Research on Hospitality Industry

For a Business Policy class, I chose the hospitality industry to focus on and within that, the strategic group of luxury hotels and for an even narrower focus, the Marriott hotel chain. The assignments involve some researching and I’ll send a pdf with background information that’ll help complete the assignments. Each one consists of some questions and some of them have excel documents to fill and the questions are based off of doing those first. See attachments for the first 2 short assignments. I’ll upload the rest later and will give you some more time to complete those. Some are already filled in and this is because I did them but want them to be redone/ added to/ improved. Please cite your sources. You can use easybib.com for it, MLA format.

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Value Chain & Value Net Analysis

What an organization does has a significant bearing on who matters to it. A
company such as Nike, given its focus on apparel design and marketing, needs to concern
itself with a different set of players than an apparel manufacturer, such as Fruit of the
Loom. Similarly, a PC component assembler and marketer such as Dell Computer
Corporation maintains a different set of organizational relationships than a PC
manufacturer such as Compaq. Given the differences that can exist from one
organization to the next, it is essential that managers develop a clear picture of their
organization’s key value adding activities. Only then can they properly identify and
assess the key players who add and detract from its value adding processes.

This chapter begins with a discussion of an organization’s key value adding
activities through the lens of Michael Porter’s classic value chain analysis.1 After a full
discussion of the value chain, the key external players that can impact the firm are
examined through value net analysis,2 which serves as the organizing framework for
several additional analyses. These additional frameworks, tools and techniques, taken up
in subsequent chapters, provide for a focused analysis on each of the value net’s specific
players.

Player Analysis – Value Chains & Nets

VALUE CHAIN ANALYSIS

One way of looking at what an organization does is to identify the many distinct
activities that it performs. Every organization can be viewed as the combination of a set
of related and unrelated activities performed in pursuit of value creation. The greater the
extent to which the activities of an organization are related and provide synergies, the
greater the efficiency and effectiveness of the organization’s value creation processes.
This in turn can translate into significant cost efficiencies that can allow the
organization’s offerings to be priced below other organizations’ offerings.

Alternatively, the way that an organization conducts its activities can provide the
organization with an ability to differentiate its products sufficiently that customers will be
willing to pay more for its offerings. According to Michael Porter, competitive
advantage “stems from the many discrete activities an organization performs in
designing, producing, marketing, delivering, and supporting its product.”3 This is
because each activity, either separately or in a linked fashion, can generate cost
efficiencies or differentiation capabilities. Thus, by looking at the organization as a value
chain of strategically relevant activities, an analyst is able to focus in on the basis for an
organization’s competitive advantages (Exhibit 3-1).

EExxhhiibbiitt 33–11 The Value Chain

Organization Infrastructure

General management, accounting, finance, planning, quality control

Supporting

Human Resources

Recruiting, training, development

Activities Technology Development

R&D, product and process improvement

Procurement

Purchasing of raw materials, machinery, equipment, supplies
Profit

Margin

Inbound
Logistics

Raw
materials
handling

and
stocking

Operations
Machining,
assembling,

testing

Outbound
Logistics

Warehousing
and

distribution of
finished
offerings

Marketing
and Sales

Advertising,
promotion,
pricing,
channel
selection

Service

Installation,

repairs,
parts

Primary Activities

Source: Adapted from M. E. Porter, Competitive Advantage: Creating and Sustaining Superior
Performance (New York: Free Press, 1985), p. 37.

Profit
Margin

Player Analysis – Value Chains & Nets

As illustrated in Exhibit 3-1, five primary and four supporting activities can be
identified for most organizations. Primary activities involve everything the organization
has to do to create its offerings (products or services), market and deliver them to
customers, and provide buying and after sale support and service to customers. For an
organization that is efficient in creating offerings, production costs can be lower than in
other organizations. This means that the organization can either charge a lower price for
its offerings, and thereby maintain a low cost provider advantage over competitors, or
earn higher profit margins by pricing at competitive levels. In addition, an efficient
operations process also may allow the organization to improve quality levels, for instance
by reducing the number of defects. This is important because higher quality generally
translates into higher organization performance.4

At the same time, an organization can also be efficient at marketing, sales and
service. This can allow it to obtain market share sufficient to gain economies of scale,
and thereby, to lower its costs. Efficient marketing can also allow the organization to
better target customer needs and differentiate its offerings, also supporting pricing
premiums.

Supporting activities are those activities that allow the primary activities to take
place on an ongoing basis. They provide inputs or infrastructure that the other activities
require. Procurement is a support activity because every activity makes use of some type
of inputs. Similarly, human resource management, technology development, and
organization infrastructure are drawn upon throughout the organization as it goes about
its business.

Efficiencies in primary and supporting activities stem not only from how each
sub-activity is performed, but also from the linkages and synergies among them.
Linkages among activities are important to the extent that the performance of one activity
can have cost implications for another activity. If an organization invests more in state-
of-the-art production facilities, for instance, it may lower its production costs, labor
requirements, and product defect rates.

As another example, consider how different quality inspection procedures can
affect value creation. In an organization where quality inspections occur throughout the
organization’s value chain, for example, the costs attributed to the function of quality
control – labor, production delays, etc. – may be higher than in an organization where
quality is checked only at the finished product stage. However, it is likely that defect
rates and repair and service support needs will be higher at the second organization, so its
total costs may actually exceed those in the first company. Moreover, the first
organization might also be able to command a pricing premium, due to the higher overall
quality of its finished offerings. Thus, while the two organizations may perform the same
set of activities, the way that they link the performance of the activities can result i n very
different outcomes.

Synergies among activities can have similar impacts. Synergies can be obtained
when multiple activities share economies of scope. The idea here is that if an
organization can push multiple offerings through the same production facilities or

Player Analysis – Value Chains & Nets

marketing and distribution channels, then costs will be less than if it had to perform these
same activities separately for each individual offering.

An important insight to gain from value chain analysis is that differently
configured value chains may generate different types of competitive advantages. In an
organization with a value chain organized to provide low cost leadership, for instance,
key value creation activities might include, among others:

 Process improvement technology – activities that can lead to more efficient
production capabilities;

 Marketing and advertising – activities that can generate the economies of scale
needed to support huge production and distribution facilities and capabilities, and
quantity buying; and

 Supply chain management – activities that can reduce throughput costs (sourcing,
inventory, warehousing, etc.).

In an organization with a value chain organized to provide premium pricing, on the other
hand, key value creation activities might include, among others:

 Quality control – activities that can enhance the overall quality of the organization’s
offerings to avoid direct price comparisons; and

 Service – activities through which customers’ satisfaction is enhanced.

While the development of a detailed diagram of an organization’s value chain
proves enlightening, analysts often simply identify the key value creation activities in list
form. Porter calls the two different approaches to competitive positioning – low cost and
differentiation – generic strategies, and argues against organizations getting stuck in the
middle.5 Being stuck in the middle implies that the organization’s value chain is likely
not as efficient or effective as competitors who are pursuing just one of the generic
strategies. This means that the organization’s competitors will be able to provide either
lower cost or higher quality offerings, thereby putting the organization at a competitive
disadvantage.

A third generic strategy, an alternative to low cost and differentiation, is the focus
strategy. According to Porter, a focus strategy involves taking a middle path, but only in
a defined segment in which such a strategy is viable.6 However, at times a focus strategy
may become viable beyond a particular segment. For instance, logic suggests that if
enough customers seek products with a few, rather than every bell and whistle, then
someone will seek to service them. As a result, at times organizations may have
successful business models that purposely seek the middle ground between low cost and
differentiation. As long as customers remain committed to getting both not the best
quality and not the lowest cost, therefore, being stuck in the middle can be just fine.

Moreover, an alternative to any of the generic strategies, including focus, is to
achieve both low cost and differentiation, a dual competitive advantage. 7 While
seemingly impossible, numerous Japanese manufacturers such as Sony have managed to

Player Analysis – Value Chains & Nets

improve quality while reducing costs through use of sophisticated flexible manufacturing
and quality control methodologies.

Finally, consistent with the idea of anticipatory management, organizations can
also seek to find the right mix of each approach as well. While pursuit of greater
differentiation will indeed likely also mean higher costs, at times the marginal rate of
pricing premium increases can exceed the marginal rate of cost increases. Organizations
with stellar reputations and brands, for instance, are often able to command pricing in
excess of the costs of obtaining such positions. This means that an organization can more
than recover the additional differentiating costs through premium pricing. On the other
hand, the means by which greater differentiation is achieved by one organization may be
less costly than the means used by others. Charles Schwab, the discount brokerage
organization, for instance, employs salaried brokers who assist with, rather than sell
transactions, to their clients. By removing the commission structure found at competing
brokerages, Schwab lowered its advising costs and simultaneously enhanced its image as
the place to get impartial, disinterested investment advice. Schwab’s use of Internet
technology further enhances its competitive positioning.

