SGMA 591

Chapter 4:
The Nature and Sources of Competitive
Advantage: Cost Leadership,
Differentiation, and Blue Ocean
Strategy

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Learning Objectives
Distinguish the two primary types of competitive
advantage: cost leadership vs. differentiation
Appreciate the pitfalls of being “stuck in the middle”
and the reality of achieving both low cost and
differentiation strategies

Understand blue ocean strategy

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 As You Analyze Companies and Formulate Good Strategies,
You Need Clear Answers to Four Key Questions
Corporate-level • Where do we compete? • What resources
Strategy and capabilities
Firm growth and performance do we
are overwhelmingly utilize/acquire?
determined by the industries Resource-based view
or markets in which
companies choose to compete
Chapters 2, 7,
Chapter 3
&8
“Strategy is about both
resources (Chapter 3)
and positioning
(Chapter 4)”
by Roger Martin (2015, HBR)

Chapter 5 Chapter 4
Business-level
Strategy Jockeying for position
• How do we sustain our • What unique
value? value do we
bring? Or, how
do we compete
and win?
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Learning Objectives
Distinguish the two primary types of competitive
advantage: cost leadership vs. differentiation

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Building Competitive Advantage through Business-
Level (or Competitive) Strategy
 Business-level strategies (How to Compete/Win)
 intended to achieve a competitive advantage in an industry

a distinct advantage a firm has over its competitors in

an industry that allows it to generate greater profits
than its competitors

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Performance Heterogeneity among Firms
within an Industry
 Why does Intel outperform others in the
semiconductor industry?
 Why does Southwest perform better
than others in the airline industry?
“Strategy is about
both resources
Chapter 3)
and positioning
(Chapter 4)”
by Roger Martin (2015,
HBR)

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Michael Porter’s (1980) Generic Competitive
Strategies: “Strategic Positioning”
 A company’s relative position within its industry matters for
its performance. But clear strategic positioning requires
value-cost trade-offs—either creating greater value at a
higher cost/price ( 1 ) or creating reasonable value at a lower
cost/price ( 2 )

(source: Kim and Mauborgne, 2017)

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Michael Porter’s (1980) Generic Competitive
Strategies: “Strategic Positioning”
 Competitive advantage in an industry derives from one of two
strategies:  Systematic understanding of costs/cost
drivers
 Relentless reduction of costs
 Sacrifice of nonconforming customers
 Commitment to standardization
 Customer value proposition: affordability

Industry
Attractiveness

Competitive Position

 Deep and holistic understanding of

customers
 Brand, style or reliability
 Commitment to innovation
 Customer value proposition: quality and
design

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Michael Porter’s (1980) Generic Competitive
Strategies: “Strategic Positioning”
 Successful companies pick a position, target a set of
consumers, and configure activities to serve them better
 Because firm resources are limited, trying to do everything to
everyone will likely result in inferior performance

Source of Competitive Advantage

Cost Differentiation

Differentiation
Competitive Scope

Narrow Cost Focus

Target Focus

Broad
Cost Leadership Differentiation
Target

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Cost Leadership: Sell Products at or below
Average Industrial Price
 Boston Consulting Group’s Bruce Henderson asserted that
there was only one way to successfully compete: gain a
relative market share advantage to have lower costs than
competitors
 BCG performed a cost analysis
for a major semiconductor
company in 1966, finding that
the company’s unit production
costs would fall 20 to 30
percent in real times for each
doubling of “experience,” or
accumulated production

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Cost Leadership: Sell Products at or below
Average Industrial Price
 Boston Consulting Group’s Bruce
Henderson asserted that there was only
one way to successfully compete: have
lower costs than all competitors
 Perhaps the most famous cost
leader is Walmart. The firm’s
advertising slogans such as
“Always low prices” and “Save
money. Live better”
communicate its emphasis on
price slashing

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Focused Cost Leadership
 Narrow markets are defined in different ways in different
settings
 Firms following this strategy
target particular demographic
groups or concentrate their
efforts on a particular sales
channel, such as the Internet only
 These firms do not necessarily
charge the lowest prices in the
industry
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easyCruise operated by
Variety Cruise
• The customer base is primarily young
passengers from 20 - 40 years old who
seek a more shore-based cruising
experience
• The concept of small, old-fashioned ship
cruises with a maximum of 72 guests
instead of traditional, luxury ship cruises
with some 3,000 to 5,000 guests
• Very basic accommodation with bare
amenities. No amenities such as casino,
gym, theater, etc.
• Not all excursions are included in the
cruise rate
Differentiation: Create Something Perceived by
Customers as being Unique
 In 1980, Michael Porter suggested another way to compete:
differentiation
 Dyson Ltd, the British Apple of home appliances, has proved
customers are willing to pay a hefty premiums for their products

 HaiDiLao Hotpot’s differentiation: high-service & high-quality (

https://www.youtube.com/watch?v=4bzDd1FhAhA )

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Focused Differentiation
 As with a focused cost leadership strategy, narrow markets
are defined in different ways in different settings
 Kopi Luwak, which is the most
expensive gourmet coffee, targets
a relatively small group of coffee
enthusiasts

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Repositioning from Focused Differentiation to
Differentiation: Tesla
 Tesla started from the top of a market, selling high-end
Models S and X. To scale, Tesla is moving down-market with
its Model 3, which it estimates will cost $35,000, or between
one-half and one-third of the price of the Model S. But one
might say: “Tesla doesn’t know how to do cheap”
Source of Competitive Advantage
Cost Differentiation
Differentiation
Focus
Competitive Scope

