Operations Strategy

Change is the only constant

Southwest Airlines Low Cost

Competitive Advantage

THE CONCEPT OF
STRATEGY
The Concept of Strategy and the Pursuit
of Sustainable Above-Normal Profits

Sources of Superior Performance

Definition
Above Normal
Profits

The determination of the long run goals

and objectives of an enterprise, the
adoption of courses of action and the
allocation of resources necessary for
carrying out these goals
Alfred Chandler, Strategy and Structure

(in Excess of the Competitive Level)

Avoid
Competitors
Attractive
Industry

Attractive
Strategic
Group

Attractive
Niche

Entry
Barriers

Mobility
Barriers

Isolating
Mechanisms

Be Better Than
Competition
Cost
Advantage

Differentiation
Advantage

Drivers of Cost Advantage

Sources of Competitive Advantage

ECONOMIES OF SCALE

ECONOMIES OF LEARNING

COST
ADVANTAGE
COMPETITIVE
ADVANTAGE

Indivisibli\ties
Specialization and division of labor
Increased dexterity
Improved organizational routines

PRODUCTION TECHNIQUES

Process innovation
Reengineering business processes

PRODUCT DESIGN

Standardizing designs & components

Design for manufacture

INPUT COSTS

DIFFERENTIATION
ADVANTAGE

Location advantages
Ownership of low-cost inputs
Non-union labor
Bargaining power

CAPACITY UTILIZATION

Ratio of fixed to variable costs

Speed of capacity adjustment

RESIDUAL EFFICIENCY

Organizational slack; Motivation &

culture; Managerial efficiency

Economies of Scale: The Long-Run

Cost Curve for a Plant

The Experience Curve

Sources of scale economies:

- technical input/output relationships
- indivisibilities
- specialization

The Law of Experience

1992

The unit cost value added to a standard product

declines by a constant % (typically 20-30%) each
time cumulative output doubles.

1994
Cost per
unit of
output (in
real $)

Cost per
unit of
output

1996
1998
2000

2002

2004

Cumulative Output

Applying the Value Chain to Cost Analysis: The

Case of Automobile Manufacture (continued)

Applying the Value Chain to Cost Analysis:

The Case of Automobile Manufacture

STAGE 1. IDENTIFY THE PRINCIPLE ACTIVITIES

PURCHASING

PARTS
INVENTORIES

R&D
TESTING,
DESIGN COMPONENT ASSEMBLY QUALITY
MFR
ENGNRNG
CONTROL

GOODS
INVENTORIES

SALES DISTRI- DEALER &

&
CUSTOMER
BUTION
MKITG
SUPPORT

STAGE 3.
IDENTIFY
COST
DRIVERS

PURCHASING

PARTS
INVENTORIES

--Plant scale for each

component
-- Process technology
-- Plant location
-- Run length
-- Capacity utilization

Applying the Value Chain to Cost Analysis: The

Case of Automobile Manufacture (continued)

-- Level of quality targets

-- Frequency of defects

R&D
COMPONENT ASSEMBLY TESTING,
DESIGN
QUALITY
MFR
ENGNRNG
CONTROL

Prices paid
--Size of commitment
depend on:
--Productivity of
-- Order size
R&D/design
--Purchases per
--No. & frequency of new
supplier
models
-- Bargaining power
-- Supplier location

STAGE 2. ALLOCATE TOTAL COSTS

Units of output
per period

Minimum
Efficient Plant
Size: the point
where most scale
economies are
exhausted

GOODS
INVENTORIES

-- Plant scale
-- Flexibility of production
-- No. of models per plant
-- Degree of automation
-- Sales / model
-- Wage levels
-- Capacity utilization

-- No. of dealers
-- Sales / dealer
-- Level of dealer
support
-- Frequency of defects
under warranty

SALES
&
MKITG

DISTRI- DEALER &

BUTION CUSTOMER
SUPPORT

--Cyclicality &
predictability of sales
--Customers
willingness to wait

The Nature of Differentiation

STAGE 4. IDENTIFY LINKAGES

Consolidation of orders to increase

discounts, increases inventories

PRCHSNG

PARTS
INVNTRS

R&D
DESIGN

DEFINITION: Providing something unique that is valuable to the

buyer beyond simply offering a low price. (M. Porter)
THE KEY IS TO CREATE VALUE FOR THE CUSTOMER

Designing different models around

common components and platforms
reduces manufacturing costs

COMPONENT
MFR

Higher quality parts and materials

reduces costs of defects
at later stages

ASSEMBLY

TESTING GOODS
QUALITY
INV

SALES DSTRBTN DLR

MKTG
CTMR

TANGIBLE DIFFERENTATION
Observable product characteristics:
size, color, materials, etc.
performance
packaging
complementary services

INTANGIBLE
DIFFERENTATION
Unobservable and subjective
characteristics that appeal to
customers image, status,
identity, and desire for exclusivity

Higher quality in manufacturing

reduces warranty costs

STAGE 5. RECCOMENDATIONS FOR COST REDUCTION

TOTAL CUSTOMER RESPONSIVENESS

Differentiation not just about the product, it embraces the whole
relationship between the supplier and the customer.

