Lesson 5 & 6

Business Level Strategy

The strategic management process

Figure 1.1 2
 Business Level Strategies
In this lecture we will discuss….
1. Business Level Strategy.
2. The five generic business-level strategies (Cost
leadership, Differentiation, Focused Cost leadership,
Focused differentiation and Integrated strategy )
3. Cost leadership strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
4. Differentiation strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
5. Focus strategies - how it provides above average returns
(using 5 forces model) and competitive risks.
6. Integrated strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
 Story 1: From Pet Food to PetSmart
• PetSmart remained on top of the pet care
industry despite fierce competition from PETCO
(#2) and major retailers including Wal-Mart and
Target
• Focus: Customer service
• Strategy
– Opened doors in 1987 and named ‘PetFood Warehouse’
(warehouse format)
– 1989 changed warehouse strategy to become “MART for PETs
that’s SMART about PETs”
• Focus: Providing best selection of products at the best
prices
– Market research indicated average dog owner could spend >4
 From Pet Food to PetSmart
• By 2000 developed….
– a new strategy: “Engaging the Enthusiast’” and
– a new vision: “…to provide Total Lifetime Care for every
pet, every parent, every time.”
• 2001: Began extensive customer training
program for associates
• By 2005: new focus
– Top executives decided to leave behind the “mart”
concept
– Move to providing “Smart” solutions and information
– Change name to “PetSmart” and create new logo
5
 Business Level Strategy
• Definition- Business-level strategy: Integrated and
coordinated set of commitments and actions the firm
uses to gain a competitive advantage by exploiting core
competencies in specific product markets
– Business level strategy: Deciding on how to compete in
individual product/service markets
– Core Strategy -Every firm from local restaurant to
multinational corporation must form and use a business-level
strategy.
• Corporate Level strategy: Determining which business
to enter.
• Diversified firms have corporate strategy as well as a
separate business level strategy for each product
market area in which it competes. 6
 Business Level Strategies
In this lecture we will discuss….
1. Business Level Strategy.
2. The five generic business-level strategies (Cost
leadership, Differentiation, Focused Cost leadership,
Focused differentiation and Integrated strategy )
3. Cost leadership strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
4. Differentiation strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
5. Focus strategies - how it provides above average returns
(using 5 forces model) and competitive risks.
6. Integrated strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
 The three questions to develop
Business Level Strategy

Key issues
Who will be served?

When selecting
What needs of target
Business-level
Strategy Customers, it will
Firm decides satisfy

How these needs

will be satisfied?

8
 Business Level Strategy (BLS) – Who,
What and How?
• To develop / understand BLS, firms must ask three questions:
Who- Identify who their customers are
– Companies divide customers into groups based on differences in the
customers’ needs through Market segmentation.
– Firms that fail to recognize changes in customers needs fail.
What - Determine customer needs or preferences
- Consumers have different needs at different times of the day
- Pepsi Caters for different needs through soft drinks, Snacks (Lay), Juices
(Tropicana), and cereals (Quaker)
How - Determine how to compete (select a strategy) that enables
them to satisfy customer needs
- Firms determine how their capabilities and core competencies can be used
to develop products and services that can satisfy the needs of customers
- Pharmaceutical firm Merck has been building its R& D capabilities. Spends
17% of sales on R&D to meet customer needs in a competitive industry.
- IBM traditionally a HW company used its customer knowledge to successfully
 Business Level Strategies
In this lecture we will discuss….
1. Business Level Strategy.
2. The five generic business-level strategies (Cost
leadership, Differentiation, Focused Cost
leadership, Focused differentiation and Integrated
strategy )
3. Cost leadership strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
4. Differentiation strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
5. Focus strategies - how it provides above average returns
(using 5 forces model) and competitive risks.
6. Integrated strategy - how it provides above average returns
(using 5 forces model) and competitive risks.
 The Purpose of a
Business-Level Strategy
• Business-Level Strategies are intended to create differences
between the firm’s competitive position and those of its
competitors.
• To position itself, the firm must decide whether it intends to:
– Perform activities differently or
– Perform different activities as compared to its rivals.
• Southwest Airlines has 6 different strategic themes
• Limited passenger service, frequent reliable departures, lean , high
productive ground and gate crews, High aircraft utilisation, very low-
ticket prices, Short haul point to point routes
• Killing competitors
 Types of business-level strategies
• In establishing Business Level strategy firms need to think on two dimensions
1. Competitive advantage and
2. Competitive scope.
Competitive advantage: Two types of potential competitive advantage firms must
choose between are
– Cost advantage (Are we achieving lower overall costs than rivals?) by performing
activities differently.
– Uniqueness (Are we possessing the capability to differentiate the firm’s product or
service and command a premium price?) by performing different (more highly valued)
activities.
• Competitive Scope: Two types of ‘competitive scope’ firms must choose
between:
• Broad Scope (Broad target)
• The firm competes in all or many customer segments.
• Narrow Scope (Narrow target – Niche segment)
• The firm selects a segment or group of segments in the industry and tailors
its strategy to serving them at the exclusion of others.
• These two dimensions in combination yield five different business 12level
strategies.
 Types of Business-Level Strategies
Basis for Customer Value / Competitive Advantage
Lowest Cost Distinctiveness