IIlllluussttrraattiioonn Value Chain of an Internet Portal

The Internet Portal Industry8

Internet portals are search engines with added bells and whistles. A search engine is a tool that
allows an Internet user to find information on the Web. As the volume of users and information on the
Internet continues to increase exponentially, finding what you need on the Web is increasingly
challenging. This is where portals step in. The main purpose of a portal is to make the Internet, a wholly
impersonal medium, tailored to the individual user. Useless information is filtered out, leaving the user
with a customized Web page filled with information and tools relevant to the individual. In addition to
Web searching tools, most portals also provide e-mail capabilities, personalized news, weather reports,
chat rooms and stock quotes. Leading portals include America Online, Yahoo!, Microsoft MSN, Lycos,
Netscape Netcenter, Excite, Infoseek, Altavista, and Snap.

Portals may be geographically focused or personally focused. Geographically focused portals
contain information relevant to a specific region, filled with local news, weather, movie listings, and
community interest stories. These are generally known as vertical portals – they have a tightly focused
content area geared towards a particular audience. Personally focused portals contain any content that the
user chooses, from weather reports to stock quotes to news. These types of portals appeal to a much
broader audience and are considered horizontal portals. The main problem facing horizontal portals lies
in differentiating themselves from one another. Studies have found that brand loyalty is low among
Internet portals, as there is an obvious lack of distinctiveness among the largest organizations. 9 Industry
analysts predict that the market can only support three to five portals, due to this problem. Those that do
not form partnerships, or cannot market on their own, will perish, consolidate, or shift strategies to
become a site catering to a specific interest, rather than continuing as a general interest portal.

What makes portal organizations unique is the fact that their largest source of revenue is from
advertising. Banner advertisements appear at the top of every portal site. When a site is customized,
advertising can be targeted at a particular user. Organizations hope that users will make the
organization’s site their personal site. The more users a portal attracts, and the more stable the base and
the longer the viewing times of users, the greater the ad revenues the portal can generate.

Player Analysis – Value Chains & Nets

In addition to advertising revenues, portals also increasingly seek revenues from e-commerce
transactions, and to a lesser extent, from subscriptions and sponsorships.

Portals, therefore, in addition to forming alliances with companies that can get viewers to their
sites, they also seek to create switching costs for users so that, once they have visited the portal, they will
remain with the portal. Portals do this by 1) encouraging users to bookmark their personal site for easy
returns, 2) seeking to form agreements with PC companies to provide the portal’s address and icon on the
PC user’s browser start page, and 3) offering interesting content – including buddy lists and other devices
that get built through the user’s use of the portal’s services.

In order to compete in the marketplace, portals must master Internet technologies, devise
efficient information categorization systems (directory databases) and presentation systems (user -viewed
Web sites), negotiate alliances with key content providers (stock quotes, news, weather, etc.) and tool
providers (e-mail, chat rooms, etc.), and establish advertising and e-commerce relationships.

Importantly, portals also have significant interoperability benefits available to them. That is, the
value of many of a portal’s features increases to a user the more that he uses them (e.g., tracking one’s
investment performance, maintaining e-mail relationships). Moreover, in some instances, value also
increases the more others use a feature (e.g., buddy lists that allow users to see who else is online at a
given time). Such virtuous cycles10 highlight the need for portals to be very proficient at attracting
visitors to their sites. Hence, another key activity of a portal is in marketing.

A value chain for a hypothetical Internet portal is illustrated below.

Organization
Infrastructure Financing, legal support, accounting, quality control

Human
Resources Recruiting, training, development

Technology
Development

Site
directory
database

Site
interface

e-commerce
transaction
processing

Site look and
feel

Contact
database

Customer
research
procedures

Procurement

Search
engines

Database
design,
content

Computers

Telecomm

Merchant
card services

Media Customer call
center

Content
and ad
collection
and
updating

Server
operations

Directory
design

Content
development

Billing

Collections

Electronic
transaction
processing

eCommerce/
advertising
agreements

Content
alliances

Awareness
and brand
marketing

eCommerce
facilitation

Customer
feedback

Inbound
Logistics

Operations Outbound
Logistics

Marketing
and Sales
Service

Player Analysis – Value Chains & Nets

VALUE NET ANALYSIS

As suggested by the value chain discussion, the ability of an organization to create
and capture value is often constrained by the various external players with whom it
interacts. Moreover, expanding the pie often also involves bringing entirely new players
into the game. Thus, in addition to understanding the role of suppliers and customers
with respect to value creation, the impact of two other external players on an
organization’s success must also be assessed. These additional players, along with the
organization and its supplies and customers, serve as the focus of the value net (Exhibit
3-2).

In order to develop comprehensive business strategies, organizations must
understand which players count and which relationships are most pronounced. Adam
Brandenburger and Barry Nalebuff’s value net is a framework through which a company
can map players on the basis of their relative impact on an organization’s value adding
activities.11 This framework suggests that four groups of organizations or “players”
interactively and interdependently define the “game” of business for a company. The
term “players” is used to represent the different roles or positions that various econom ic
stakeholders “play” in their interactions with the focal company’s economic value
creation process. The four players include customers, suppliers, competitors, and
complementors.

The players along the horizontal axis of the value net are the company’s
customers and suppliers. Resources, such as raw materials, labor and services, flow
through the value chain from suppliers through the company to its customers. Financial
wealth flows in the reverse direction, from customers to the company, and from the
company to suppliers. Analysis of the focal company’s value chain and value system
provides guidance in terms of identifying the suppliers and customers at each phase
within the economic value creation process. The organization adds value through this
process to the extent that it is able to efficiently gather inputs, and then efficiently and
effectively transform inputs into outputs that are valued by customers. This, in turn,
requires it to have devised an appropriate business model through which the organization
can continually capture value from the right customers by conducting the right activities.

Player Analysis – Value Chains & Nets

EExxhhiibbiitt 33–22 Value Net

Economic
Competitors

Make it harder to obtain
customers & supplies

(-)

Suppliers
Provide goods &

services in
exchange for

money

(-)

(+)

Company
(-)

(+)

Customers
Provide money in

exchange for goods
& services

(+)

Economic
Complementors

Make it easier to obtain
customers & supplies

Source: Adapted from A. M. Brandenburger and B. J. Nalebuff, Co-opetition (New York: Doubleday,
1996).

In addition to customers and suppliers, two other players have an impact upon the
organization’s ability to sustain profitability. These players, along the vertical axis of the
value net, are the company’s economic competitors and economic complementors.

Economic competitors are defined as those companies who compete with the
company for customers, suppliers or both. A player is a customer competitor if
customers value the focal company’s offerings less when they also or instead possess or
have access to the other player’s offerings.12 In this context, “offerings” refers to goods
and services. Customers who can choose among multiple cell phone providers would
value their provider less than those who only have one choice would value their provider.
This is especially true if switching costs are low.

The second type of economic competitor is a supplier competitor. A company is
a supplier competitor if suppliers value the focal company’s supply opportunities less
when they also or instead possess or have access to the other player’s supply

Player Analysis – Value Chains & Nets

opportunities. In this context, “supply opportunities” refers to the supplier’s opportunity
to sell goods and services to the company. An automobile parts manufacturer which
supplies parts to GM would likely value GM’s supply opportunities less if it also
possessed supply opportunities from Ford. As the focal company, GM would find its
supply opportunities more valuable to the parts supplier in the absence of any from Ford.

A third type of economic competitor is a value chain competitor. A company is a
value chain competitor if it makes it harder for the focal company to build, operate or
sustain its means of conducting its value chain of activities. A company such as Peapod,
which makes it very convenient and cost-efficient to order groceries online and have
them delivered to your home, makes its harder for retailers who locate in close proximity
to major grocery stores to attract as much customer traffic, since many potential
customers may not frequent the anchor grocery store as frequently. Thus, the value
chains of these retailers are affected negatively by the presence of Peapod and it can be
deemed a value chain competitor to them.

In Exhibit 3-2, the impact of economic competitors is illustrated by flows of
money and goods and services that bypass the focal company, as represented by the
negative sign (-) next to the unshaded arrows flowing from the customers and suppliers to
the company; and by the greater challenges the presence of economic competitors can
exert upon the organization’s ability to operate its chosen value chain of activities (also
represented by a negative sign (-) between competitors and the company). In the
presence of companies playing competitor roles, the company sells less of its goods and
services to customers, gains access to fewer resources from suppliers, and experiences
greater challenges in operating its value chain than it might if this player were not in the
game in this way.

Economic complementors are defined as those players who complement the
company for customers, suppliers or both. A company is a customer complementor if
customers value the focal company’s offerings more when they also possess the other
player’s offerings than when they possess only the focal company’s offering. Customers
who possess computers would likely value their computers more if they also possess
high-quality computer software. As the focal company, the computer maker would find
its offerings more valuable to customers in the presence of those from high-quality
computer software makers.

