advantage.

Patents or isolating mechanisms can reduce or eliminate temporarily the opportunity for a rival to
Chapter 4: Evaluating the Internal Environment imitate.

Another tool used for internal assessment is Value Chain Analysis. Each element of a firm’s primary and
4.1 Introduction supportive activities are examined to see if it can provide a competitive advantage over its rivals. Weaknesses
that are identified can be addressed to improve organizational performance.
4.2 Managing Firm Resources
Once the external and internal assessments are complete, the firm can use the most relevant information to
4.3 Resource-Based View
develop a SWOT analysis and identify the most pressing strategic issue(s) the firm must address, as discussed

4.4 Value Chain in Chapter 5.

4.5 Conclusion

Learning Objectives

After reading this chapter, you should be able to understand and articulate answers to the following
questions:

1. What is the Resource-Based View and why is it important to organizations?

2. How is the VRIO tool applied to strategic resources?
3. In what ways can intellectual property serve as a value-added resource for organizations?
4. What are isolating mechanisms and how can they contribute to a firm’s competitive advantage?
5. How can the Value Chain be applied to achieve a competitive advantage?

4.1 Introduction

In addition to evaluating the external environment of a firm and the industry in which it operates, strategic
management requires that a firm conduct an internal assessment of its resources and capabilities. This further
helps the firm answer the question “Where are we?” before setting strategies for reaching the goals and vision
of the organization. Part of this assessment is the organizational performance evaluation discussed in Chapter 2
that deals primarily with financial and other quantitative information. This helps the firm determine where it is
in comparison with its competitors. Next, the firm needs to look inside to see how it can achieve a competitive
advantage over its rivals, so customers will buy what the firm has to sell instead of buying from competitors.

One method of internal assessment is using the Resource-Based View. This model examines any resources and/
or capabilities of the firm that may provide a competitive advantage. The VRIO framework is used to evaluate
each resource or capability to determine what type, if any, of competitive advantage it brings. If a resource
or capability cannot be imitated by a competitor, then that resource may create a sustained competitive

88 | Chapter 4: Evaluating the Internal Environment Chapter 4: Evaluating the Internal Environment | 89

4.2 Managing Firm Resources

cities adds hours to a traveler’s itinerary and increases the chances of luggage being lost. In
contrast, Southwest does not have a hub airport; preferring instead to connect cities directly. This
makes flying on Southwest attractive to many travelers.

Southwest has also been more efficient than its rivals. While most airlines use a variety of different
airplanes, Southwest operates only one type of jet: the Boeing 737. This means that Southwest can
Southwest Airlines: Let Your LUV Flow service its fleet much more efficiently than can other airlines. Southwest mechanics need only the
know-how to fix one type of airplane, for example, while their counterparts with other firms need a
working knowledge of multiple planes. Southwest also gains efficiency by not offering seat
assignments in advance, unlike its competitors. This makes the boarding process move much faster,
meaning that Southwest’s jets spend more time in the air transporting customers (and making
money) and less time at the gate relative to its rivals’ planes.

Organizational culture is the dimension along which Southwest perhaps has differed most from its
rivals. The airline industry as a whole suffers from a reputation for mediocre (or worse) service and
indifferent (sometimes even surly) employees. In contrast, Southwest enjoys strong loyalty and a
sense of teamwork among its employees.

One tangible indicator of this culture is Southwest’s stock ticker symbol. Most companies choose
stock ticker symbols that evoke their names. Ford’s ticker symbol is F, for example, and Walmart’s
symbol is WMT. When Southwest became a publicly traded company in 1977, executives chose LUV
as its ticker symbol. LUV pays a bit of homage to the firm’s humble beginnings at Love Field. More
important, however, LUV represents the love that executives have created among employees,
between employees and the company, and between customers and the company. This “LUV affair”
has long been and remains a huge success. As recently as March 2011, for example, Southwest was
ranked fourth on Fortune magazine’s World’s Most Admired Company list.

Figure 4.1: Southwest Airlines marked forty-seven consecutive In early 2020, the US and the world were hit by the coronavirus pandemic. The number of airline
profitable years in 2019 passengers dropped by over 90% during the peak months early in the pandemic. Southwest
implemented cost saving measures, but still lost $94 million in the first quarter (PRNewswire, 2020).
Known for its efficiency, how can Southwest drive down costs to reflect the new reality of less air
travel and lower volumes for years to come? Where in its value chain can it not only trim costs but
In 1971, a new firm named Southwest Airlines opened for business by offering flights between reinvent itself as a more cost effective organization? What resources and capabilities does the
Houston, San Antonio, and its headquarters at Love Field in Dallas. From its initial fleet of three airline have to help it re-tool and not only survive the crisis, but come out a sustainable winner for
airplanes and three destinations, Southwest has grown to operate hundreds of airplanes in scores the future?
of cities. Despite competing in an industry that is infamous for bankruptcies and massive financial
losses, Southwest marked its forty-seventh profitable year in a row in 2019.