Narrow Cost Focus

Target

Broad
Target Cost Leadership
Differentiation
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(source: Bartman, 2015, HBR)
Learning Objectives

Appreciate the pitfalls of being “stuck in the middle”

and the reality of achieving both low cost and
differentiation strategies

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The Value-Cost Trade-off
 Michael Porter (1980) stressed the
idea that only one generic
competitive strategy should be
adopted by a firm

 Namely, a firm’s failure to make a

choice between cost leadership and
differentiation strategies essentially
implies that the company is “stuck
in the middle,” a strategic mistake
that Michael Porter calls “the kiss of
death”

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“Stuck in the Middle”: Neither Cost Leader Nor
Differentiator
 The danger of being “stuck in the
middle”
 Create a muddle for customers
 Do not offer sufficient value in terms of
either low cost or differentiation

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“Stuck in the Middle”: Neither Cost Leader Nor
Differentiator
 The danger of being “stuck in the
middle”
 Create a muddle for customers
 Do not offer sufficient value in terms of
either low cost or differentiation

Porter’s (1988) convexity hypothesis

Profitability/efficiency

Differentiator Competitive advantage Cost leader

“Stuck in the Middle” = Competitive disadvantage

(e.g., RIM’s BlackBerry in the smartphone market)
Market share/volume

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Beyond Michael Porter: A Critique of Porter’s
Generic Strategies
 Some companies (e.g., Costco,
Samsung Electronics) pursue
differentiation and low cost
simultaneously
 Reconcile the value-cost trade-
off, that is, reject Porter’s (1980)
idea that a trade-off between
value and cost is inevitable

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Integration Strategy: Samsung Electronics
(256Mbit DRAM Market)

(Source: Kapoor & Adner, 2012, Organization Science)

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Integration Strategy: Samsung Electronics
(256Mbit DRAM Market)
Worldwide DRAM Average Selling Price History

• New and old generations of DRAMS coexist in the market

• While the price of a new generation is highest, it declines quickly over time
– very steep initial declines, followed by much less rapid decline

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Integration Strategy: Samsung Electronics
(256Mbit DRAM Market)
DRAM Cost of Materials vs. Volume
2.5

Hynix Micron
2
Cost of Raw Materials ($)

SMIC
1.5
Infineon
Samsung
1

0.5

0
0 200 400 600 800 1000

Production Volume (Million Units)

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Integration Strategy: Samsung Electronics
(256Mbit DRAM Market)
18
16
14
12
Samsung’s
10 operating
8 cost is lower
than its
6 competitors’
4
2
0
Samsung Micron Infineon Hynix

Average Selling Price ($) Operating Cost ($)

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Integration Strategy: Samsung Electronics
(256Mbit DRAM Market)
18 Premium pricing strategy is possible only
16 when a firm’s product is perceived to be
differentiated from its competitors’
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Worldwide ASP
12
10
8
6
4
2
0
Samsung Micron Infineon Hynix

Average Selling Price ($) Operating Cost ($)

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Integration Strategy: Samsung Electronics
(256Mbit DRAM Market)
18 Samsung’s high operation margin is a function
16 of cost leadership and differentiation
14
Operating
Margin

12
10
8
6
4
2
0
Samsung Micron Infineon Hynix

Average Selling Price ($) Operating Cost ($)

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Learning Objectives

Understand blue ocean strategy

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Blue Ocean Strategy
 Blue Ocean strategy involves market-
creating innovation. It often enables
higher value at lower cost

 An explicit focus on attracting non-

customers is needed
 Looking to very young children, older non-
gamers, and the elderly, Nintendo created
the Wii based on simplicity, functionality,
and interactivity

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Blue Ocean Strategy: Cirque du Soleil
 The Canadian company Cirque du Traditional Circus: Cirque du Soleil:
Soleil created an unprecedented High Cost, Low Price Low Cost, High Price

form of live entertainment while

lowering the cost by reconstructing
the boundaries between traditional
circus and theater, thereby
reinventing the declining circus
industry

 Eliminated the animals and reduced the importance of individual stars

 Created a new form of entertainment that combined dance, music and

athletic skill to appeal to an upscale adult audience

29 https://www.youtube.com/watch?v=GkF_yStN4pw
Blue Ocean Strategy: Cirque du Soleil (cont.)
 Cirque du Soleil’s strategy canvas for building a compelling blue
ocean strategy

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Is Competitive Advantage Sustainable?
 Competitive strategy was all about finding a favorable
position in a well-defined industry, throwing up entry
barriers, and then exploiting a sustainable competitive
advantage

 But the obsession with existing rivals often blinds firms to the
permanent, enduring threat from disruptive entrants armed
with new business models, products, or technologies

 Kim and Mauborgne’s (2004) blue strategy

 Christensen’s (1997) disruptive innovation (see Chapter 5)

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Competitive Advantage Is Transient, Not
Sustainable
 Today it is increasingly difficult for companies (e.g., Kodak,
RIM, etc.) to maintain a truly lasting advantage
Analysis of Top 20 Fortune 1000 Companies
20

Incumbents
18
40%
16
55% ?
14 65%

12
10

New Entrants
8
60%
6 45%
35%
4
2
0
1973-1983 1983-1993 1993-2003 2003-2013
(Source: Lawler & Worley, Built to Change, 2006: 1)

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