Infra-
interior design (at a price)
Service -Self-service in store shared parts) Structure
-Suburban locations, with gas (design, real
estate, finance)
station, van rental, parking
-Restaurants, kids area

1207-Strategy - Afonso Almeida Costa (Adapted with permission from Fares Boulos’s slides) 26
 IKEA’s value creation also about the FIT between different activities…

→ IKEA’s activity system map:

– Strategic positioning/main themes of value proposition (dark purple)…
– … Implemented by tight clusters of interlinked activities (light purple)

Source: Porter
ME. 1996.
What is
strategy?
Harvard
Business
Review, 74(6):
61-78.

1207-Strategy - Afonso Almeida Costa 27

 IKEA’s resources and capabilities
→ Which resources and capabilities support and sustain IKEA’s activities?
+ Virtuous cycle of resource and
capability accumulation over time
- E.g.: Advertising and
brand/reputation; global sourcing
and procurement capability, etc.
1207-Strategy - Afonso Almeida Costa
Physical/tangible assets
- Timber operations (key input) → Allowing for smooth
and efficient operations
- Store network and size → Enabling high-volume/low-cost
manufacturing and procurement (+ market pre-emption)
Intangible assets
- Intellectual property: Patents for furniture, processes,
parts (even for pallets!) → Restricting imitation
- Brand, “Made in Sweden” reputation for affordable and
functional home furnishings → Drawing in target
customers, increasing effectiveness of advertising
- Managerial talent → Improving in-store and company
overall performance
Organizational capabilities
- Design capability → Enabling functional, modular designs,
and flat packs
- Supply chain management capability → Supporting tight
relationships with suppliers
- Procurement capability → Allowing for global sourcing
28
 Understanding IKEA’s competitive advantage: The V-A-RC framework

• In sum, what we have been doing so far:

Virtuous cycle: Performing activities Target
allows IKEA to accumulate resources and Customers
capabilities over time (“inflow” to IKEA’s Benefit
resource/capability “stocks”) drivers

Value creation
IKEA’s resources and Cost
... Resources and capabilities capabilities increase drivers
may also erode/depreciate the effectiveness of its
over time (“outflow” from activities
IKEA’s resource/capability
“stocks”)
- E.g.: IKEA’s outsourcing of
manufacturing → Erosion
of IKEA’s manufacturing
capabilities?

1207-Strategy - Afonso Almeida Costa 29

DISCLAIMER: This document is authorized for use only in the Bachelor course 1207-Strategy at Nova SBE –Semester 1,
2018/2019–, taught by Professor Afonso Almeida Costa.