Identifying Differentiation Potential:

The Demand Side
What needs
does it satisfy?

THE PRODUCT

By what
criteria do they
choose?
THE
CUSTOMER

What are key

attributes?
Relate patterns of
customer
preferences to
product attributes

FORMULATE
DIFFERENTIATION
STRATEGY
Select product
positioning in relation
to product attributes
Select target
customer group

What price
premiums do
product attributes
command?
What
motivates
them?

Ensure customer /
product compatibility

Using the Value Chain to Identify

Differentiation Potential on the Supply Side
MIS that supports
fast response
capabilities

Training to support
customer service
excellence

Unique product features.

Fast new product
development

FIRM INFRASTRUCTURE
HUMAN RESOURCE MANAGEMENT
TECHNOLOGY DEVELOPMENT

INBOUND

OPERATIONS

LOGISTICS

OUTBOUND

MARKETING

LOGISTICS

& SALES

SERVICE

Evaluate costs and

benefits of
differentiation

What are
demographic,
sociological,
psychological
correlates of customer
behavior?

Quality of
components &
materials

Differentiation
Wine Producer wineyards special wine

Defect free
products.
Wide variety

Fast delivery.
Efficient order
processing

Building brand
reputation

Customer technical
support. Consumer
credit. Availability of
spares

INDUSTRY ANALYSIS
AND POSITIONING

Organic Farms Organic products range

Design studio engineering expertise products

Determining Industry Attractiveness and

Identifying Strategic Opportunities

News papers magazines news channels

From Environmental Analysis

to Industry Analysis
The national/
international
economy

Technology

Government
& Politics

The Spectrum of Industry Structures

The natural
environment

Concentration

THE INDUSTRY
ENVIRONMENT
Suppliers
Competitors
Customers

Demographic
g p
structure

Social structure

The Industry Environment lies at the core of the Macro Environment.

Perfect
Competition

Oligopoly

Duopoly

Monopoly

Many firms

A few firms

Two firms

One firm

Entry and E
Entr
Exit
it No/Low barriers
Barriers

Significant barriers

Product
Differentiation

Homogeneous
Product

Potential for product differentiation

Perfect
Information flow

Imperfect availability of information

Information

High barriers

The Macro Environment impacts the firm through its effect on the Industry
Environment.

Porters Five Forces of Competition Framework

The Structural Determinants of Competition

SUPPLIER POWER
Supplier concentration
Relative bargaining
power

SUPPLIERS
Bargaining power of suppliers
INDUSTRY
COMPETITORS
POTENTIAL Threat of
ENTRANTS
new
entrants

THREAT OF ENTRY

Threat of
Rivalry among
existing firms

SUBSTITUTES
substitutes

economies of scale
capital requirements
for R&D and clinical
trials
product differentiation
control of distribution
channels
patent protection

Buyers propensity
to substitute
Relative prices &
performance of
substitutes

DRUG
INDUSTRY
(ROE=22%)

INDUSTRY
COMPETITIVENESS
LOW
high
high concentration
product differentiation
patent protection
steady demand growth
no cyclical fluctuations
of demand

SUBSTITUTE
COMPETITION

Buyers price sensitivity

Relative bargaining
power

BUYERS

THREAT OF ENTRY
LOW

INDUSTRY RIVALRY
Concentration
Diversity of
competitors
Product differentiation
Excess capacity &
exit barriers
Cost conditions

BUYER POWER

Bargaining power of buyers

SUPPLIER POWER
LOW

Capital requirements
Economies of scale
Absolute cost advantage
Product differentiation
Access to distribution
channels
Legal/ regulatory barriers
Retaliation

THREAT OF
SUBSTITUTES
LOW
No substitutes.
(Changing as managed care
encourages generics.)

BUYER POWER
LOW
Physician as buyer:
Not price sensitive
No bargaining power.
(Changing with managed care.)

28

Neutralizing The Five

Competitive Forces
Force
Entry

Method for Neutralizing Force

Erecting barriers (isolating
mechanisms) create & exploit economies of
scale, aggressive deterrence, design in switching
costs, etc.

Rivalry

C
Compete
t on nonprice
i di
dimensions:
i
cost leadership, differentiation, cooperation, etc.

Substitutes
Buyers
Suppliers

Improve attractiveness compared to

substitutes: better service, more features, etc..
Reduce buyer uniqueness: forward

RESOURCES,
CAPABILITIES, AND
CORE COMPETENCES

integrate, differentiate product, new customers, etc..

Reduce supplier uniqueness:

backward
integrate, obtain minority position, second source, etc..