Why has Southwest succeeded while many other airlines have failed? Historically, the firm has
differed from its competitors in a variety of important ways. Most large airlines use a “hub and
spoke” system. This type of system routes travelers through a large hub airport on their way from References
one city to another. Many Delta passengers, for example, end a flight in Atlanta and then take a
connecting flight to their actual destination. The inability to travel directly between most pairs of
PRNewswire. (2020, April 28). Southwest reports first quarter 2020 results.
http://investors.southwest.com/news-and-events/news-releases/2020/04-28-2020-110107839.

90 | Chapter 4: Evaluating the Internal Environment Chapter 4: Evaluating the Internal Environment | 91
 Table 4.1 Resource-Based View: The Basics
Image Credits
Strategic Resources Expansion

VALUABLE resources aid in improving the Although the airline industry is extremely competitive, Southwest
Figure 4.1: Seeger, Stuart. “A Southwest Airlines Boeing 737 aircraft parked on the tarmac under cloudy skies at organization’s effectiveness and efficiency while Airlines’s turns a profit virtually every year. One key reason for their
Bob Hope Airport in Burbank, California, United States.” CC BY 2.0. Cropped. Retrieved from neutralizing the opportunities and threats of success is a legendary organizational culture that inspires employees
competitors. to do their very best.
https://upload.wikimedia.org/wikipedia/commons/d/d8/Southwest_737_At_Burbank.jpg.
Southwest Airlines’s culture provides the firm with uniquely strong
RARE resources are those held by few or no other
employee relations in an industry where strikes, layoffs, and poor
competitors.
morale are common.

DIFFICULT-TO-IMITATE resources often involve

4.3 Resource-Based View legally protected intellectual property such as
Southwest’s culture arose from its very humble beginnings and has
evolved across decades. Because of this unusual history, other
trademarks, patents, or copyrights. Other
airlines could not replicate Southwest’s culture, regardless of how
difficult-to-imitate resources, such as brand
hard they might try.
names, usually need time to develop fully.

ORGANIZED TO CAPTURE VALUE: Having in The influence of Southwest’s organizational culture extends to how
place the organizational systems, processes, and customers are treated by employees. Executives strongly encourage
structure to capitalize on the potential of the flight attendants to entertain passengers, like hiding in an overhead
resources and capabilities of the firm to provide a compartment. Processes related to passengers are infused with
competitive advantage. customer service attention and actions.

Important Points to Remember:

1. Resources such as Southwest’s culture that reflect all four qualities—valuable, rare, difficult to imitate, and
organized to capture value—are ideal because they can create sustained competitive advantages. A
resource that has three or less of the qualities can provide an edge in the short term, but competitors can
overcome such an advantage eventually.
2. Firms often bundle together multiple resources and strategies (that may not be unique in and of
Figure 4.2: Southwest Airlines’s unique organizational culture is reflected in the customization of their themselves) to create uniquely powerful combinations. Southwest’s culture is complemented by
aircraft, such as the “Lone Star One” design. approaches that individually could be copied—the airline’s emphasis on direct flights, its reliance on one
type of plane, and its unique system for passenger boarding—in order to create a unique business model in
which effectiveness and efficiency is the envy of competitors.
3. Satisfying only one or two of the valuable, rare, difficult-to-imitate, organized to capture value criteria
According to resource-based theory, organizations that own “strategic resources” have important competitive will likely only lead to competitive parity or a temporary advantage.
advantages over organizations that do not. Some resources, such as cash and trucks, are not considered to be
strategic resources because an organization’s competitors can readily acquire them. Instead, a resource is Resources and capabilities are the basic building blocks that organizations use to create strategies. These two
strategic to the extent that it is valuable, rare, difficult to imitate, and organized to capture value. Consider how building blocks are tightly linked—capabilities from using resources over time.
Southwest Airlines’s organizational culture serves as a strategic resource.
Resources can be divided into two main types: tangible and intangible. While resources refer to what an
organization owns, capabilities refer to what the organization can do. More specifically, capabilities refer to the
firm’s ability to bundle, manage, or otherwise exploit resources in a manner that provides added value and,
hopefully, advantage over competitors.

92 | Chapter 4: Evaluating the Internal Environment Chapter 4: Evaluating the Internal Environment | 93

Table 4.2 Resources and Capabilities

VRIO: Four Characteristics of Strategic Resources
Resources

Tangible resources are resources that can be readily seen, touched, and quantified. Physical assets such as a firm’s
property, plant, and equipment are considered to be tangible resources, as is cash.

Intangible resources are quite difficult to see, touch, or quantify. Intangible resources include, for example, the
knowledge and skills of employees, a firm’s reputation, and a firm’s culture. In a nod to Southwest Airlines’ outstanding
reputation, the firm ranks eighth in Fortune magazine’s 2018 list of the “World’s Most Admired Companies.”

Capabilities

A dynamic capability exists when a firm is skilled at continually updating its array of capabilities to keep pace with
changes in its environment. Coca-Cola, for example, has an uncanny knack for building new brands and products as the
soft drink market evolves. Not surprisingly, this firm ranks among the top twelve in Fortune’s “World’s Most Admired
Companies” for 2020.