Broad Cost Leadership Differentiation

Target

Target Integrated Cost

Market/ Competitive Scope Leadership/
Differentiation

Narrow Focused Cost

Target Leadership Focused Differentiation
The 5 types of Business Level Strategies
• The 5 generic Business Level Strategies are :
1. Cost Leadership Strategy
2. Differentiation.
3. Focused Cost Leadership Strategy.
4. Focused Differentiation.
5. Integrated cost leadership/differentiation.
• Management may choose any one of the
above Business Level strategies for their firm.
• None of them are inherently superior to others.
 Business Level Strategies
In this lecture we will discuss….
1. Business Level Strategy.
1. The five generic business-level strategies (Cost
leadership, Differentiation, Focused Cost leadership,
Focused differentiation and Integrated strategy )
2. Cost leadership strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
3. Differentiation strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
4. Focus strategies - how it provides above average returns
(using 5 forces model) and competitive risks.
5. Integrated strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
 Cost Leadership Strategy
• Definition: Cost Leadership Strategy is an integrated set of
actions taken to produce or deliver goods or services with
features that are acceptable to customers at the lowest cost,
relative to competitors
• Features:
– No-frill, standardized goods sold to industry’s typical customers.
– Lowest competitive price.
– Create value to customers with competitive levels of quality and
differentiation
• Example :
– Kia cars in US follow cost leadership but is emphasizing on the design to
create differentiation.

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 Cost Leadership Strategy
• Firms using Cost leadership strategy continuously and
carefully look for ways and means of reducing costs of
primary (Inbound/outbound logistics account for significant
cost in many) and secondary activities of the value chain but
maintaining competitive levels of differentiation (Very
Important). The product/ service need to be as good as
competitors.
– Example: Grey Hound and Big Bus
• Competitive advantage in logistics creates more value while
using cost leadership strategy.
• Procurement (support activity) can support cost leadership
strategy by procuring low cost (but acceptable quality) raw
materials required to produce firm’s goods more
economically than competitors
Analysis of Cost Leadership Strategy using
five forces model
Cost leadership strategy - Rivalry among existing
competitors
• Due to cost leader’s advantageous position:
• Rivals hesitate to compete on basis of price
– Walmart and Dollar General avoid focusing on price variable, as a primary means

• Lack of price competition leads to greater profits

• Factors that influence rivalry in CLS include Organizational size, resources,

dependence on market etc.

• Example:
– Wall-Mart achieves cost control using several ways– At its 660,000 square foot
Headquarters
– Drab offices, Business is done in no frills cafeteria, meet suppliers in offices,
Employees double up in rooms on tours etc
– K-mart tried to compete on cost with Wal-Mart, ended up in bankruptcy, due to
inferior distribution system
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Cost Leadership Strategy: Bargaining power
of Buyers
• Can mitigate buyers’ power
• Achieving the low-cost position provides some protection against
powerful customers who attempt to drive down prices.
• If customers attempt to drive prices below the cost of the next
most efficient firm, that firm might choose to exit the market
(rather than remain and earn below-average profits).
• This leaves the low-cost firm ( next most efficient firm) with a
monopoly position.
– Chinese Toy Industry
• If that happens, customers would lose any bargaining power as
the monopoly firm would be in a position to raise prices.
• Hence CLS can mitigate buyer power.