The second type of economic complementor is a supplier complementor. A
company is a supplier complementor if a supplier finds it more attractive to supply the
focal company when it also supplies the other company than when it supplies only the
focal company. An aircraft manufacturer such as Boeing which supplies aircraft to
American Airlines would likely value American’s supply opportunities more if it also
possessed supply opportunities from Delta Airlines, given the potential to share the huge
costs involved in aircraft development and the benefits of joint orders. At the same time,
as the focal company, American would find its supply opportunities more valuable to
aircraft suppliers such as Boeing in the presence of those from Delta.

Player Analysis – Value Chains & Nets

A third type of economic complementor is a value chain complementor. A
company is a value chain complementor if it makes it easier for the focal company to
build, operate or sustain its means of conducting its value chain of activities. For the
major, anchor grocery stores that it works with, Peapod functions as a value chain
complementor in that it allows the groceries to focus their efforts on running their stor es,
while also providing them an opportunity to better serve some customers who might not
patronize their stores but for the presence of Peapod. Thus, to the anchor grocery stores,
Peapod is a value chain complementor; while to the smaller retailers who co-locate
nearby the major grocery stores, Peapod is a value chain competitor.

The impact of economic complementors is illustrated in Exhibit 3-2 by flows of
money and goods and services that are directed toward the focal company, as represented
by the positive sign (+) next to the shaded arrows flowing from the customers and
suppliers to the company; and by the positive effects the presence of economic
complementors can exert upon the organization’s ability to operate its chosen value chain
of activities (also represented by a positive sign (+) between complementors and the
company). In the presence of companies adopting complementor roles, the company
sells more of its goods and services to customers, gains access to more resources from
suppliers, and experiences greater ease in operating its value chain of activities than it
might if complementors were not positioned as an active player in this set of exchanges.
This is the complete mirror effect of that described for competitors. In sum,
complementors are players with which the focal company can interact on a win-win,
rather than on a win-lose basis.

Multiple and changing roles

As is evident from the American and Delta example, companies may play
different roles simultaneously, and/or their roles may evolve over time. While American
and Delta are indeed supplier complementors when it comes to procuring aircraft, they
are supplier competitors when it comes to obtaining pilots, flight attendants and other
employees. Moreover, the two organizations are clearly customer competitors as well –
the offerings of each make it harder for the other to obtain customers. On certain routes,
however, the presence of service by each allows a customer to reach his or her destination
by flying a leg of the trip on each airline. This makes the two organizations customer
complementors in this regard.

The value net framework provides managers with a tool to map those players, in
all of their roles, which have the greatest impact on the organization’s economic value
creation process. This then allows managers to develop micro- and macro-level
strategies with respect to important economic players. For example, while long distance
companies AT&T, Sprint and MCI have been competing vigorously for long distance
service market share for many years, AT&T’s equipment business, recently spun off as
Lucent Technologies, also sought to serve as a network equipment supplier to both MCI
and Sprint.

A second aspect of the value net is that players may frequently shift both their
strategies and roles with respect to the focal company, adding a dynamic element to the

Player Analysis – Value Chains & Nets

framework. When suppliers, customers and the focal company come together to create
value for all involved, for example, they generally operate on a cooperative basis. But
when the pie has to be divided up, customers press for lower prices and suppliers also
want their slice of the pie.13 In other words, the organizations shift their strategies from
cooperative to competitive. In addition, at times players may shift from one role to
another, such as from supplier to supplier competitor, or vice versa, depending upon
integration or other strategies the players follow. Since such strategy and role shifts may
prove detrimental to the focal company, the development of a clear picture of which
players occupy which roles currently, and which ones might shift to which new roles with
what detriments, is something that could greatly enhance managers’ abilities to engineer
these interdependencies.

In summary, doing well in the market context requires companies to create value
by efficiently transforming inputs into products and services. This economic value
creation process is complicated by multiple interdependencies among the organization
and organizations whose actions make it easier or harder for the focal company to obtain
and keep both customers and suppliers. Moreover, given that organizations may
simultaneously and/or dynamically adopt different roles with respect to the focal
company, an understanding of which companies occupy which roles, and which
companies may switch to which roles, seems key to effectively managing this value
creation process.

The key insight to be drawn from value net analysis is that there are both players
that can make the company’s economic value creation process harder to manage
(competitors) and players that can make it easier to manage (complementors). In terms
of those making it harder, in addition to traditional competitors – those that compete with
the company for customers – the value net also points out that there are also competitors
for supplies. These supplier competitors are often overlooked as a focus of strategy
making. The recent attempt by barnesandnoble.com to acquire Ingram Book Group, the
leading book supplier for competitor Amazon.com, however, highlights how developing
an understanding of supplier competitors and their related strategies can be critical.14
This acquisition, despite its ultimate dissolution,15 forced Amazon to recognize that one
of its leading suppliers could end up in the hands of one of its leading customer
competitors.

In terms of those making it easier for a company to manage value creation, this
very idea opens up numerous strategic possibilities. Consider Microsoft and Intel, two
customer complementors. Whenever Microsoft releases a new, more processing-heavy
version of its Windows operating system, PC owners demand faster chips in their PCs to
run the new products. This means that demand for Intel’s microprocessor chips increases
simply because Microsoft releases a new version of its products.16 The sellers of
motorbikes and motorcycles similarly act as customer complementors for motorcycle
helmet organizations. Every sale of a bike represents a likely sale of a helmet, no matter
what the helmet manufacturers do. Given this, it is essential for managers to broaden
their view of who matters to their organization in order to develop strategies that
explicitly link their offerings to those that can best help them succeed in obtaining
customers.

Player Analysis – Value Chains & Nets

On the supply side, moreover, there are also players in most industries that can
help an organization gain access to supplies that otherwise would be difficult or
expensive to obtain. The case of Delta and American in terms of their airframe needs
provides an example of this. Direct competitors for customers, they join forces to obtain
new airplanes.

In whole, value net analysis provides an approach to identify the key players who
add and detract from an organization’s economic value adding process. Importantly,
while value analysis examines players within the traditional economic context, it may
also be used to examine players within the technological and the political-social contexts
as well. In the external trend analysis chapters, therefore, extensions of value analysis to
these additional dimensions are described. Through application of the more advanced
mapping procedures provided in these chapters, managers can gain access to powerful
tools to systematically examine value creators and destroyers in each context, from which
they can pursue comprehensive player mapping and valuation analyses.

Below is an illustration of an economic value net for Nintendo. Following this
illustration, Exhibit 3-3 provides a summary framework that managers might find helpful
in reporting their player analyses. Note therein that the framework supports inclusion of
the focal firm’s key activities in the center, as derived from value chain analysis, as well
as each of the key external players on the focal firm’s value net in their respective cells.

Player Analysis – Value Chains & Nets

IIlllluussttrraattiioonn Value Net of Nintendo
17

Adam Brandenburger and Barry Nalebuff describe Nintendo’s rise to domination of the home
video game business as being the result of its creation of a virtuous circle among the key players on its
value net. By offering game hardware at prices that competitors claimed were below its costs, and
developing hot game titles under tight licensing arrangements, Nintendo was able to limit competition and
reduce the negotiating power of the other players. As a result, it was able to capture a major slice of the
value-added pie. See Chapter 5 for further development of the role of bargaining power in an
organization’s performance..

Competitors
Atari, Commodore, Sega

(hardware)
Other entertainment

providers
(TV, books, sports)

(-)

Nintendo
Video games and
related products

(magazines, toys)

Suppliers
Ricoh, Sharp
(microchips)

Marvel, Disney
(game characters)

(-)
(+)
(-)
(+)

Customers
Toys “R” Us, Wal-
Mart, other retailers

(+)

Complementors
Acclaim, Electronic Arts

(game developers)

Source: Adapted from A. M. Brandenburger and B. J. Nalebuff, Co-opetition (New York: Doubleday,
1996), p. 115.

