Business Strategies based on Value Chain

Corporate Strategy in a Global Economy

Session 4: Business Strategies Based on Value Chain

Recall from the first session that a major tension in business-level strategy is whether it should be resource-driven or market-driven. In the second and the third sessions, we explored the content of strategic advantage in terms of the role of resources and of markets. In the fourth session, we will explore a range of options that are available to the firms when strategizing based on both resources and markets.

In the opening case, Nestle as a global corporation has five major business groups – culinary foods, beverages, confectionary, milk products and nutrition; in each, Nestle links its resource transforming functions in very different ways, reflecting the personality and the positioning of its specific brands. Since 2008, Nestle has suffered market share losses, as it operates primarily in the mass markets where the customers suffered employment and income losses become of the economic recession. To offset its losses, Nestle has sought to aggressively promote linkages in the premium, luxury market – that has been immune to the recession and has been growing rapidly. For instance, to revive its beverages business, it launched Nespresso – a single-serving expresso-maker capsule in the select European markets, to complement its mass global brand Nescafe. Nespresso stretches and builds on its existing beverage resources, and addresses market issues by targeting new segments. Its new luxury beverage business has required new value linkages internally and externally.

The internal and external value linkages constitute meso-foundations of strategic advantage. According to the value chain hypothesis, the primary value linkages should be organized as a sequential chain, for instance, design, produce, market, deliver and support. Strategies for manipulating value linkages for improving strategic advantage of a business are referred to as the “Business-level strategies”

In Porter’s framework, the functions in a firm’s value chain are grouped into two broad categories of activities: primary and secondary. Primary activities are directly involved in transforming inputs into outputs and in delivery and after-sales support, and include inbound logistics, operations, outbound logistics, marketing and sales, and service, i.e. installation, usage guidance, maintenance, parts, and returns. Support activities are involved in supporting primary activities, and include procurement, technology development, human resource management, and firm infrastructure, i.e. general management, planning, finance, accounting, legal, government affairs and quality management.

One of the major purposes of Porter’s framework is to explicate three generic sources of strategic advantage for the businesses of a firm – value, cost and focus. Value implies if customers perceive a product or service as superior, they are willing to pay a premium relative to the price they will pay for competing offerings. Cost implies if a firm gains a cost advantage for performing activities in its value chain at a cost lower than its major competitors, then it has flexibility to undercut competitors and offer greater value for money. Focus implies if a firm links activities in a value chain to a highly specialized and unique application or target market, then it may improve its strategic advantage in that distinctive market niche. In the opening case, for Nestle, Nescafe builds on cost advantage, while Nespresso seeks to offer a premium value advantage and does so by focusing on select European markets.

There are two views on the value chain hypothesis – consistency and blue ocean. According to the consistency view, the firms that make consistent, persistent and dedicated investments in “value” differentiation or “cost” leadership, either broadly or in a “focus” area, are likely to generate stronger and more sustainable competitive advantage. The Blue Ocean view on the other hand holds that a strategy built on an integrated approach will position the firm in strategically advantageous uncontested space. In other words, consistency view states that a firm must choose to offer low costs or great value, while the blue ocean view says that the firm must offer both low costs as well as great value.

The consistency view is based on three implicit assumptions. First, knowledge processes or routines assumption, i.e. the firms who strategically concentrate all their investments in either cost reduction or in differentiation are likely to develop deep, strong knowledge processes, or routines, to undergird their competitive advantage, as compared to those who strive to do both. Second, motivational processes or culture assumption, i.e. the firms who strategically strive to promote either cost reduction or differentiation only are likely to develop deep, strong motivational processes, or culture, to undergird their competitive advantage. Finally, reputational processes or credibility assumption, i.e. the firms who strategically position themselves as capable of cost reduction or differentiation are likely to develop deep, strong reputation, or credibility, to undergird their competitive advantage.

The Consistency View offers a typology of three pure business strategies, based on the three generic sources of strategic advantage: Cost leadership strategy, which involves making a fairly standardized product, combined with aggressive underpricing all rivals. Differentiation strategy, which involves offering superior product features to customers. And, focus strategy, where specialized domain may take a variety of forms, such as a niche market or geographical segment, a niche distribution channel, a niche workforce, a niche application or user need, and so on.

The consistency view offers three different sub-hypotheses on the relationship between cost leadership and differentiation strategies. First, Mutually-exclusive hypothesis, calling for a firm to make a choice among generic strategies, otherwise it will become “stuck in the middle.” Second, Lifecycle hypothesis, holding that at different phases of product and organizational lifecycles, changing conditions enable change in generic strategies and the firms who embrace this change outpace their competitors. Third, singularity hypothesis, asserting that both cost reduction and value addition are integral to any business strategy, and are not distinct but singular – i.e. cost is one variable in the overall differentiation strategy.