Resources and Capabilities

The tangibility of a firm’s resources is an important consideration within resource-based theory. Tangible
resources are resources that can be readily seen, touched, and quantified. Physical assets such as a firm’s
property, plant, and equipment, as well as cash, are considered to be tangible resources. In contrast, intangible
resources are quite difficult to see, to touch, or to quantify. Intangible resources include, for example, the
knowledge and skills of employees, a firm’s reputation, brand name, exclusive rights to intellectual property,
leadership traits of executives, and a firm’s culture. In comparing the two types of resources, intangible
resources are more likely to meet the criteria for strategic resources (i.e., valuable, rare, difficult-to-imitate,
and organized to capture value) than are tangible resources. Executives who wish to achieve long-term
competitive advantages should therefore place a premium on trying to nurture and develop their firms’
intangible resources.

Capabilities are another key concept within resource-based theory. An effective way to distinguish resources
and capabilities is this: resources refer to what an organization owns, capabilities refer to what the organization
can do (Table 4.2). Capabilities tend to arise over time as a firm takes actions that build on its strategic
resources. Southwest Airlines, for example, has developed the capability of providing excellent customer
service by building on its strong organizational culture. Capabilities are important in part because they are
how organizations capture the potential value that resources offer. Customers do not simply send money to an
organization because it owns strategic resources. Instead, capabilities are needed to bundle, to manage, and
otherwise to exploit resources in a manner that provides value added to customers and creates advantages over
competitors.
Figure 4.3: The VIRO Framework
Some firms develop a dynamic capability. This means that a firm has a unique ability to create new capabilities.
Said differently, a firm that enjoys a dynamic capability is skilled at continually updating its array of capabilities
to keep pace with changes in its environment. Coca-Cola has an uncanny knack for building new brands and
products as the soft-drink market evolves. Not surprisingly, Coca-Cola ranks among the top twelve in Fortune’s Resource-based theory can be confusing because the term resources is used in many different ways within
“World’s Most Admired Companies” for 2020. everyday common language. It is important to distinguish strategic resources from other resources. To most
individuals, cash is an important resource. Tangible goods such as one’s car and home are also vital resources.

94 | Chapter 4: Evaluating the Internal Environment Chapter 4: Evaluating the Internal Environment | 95
When analyzing organizations, however, common resources such as cash and vehicles are not considered 4. Has Southwest organized this resource of culture to capture value? If not, then it still only provides a
to be strategic resources. Resources such as cash and vehicles are valuable, of course, but an organization’s temporary competitive advantage. If yes, then Southwest’s culture is providing a sustained competitive
competitors can readily acquire them. Thus an organization cannot hope to create an enduring competitive advantage.
advantage around common resources.
For the company culture resource of Southwest Airlines, a yes can be answered for each of the four steps,
Southwest Airlines provides an illustration of resource-based theory in action. Resource-based theory providing a sustained competitive advantage for this organization. As can be seen from its exceptional
contends that the possession of strategic resources provides an organization with a golden opportunity to organizational performance over many years when compared to other airlines, VRIO shows that company
develop competitive advantages over its rivals (Table 4.1). These competitive advantages in turn can help the culture is one reason why it is more successful than its competitors.
organization enjoy strong profits (Barney, 1991; Wernerfelt, 1981).
Figure 4.4 The VRIO Framework Decision Matrix: Southwest’s Company Culture
A strategic resource is an asset that is valuable, rare, difficult to imitate, and organized to capture value (Barney,
1991; Chi, 1994). A resource is valuable to the extent that it helps a firm create strategies that capitalize on Organized to capture Competitive
Valuable? Rare? Difficult to imitate?
value? Advantage
opportunities and ward off threats. Southwest Airlines’ culture fits this standard well. Most airlines struggle to
be profitable, but Southwest makes money virtually every year. One key reason is a legendary organizational Sustained
Yes Yes Yes Yes Competitive
culture that inspires employees to do their very best. This culture is also rare in that strikes, layoffs, and poor Advantage
morale are common within the airline industry. Southwest embraces a culture of fun for both its customers and
employees. Most other airlines do not have this philosophy. As another example, what about Southwest Airlines’ capability to arrive on time at a much higher rate than the
industry average? What kind of competitive advantage, if any, does this capability provide?
Competitors have a hard time duplicating resources that are difficult to imitate. Some difficult to imitate
resources are protected by various legal means, including trademarks, patents, and copyrights. Other resources Capability: High on-time arrival
are hard to copy because they evolve over time and they reflect unique aspects of the firm. Southwest’s culture
arose from its very humble beginnings. The airline had so little money that at times it had to temporarily Figure 4.5 VRIO Analysis of On-Time Arrival Capability of Southwest Airlines
“borrow” luggage carts from other airlines and put magnets with the Southwest logo on top of the rivals’ logo.
Southwest is a “rags to riches” story that has evolved across several decades. Other airlines could not replicate Difficult to
Valuable? Rare? Organized to Capture Value? Competitive Advantage?
Imitate?
Southwest’s culture, regardless of how hard they might try, because of Southwest’s unusual history.