Player Analysis – Value Chains & Nets

EExxhhiibbiitt 33–33 Value Analysis Initial Summary Diagram

Competitors
______________________
______________________
______________________
______________________

Suppliers
__________________
__________________
__________________
__________________
__________________

Company
Key Activities:
______________________
______________________
______________________
______________________
______________________

Customers
__________________
__________________
__________________
__________________
__________________

Complementors
______________________
______________________
______________________
______________________

RReeaaddyy ttoo LLeeaarrnn Value Chains & Nets

Upon completion of this chapter students should be able to:

1. Describe the value chain and each of its components.

2. Describe the value net and each of its components.

3. Devise a value chain of activities for a given company.

4. Identify the key relationships and interdependencies of a given company.

Player Analysis – Value Chains & Nets

Notes

1 M. E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York: Free
Press, 1985).
2 A. M. Brandenburger and B. J. Nalebuff, Co-opetition (New York: Doubleday, 1996).
3 M. E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York: Free
Press, 1985), p. 33.
4 R. D. Buzzell and B. T. Gale, The PIMS Principles (New York: Free Press, 1987).
5 M. E. Porter, Competitive Strategy (New York: Free Press, 1980).
6 M. E. Porter, Competitive Strategy (New York: Free Press, 1980).
7 R. Hallowell, “Dual Competitive Advantage in Labor-Dependent Services: Evidence, Analysis and
Implications,” in D. E. Bowen, T. A. Swartz, and S. W. Brown, eds., Advances in Services Marketing and
Management (Greenwich: JAI Press, 1997).
8 This illustration is adapted from T. Loiacano, “Yahoo!: A Strategic Audit” (unpublished manuscript,
School of Business and Public Management, George Washington University, April 27, 1999). Facts, unless
otherwise attributed, were obtained from portal company Web sites.
9 J. Kornblum, “Portals Open New Frontiers: USA/Lycos Deal Treads on Heels of Internet Gold Rush,”
(USA Today, February 10, 1999), p. 1B.
10 Sources for discussion of virtuous cycles include in P.W. Anderson, K.J. Arrow, and David Pines, eds.,
The Economy as an Evolving Complex System (Redwood City, CA: Addison-Wesley, 1988); B. W.
Arthur, “Increasing Returns and the New World of Business,” Harvard Business Review (Jul/Aug, 74: 4,
1996), pp. 100-109; K. E. Boulding, Evolutionary Economics (Beverly Hills, CA: Sage, 1984); P. Hall,
Innovation, Economics and Evolution: Theoretical Perspectives on Changing Technology in Economic
Systems (New York: Harvester Wheatsheaf, 1994).
11 A. M. Brandenburger and B. J. Nalebuff, Co-opetition (New York: Doubleday, 1996); M. E. Porter,
Competitive Strategy: Techniques for Analyzing Industries and Companies (New York: Free Press, 1980).
12 The potential possession of offerings is assumed to be as valid as the actual possession of offerings.
Hence, ‘possession’ refers to both actual and potential possession.
13 A. M. Brandenburger and B. J. Nalebuff, Co-opetition (New York: Doubleday, 1996), p. 36.
14 P. A. Madden, “Less Than Zero Margins,” Red Herring (64, March 1999).
15 S. Labaton and D. Carvajal, “Book Retailer Ends Bid for Wholesaler,” New York Times, June 3, 1999
C1.
16 A different perspective on this relationship is that Microsoft has aggressively enhanced and marketed the
functionality of its products in attempt to match the microprocessor improvement rates, thereby avoiding
the occurrence of performance oversupply. See Chapter 10 and C. M. Christensen, The Innovator’s
Dilemma: When New Technologies Cause Great Organizations to Fail (Boston, MA: Harvard Business
School Press, 1997), pp. 179-182.
17 A. M. Brandenburger and B. J. Nalebuff, Co-opetition (New York: Doubleday, 1996), pp. 110-117.

PREP 3 Business Policy:

For the industry that you plan/hope to work in, what do you think are the key value-adding activities in most of the firms?

The primary activities in value chain include:

Inbound logistics of handling and stocking raw materials including linen, bathroom supplies, carpeting, wall paint, decorations, lamps, furniture, etc.

Operations- assembling and putting together the materials and employees to work towards the purpose of serving and accommodating customers, divide the hotel into departments with managers who report to a general manager, who reports to owners, franchisors, and corporate offices.

Outbound logistics: Include day-to-day upkeep of the hotel rooms and public areas

including reception, concierge, bellmen and valet crew. Maintenance, preventative maintenance, construction and emergency systems, reservations, catering, banquet bookings, marketing, quality and availability of all food and beverage outlets, banquet and catering operations, room service, bars, kitchens, menus, food ordering, security, etc.

Marketing and sales: Advertising, promotion, and pricing

Service: guests are settled in their booked accommodations, room rates and incidental (extra) charges are posted, restaurant waiters and cooks, front desk receptionists, butlers, cleaning crew, etc.

CChhaapptteerr 22 CCoommppeettiittiivvee
AAddvvaannttaaggee

Arguably, the most important role of a CEO and his or her senior management
team is creating, maintaining and extending their organization’s competitive advantage.
As described in Chapter 1, pursuit of competitive advantage is the goal of the strategic
management process. Through an iterative process of setting the aims of the firm,
crafting and implementing viable strategies, and constantly evaluating and controlling
firm performance, senior management has the potential to allow their firm to ‘win’
against competitors and shape the firm’s broader environment.

In this chapter, the focus turns to what ‘winning’ means to a firm. The first
section focuses on the concept of added value. Based on the recent work in game
theory, the added value concept provides a useful way of looking at how firms create
value. The second section explores four types of competitive advantages that flow from
and create added value. It draws on the B-C framework to explain how the various
competitive advantages translate into real benefits for a firm. As part of this second
section, detailed examples of business designs focused on various forms of competitive
advantage are provided.

Competitive Advantage

ADDED VALUE

According to Adam Brandenburger and Barry Nalebuff, in order to maximize its
competitive positioning, an organization attempts to drive as large a wedge as possible
between (1) suppliers’ minimum payment expectations and (2)

customers

’ maximum
willingness to pay.1 Simultaneously, a truly successful organization also seeks to (3)
drive down its costs so that there is more of the wedge left over for it in terms of profits.
To the extent that the organization is successful in 1, 2 and 3, it is likely to obtain a larger
portion of the total added value. In addition to adding value by driving down supplier
costs, lowering operating costs and raising customers’ willingness to pay, an organization
can also seek to (4) expand the pie, writ market. These relationships are depicted in
Exhibit 2-1.

EExxhhiibbiitt 22–11

Added Value

Suppliers Company Customers
Smallest amount willing to be paid

for producing the supply
What it costs to convert

the supplies into offerings
Largest amount willing to pay

for the company’s offering
$100 $25 $140

$ 1 4 0

$ 1 0 0

$ 2 5

$ 1 5

$ 4 0

Charles Schwab provides an example of a firm that has managed to create
significant added value. Charles Schwab has tried to widen the gap between (2) what
customers are willing to pay for its offerings and (1) what suppliers of mutual funds are
willing to accept. Schwab put in place a set of technological systems that allows both it
and its mutual fund companies to more efficiently manage their operations (3), and that

All players try
to capture

Added Value

Successful
organizations drive a
wider wedge between

cost and price

(3) Try to drive down
operating costs

(2) Try to gain
premium pricing

(1) Try to obtain
lowest cost of supplies

(4) Try
to grow
the pie

Competitive Advantage

also allows customers to more readily obtain access to these funds, which effectively
allowed the firm to (4) grow the pie. If Schwab were to exit the business, both suppliers
(mutual fund companies) and customers would be worse off. That is, Schwab has
produced significant added value.

Thus, according to the added value perspective, for an organization to capture
added value, it can do one or more of three things. First, the organization can lower its
input costs from suppliers. Wal-Mart, for example, has significantly lowered its supply
costs by consolidating multiple orders into larger ones that suppliers can fill more
economically and at better pricing. The second way that an organization can seek to
capture added value is to lower its operating costs. Wal-Mart has done this through use
of a sophisticated logistics system that not only reduces inbound logistics’ costs, but also
helps to streamline store operations. Its lower operating costs have in turn allowed it to
offer every-day-low-pricing in its stores. In other organizations, moving up the learning
curve, increasing economies of scale, and outsourcing less efficient activities can drive
down operating costs. Finally, the third way that an organization can seek to capture
added value is to raise the amount that customers are willing to pay for its offerings. This
is accomplished by differentiating the organization’s offerings by varying their quality,
availability, features, etc. In essence, by differentiating its offerings, the organization is
able to effectively limit the degree of direct competition that its offerings face.

However, in addition to capturing added value through one or more of these three
approaches, an organization can also seek to change the size and shape of the added value
pie as well. That is, rather than taking the game as a given, the organization can seek to
enlarge it or change it so that there is more to be gained by all of the players. As
described in Chapter 1, for example, Intel sought to grow the PC business through its
advertising campaign, thereby increasing the overall market for PCs and its offerings.
Thus, the fourth way that organizations can create and capture added value is to expand
the market for its offerings.

Competitive Advantage

COMPETITIVE ADVANTAGES

The foregoing added value discussion highlighted three broad approaches to
competitive advantage. These included: cost leadership, whether due to lower input or
operating costs; differentiation, by which the firm is able to increase willingness to pay;
and innovation, upon which the firm can launch into new markets, grow its markets or
change the shape and nature of its markets. While not specifically highlighted in the
added value discussion, a fourth approach to competitive advantage is diversification.
Diversification can allow a firm to avoid risks and level revenue, cost, growth and other
business dynamics, thereby potentially supporting creation of other competitive
advantages. In the following sub-sections, each of these approaches to competitive
advantage is explored in greater detail. In order to facilitate an understanding as to how
each competitive advantage translates into tangible results for a firm, the B-C
framework2 is used.