. 4–20
 Cost leadership strategy & Five Forces -
Bargaining power of suppliers
• Can mitigate suppliers’ power by:
– Because it has achieved the lowest cost position in the
industry, the cost leadership strategy enables a firm to absorb a
greater amount of cost increases from powerful suppliers
before it must raise prices charged to customers
– This may enable the firm to be alone among its competitors in
earning above-average returns.
– In case of substantial cost rise in the industry, only cost leader
may be able to pay higher price and still earn AARs.
– Powerful firms , being able to make very large purchases, can
influence the suppliers to hold down /reduce their level of
price increases, thus reducing their power.
– Wall-Mart does this all the time.
– Some firms use alliances with suppliers to gain competitive21
 Cost leadership strategy & Five Forces
-Potential New entrants
• Firms successfully following cost leadership strategies generally
must produce and sell in large volumes to earn above-average
returns. And with a continuous focus on efficiency and reducing
costs, cost leadership firms create barriers to entry.
• Efficiencies (like economics of scale ) serve as an entry barrier
• Frighten off potential new entrants due to:
– Their need to enter on a large scale (sell large volumes) in order
to be cost competitive
– Accept average returns till they develop cost leader’s efficiency
– Learning curve may be long
– Must have competencies equal at least to that of other rivals
than cost leader
22
Cost leadership strategy & Five Forces -
Product substitutes
• Cost leader is well positioned to:
– To retain customers, the cost leader can more easily
reduce prices to maintain the price-value relationship
and retain customers.
– Buy patents developed by potential substitutes
– Acquire companies offering substitute products.

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 Effective Cost Leaders can remain profitable
even when the Five Forces appear unattractive
Can mitigate supplier power: Can frighten off New Entrants due
Threat of to the need to:
* Low-cost position makes them
better able to absorb cost increases New * Enter at Large Scale to be
Cost Competitive
* More likely to make very large Entrants
* Take time to move through the
purchases which reduces chance ‘learning curve’
of supplier power
Can mitigate buyer
Bargaining power by:
Bargaining Rivalry Among Power of Driving prices far
Power of Competing Firms in Buyers below competitors’
Suppliers Industry prices, which may
cause them to exit and
so shift power back to
Well-positioned relative to the firm
substitutes in order to:
* Make investments to create substitutes
Threat of
Substitute Competitors avoid price wars with
* Buy patents developed by
potential substitutes Products cost leaders, which creates higher
* Lower prices to maintain profits for entire industry
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value position
 Competitive risks of the cost leadership
strategy (Three)
 Technological innovations by competitors could eliminate
the cost leader’s cost advantage. Producing products at a
lower cost.
• Focus on cost reductions may occur at expense of
understanding customers’ perceptions of differentiation
and driving them to competitors’ products and services
– Costco is beating Wal-Mart by combining low cost and
differentiation
• Competitors may learn to successfully imitate the cost
leader’s Value Chain
– If this happens competitor must try to create value in terms of
further lowering prices or differentiation
– Caterpillar and Komatsu

25
 Dramatic technological
change could take away
cost leader’s cost
The Major advantage
Risks involved
with a Competitors may learn
Cost Leadership how to imitate value chain
Business-Level
Strategy

Focus on efficiency could cause

cost leader to overlook changes
in customer preferences 26
 Business Level Strategies
In this lecture we will discuss….
1. Business Level Strategy.
2. The five generic business-level strategies (Cost
leadership, Differentiation, Focused Cost leadership,
Focused differentiation and Integrated strategy )
3. Cost leadership strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
4. Differentiation strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
5. Focus strategies - how it provides above average returns
(using 5 forces model) and competitive risks.
6. Integrated strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
 Differentiation strategy
• Definition
A differentiation strategy is an integrated set of actions designed to
produce goods or services that customers perceive as being different
in ways that are important to them
– Through the differentiation strategy, the firm produces non-
standardized products for customers who value differentiated
features more than they value low cost
– Toyota’s Lexus products – High reliability, durability and high-
performance sound systems at competitive cost
• For continuous success firms need to consistently upgrade
differentiated features – Apple iPhones
• Also needs the company to change its product lines – Nokia, RIM
• Less similarity between own products and competitors the more
immune to rivals actions
– Toyota in automobiles,
– Caterpillar heavy duty earth moving equipment and tractors
– McKinsey &Co in consultancy services 28
 Differentiation strategy
• Firms that follow a differentiation strategy concentrate or
focus on product innovation and developing product features
that customers value rather than on maintaining the lowest
competitive price (the case for cost leadership strategy).
• Often, this strategy seeks to differentiate the product/service
on as many dimensions as possible
• Ways of differentiating
– Superior Quality
– Unusual features
– Responsive customer service
– Rapid product innovations
– Technological leaderships
– Perceived prestige and status
– Different tastes
– Engineering design and performance
29
– Additional features
 Differentiation Business-Level Strategy
Effectiveness with Differentiation grows out of
Value-Chain activities
Examples:
Heineken beer Raw materials