A resource is organized to capture value when the firm has organizational systems, processes, and structure
in place to capitalize on the resource for a competitive advantage. This may provide bargaining power for the Yes Yes No Temporary Competitive Advantage
firm in the marketplace. A key benefit of Southwest’s culture is that it leads employees to treat customers well,
which in turn creates loyalty to Southwest among passengers. This customer loyalty is why many passengers
choose Southwest over other airlines. In the case of on-time arrival capability, Southwest Airline enjoys a temporary competitive advantage (the third
line), but it is not that difficult for rivals to imitate this ability. In working through the decision tree, once a no
The key to using the Resource Based View is to evaluate a firm’s resources and capabilities using the VRIO
is obtained, there is no need to continue through the tree.
framework decision tree.
Ideally, a firm will its own resources, like Southwest’s culture, that embrace the four VRIO qualities shown in
Note that the decision tree is used to assess resources and capabilities, NOT a firm’s products, services, or
Table 4.1. If so, these resources can provide not only a competitive advantage but also a sustained competitive
the firm itself. The evaluation occurs within the industry of the firm being evaluated. Using Southwest Airlines
advantage—one that will endure over time and help the firm stay successful far into the future. Resources that
culture as the resource to evaluate with VRIO:
do not have all four qualities can still be very useful, but they are unlikely to provide long-term advantages. A
resource that is valuable and rare but that can be imitated, for example, might provide an edge in the short
1. Is Southwest’s culture valuable? If not, all the effort to develop it is a waste of resources and a competitive
term, but competitors can eventually overcome such an advantage.
disadvantage. If yes, go to number 2.
2. Is Southwest’s culture rare within the airline industry? If not, then this resource only provides Southwest
competitive parity. It does not help or hurt Southwest competitively. If yes, go to number 3.
3. In the airline industry, is Southwest’s culture hard to imitate? If not then culture provides Southwest with
a temporary competitive advantage over its rivals, but competitors can imitate it. If yes, go to number 4.

96 | Chapter 4: Evaluating the Internal Environment Chapter 4: Evaluating the Internal Environment | 97

Figure 4.6 VRIO Analysis Worksheet

Resource or Organized to Competitive

Valuable? Rare? Costly to Imitate? musical talent. Another is guitarist Lenny Haise, whose fun attitude reigns in the enigmatic
Capability capture value? Implication
Mattingly. Although not a formal band member, Mattingly’s girlfriend Faye provides emotional
support to the group and even suggests the group’s name. When the band’s usual drummer has to
miss a gig due to injury, the door is opened for charismatic drummer Guy Patterson, whose energy
proves to be the final piece of the puzzle for The Wonders.

Despite Mattingly’s objections, Guy spontaneously adds an up-tempo beat to a sleepy ballad called
“That Thing You Do!” during a local talent contest. When the talent show audience goes crazy in
response, it marks the beginning of a meteoric rise for both the song and the band. Before long,
The Wonders perform on television and “That Thing You Do!” is a top-ten hit record. The band’s
Resource-based theory also stresses the merit of an old saying: the whole is greater than the sum of its parts. magic vanishes as quickly as it appeared, however. After their bass player joins the Marines, Lenny
Specifically, it is important to recognize that strategic resources can be created by taking several strategies and elopes on a whim, and Jimmy’s diva attitude runs amok, the band is finished and Guy is left to
resources that each could be copied and bundling them together in a way that cannot be copied. For example, “wonder” what might have been. That Thing You Do! illustrates that while bundling resources in a
Southwest’s culture is complemented by approaches that individually could be copied—the airline’s emphasis unique way can create immense success, preserving and managing these resources over time can
on direct flights, its reliance on one type of plane, and its unique system for passenger boarding—to create a be very difficult.
unique business model whose performance is without peer in the industry. The Wonders- That Thing You Do!

On occasion, events in the environment can turn a common resource into a strategic resource. Consider, for This video is the song “That Thing You Do!” by the Wonders.
example, a very generic commodity: water. Humans simply cannot live without water, so water has inherent You can view this video here: https://youtu.be/BJn-Jl2ZeQU.
value. Also, water cannot be imitated (at least not on a large scale), and no other substance can substitute for
the life-sustaining properties of water. Despite having three of the four properties of strategic resources, water
in the United States has remained cheap; however, this may be changing. Major cities in hot climates such as
Las Vegas, Los Angeles, and Atlanta are confronted by dramatically shrinking water supplies. As water becomes
more and more rare, landowners in Maine stand to benefit. Maine has been described as “the Saudi Arabia of Key Takeaway
water” because its borders contain so much drinkable water. It is not hard to imagine a day when companies
in Maine make huge profits by sending giant trucks filled with water south and west or even by building water
pipelines to service arid regions.
• Resource-based theory suggests that tangible or intangible resources that are valuable, rare,
difficult to imitate, and organized to capture value best position a firm for long-term success.
These strategic resources can provide the foundation to develop firm capabilities that can lead
to superior performance over time. Capabilities are needed to bundle, to manage, and otherwise
to exploit resources in a manner that provides added value to customers and creates advantages
Strategy at the Movies over competitors. The VRIO tool can be used to determine if resources or capabilities are
valuable, rare, difficult-to-imitate, and organized to capture value, and thereby understand what
type of competitive advantage they offer to a firm.
That Thing You Do! [02:48]