B-C Framework

In its simplest form, what any company seeks to do is create value by offering
products or services at prices that are above what it costs the firm to make or deliver, and
below or just up to the perceived benefits that customers believe they will derive by
purchasing the offerings. Exhibit 2-2 illustrates these relationships. As depicted, the
value created by a firm is the difference between what it cost the firm to make an offering
and the benefits enjoyed by customers and the company. This created value is then
divided between the company and customers; the company earns profits to the extent that
price is above costs; the customers enjoy benefits to the extent that the price is below
their perceived value point.

EExxhhiibbiitt 22–22 Benefits Minus Costs (B-C) Framework:
General

Profits earned
by

company

Benefits CostPrice

Value created by company

Benefits enjoyed
by

customers

Competitive Advantage

Not surprisingly, different competitive advantages shift cost, price and benefits
points within the B-C framework, thereby providing different levels of tangible results to
firms. However, firms do not provide their offerings in a vacuum. Instead, each of these
variables (cost, price and benefits) is assessed in reference to what rivals offer. Exhibit 2-
3 captures this idea and serves as the basis for a comparison of the four approaches to
competitive advantage detailed below.

EExxhhiibbiitt 22–33 Benefits Minus Costs (B-C) Framework:
Rivals

Benefits CostPrice $0

Company

Competition

Cost Leadership Advantage

As described above, firms such as Wal-Mart have streamlined many aspects of
their purchasing processes and operating systems to allow for significant cost leadership
advantages. This then allow them to do one or the combination of two things, namely,
(1) use their lower costs to lower their prices, thereby gaining market share; or (2) use
their lower costs to increase profits, by keeping prices the same.

Each of these options is depicted in Exhibit 2-4.

EExxhhiibbiitt 22–44 Cost Leadership Advantage

Benefits CostPrice $0
Company

Competition

(1) Increase
market

Benefits CostPrice $0

Company
Competition

(2) Increase
profits

Benefits CostPrice $0
Company
Competition

Change

+ To Customer

+ To Company

Competitive Advantage

How to lower operating costs. Operating costs are driven by a number of factors, the
most important of which include operating scale, offering scope, learning/experience
curve position, degree of specialization, and technological sophistication/adoptio n. A
number of business designs that can lead to decreased operating costs are profiled in
Exhibit 2-5.

EExxhhiibbiitt 22–55 Business Designs to Decrease Operating
Costs

1. Multi-
component

Coca-Cola Service several components/segments in a business to gain the
margins that some offer only to those in other segments (e.g.,
Coca-Cola earns premiums in the fountain and vending
segments, but needs to remain in the fiercely competitive
supermarket segment to sustain brand power and scale).

2. Switch-
board

Schwab,
computer
time-sharers

Act as an intermediary between multiple buyers and multiple
sellers, thereby reducing both sets of players’ costs, and adding
value in the process (e.g., Schwab provides access to hundreds
of sellers’ mutual funds through its One Source service, thereby
facilitating buyers’ access to the mutual funds to the benefit of
both buyers and sellers, as well as to Schwab; computer time-
share companies provide access to large computer services to
small organizations unable to obtain such access on their own).

3. Local
leadership

Home heath
care,
groceries,
retailing

Leverage the extent to which costs are local by conquering
regions before larger scales (e.g., Starbucks obtained dominant
positions in Seattle, then Chicago, etc. before expanding across
the U.S.; Wal-Mart sought local leadership in every market it
entered to reduce logistics, advertising, recruiting, etc. costs).

4. Relative
market
share

Numerous Gain relatively greater market share than competitors in select
businesses where pricing advantages and cost economies are
available (e.g., office furniture is a business where buying,
marketing and installation economies provide larger players
with significant margin advantages over smaller organizations).

5. Experience
curve

Numerous Aggressively apply the organization’s experience to lower costs
(e.g., expand offering scope to similar offerings).

6. Transaction
scale

Investment
banking, real
estate, long-
haul air travel

In industries where the costs to deliver an offering increase at a
lower rate than the revenues derived, seek preeminence as the
big deal maker (e.g., in an investment banking transaction, the
difference in costs to handle medium vs. large transactions are
minimal, but the fees and commissions increase with size).

7. Systems Southwest
Air, Dell,
Wal-Mart

Develop a business design that trumps incumbents’ cumulative
experience advantages (e.g., use Internet to market, sell and
deliver offerings; Wal-Mart’s sophisticated supply chain
management system in retail).

Source: Adapted from A. J. Slywotzky and D. J. Morrison, The Profit Zone: How Strategic Business Design Will
Lead You to Tomorrow’s Profits (New York: Random House, Inc., 1997).

Competitive Advantage

How to lower input costs. The costs of supplies to an organization vary by region,
scale, quality, etc. Moreover, they also vary based on the degree of bargaining power
that suppliers maintain over the organization. The primary factors that increase supplier
power include their numbers (the fewer, the more powerful), few quality substitutes, high
switching costs to be borne by the buyer, and a high forward integration threat into the
company’s business. A number of business designs that can lead to decreased input costs
are profiled in Exhibit 2-6.

EExxhhiibbiitt 22–66 Business Designs to Decrease Input Costs

1. Flexible
inputs

Nucor Devise production process that can accommodate different input
qualities or raw materials.

2. Limit
proportions

Nintendo In some businesses, such as video games, proprietary inputs are
needed from suppliers. By issuing limited licenses to suppliers,
organizations are able to limit the power that they can establish
(e.g., Nintendo limited the number of video games that any one
maker could produce under license).

3. Buying
alliances

Numerous Consolidate buying into buying consortiums so that the relative
bargaining powers of the suppliers are limited.

Source: Adapted from A. J. Slywotzky and D. J. Morrison, The Profit Zone: How Strategic Business Design Will
Lead You to Tomorrow’s Profits (New York: Random House, Inc., 1997).

Differentiation Advantage

As described in greater detail in Chapter 6, “anything which makes buyers prefer
one seller to another, be it personality, reputation, convenient location, or the tone of his
shop,” will cause differentiation to occur.3 Once there is differentiation, there will be
differences in the utility packages offered by different organizations, which in turn
affords them a degree of control over their prices. As with cost leadership advantages,
differentiation advantages provide a firm with several options in terms of capturing value.
Firms with differentiated offerings can do one or the combination of two things, namely,
(1) use the higher perceived benefits available from their offerings to gain market share,
by keeping prices the same; or (2) use higher perceived benefits to increase profits, by
increasing prices.

Each of these options is depicted in Exhibit 2-7.

Competitive Advantage

EExxhhiibbiitt 22–77 Differentiation Advantage

Benefits CostPrice $0
Company
Competition
(1) Increase
market
share
(2) Increase
profits
Change
Benefits CostPrice $0
Company
Competition
Benefits CostPrice $0
Company
Competition

+ To Company

+ To Customer

How to increase customers’ willingness to pay. One way to understand how an
organization increases its customers’ willingness to pay is to consider how customers
make use of the organization’s offering within the customer’s own value creation system.
From such a perspective, an organization’s offering is seen as but a small piece of a
customer’s business puzzle (Exhibit 2-8). A successful company recognizes this,
attempts to understand how its offering contributes to the customer’s needs, and then
attempts to enhance its offering to better meet the customer’s need, or even enhance the
customer’s own offering.

Consider the example of Federal Express (FedEx).4 FedEx has been in the
package delivery business since the 1970s. In addition to residential customers,
significant portions of the company’s customers are manufacturers that ship their
products to stores worldwide. Each of these manufacturers, FedEx’s customers, had to
develop and manage their own product pick-up, tracking and delivery logistics systems in
order to get their products to their stores and their customers. That is, each company had
to devote valuable managerial, technological and human resources to a part of the value
chain that provided most with little if any competitive advantage – this was not a value
added part to most businesses.

Competitive Advantage

EExxhhiibbiitt 22–88 Customer’s System Economics

The Customer’s
Total Economic

System
How can
the focal
firm
capture
more of
the
customer’s
needs? The

Organization’s
Offerings

How does
the firm’s
offering
get used
within the
customer’s
business
processes?

Source: Adapted from A. J. Slywotzky and D. J. Morrison, The Profit Zone: How Strategic Business
Design Will Lead You to Tomorrow’s Profits (New York: Random House, Inc., 1997), p. 26.

FedEx, as part of its internal operating systems, had developed and had been
using since the early 1980s one of the most sophisticated package pick-up, tracking and
delivery logistics systems. In the mid-1990s, it reached into its customers’ value systems
by offering access to the capabilities of this technology.

