Test #2 Juma

What are the five sources of cost advantage?

Economies of scale, learning and experience, lower costs due to proprietary knowledge, lower input costs, and different business models.

Which of the five major sources of cost advantage contributed to the Tata Nano being the world's least expensive car?

Proprietary knowledge (note: Tata also uses low cost production labor in India).

Explain three ways that economies of scale produce cost advantages.

- The ability to spread fixed costs of production such as plant and equipment by having more customers (revenue)

- The ability to spread non-production costs. High volumes of production spread the costs of R&D, advertising, and G&A.

- Specialization of machines and equipment. Companies with large volumes can invest in specialized machines and equipment that small firms cannot afford.

- Specialization of tasks and personnel in specific tasks.

What is a scale curve, and how is it different from an experience curve?

The scale curve shows the relationship between unit volume for a given time period, usually a year (x-axis) and the cost per unit (y-axis) for the unit volume for each year. An experience curve shows the relationship between cumulative unit volume (y-axis) and the cost per unit (y-axis) at different levels of cumulative volume. The scale curve does not require cumulative volume on the x-axis, whereas the experience curve does. Therefore, the experience curve is better at capturing the effects of cumulative learning on cost per unit.

What data would you need to calculate a scale curve or experience curve?

- Scale curve: total costs and unit volume over a period of time (usually for each year over a number of years; preferably at least seven years to see a pattern).

- Experience curve: cumulative volume and cost per unit at different levels of cumulative volume (usually just units per year and cost per unit for each year like the scale curve but then the units per year can be added together to create a measure of cumulative volume on the Y-axis).

Why do companies have difficulty increasing their profitability by simply buying market share (e.g., lowering prices to increase market share)?

If one company were to lower prices to increase market share, the rest of the market would do the same, which results in a price war and lower profits. No one then captures more market share.

Identify at least two ways that companies can achieve a cost advantage through lower-cost inputs.

- Bargaining power over suppliers by high purchasing volume or purchasing and negotiating tactics

- Cooperation with suppliers (Toyota example)

- Location advantages that lower costs through wage rates, exchange rates, and/or raw material and energy costs

- Preferred access to inputs

Give an example of a company that has a cost advantage because it uses a different business model or shorter value chain than its competitors.

Ryanair cuts costs by not offering some services such as in-flight meals, pillows blankets, or even "sick" bags. Amazon also cut high costs of brick and mortar stores by eliminating buildings.

Define a differentiation strategy.

Gaining competitive advantage by offering value that is not available in other products or services or that other products and services don't offer at the same level.

What are the four major categories or sources of product differentiation?

1. Different product/service features

2. Superior quality or reliability

3. Convenience

4. Brand image

What are two processes companies can use to search for differentiation opportunities?

Customer segmentation and mapping the consumption chain.

What is customer segmentation? Describe three different ways that customer segmentation can be done.

The process of grouping customers based upon similar needs. This can be done by demographics/customer attributes, products attributes, and "job to be done".

What is the consumption chain? Describe as many stages of the consumption chain as you can.

The consumption chain includes the stages through which customers pass through from the time they first become aware of your products to the time when they have to dispose of it or discontinue using it. See below.

What is a "net promoter score" and how is it calculated? Why is the net promoter score a useful indicator of how successful a company is at differentiating its product?

This metric is used to assess how well differentiated a product or service is. It is based on how willing a customer is to recommend your company (or product) to a friend or colleague on a scale of 1-10. A rating of 1-6 is classified as detractors, 7-8 as passives, and 9-10 as promoters. The "net promoter score" is calculated by the percentage of customers who answer 9 or 10 minus the percentage who answer 6 or below.

Why and when do firms create value through diversification?

Diversification adds value when it allows the combined businesses to deliver greater value and utility to new or existing customers than the firm could without being diversified. Diversification also adds value if the combined businesses reduce the firm's overall cost of producing goods or services.

Apple is primarily an electronics company, creating products for business and consumer markets. Apple also operates its own chain of retail outlets. In terms of Richard Rumelt's categories of the level of diversification, where does Apple fit?

Apple would be a dominant business since most of its revenue comes from direct product sales, and only about 10% (as of 2013) came from the retail operations.

List the reasons why diversification fails to add value. Which one do you believe is most common? Which is least?

- Hubris—overconfidence on the part of managers in their ability to add value through diversification.

- Sunk Cost Fallacy—the belief that a failing investment just needs more cash and time to become successful.

- Imitation—managers enter a new market, or make an acquisition, simply because a competitor did so.