There are three different sub-hypothesis on how generic strategies are related to firm performance. First, differentiation hypothesis: some scholars assert that the firms using differentiation strategy in a market outperform those using a cost-leadership strategy. Second, equivalence hypothesis. Porter (1980) asserts that cost leadership and differentiation strategies offer an equally successful and profitable path to strategic advantage. This may be true in a highly cyclical economic environment, as cost leaders perform better in downturns and differentiators in upturn, thus averaging equivalent performance over time. Third, contingency hypothesis. Firms from different nations may have different capabilities for cost leadership vs., differentiation advantage. Firms from the emerging markets tend to compete using a cost leadership strategy, while those from the industrial markets rely more on the differentiation strategy.

Research shows a lack of support for the Consistency view in highly dynamic and turbulent markets – here the firms that focus on only cost leadership, differentiation, and/or focus may not be as successful because of the risks from the following three risk factors. First, risks of diminishing returns, i.e. as firms invest more and more in one objective such as cost reduction, it becomes more and more difficult to achieve further cost efficiencies. Second, risks of diminishing demand, i.e. as firms invest more and more in one objective such as differentiation, it becomes less and less attractive to a larger mass market. For instance, only a few people are able to afford dinner at a seven star hotel. Third, risks of competitive interplay, i.e. as firms capture a larger share of the market, other firms are attracted to find other strategies. In dynamic markets, the firms that integrate linkages for cost leadership, differentiation, and focus tend to be more successful because of the following three benefit factors. First, benefits of increasing demand, i.e. when firms apply cost efficiencies for adding unique value, a larger group of customers is attracted. Second, benefits of increasing returns, i.e. when learn how to add value for the customers, and are able to do so without adding significant costs, they accrue greater operating surplus. Third, benefits of competitive priorities, i.e. when firms are sensitive to both value and costs, they are more likely to support and discover out-of-box solutions.

The Blue Ocean view is a powerful framework for analyzing opportunities for both cost reduction and value differentiation. Kim and Mauborgne (2005) characterize cut-throat target markets as ‘Red oceans’, where the sharks compete mercilessly. Blue ocean strategy, in contrast, refers to the creation by a firm of a new, uncontested market space that makes competitors irrelevant and that creates new consumer value often while decreasing costs. This strategy is designed using four actions framework. Start by identifying alternative group of customers that do not care about the key value factors offered presently. Then, examine opportunities to Reduce, Create, Raise and Eliminate. First, what factors should be reduced well below the industry standard? Second, what factors should be created that the industry has never offered? Third, what factors should be raised well above the industry standard? Fourth, what factors should be eliminated from what the industry has taken for granted?

Each value factor is assigned a rating from 1 to 10, for the present and for the proposed, or for the rival firms and for the focal firm. These value factors are then mapped on a Strategy Canvas. For instance, Cirque du Soleil designed a new product – circus theatre, which eliminated from the conventional circus industry model the animals and high-priced concessions, and reduced the importance of individual stars – the three very high cost elements. It augmented this new product by introducing an entirely new form of entertainment based on the intellectual sophistication of theatre shows that combined dance, music and athletic skill – thus furthering its differentiation appeal for both circus customers and non-customers.

In fast changing environments, firms often use bricolage to construct blue oceans. Bricolage refers to using whatever resources are available to offer a valuable solution to the customers. Monster Mini Golf, for instance, couples a miniature golf course with the thrills of a haunted house, to offer a unique experience and attract new types of customers to golfing.

A major limitation of the traditional value chain analysis is that it takes a static view of capabilities and markets, and thus contributes to the commodification of the functions, by promoting similarities in what firms do. It tends to ignore how the capabilities of firms for different activities might shift, under alternative market dynamics, corporate strategies, or target markets.

The video cases on Coca Cola highlight three primary activities that underpin its strategic advantage – these are inbound and outbound logistics, and marketing and sales. Coca Cola asserts value in these functions through innovative vendor management and strategic partnerships, customer service excellence, product offering based on deep market knowledge, and techniques such as customer relationship management and enterprise resource planning. If other firms wish to learn from Coke’s success, should they prioritize the same value factors, and assert value in a similar way? What other value factors might be important to target new sets of customers?

The case materials on Nintendo Wii show how Wii offered a new strategy canvas. In 2006, Wii became a market leader by emphasizing a unique gaming experience, simplicity and lower price (compared to Sony and Microsoft) to break down barriers for new customers who were not interested in hard core gaming. However, Sony and Microsoft followed by entering the new space opened by Nintendo. Nintendo has not been able to find another blue ocean, and has introduced a Wii U console that reverts back to the original market space. Why has Nintendo not been able to construct another blue ocean, or sustain its first-mover advantage in the blue ocean space it created? Is Nintendo using consistency hypothesis, in reviving again its focus strategy targeted at hard core game users?

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