FedEx’s Business and Logistics Services (BLS) unit allowed customers, rather
than running mediocre delivery businesses of their own, to obtain significant cost and
operational benefits by using FedEx’s state-of-the-art systems. From the customer’s
perspective, FedEx added value to its total economic system by taking over these
activities. To the extent that FedEx could perform the activities for less cost and with
greater efficiency and effectiveness, it added value to the manufacturers. FedEx would
clearly be the winner in competition with another delivery organization not offering such
capabilities.

Delivering packages, like manufacturing cars, consumer electronics, and many
other categories of products, is becoming a profitless activity. As a result, organizations
need to move beyond manufacturing a product to also providing solutions to customers’
problems. FedEx did this by helping organizations better manage their logistics systems.
General Electric has done this by selling not only products, but also options, accessories,
financing and services related to its products.

In addition to becoming an essential player within customers’ value systems, there
are also many other ways that organizations can enhance customers’ willingness to pay.
A number of these designs are profiled in Exhibit 2-9. In each case, the idea is
essentially the same – to differentiate the offerings sufficiently that there is no effective
competition.

Competitive Advantage

EExxhhiibbiitt 22–99

Business Designs to Increase Customers’
Willingness to Pay

Design Examples Description

1. Customer
solutions

FedEx, GE,
USAA

Move into the customers’ economic systems to enhance their
operations or offerings (e.g., GE sells the whole solution to
customers; FedEx takes over the logistics process).

2. Time Intel,
investment
banks,
consumer
electronics

Maintain lead to reap higher margins, and to cause the followers’
offerings to be commoditized (e.g., Intel’s microprocessors
generate significant margins, but followers’ chips are seen as old,
and their margins reflect this; new consumer electronics and
investment banking offerings maintain similar characteristics).

3. Special-
ization

ABB, EDS,
Home Depot

Focus on one customer group or product, and derive lower costs,
higher quality, shorter selling cycles, and better prices as a result.

4. De facto
standard

Microsoft,
Oracle,
SABRE

Seek to own the standard to reap increasing returns (e.g., SABRE
is the primary system used by reservation agents to schedule
travel. As more airlines and agents adopted the system, it
became more valuable since it covered more offerings).

5. Brand Numerous Build a power brand to obtain superior pricing (e.g., Sony
products sell at higher margins than other companies’ products
because of Sony’s brand image).

6. Specialty/
new
product

Numerous Manage the product life cycle to maximize earnings on newer
offerings, while continually shifting investments into newer ones
(e.g., while PCs are a commodity business, notebooks are
marginally profitable, and servers are high margin. It is ideal to
shift R&D and production to notebooks and servers and then to
next platform to continually obtain premium pricing).

7. After-sale Numerous Target profit zones in upstream or downstream activities, whether
part of the industry or in another (e.g., many companies sell add-
on memory chips, PC performance enhancement products, and
training videos to the installed base of PC owners).

8. Value
chain
position

Numerous Focus on the activities within an industry’s value chain that
generate the highest margins (e.g., in the automotive industry,
higher margins are obtained from financial services and extended
warrantees than from assembly and distribution).

9. Block-
buster

Film
making,
music,
publishing,
pharma-
ceuticals

Invest in a few potentially big hit offerings (e.g., while drug
development can cost upwards of half a billion dollars, revenues
can reach $15 billion for some; film costs run as high as $100
million, with revenues as high as $500 million. Few competitors
can afford to take such bets).

Competitive Advantage

EExxhhiibbiitt 22–99
CCoonnttiinnuueedd

Business Designs to Increase Customers’
Willingness to Pay

Design Examples Description
10.Value

migration
Swatch,
Mattel

Continue to develop low-price, high-volume products while
migrating to high-price, low-volume products, thereby preventing
others from getting a foothold in the business (e.g., Japanese
automakers gained a foothold for low-cost autos without
suffering extensive competition, and then began taking market
share in increasingly higher margin segments).

11. Entre-
preneurial

ABB, 3M Joseph Schumpeter claims entrepreneurial profits are available
only to organizations doing innovative things, and that others
earn only managerial profits.5

12. Cycle Capacity-
driven
industries

Lower breakeven point and manage cycle (e.g., as capacity
tightens, lead price increases and lower breakeven point so that
cycle has less impact on performance stability).

Source: Adapted from A. J. Slywotzky and D. J. Morrison, The Profit Zone: How Strategic Business Design Will
Lead You to Tomorrow’s Profits (New York: Random House, Inc., 1997).

How to increase market size/share. Organizations also seek to capture added value by
increasing the pie available to all players. They do this primarily by reaching forward
into their customers’ value chains, in order to promote expansion of these organizations’
sales, and by seeking to shape emerging technological or business standards through
pursuit of key adopter and/or diffusion strategies. A number of business designs that can
lead to an increase in the size of the pie are profiled in Exhibit 2-10.

EExxhhiibbiitt 22–1100

Business Designs to Increase the Size of the
Pie

1. Multiplier Disney, other
powerful
brands

Seek to gain additional profits from the same offering,
trademark, copyright, etc. (e.g., Disney’s characters are licensed
in watches, apparel, cartoons, books etc.).

2. Diffusion/
installed
base

Netscape,
Lotus, Otis
Elevators

Follow a Trojan horse approach through which widespread
offering diffusion is used to create a de facto standard which
leads to establishment of a large installed base (e.g., Netscape
opened up its source code to allow development of a virtual
programming network; the widespread copying of Lotus’
products allowed it to issue later versions with large margins
once users became hooked on the software; Otis Elevator earns
more on servicing its elevators than selling them).

3. Installed
base

Copiers,
printers,
razors,
elevators,
software

Make margins on follow-on offerings to installed base (e.g.,
Microsoft and other software companies often give away first
versions of products in order to foster a virtuous cycle in which
the installed base grows exponentially, and once it gets large
enough, the organizations can then sell new versions to it at high
margins).

Competitive Advantage

EExxhhiibbiitt 22–1100
CCoonnttiinnuueedd

Business Designs to Increase the Size of the
Pie

4. Key
adopters

Sony-Philips,
Toshiba-Time
Warner, Sun-
Philips, MIPS

Co-opt competition for standards by forming coalition of
powerful players who collectively legitimize standard (e.g.,
rather than pursuing end-user diffusion to gain adoption, rival
groups Toshiba-Time Warner and Sony-Philips instead pursued
a strategy of reaching a consensus on a DVD standard prior to
manufacturing a single product. In the microprocessor field,
Sun Microsystems and Philips have pursued joint production
agreements allowing Sun’s RISC chips to be more readily
incorporated within a broader range of products than Sun was
able to accomplish on its own. Standard competitor MIPS
Computer Systems, similarly, has pursued licensing agreements
with major manufacturers such as Siemens).

5. Blue oceans Curves,
Cirque de
Soleil,
Southwest
Airlines

Eliminate, reduce, raise or create factors to compete on and
invest in that allow for access to non-customers and avoid direct
competition. Curves targets women only in facilities designed
to enhance social interaction and avoid rivalry. Cirque de Soleil
changed a circus atmosphere into a Broadway-type production.
Southwest pursued customers who would ordinarily drive rather
than fly.

6. Value chain
control

Intel Rather than relying upon customers’ efforts to sell their offering
to spur demand for company’s offerings, reach in front of them
to market to their customers (e.g., Intel’s “Intel inside”
campaign).

7. Sales
drivers

Debeers,
Cross Pens,
Burger King,
surge
protectors

Develop new drivers of sales (e.g., diamonds are marketed as
appropriate for engagement rings, and anniversary/event
jewelry; writing instruments are marketed as celebration gifts;
Burger King offers “Pokemon trading card nights”; surge
protector makers link sales to PC sales).

Source: Adapted from A. J. Slywotzky and D. J. Morrison, The Profit Zone: How Strategic Business Design Will
Lead You to Tomorrow’s Profits (New York: Random House, Inc., 1997); W. C. Kim and R. Mauborgne, Blue Ocean
Strategy: How to Create Uncontested Market Space and Make the Competition Irrelevant (Boston, MA: Harvard
Business School Press, 2005).

Innovation Advantage

Game theory has taught us not only that companies can pursue low cost or
differentiation strategies, but also that they can literally change who they interact with
among industry players.6 Just as the players can change, so can their impacts on who gets
a bigger piece of the value creation pie. In addition, the rules – unwritten norms and
business customs – that govern the interactions among the players can change, as can the
tactics of the players, and the scope of the game being played. As a result, as depicted in
Exhibit 2-11, rivals are at times effectively eliminated.

Competitive Advantage

EExxhhiibbiitt 22–1111 Innovation Advantage

Change Benefits CostPrice $0
Company

Competition X X X

A number of innovation-based business designs are profiled in Exhibit 2-12 and
described below. Of course, in addition to these examples, most people typically think of
innovations as those that occur with respect to products, markets and technologies. Such
innovations are incorporated within the various differentiation and cost leadership
examples profiled above. Here, instead, the focus is on business design innovations.