- Poor Governance and Incentives—managers have weak financial incentives to focus on value creation and strong incentives to focus their energy on politics, resource allocation constraints, or transfers of assets between divisions.

- Poor Management—managers use the wrong resource allocation criteria, do not understand the new business, or just make bad decisions.

- Lack of Resources—managers lack adequate resources to make the investment pay off.

What factors should executives consider when making a decision on entering a new market through Greenfield entry versus making an acquisition?

Managers should consider how easily their existing resources and capabilities will transfer to the new market and business. If they can be transferred easily and successfully, then the firm may want to use Greenfield entry. If not, the firm should use acquisition. Also, if entering at large scale, or very quickly is important for success, then the firm should enter through acquisition. If these two things are less important, then Greenfield is preferred.

How can acquiring firms increase the likelihood of a successful integration of an acquired firm?

Acquisitions that have a strong strategic rationale and fit have the highest chance of success. The acquirer must do comprehensive due diligence to determine an accurate price and avoid overpaying. Finally, with a clear strategic understanding, the acquirer can choose the level of integration that creates the most value from the acquisition.

Define vertical integration, forward vertical integration, and backward integration.

Vertical integration is bringing business processes or activities previously conducted by outside companies in-house. Vertically integrating downstream in the value chain is forward vertical integration, and vertically integrating upstream in the value chain is backward integration.

What are the "three Cs" and how do they explain why companies choose to perform an activity internally versus outsource the activity to a supplier (buy).

1. Capabilities-companies can develop more capabilities when performing activities internally.

2. Coordination-companies can better coordinate activities in the business when activities are performed internally.

3. Control-Companies have more control over activities that are performed internally.

Describe what the chapter calls a "classic mistake" that firms make when making a decision to make vs. buy.

Firms compare the price of buying from suppliers to the cost of internally making a product, but the price that suppliers put on a product includes a profit margin, not the actual cost. When firms don't consider this profit margin, they are making the "classic mistake". A firm may be able to negotiate prices down closer to the actual cost of production.

Describe the advantages of outsourcing and the conditions under which it might be advantageous to outsource an activity to an external supplier.

Outsourcing creates flexibility and focus within a firm. Flexibility is the ability to adjust easily to market shocks or demands. Focus is the ability for a firm to place attention on a narrower range of activities. A firm may want to outsource when the industry requires flexibility and the firm wants to be the best in the world at performing a particular activity.

Define crowdsourcing and explain the different ways companies can use an external crowd to do its work (e.g., the different types of crowdsourcing).

Crowdsourcing is outsourcing tasks to "crowds" or large groups of anonymous people. This can be done through the following:

- Crowd-tasking - enlisting a crowd to complete a simple, repetitive task.

- Crowd-creating - turning to a crowd to create content or complete a task that requires specific knowledge or expertise on the part of the members of the crowd.

- Crowd-voting - using a crowd to evaluate an offering or to make predictions about uncertain events.

- Crowd-innovation - using the crowd to solve a challenging problem that requires an innovative solution.

Explain what actions you could take to prevent a subcontractor from becoming a competitor.

- Build barriers to imitation such as a strong brand, i.e., Nike.

- Limit knowledge of the full product by manufacturing the key component of a product or not allowing one supplier to capture production.

- Take an equity stake in the supplier, which prevents the supplier from becoming too powerful and becoming a competitor.

What is a strategic alliance?

A cooperative arrangement in which two or more firms combine their resources and capabilities to create new value.

Describe and give examples of the three different types of strategic alliances. Identify the conditions under which each type is preferred.

1. Contractual alliance - interdependence between partners is low and it's easy to measure the contributions of each partner and write it in a contract.

2. Equity alliance - interdependence between firms is moderate and firms bring knowledge or difficult-to-measure contributions but each can perform their roles separately.

3. Joint Venture - interdependence between firms is very high and firms bring knowledge or difficult-to-measure contributions that must be combined into a single organization to coordinate effectively.

What is the difference between a vertical alliance and a horizontal alliance?

Vertical alliance is an alliance between firms who are positioned at different stages along the value chain. Horizontal alliance is an alliance between firms that are typically positioned at a similar stage of the value chain.

What are four primary ways in which firms create value through strategic alliances?

1. Combine unique resources

2. Pool similar resources

3. Create new alliance-specific resources

4. Lower transaction costs

Describe the two potential dangers of strategic alliances summarized by the initials H&M, and four ways that firms in an alliance can build trust to minimize the risk of these dangers.