Shifting the Focus of Strategy Analysis:

From the External to the Internal Environment

THE FIRM

THE
INDUSTRY
ENVIRONMENT

Goals and
Values
Resources and
Capabilities
Structure and
Systems

STRATEGY

Competitors
Customers
Suppliers

STRATEGY

The
Firm-Strategy
Interface

The
Environment-Strategy
Interface

Rationale for the Resource-based

Approach to Strategy

When the external environment is subject to

rapid change, internal resources and capabilities
offer a more secure basis for strategy than
market focus.
Resources and capabilities are the primary
sources of profitability.

Canon: Products and Core Technical Capabilities

Eastman Kodaks Dilemma
Precision
Mechanics

Fine
Optics

Resources & Capabilities

Chemical Imaging
1980s

35mm SLR camera

Plain-paper copier
Compact fashion camera
Color copier
EOS autofocus camera
Color laser copier
Digital camera
Basic fax Laser copier
Video still camera
Laser fax
Mask aligners
Inkjet printer
Laser printer
Excimer laser aligners
Color video printer
Stepper aligners
Calculator
Notebook computer

Cameras
Fine Chemicals

Optomechtronics
Thin-film coatings

Pharmaceuticals

The Links between Resources, Capabilities

and Competitive Advantage
COMPETITIVE
ADVANTAGE

Diagnostics

DIVESTS: Eastman Chemical, Sterling Winthrop, Diagnostics

Need to build digital
imaging capability

MicroElectronics

Film

Organic Chemistry
y
technology
gy
Polymer

Brands
Global Distribution
1990s

Businesses

Digital Imaging
Products (e.g. Photo CD
System; Advantix
cameras & film

Defining Organizational Capabilities

INDUSTRY KEY
SUCCESS FACTORS

STRATEGY
ORGANIZATIONAL
CAPABILITIES

Organizational Capabilities = firms capacity for

undertaking a particular activity. (Grant)
Distinctive Competence = things that an organization
does particularly well relative to competitors. (Selznick)

RESOURCES
TANGIBLE
Financial
Physical

INTANGIBLE
Technology
Reputation
Culture

HUMAN
Skills/know-how
Capacity for
communication
& collaboration
Motivation

Core Competence = capabilities that are fundamental to a

firms strategy and performance. (Hamel and Prahalad)
What are capabilities? How are they developed & retained? How are they
lost? How to categorize capabilities? We will answer this on a later date.

Resource Based View -contribution

The Rent-Earning Potential
of Resources and Capabilities
Scarcity

THE EXTENT OF THE

COMPETITIVE ADVANTAGE
ESTABLISHED

Relevance
Durability
y

THE PROFIT
EARNING POTENTIAL
OF A RESOURCE OR
CAPABILITY

SUSTAINABILITY OF THE
COMPETITIVE
ADVANTAGE

Transferability
Replicability
Property rights
Relative
bargaining power

APPROPRIABILITY

Embeddedness

37

Identifying Organizational Capabilities:

A Functional Classification
EXEMPLARS
ExxonMobil, GE
IBM, Samsung
BP, P&G
Citigroup, Cisco

MIS

Speed and responsiveness through

rapid information transfer

Wal-Mart, Dell
Capital One

R&D

Research capability
Development of innovative new products

Merck, IBM
Apple, 3M

Manufacturing

Efficient volume manufacturing

Continuous Improvement
Flexibility

Briggs & Stratton

Nucor, Harley-D
Zara, Four Seasons

Design

Design Capability

Apple, Nokia

Marketing

Brand Management
Quality reputation
Responsiveness to market trends

P&G, LVMH
Johnson & Johnson
MTV, LOreal

Sales, Distribution
& Service

Sales Responsiveness
Efficiency and speed of distribution
Customer Service

PepsiCo, Pfizer
LL Bean, Dell
Singapore Airlines
Caterpillar

Operations Strategy _ Trade Offs, efficiency frontier

Skinner HBS_ Focus, Trade offs
Emergence of three letter improvement initiatives- JIT,
TQM, BPR, ERP etc
Frontier shifts not explained>shift to competencies, RBV
A

The efficient
frontier

Variety

CAPABILITY
Financial management
Strategic control
Coordinating business units
Managing acquisitions

Variety

FUNCTION
Corporate
Management

B1

The new efficient

frontier

D
Cost efficiency

D
Cost efficiency

A capabilities framework for competitiveness

2010 view

Capacity : Flexibility,
Agility

Company
RESOURCES:

Innovation
(& NPD)

Finance
Assets
Technology
People
R&D labs
Intellectual
Property

T
i
m
e
D
e
L
a
y

Network
Mgmt

Manufacturing
Process Technology
Process Management
& Improvement
IT infrastructure and
applications portfolio

Environmental &
Regulatory Factors

Competitors,
complementors
Relevance, demand
and scarcity

Supplier Network
Marketing and Sales
network : Partners

Industry Positioning

Customer
and Market
:
Segment
Niche
Promotion /
Advertising
Customer
Vi ibilit &
Visibility
Availability

Project Management
New Product
Development

Competitive
Intelligence : Market
Positioning

Design Capability
Brand Management
Technology Mgmt,
R&D, IPR

Feedback Loop

Capabilities

Feedback Loop

Thank You