1. How to change the players. Any new player to enter a game changes the game. In a
monopoly supplier situation, for instance, the entry of a second supplier requires the
monopolist to adjust its pricing, or to face losing sales to the new entrant. As such,
current buyers from a monopolist supplier gain significantly by the entry of the second
supplier. In the case of the artificial sweetener NutraSweet, for example, the mere threat
of an entry of a second supplier allowed Coke and Pepsi to negotiate long-term contracts
with NutraSweet’s maker, Monsanto, which led to combined savings for these companies
of $200 million annually.

EExxhhiibbiitt 22–1122 Business Designs to Foster Innovation

1. Change
players

BellSouth,
Intel,
NutraSweet

Find new players who can be brought into the game, in order to
reduce existing suppliers’ or customers’ bargaining power.

2. Change
nature of
competitive
advantage

Intel,
TWA,
Club Med

Find a way to cause customers or suppliers to change their
purchase-decision behavior; or simply compete on a different
basis or in a different arena.

3. Change
contractual
rules

GM Credit
Card

Develop Most Favored Customer clauses (MFCs), Meet-the-
Competition Clauses (MCCs) and Most-Favored-Supplier
clauses (MFSs).

4. Change
players’
perceptions

FedEx,
Nintendo

Offer guarantees that cost little in practice but that competitors
cannot match; provide offerings at low initial price knowing that
users must buy high premium offerings later.

5. Change
scope of
offerings

NationsBank,
DVD seller,
TCI Cable

Link one offering to another one even if it is unrelated.

Competitive Advantage

At times, this means that existing buyers from monopoly or oligopoly suppliers
might even be willing to pay a potential new supplier to enter the game. Alternatively, it
can mean that sellers might also be willing to pay to obtain additional bidders for its
offerings. BellSouth Corporation, for example, was able to get LIN Broadcasting
Corporation to pay it to enter a competing takeover bid to counter Craig McCaw’s
takeover bid for the company in 1989. It was in LIN’s best interest to have other bidders
competing for ownership, and it ultimately agreed to pay BellSouth a $54 million bidding
fee, plus $25 million to cover related expenses, just to provide competition to McCaw.
Indeed, it was also in McCaw’s ultimate best interest to have BellSouth leave the bidding
game – and he paid BellSouth $22.5 million to do so. In total, BellSouth was paid $76.5
million in fees, plus all expenses. Clearly, understanding the dynamics of a given game
can lead to extraordinary returns.

2. How to change the nature of competitive advantage. In order to maximize its
profits, an organization attempts to drive as large a wedge as possible between supplier’s
minimum payment expectations and buyer’s maximum willingness to pay.
Simultaneously, a truly successful organization also seeks to drive down its costs so that
there is more of the wedge left over for it in terms of profits. To the extent that the
organization is successful in doing this, it is likely to obtain a larger portion of the value
added pie. Of course, doing all this is not easy and often requires the organization to
challenge its assumptions about how it operates. An illustration proves insightful.

In 1993, Trans World Airlines (TWA) was in financial distress, and in fact, in
Section 11 reorganization. Unable to fill more than a fraction of its seats, the airline
removed 10-40 empty seats per plane to make the seats that were filled more comfortable
for its passengers. It cost TWA $1 million to remove the seats and another $9 million to
promote its new Comfort Class. Within six months, TWA’s average revenue per seat
was up 30%, as its customers were willing to pay premiums for the more roomy seating
arrangement. Moreover, competitors did not copy the strategy because they feared
depletion of too much capacity would fuel additional price wars. As such, TWA was
able to develop a higher-quality offering at little incremental cost. Had its planes been
full to begin with, it could not have pursued this strategy. On the other hand, because it
had such a huge weakness, namely its inability to fill empty seats, it was able to turn this
weakness into higher added values through brilliant strategy.

What TWA did with its strategy was to manage the tradeoffs between improving
quality and the costs of doing so. By spending less on the quality improvement than the
increase in customers’ willingness to pay for this improvement, it was able to engineer
increased added value. At times, however, it is also possible to use low cost as a basis for
increasing the customers’ willingness to pay. Club Med, for example, has minimalist
accommodations that lack telephones, clocks, televisions and all of the other expensive
accoutrements that normally accompany resort facilities. However, it is for this reason
that Club Med is able to create a unique, group-based social environment for which
customers are willing to pay premium dollars. Given its exotic image, moreover, it has
ten times as many applicants as positions at its resorts. In other words, its high quality
comes at low cost, both in terms of facilities and in terms of staffing.

Competitive Advantage

Yet another way that an organization can affect its added value is managing
customer bargaining power; the higher a customer’s bargaining power, the larger share of
the value added that they can claim. One way to limit power is to limit supply. While it
sounds counterintuitive, since limiting supply means giving up sales, an organization that
effectively manages supply can gain significant bargaining power with respect to
customers. Nintendo limited supply of its video games to its powerful retailer customers,
for example, and since the retailers’ own customers demanded more of the games,
Nintendo gained leverage over these retailers. Rather than waiting on these retailers to
submit their purchase orders on their terms, Nintendo took charge of the process and
required retailers to meet its requirements. Intel has taken equivalent control over its
customer situation by extending its reach to the OEM’s ultimate consumers through its
“Intel Inside” marketing campaign.

3. How to change contractual rules. In any game, including the game of business, there
are rules. However, organizations can and do shift the rules of competition to their favor.
When faced with severe price-quality competition, for instance, organizations can move
to compete on timing and know-how instead, thereby shifting the rules from cost-quality
to speed and innovation.

Other ways that organizations can change the rules are through most-favored-
customer clauses (MFCs), meet-the-competition clauses (MCCs), and most-favored-
supplier clauses (MFSs). Interestingly, when evaluated from the perspective of game
theory, these clauses often work out differently than might be expected. For example,
MFCs ensure a customer that they will receive the same price as any other customer.
That is, they are promised to receive the best price that is paid to anyone else. From the
customers’ perspective, this means that they do not have to worry that a competitor is
getting a better price, nor do they have to shop around as much. As such, while MFCs
appear to be to the customers’ benefit, suppliers gain significant bargaining power from
MFCs. This is because a supplier would have to offer any price cut awarded to one
customer to all customers with MFCs. This means that the supplier can say no, not
because it does not want to meet a customer’s request, but because to do so would be
prohibitively expensive. Research has found that the presence of MFCs does indeed
correlate with higher prices.7

MCCs are also good for the focal organization in general. This is because they
raise the costs of bidding for rivals. For example, since the organization is invited to
meet any rival’s bid, a rival is unlikely to succeed in its bid unless it way underbids, and
it costs the rival time and energy to generate the bid. Moreover, MCCs also take the
guesswork out of pricing, so that the focal organization does not need to lower its prices
preemptively to avoid losing business. Rather, it can continue to earn premium pricing
up to the point where the bidding costs to rivals just exceed the organization’s excess
revenues. MCCs may also be granted from the supplier perspective.

The only difference is that this time [the organization gets] a right to buy
as opposed to a right to sell. Formally, an MCC with a supplier is a
contractual arrangement between company and supplier that requires the
supplier to continue supplying the company provided that the company
agrees to match the best price anyone else offers the supplier for its

Competitive Advantage

resources. Just as customers typically pay more when they’ve granted an
MCC, suppliers typically get paid less when they’ve granted an MCC. 8

The one way that MCCs can hurt an organization is if a rival is out to hurt it. In
such a case, the rival may establish such a low price through the bidding process that the
focal organization’s margins become razor thin.

The last of the clauses are MFSs, which function in a mirror effect to MFCs. That
is, while it sounds good to have a clause that says that the organization will be offered the
best price for its supplies, this best price is difficult to raise, as doing so would cause the
buyer too much financial harm. This means that MFSs are good from the perspective of
the focal organization, since it raises its bargaining power with respect to suppliers.

In addition to these clauses, it is also possible to change broader rules of
engagement as well, such as by reaching into customers’ total system economics to find
ways to change the way the game is played. General Motors, for example, changed the
car business when it created its credit card rebate program through which credit card
users could earn up to $5,000 in rebates on GM cars for using their GM co-branded credit
card. While quickly imitated by Ford, the net effect was to increase loyalty to the two
companies, thereby limiting price competition. It did this by creating switching costs for
customers. If a GM credit card user had earned $5,000 in rebates good toward the
purchase of a GM car only, then this customer would find it difficult to compare pricing
with other automakers’ cars. Indeed, they would be wed to buying GM cars, thereby
enhancing GM’s bargaining power over its customers. The same processes took hold
with respect to the frequent flier programs initiated by American Airlines. Customers
became less willing to switch from airline to airline based on price since they also had to
consider the miles that they would give up in their frequent flier program.