Hold-up occurs when one partner tries to exploit the alliance-specific investments made by another partner. Misrepresentation occurs when one partner in an alliance creates false expectations about the resources it brings to the relationship or fails to deliver what it originally promised. Four ways that firms can build trust:

1. Personal trust

2. Legal contracts

3. Shared ownership

4. Financial collateral bonds

What is a "strategic alliance function"? Identify at least two ways that a strategic alliance function helps a firm be more successful with its alliances.

A strategic alliance function is a function within a company that has a VP or director with his or her own staff and resources dedicated to all alliance-related activity. This function helps in the following ways:

1. Improves knowledge management

2. Increases external visibility

3. Provides internal coordination

4. Facilitates intervention and accountability

What are the five main reasons firms expand into international markets?

Growth, efficiency, managing risk, knowledge, and responding to customers or competitors.

Describe the four types of distance that firms should consider when choosing which foreign markets to enter. What factors help managers determine which type of distance is most likely to affect the success of an international expansion?

1. Cultural - differences in language and culture, the way people live and think about the world

2. Administrative - differences in legal, political, and regulatory institutions

3. Geographic - how many miles separate two countries

4. Economic - differences in the average income of customers, usually measured as per capita GDP

Describe the three primary international strategies.

1. Multi-domestic strategy - local responsiveness over standardization

2. Global strategy - standardization and economies of scale over local responsiveness

3. Arbitrage strategy - country-comparative advantages such as sources of low cost or unique resources

Describe the concepts of local responsiveness and standardization. Determine which international strategy is best suited to each pressure and explain why.

Local responsiveness is the need to tailor products, marketing, and distribution strategies to local customers in a foreign country. Standardization is not adjusting to local customers, which results in achieving economies of scale (cost reduction). Multi-domestic strategy is suited for local responsiveness because companies are trying to adapt to customer preferences in different regions, whereas a global strategy is suited for standardization because products will be standardized globally for cost reduction.

Describe the ways that managers can help keep multi-domestic strategies from becoming too costly and global strategies from failing to meet local needs.

Multi-domestic strategies: To prevent from becoming too costly, manage variation in the following ways:

1. Focus adaptations - focus on a particular product, customer segment, or geographic area.

2. Externalize adaptations - arrange for local customers to adapt to local needs, such as using franchises or alliances.

3. Design adaptability - cheap adaptation through flexible manufacturing or creating a set of standard interfaces that allow many different types of alternatives to plug into one another.

Global strategies: To prevent from failing to meet local needs, companies may not centralize all parts of the value chain. Some functions can be localized, while others are centralized.

Explain the International Strategy Triangle and list the steps to construct one.

The International Strategy Triangle is a tool for determining which international strategy a company should pursue. It consists of three axes labeled multi-domestic, global, and arbitrage. To construct where companies fall on the triangle, follow these steps:

1. Determine the appropriate measures to use for the three axes. For many manufacturing industries, these measures will be:

Ø Multi-domestic axis -Advertising to sales

Ø Global axis - R&D to sales

Ø Arbitrage axis - Labor to sales

2. Plot the median and 90th percentiles for the industry as a whole on each axis. You will do this by gathering data on the measure for each axis from the most important firms in the industry you are examining. When you have the data, calculate the median and the 90th percentile point, where 90 percent of the firms are below that point. This is likely to be close to the firm who is farthest along the axis.

3. Plot the appropriate point on each axis for the firm you are analyzing. Draw a triangle connecting these three dots. You may also want to carry out this process for two or more of the firm's major competitors.

1. Use the shape of the triangle to help determine the appropriate international strategy for the firm being analyzed and to understand competitive dynamics in the firm's industry.

Explain how you would use the International Strategy Triangle to identify which international strategy a firm should use. Explain how you would use it to evaluate the strategies of a firm that has already gone international.

If a company ranks at any point beyond the median along any axis, managers should consider pursuing that strategy. If a firm ranks beyond the 90th percentile, it is critical that a firm consider that strategy. This can be used to look at the dynamics of competition in the industry, including who is likely to win and who is likely to lose.

What is a mode of entry? Describe the four main types of entry a firm can choose.

A mode of entry is the way or strategy a firm uses to enter foreign markets. There are 4 main types:

1. Exporting - producing goods in a single location and selling them in foreign markets.

2. Licensing and franchising - selling the rights to produce a firm's products or services.

3. Joint venture and alliances - alliances involve sharing resources, risks, and rewards. Joint ventures are a special form of an alliance involving the joint creation of a new firm.