Steinway pianos Raw materials and workmanship

Mercedes Benz cars Technology and workmanship

Intel microprocessors Technological superiority

Caterpillar tractors Service buyers’ needs quickly

anywhere in the world
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Analysis of Differentiation Strategy using
Porter’s five forces
 Differentiation strategy & Five Forces
Rivalry among existing competitors
• Achieving customer loyalty means Threat of
differentiating products in ways that are new
entrants
meaningful to customers. Rivalry
among
Bargainin
g power
• Brand loyalty to a differentiated product competing
of
tends to reduce customers’ sensitivity to firms
Threat of
suppliers
Bargaining
price increase, testing of new products or substitute power of
switching brands products buyers
– Bose Stereo Equipment
• Brand loyalty to a differentiated product
tends to offset price competition
• As long as the firm satisfies the
differentiated needs of loyal customers, it
may be insulated from price-based
competition and competitive rivalry.
32
 Differentiation strategy - & Five Forces
Bargaining power of buyers
Threat of
• Uniqueness of product reduces new
customer sensitivity to price increases Rivalry entrants
Bargainin
among
g power
– Golfers normally buy Callaway Golf competing
of
firms
clubs or Ping G Stretch series even Threat of
suppliers
Bargaining
power of
if the price is higher than substitute
products buyers
competitors
– Louis Vuitton wallets
• Band –name food items ( Heinz
ketchup, Kleenex tissues)- Customers
accept higher prices.
• Lack of perceived alternatives to
buyers
33
Differentiation Strategy: Suppliers
Bargaining Power • Because of the differentiator’s focus on
of Suppliers product quality and responsiveness to
customer preferences, suppliers also may
Threat
of new be forced to provide differentiators with
Rivalry
entran
ts Bargai
higher-quality materials, components, or
among
competi
ning services, which can drive up the firm’s per-
powe
ng firms
r of unit costs
suppli
Threat Bargain
of ingers
• Can mitigate suppliers’ power by:
substitu power – Absorbing price increases due to higher
te of
product buyers margins.
s
– Passing along higher supplier prices because
buyers are loyal to differentiated brand lower
price sensitivity of customers.
. 4–34
Differentiation strategy & Five Forces
Potential entrants
• Can defend against new entrants because:
– Customer Loyalty – Principal barrier to entry.
– Entrants’ new products must surpass unique
features of proven products
– Demands significant investments and a long
waiting period ( If they can match products/
service’s differentiation)
– New products must be at least equal to
performance of proven products but offered at
lower prices.
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 Differentiation strategy & Five Forces

Product Substitutes
• Brand named goods are safe from substitutes
• But non-branded products face a challenge
• Without brand loyalty, customers might switch
to differentiated products offering same
function or products that offer more features
 Competitive risks of the Differentiation
strategy
• Customers might perceive that the price differential
between the differentiator’s product and the cost
leader’s product is too large
• Differentiation ceases to provide value for which
customers are willing to pay ( Customer feels cost
leader is also offering similar/same features)
– Walt Disney Vs other companies like Six Flags – Disney
continuously tries to improve
• Experience can narrow customers’ perceptions of the
value of a product’s differentiated features
– Other ties providing similar experience like ‘Best of Class’
– Counterfeit goods replicate differentiated features of the firm’s
products at significantly reduced prices – Callaway Golf
Company products , US authorities seized 100,000 counterfeit
in 3 years 37
 Business Level Strategies
In this lecture we will discuss….
1. Business Level Strategy.
2. The five generic business-level strategies (Cost
leadership, Differentiation, Focused Cost leadership,
Focused differentiation and Integrated strategy )
3. Cost leadership strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
4. Differentiation strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
5. Focus strategies - how it provides above average
returns (using 5 forces model) and competitive risks.
6. Integrated strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
 Focus strategy
• Definition
– A focus strategy is an integrated set of actions designed to
produce or deliver goods or services that serve the needs of
a particular competitive segment or niche to the exclusion of
others.
• Examples of specific market segments that can be
targeted by a focus strategy:
– Particular buyer group (e.g. youths or senior citizens)
– Different segment of a product line (e.g. professional
craftsmen versus do-it-your self group)
– Different geographic markets
• Goya Foods – Largest Hispanic food chain ‘To be the be–all for
Latin Community’
– 2500 high-quality food products at affordable prices.

• Types of focused strategies:

– Focused cost leadership strategy
– Focused differentiation strategy 39
 Focused Cost Leadership Strategy
• Firms that compete by following cost leadership strategies to
serve narrow market niches generally target the smallest
buyers in an industry. They look for those who purchase in
such small quantities that industry-wide competitors cannot
serve them at the same low cost.