4. How to change players’ perceptions. Tactics are a means of managing and shaping
players’ perceptions. By changing players’ perceptions of a situation, an organization
can change a game in its favor by altering the bargaining powers and incentives among
the players. For instance, consider how guarantees can change perceptions. If an
organization such as FedEx offered $200 to a customer if it failed to meet its delivery
promise, it would have to pay very few claims since it is on time 99.9 percent of time.
Thus, its guarantee would cost it an average of 20 cents per package – 0.1 percent times
$200 – but would make its customers feel that they are being fairly compensated for the
actual harm done to them by the failure to deliver on time. For FedEx’s main competitor,
the US Post Office, to follow suit with a similar guarantee, it would cost it more like $2
per package. Such a FedEx guarantee gives it a degree of credibility that others simply
cannot match.

Once such credibility is established, it must be maintained to avoid negative
consequences. For example, when CNA Insurance made a bid to acquire Continental
Corporation, a financially troubled insurance company, Continental turned down the bid,
despite its substantial premium over other bids. It did this because CNA insisted on a due
diligence clause. Had CNA found something distressing in its due diligence, it would be
able to walk away from its bid. But if it did so, Continental’s chance of obtaining a
strong bid would be substantially diminished.

Competitive Advantage

One other tactic that needs to be considered is the creation of confusion rather
than clarity. Nintendo’s game system costs about $125, but each game costs another
$35-45. Thus, if parents could see through the fog, they would see that it would cost
upwards of $350 plus to make a number of games available to their kids. By preserving
the fog around the true costs, Nintendo is able to get parents to make the first purchase,
and then be hooked from there. A related tactic is to throw a favorable light on pricing
by putting the blame for excesses or increases on other parties. For example, Nintendo
could inform the public that if retailers did not mark-up prices by 50%, then the games
would be more affordable. In other words, it could shift the perceptions of customers to
blame the retailers and not Nintendo for the high game prices.

5. How to change the scope of offerings. There are often linkages among games,
players, and rules that can be brought into a current game. That is, it is often possible to
link together two apparently different situations to create a more positive outcome in
both. Consider how videos are sold with multiple dollars off coupons.

Imagine that a video producer conducted a survey of four hundred regular video
buyers, and the results revealed four equal-sized market segments: 100 people would pay
$20 for video A, but had no interest in video B; 100 people liked B at $20 but not A at
any price; 100 people would buy both movies at $20; and 100 people liked both videos,
but didn’t want to pay $20 each. To reach that fourth group, the producer could offer a
coupon for $5 off the purchase of a second movie. In this way, the first two groups
would buy their respective video preferences at full price, but the third and fourth groups
would buy both videos for an average price of $17.50. Since retailers share the cost of
this $5 discount, the producer ends up ahead by $1 per video sold to these third and
fourth groups.9 Thus, by extending the scope of the game by linking two products, even
cross-company ones (e.g., open an account at NationsBank and get a $100 flight coupon
for American), an organization can enhance its profits.

Another common scope extension is to link one negotiation with another. For
example, when local broadcasters in Texas found cable operator TCI unwilling to pay
them for their broadcasts, they dropped their broadcasts from TCI’s offerings. When
TCI’s customers became furious with TCI, it responded by refusing to allow one local
broadcaster access to its cable programming, thereby turning the tables on the
broadcaster. However, other local broadcasters “understood TCI’s tactics and recognized
that [the one broadcaster’s] problem was their problem, too. If TCI could get [the one
broadcaster] to give away consent in [his market], then their bargaining position would be
seriously compromised [in theirs].”10 So what they did was to refuse to discuss any TCI
proposals until the one broadcaster was back on cable. By linking these separate games,
the local broadcasters reshaped the game to their advantage.

Diversification Advantage

The final competitive advantage is diversification. Business-level
diversification—the adding of new businesses to the firm that are distinct from its
existing operations—has long been a core element to strategy. Fundamentally, firms
pursue diversification when they begin to run out of profitable growth opportunities in

Competitive Advantage

their core business, often because their core business is weak, their current markets are
saturated, or new entrants have created significant innovations in their products or
business designs. Nonetheless, “diversification does not create shareholder value unless
a diversified group of businesses perform better under a single corporate umbrella than
they would perform operating as independent, stand-alone businesses.11

While business-level diversification can bring opportunities for cost-sharing,
skills transfers and business-portfolio benefits, firms with a single business concentration
can also gain significant benefits through within-the-current-business forms of
diversification. For example, by diversifying across product markets, firms can reduce
exposure to customer whims and new product entries; by participating in assorted
geographic markets, they can reduce or increase exposure to various economic and
demographic cycles; by making use of several technological platforms, they can both
seek to leverage innovative changes and reduce their chances of being technologically
locked-out; by engaging in business across multiple currencies, they can, if they hedge
their exposures effectively, reduce foreign exchange rate risks and enhance tax planning
options; and lastly, by diversifying across suppliers and facilities, they can limit stock-
outs, hold-ups and at least some of the repercussions of a major catastrophe somewhere
within the firm’s value system.

Exhibit 2-11 depicts how diversification can lead to many changes in the benefits,
price and cost variables that serve as the basis for establishing the value created through
various strategies.

EExxhhiibbiitt 22–1111 Diversification Advantage

Change Benefits CostPrice $0
Company
Competition

In summary, executives craft strategies through application of the strategic
management process to pursue, maintain or enhance one or more of the four competitive
advantages discussed in this chapter. In the following chapters, detailed analysis tools,
frameworks and approaches are developed through which appropriate potential
alternative strategies can be developed. However, it is important to remember that the
aim through this book, as well as in the strategic management process, is to devise a
means of creating competitive advantage.

Competitive Advantage

RReeaaddyy ttoo LLeeaarrnn Competitive Advantage

Upon completion of this chapter students should be able to:

1. Describe how firms go about seeking to create added value.

2. Describe each of the forms of competitive advantage pursued by firms.

3. Describe how each form of competitive advantage translates into tangible results for a firm
using the B-C framework.

4. Identify one or more specific business designs a given company is pursuing in order to
accomplish its selected competitive advantage.

5. Explain the extent to which firms are able to pursue more than one competitive advantage
and why.

Notes

1 A. M. Brandenburger and B. J. Nalebuff, Co-opetition (New York: Doubleday, 1996).
2 D. Dranove & S. Marciano, Kellogg on Strategy: Concepts, Tools, and Frameworks for Practitioners
(Hoboken, NJ: Wiley & Sons 1995).
3 E. H. Chamberlin, The Theory of Monopolistic Competition (Cambridge, MA: Harvard University Press,
1933), p. 8.
4 This illustration draws on L. Crowder, R. E. Spekman and R. Bruner, “FedEx vs. UPS: The War in
Package Delivery,” (Darden School Foundation, University of Virginia, Charlottesville, VA, 1996).
5 J. A. Schumpeter, Capitalism, Socialism and Democracy (Harper & Brothers: New York, 1942).
6 This analysis approach draws on A. M. Brandenburger and B. J. Nalebuff, Co-opetition (New York:
Doubleday, 1996).
7 F. S. Morton, “The Strategic Response by Pharmaceutical Organizations to the MFN Clause in the
Medicaid Rebate Law of 1990,” (Ph.D. dissertation, Massachusetts Institute of Technology, 1994).
8 A. M. Brandenburger and B. J. Nalebuff, Co-opetition (New York: Doubleday, 1996), pp. 176-177.
9 This assumes a 50% retailer markup.
10 A. M. Brandenburger and B. J. Nalebuff, Co-opetition (New York: Doubleday, 1996), p. 255.
11 A. A. Thompson and A. J. Strickland, Strategic Management: Concepts and Cases, 8th edition (Chicago,
IL: Irwin, 1995), p. 190.

Business Policy Check Up 2:

Competitive Advantage One: Describe one of the general forms of competitive advantage (cost leadership, differentiation, innovation, diversification) that the firms in your industry appear to be pursuing.

Explain how this competitive advantage applies to firms in your industry using the B-C framework.

Please be explicit about Benefit, Cost and Price aspects of the framework.

Identify the specific type(s) of approach(es) (see Exhibits 2-5 to 2-12 in Ch 2) that the firms seem to be using to pursue this general form of competitive advantage.

References: Identify the sources for what you wrote in answers 1-3. Note: Most of you will need to add new references to get better information about your industry and its players. Be sure to use the same format as last time with respect to putting reference numbers within parentheses.

Competitive Advantage Two: Describe a different general form of competitive advantage (e.g., cost leadership, differentiation, etc.) that the firms in your industry also appear to be pursuing.

Explain how this competitive advantage applies to firms in your industry using the B-C framework.

Identify the specific type(s) of approach(es) (see Exhibits 2-5 to 2-12 in Ch 2) that the firms seem to be using to pursue this general form of competitive advantage.

References: Identify the sources for what you wrote in answers 5-7.

What is/was the hardest part of figuring out what competitive advantages the firms in your industry are pursuing?

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