How can the members of an organization reach success “doing that thing they do”? According to
resource-based theory, one possible road to riches is creating—on purpose or by accident—a unique
combination of resources. In the 1996 movie That Thing You Do!, unwittingly assembling a unique
bundle of resources leads a 1960s band called The Wonders to rise from small-town obscurity to
the top of the music charts. One resource is lead singer Jimmy Mattingly, who possesses immense

98 | Chapter 4: Evaluating the Internal Environment Chapter 4: Evaluating the Internal Environment | 99
 4.4 Intellectual Property & Isolating Mechanisms
Exercises

Intellectual Property
1. What tangible and intangible resources does your favorite restaurant have that might give it a
competitive advantage?
2. Do any of the resources or capabilities of your favorite restaurant have the four qualities of
resources (VRIO) that lead to success as articulated by resource-based theory?
Defining Intellectual Property

The inability of competitors to imitate a strategic resource is a key to leveraging the resource to achieve
long–term competitive advantages. Companies are clever, and effective imitation is often very possible. But
resources that involve intellectual property reduce or even eliminate this risk. As a result, developing
References intellectual property is important to many organizations.

Intellectual property refers to creations of the mind, such as inventions, artistic products, and symbols. The
Barney, J. B. (1991). Firm resources and sustained competitive advantage. Journal of Management, 17, 99–120. four main types of intellectual property are patents, trademarks, copyrights, and trade secrets (Table 4.5). If
a piece of intellectual property is also valuable, rare, difficult to imitate, and organized to capture value, it
Chi, T. (1994). Trading in strategic resources: Necessary conditions, transaction cost problems, and choice of
constitutes a strategic resource. Even if a piece of intellectual property does not meet all four criteria for
exchange structure. Strategic Management Journal, 15(4), 271–290.
serving as a strategic resource, it can be bundled with other resources and activities to create a resource.
Wernerfelt, B. (1984). A resource-based view of the firm. Strategic Management Journal, 5, 171–180.
The term intellectual property refers to creations of the mind, such as inventions, artistic products, and symbols.
Some forms of intellectual property are protected by law while others can best be defended by surrounding them
in secrecy.
Image Credits
Table 4.5 Intellectual Property

Types of Intellectual Property

Figure 4.2: Planephotoman. “Southwest Airlines Boeing 737 Lonestar One (N352SW) at LAS in November 2005.”
CC BY 2.0. Cropped. Retrieved from https://commons.wikimedia.org/wiki/ Patents protect inventions from direct imitation for a limited period of time. Within the pharmaceutical industry, patents
File:Southwest_737_Lonestar_One.jpg. protect the new drugs created by firms such as Merck and Pfizer for up to twenty years. If a new drug gains acceptance
in the market, its patent creates a window of opportunity for the patent holder to enjoy excellent profits.

Figure 4.3: Kindred Grey (2020). “The VRIO Framework with numbers.” CC BY-SA 4.0. Retrieved from
Trademarks are phrases, pictures, names, or symbols used to identify a particular organization. McDonald’s golden
https://commons.wikimedia.org/wiki/File:The_VRIO_Framework_with_numbers.png. arches, the phrase “Intel Inside,” and the brand name Virginia Tech are examples of trademarks.

Copyrights provide exclusive rights to the creators of original artistic works such as books, movies, songs, and
screenplays. Sometimes copyrights are sold and licensed. The late pop star Michael Jackson bought the rights to The
Video Credits Beatles’ music catalog and later licensed songs to Target and other companies for use in television advertisements.

Trade secrets refer to formulas, practices, and designs that are central to a firm’s business and that remain unknown to
competitors. One famous example is the blend of eleven herbs and spices used in Kentucky Fried Chicken’s original
LegacyRecordingsVEVO. (2020, April 24). The Wonders-That Thing You Do! [Video]. YouTube. recipe chicken. KFC protects this secret by having multiple suppliers each produce a portion of the herb and spice blend;
no one supplier knows the full recipe.
https://youtu.be/BJn-Jl2ZeQU.

A variety of formal and informal methods are available to protect a firm’s intellectual property from imitation by
rivals. Some forms of intellectual property are best protected by legal means, while defending others depends
on surrounding them in secrecy. This can be contrasted with Southwest Airlines’s well-known culture, which

100 | Chapter 4: Evaluating the Internal Environment Chapter 4: Evaluating the Internal Environment | 101

rivals are free to attempt to copy if they wish. Southwest’s culture thus is not intellectual property, although Trademarks
some of its complements such as Southwest’s logo and unique color schemes are.