• Firms succeed when they can effectively serve a segment

where :
– Competitors choose not serve
– Which is poorly served
– Competitor firms may overlook small niches
– May lack resources to compete in the broader market
– May be able to more effectively serve a narrow market
segment than larger industry-wide competitors
– Firms may direct resources to certain value chain
activities to build competitive advantage 40
 Focused cost leadership
• Ikea – Sweden firm with locations in 44 countries
sales revenue - $ 23.5 billion in 2006
– Company Vision - “Good Design and function at
low Prices’
– Target young byres desiring style at low cost
– Firm’s Engineers design low cost, modular, ready
for assembly furniture
– Eliminates need for associates - Displays furniture
like they are placed in the houses unlike
competitors who display individual items
– Customers transport their items
– Also provides some differential features – unique
designs, play areas for children and wheel chair
access

41
 Focused differentiation Strategy
• Firms following focused differentiation strategies produce customized
products for small market segments.
• They can be successful when either the quantities involved are too small
for industry-wide competitors to handle economically, or when the
extent of customization (or differentiation) requested is beyond the
capabilities of the industry-wide competitors.
• Activities are identical to the industry wide differentiation strategy
– ‘New balance’ concentrates on the athletic shoe needs of baby
boomer generation
• Better fit
• AA to EEEE ( all sizes)
• Own design and product
• Comfort over style
• Chinese food restaurants in US
– Offer similar fare, largely compete on price, leading to poor quality
– Cutthroat competition – sends spies to other kitchens for recipes.
– Gong ( President of American Chinese Restaurant Association) hired
an Australian Chinese cook to be the food director with focus on
developing finest Chinese food 42
– His food has been rated as the finest Chinese food in San Gabriel
 Competitive risks of focus strategies
• Competitors may focus on more narrowly defined
segment and out focus the firm
– Confederate Big Dog Builds more powerful motor
cycles than Harley Davidson
– Cost $65,000 or more,
– takes away some Harley Davidson’s customers
• A firm competing on an industry-wide basis decides to
pursue the niche market of the focuser firm
– Anne Fontaine launched ‘Forth & Towne’ targets at
women above 35
– GAP Inc may follow suit
• Customer preferences in the niche market may change
to more closely resemble those of the broader market
– IKEA and Office depot (Or Home depot)

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 Firm may be ‘outfocused’ by
competitors

The Major
Risks involved A large competitor may
with a Focused set its sights on your
Differentiation niche market
Business-Level
Strategy are:

Preferences of niche market

may change to match those of
broad market 44
 Business Level Strategies
In this lecture we will discuss….
1. Business Level Strategy.
2. The five generic business-level strategies (Cost
leadership, Differentiation, Focused Cost leadership,
Focused differentiation and Integrated strategy )
3. Cost leadership strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
4. Differentiation strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
5. Focus strategies - how it provides above average returns
(using 5 forces model) and competitive risks.
6. Integrated strategy - how it provides above average
returns (using 5 forces model) and competitive risks.
Integrated cost leadership/ differentiation
strategy
• Involves pursuing cost leadership and differentiation strategies simultaneously.
Compared to firms with one strategy,
• A firm that successfully uses the integrated strategy should be in a better position
to:
– Adapt quickly to environmental changes
– Learn new skills and technologies more quickly
– Effectively leverage its core competencies while competing against its rivals
• Korean Electronic firms like LG
• Three flexible sources to implement this strategy include:
– Flexible manufacturing systems (FMS)
• Computer controlled process used to produce a variety of products in moderate, flexible
quantities with a minimum of manual intervention
• Goal: eliminate ‘low cost vs. product variety, tradeoff inherent in traditional manufacturing
technologies
– Information networks
• Using technology to link suppliers, distributors and customers
– Total Quality Management (TQM) systems
• Emphasizes firm’s total commitment to the customer and continuous improvement of every
process through data-driven, problem-solving approaches based on empowering
employees

46
Competitive risks of the integrated strategy
• Often involves compromises
– Becoming neither the lowest cost nor the most
differentiated firm
• Becoming ‘stuck in the middle’
– Lacking the strong commitment and expertise that
accompanies firms following either a cost leadership or
a differentiated strategy
– Earning below-average returns
– Competing at a disadvantage
• Research suggests that firms pursuing pure strategies
(Cost leadership/differentiation) fare better than the one
following hybrid strategy (Integrated)
• Even so, the integrated strategy is an appropriate choice
for firms possessing the core competencies to produce
somewhat differentiated products at relatively low prices

47