4. Wholly-owned subsidiaries - local units owned outright by the entering firm.

Which type of entry mode is most appropriate for each of the primary international strategies? List the factors that firms using each primary strategy should consider when choosing an entry mode.

Factors to consider include amount of control a firm wants to keep and risk is willing to take. Global strategies require more control, moving firms toward exporting and wholly owned subsidiaries. Multi-domestic strategies need local innovation, so franchising, joint ventures, or autonomous wholly-owned subsidiaries would be more appropriate choices. Arbitrage requires ownership, so exporting and licensing/franchising will not be good choices.

What is the difference between an invention and innovation? What are the differences between incremental versus radical innovations?

Invention is the creation of a unique or novel concept, method or process, whereas innovation is the conversion of a novel concept into a product, process, or business model that generates revenues and profits. Incremental innovation builds on a firm's established knowledge base and steadily improves the product or service it offers, whereas radical innovation draws on a different knowledge base, technologies, or methods to deliver value in a truly unique way.

How do companies create an innovative strategy by eliminating steps in the value chain?

Companies who eliminate steps in the value chain are able to offer lower prices for similar products and services. One example is that of Amazon offering books online.

What is the difference between "low-end" and "high-end" disruptive innovations?

"Low-end" disruptive innovations offer a low-cost product or service with less technology or ability, whereas "high-end" disruptive innovations offer products that outperform existing products and are sold for a premium price rather than a discount.

What does "mass customization" mean? How do companies use mass customization to succeed in the market?

Mass customization means providing products or services that are customized for individual customers but on a large scale, such as Build-A-Bear Workshop. This works in markets that have customers with a variety of different needs where many want a product that is personalized to those needs.

What does it mean to target "non-consumption?" How does a company create new markets with a Blue Ocean Strategy?

Targeting "non-consumption" means looking for individuals who do not currently purchase a product or service and offering a product or service that might induce consumption. A company creates new markets by creating new demand in an uncontested market space.

What are four behaviors of business innovators that help them generate ideas for innovative strategies?

Observing, questioning, experimenting, and associating.

Name two frameworks for understanding the competitive landscape.

Strategic group map, the strategy canvas, competitor response profile, and game theory.

What is a strategic group analysis, and how is it useful?

A strategic group analysis breaks down the structure of a market or industry into constituent groups. These groups are shown on a diagram with axes represented by factors that are particularly key to the industry or market. This analysis helps companies visualize and identify the major arenas of competition and who competes directly with whom.

What factors might limit a company's ability to switch strategic groups?

Factors that are not easy to change quickly and require significant investments. This would include structures and capabilities that are built over time such as cost structures, organizational culture, large fixed costs, etc.

What is a competitor response profile and how is it useful in evaluating competitors?

A competitor response profile identifies characteristics of a competitor in order to assess how they might respond in the face of rival actions. This involves the answers to such questions as "What drives the competitor?", "What is the competitor doing or capable of doing?", and "How will a competitor respond to specific moves?" This assists companies in predicting the reaction of competitors and understand whether they will make certain moves or decisions.

Define the Nash equilibrium used in game theory to predict the outcome of competitive interaction.

The Nash equilibrium is reached when a decision in game theory maximizes each firm's payoff given the choices of rivals and removes incentives to defect so that no player can improve his payoffs by changing his choice.

Identify the four general principles of competitive strategy.

1. Know your strengths and weaknesses

2. Bring strength against weakness

3. Protect and neutralize vulnerabilities

4. Develop strategies that cannot be easily imitated or copied (go where the competitor is not)

What are the three types of market structures?

Monopoly, oligopoly, and perfect competition (sometimes referred to as just "competition").

What are the strategies most likely to be useful for a monopolist?

Raising entry barriers, limiting competitive access to scarce resources, innovating and patenting, and introducing new products frequently.

What are the strategies most likely to be useful for an oligopolist?

Monitoring and mimicking rival behavior, and employing tit-for-tat strategies.

Why do firms in an oligopolistic environment often hesitate to make moves that will take them outside of the status quo?

Because the companies are locked in tight competition with only a few other firms that are watching behavior very closely. Other firms will respond accordingly.

What strategies are most likely to be useful for firms in "perfectly" competitive markets?

Consolidating markets, pursuing low cost, or pursuing differentiation strategies.

What types of strategies are most useful for firms operating in dynamic markets?

Reconfiguring processes and capabilities to emphasize both innovation and speed.