Trademarks are phrases, pictures, names, or symbols used to identify a particular organization (Table 4.7).
Trademarks are important because they help an organization stand out and build an identity in the marketplace.
Patents Some trademarks are so iconic that almost all consumers recognize them, including McDonald’s golden arches,
the Nike swoosh, and Apple’s outline of an apple.
Patents protect inventions from direct imitation for a limited period of time. Some examples and key issues
Other trademarks help rising companies carve out a unique niche for themselves. For example, French shoe
surrounding patents are illustrated below.
designer Christian Louboutin has trademarked the signature red sole of his designer shoes. Because these
Table 4.6 Patents shoes sell for many hundreds of dollars via upscale retailers such as Neiman Marcus and Saks Fifth Avenue,
competitors would love to copy their look. Thus, legally protecting the distinctive red sole from imitation helps
Examples of Patents
preserve Louboutin’s profits.
To earn a patent from the US Patent and Trademark Office, an inventor must demonstrate that an invention is new, non
obvious, and useful.
Trademarks are important to colleges and universities.
Perhaps the greatest inventor in history was Thomas Edison, who was awarded over one thousand patents. Schools earn tremendous sums of money through
As several different inventors raced to create a workable system for voice transmission over wires, Alexander Graham royalties on t-shirts, sweatshirts, hats, backpacks, and
Bell was awarded a patent for the telephone in 1876. other consumer goods sporting their names and logos.
Apple and Samsung began suing each other in 2011 for patent infringement, with numerous court cases and appeals. The On any given day, there are probably several students
multiple lawsuits were finally settled in 2018, with a jury awarding Apple $539 million (Reuters, 2018).
in your class wearing one or more pieces of clothing
featuring your school’s insignia; your school benefits
Patents are legal decrees that protect inventions from
every time items like this are sold. Schools’ trademarks
direct imitation for a limited period of time (Table 4.6).
are easy to counterfeit, however, and the sales of
Obtaining a patent involves navigating a challenging
counterfeit goods take money away from colleges and
process. To earn a patent from the US Patent and
universities. Not surprisingly, many schools fight to
Trademark Office, an inventor must demonstrate that
protect their trademarks. Virginia Tech filed a lawsuit
an invention is new, non-obvious, and useful. If the
in 2011 against a new local business called Hokie Real
owner of a patent believes that a company or person
Estate, claiming trademark infringement. Virginia Tech Figure 4.8: Fashionistas instantly recognize the trademark red
has infringed on the patent, the owner can sue for sole of Christian Louboutin’s high-end shoes.
had received a legal trademark for its nickname Hokies.
damages. Patenting an invention is important because
Hokie Real Estate prevailed, as there were a number of
patents can fuel enormous profits. Imagine, for
other businesses in the locality also using the Hokie name.
example, the potential for lost profits if the Slinky had
not been patented. Shipyard engineer Richard James An organization’s trademarks consist of phrases, pictures, names, or symbols that are closely associated with the
came up with the idea for the Slinky by accident in 1943 organization. Some examples and key issues surrounding trademarks are illustrated below.
while he was trying to create springs for use in ship Figure 4.7: Patenting inventions such as the Slinky helps
ensure that the invention is protected from imitation. Table 4.7 Trademarks
instruments. When James accidentally tipped over one
of his springs, he noticed that it moved downhill in a Examples of Trademarks
captivating way. James spent his free time perfecting the Slinky and then applied for a patent in 1946. To date, To be fully protected in the United States, a trademark must be registered with the United States Patent and Trademark
more than three hundred million Slinkys have been sold by the company that Richard James and his wife Betty Office. A capital R with a circle around it denotes a registered trademark.

created. As part of the punishment for German aggression during World War I, German drug maker Bayer lost its trademark on
“Aspirin” in France, Russia, the United Kingdom, and the United States. Today, Bayer still retains its trademark in
Germany, Canada, Mexico and dozens of other countries.

Many small companies use their founders’ name as the basis for a trademarked company name.

The distinctive pattern of clothing retailer Burberry Ltd. is an example of a trademark that does not involve words or
symbols.

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Copyrights Trade Secrets

The rights of creators of original artistic works such as books, movies, songs, and screenplays are protected by Trade secrets refer to formulas, practices, and designs that are central to a firm’s business and that remain
copyrights. Some examples and key issues surrounding copyrights are illustrated below. unknown to competitors (Table 4.9). Trade secrets are protected by laws on theft, but once a secret is revealed,
it cannot be a secret any longer. This leads firms to rely mainly on silence and privacy rather than the legal
Table 4.8 Copyrights
system to protect trade secrets.
Examples of Copyrights
Trade secrets are formulas, practices, and designs that are central to a firm’s business and that remain unknown
Illegal downloads of music are copyright infringements. In spite of laws and increased enforcement, millions of songs are
obtained illegally. to competitors. Everyone loves a good mystery, so it is no surprise that legends have arisen around some trade

Today’s cheesy television ads aimed at inventors follow a long tradition of companies offering to help individuals
secrets. Some examples and key issues surrounding trade secrets are illustrated below.
copyright their ideas—for a small fee, of course.
Table 4.9 Trade Secrets
The presence of the copyright symbol tells consumers that they are not allowed to duplicate the product that carries the
copyright. Examples of Trade Secrets
A painting such as Johannes Vermeer’s “Girl with a Pearl Earring” enters the public domain (i.e., is not subject to Low-end fast food chain Long John Silver’s considers its “crumblies” (small bits of fried batter) to be a trade secret, but
copyright) one hundred years after its creator’s death. would anyone really want to solve the mystery?
When it became apparent that The Verve’s 1997 hit single “Bittersweet Symphony” duplicated a Rolling Stones song, The In 2006, Pepsi was offered a chance to buy a stolen copy of Coca-Cola’s secret recipe. An FBI sting was created and the
Verve was forced to give up the copyright for the song. thieves were arrested.

WD-40 was developed to repel water and prevent corrosion, but it was later found to have over two thousand uses.
Copyrights provide exclusive rights to the creators of Creating WD-40 took a lot of work: the product’s unusual name stands for “Water Displacement, 40th attempt.” Despite
being created in 1953, the formula for making WD-40 remains unknown outside the company that sells it.
original artistic works such as books, movies, songs,
and screenplays for an author’s lifetime plus 70 years FarmVille creator Zynga alleged in a lawsuit that Disney had lured away Zynga employees to work for Disney and then
urged the employees to turn over a secret “playbook” that described Zynga’s strategy. The case was settled out of court
(Figure 4.8). Sometimes copyrights are sold and in late 2010.
licensed. In the late 1960’s, Buick thought it had an In a 1995 episode of the hit comedy Seinfeld, a very successful but mean-spirited restaurateur nicknamed the “Soup
agreement in place to license the number one hit, Nazi” saw his business collapse when his secret recipes were revealed to customers. Individuals could now make
delicious soups at home rather than endure the Soup Nazi’s verbal abuse when buying soup.
“Light My Fire” by The Doors, for a television
advertisement until the band’s volatile lead singer Jim
Some trade secrets have become legendary, perhaps
Morrison loudly protested what he saw as mistreating
because a mystique arises around the unknown. One
a work of art. Classic rock by The Beatles has been used
famous example is the blend of eleven herbs and spices
in television ads in recent years. After the late pop star
used in Kentucky Fried Chicken’s original recipe
Michael Jackson bought the rights to the band’s music
Figure 4.9: He looks calm here, but the licensing of a chicken. KFC protects this secret by having multiple
catalog, he licensed songs to Target and other copyrighted song for a car commercial enraged rock legend suppliers each produce a portion of the herb and spice
companies. Some devoted music fans consider such Jim Morrison.
blend; no one supplier knows the full recipe. The
ads to be abominations, perhaps proving the merit of
formulation of Coca-Cola is also shrouded in mystery.
Morrison’s protest decades ago.
In 2006, Pepsi was approached by shady individuals
Over time, piracy has become a huge issue for the owners of copyrighted works. In China, millions of pirated who were offering a chance to buy a stolen copy of
DVDs are sold each year, and music piracy is estimated to account for at least 95% of music sales. This piracy Coca-Cola’s secret recipe. Pepsi wisely refused. An FBI
deprives movie studios, record labels, and artists of millions of dollars in royalties. In response to the damage sting was used to bring the thieves to justice. The soft- Figure 4.10: The recipe for Dr Pepper is a secret dating back to
drink industry has other secrets too. Dr Pepper’s the 1880s.
piracy has caused, the US government has pressed its Chinese counterpart and other national governments to
better enforce copyrights. recipe remains unknown outside the company.
Although Coke’s formula has been the subject of greater speculation, Dr Pepper is actually the original secret
soft drink; it was created a year before Coca-Cola.

104 | Chapter 4: Evaluating the Internal Environment Chapter 4: Evaluating the Internal Environment | 105

members of Congress that help bring business to that firm, at the expense of the competition (in this example,
this might be called collusion, but that is a story for another day, and Chapter 11 on corporate ethics).

Section Video Path Dependence

Understanding Intellectual Property (IP) [02:14]

The path that a firm takes over time to achieve the point of a competitive advantage may also provide a barrier
The video for this lesson further explains intellectual property. to imitation. Decisions made in the past that brought a firm to its current position may make it very difficult

You can view this video here: https://youtu.be/UqZJPuyK9VY. for other firms to imitate. The accumulated learning and experience gained along the historical path are not
easily duplicated. This path dependence can serve as an isolating mechanism to block competitors from gaining
the same position in the market. Warby Parker, for example, made a decision early in its development to build
relationships with a variety of suppliers and to use the “buy one, give one” strategy, where a pair of glasses is
given away to someone in need for every pair sold. This decision and path created loyal suppliers and customers
within the online eye wear industry, and a copycat strategy by a competitor would likely be cost prohibitive.
Isolating Mechanisms

The goal of a firm is to have a sustained competitive advantage, whereby a resource or capability of the firm Causal Ambiguity
provides a competitive edge for a long time. The length of time a firm can maintain a sustained competitive
advantage depends on the industry. A company in a fast-moving industry, such as information technology or
fast fashion, may be quite satisfied if they can hold a competitive advantage for a year. A sustained competitive The third isolating mechanism, causal ambiguity, means the reason for achieving a competitive advantage is
advantage in another type of industry, like feminine hygiene that does not have such frequent changes may last not apparent. The cause for success is obscure and not understood well. Because the firm itself does not really
much longer. No firm is able to keep a sustained competitive advantage indefinitely. The competition is always know why it has achieved success, it is quite difficult for a competitor to replicate it. For example, why does
attempting to gain its own competitive advantage. Netflix still enjoy immense popularity in spite of numerous streaming competitors? In 2020 Netflix had a market
penetration of 54%, while Amazon Prime is a distant second at 30% (Roxorough, 2019). Is it because they were
If a firm can prevent a competitor from imitating the resource or capability that gives it a competitive the first mainline streaming service? Is it related to CEO Reed Hastings? Does content make a big difference?
advantage, it is able to sustain that advantage longer. This strategy is called isolating mechanisms. A patent, Competitors find it difficult to duplicate Netflix’s success model because it is not clear what has caused it.
for example, is a legal way to prevent imitation. Sometimes a competitor is able to “re-engineer” the patented
concept by making slight changes, working around the patent to imitate the idea without infringing on the It was noted earlier in this chapter that intangible resources are usually more valuable than tangible ones in
patent. There are other isolating mechanisms a firm may be able to employ to lessen the likelihood of imitation the context of sustained competitive advantage. The reason for this is due, in part, to the isolating mechanisms
by a competitor. These other isolating mechanisms are Social Complexity, Path Dependence, and Causal discussed above. Physical resources tend to be in abundance and are far easier to obtain. So, if two firms
Ambiguity. have the same physical resources, then there is little to no differentiation. The key distinction that firms can
make is how they use those physical resources in their value chain. The intangible resources including skills,
knowledge, or brand name used to capitalize on physical resources are far more likely to produce an advantage
for firms than simply possessing a physical resource alone. In this way, firms such as Nike can capitalize on
Social Complexity marketing and their brand to sell shoes at a premium when their shoes have few physical differences from
their competitors. In some cases, a manufacturing facility may very well produce the same product for multiple
The interrelationships within a firm, along with relationships within or across a business process, can be companies (e.g., t-shirts). In such cases the difference to consumers is the brand.
difficult to imitate. For example, key relationships that members of a firm have with a supplier of a key strategic
resource create a condition that a competitor cannot duplicate. This social complexity creates a barrier to
imitation and can prolong a competitive advantage possessed by an organization. Social complexity might
arise through certain customer relationships or with key political figures, provided they can help the firm’s
competitive position. For example, a CEO of a firm in the defense industry may cultivate relationships with key

106 | Chapter 4: Evaluating the Internal Environment Chapter 4: Evaluating the Internal Environment | 107
 Figure 4.8: Arroser. “Christian Louboutin.” CC BY-SA 3.0. Retrieved from
https://upload.wikimedia.org/wikipedia/commons/6/62/Louboutin_altadama140.jpg.
Key Takeaway
Figure 4.9: Persson, Jan and Polfoto. “The Doors performing for Danish television in Copenhagen.” Public
Domain. Retrieved from https://upload.wikimedia.org/wikipedia/commons/1/15/
• Intellectual property can serve as a strategic resource for organizations. While some sources of The_Doors_in_Copenhagen_1968.jpg.
intellectual property such as patents, trademarks, and copyrights can receive special legal
Figure 4.10: Anyjazz65. “Dr. Pepper.” CC BY 2.0. Retrieved from https://flic.kr/p/7uDd8e.
protection, trade secrets provide competitive advantages by simply staying hidden from
competitors.
• Utilizing isolating mechanisms strategically is a way for organizations to prevent imitation and
maintain their competitive advantage. Video Credits

Federallabs. (2019, March 27). Understanding intellectual property (IP) [Video]. YouTube.
https://youtu.be/UqZJPuyK9VY.
Exercises

1. What designs for your college or university are protected by trademarks?

2. What type of intellectual property provides the most protection for firms?
3. Why would a firm protect a resource through trade secrets rather than by a formal patent?

References

Reuters. (2018, May 24). Jury awards apple $539 million in Samsung patent case. The New York Times.
https://www.nytimes.com/2018/05/24/business/apple-samsung-patent-
trial.html#:~:text=The%20world’s%20top%20smartphone%20rivals,to%20a%20retrial%20over%20damages.

Roxborough, S. (2019, November 13) Netflix dominates global SVOD market, but local services gain ground,
study finds. The Hollywood Reporter. https://www.hollywoodreporter.com/news/netflix-dominates-global-
svod-market-but-local-services-gain-ground-1254438.

Image Credits

Figure 4.7: McLassus, Roger. “Metal slinky.” CC BY-SA 3.0. Retrieved from
https://upload.wikimedia.org/wikipedia/commons/f/f3/2006-02-04_Metal_spiral.jpg.

108 | Chapter 4: Evaluating the Internal Environment Chapter 4: Evaluating the Internal Environment | 109

4.5 Value Chain Elements of the Value Chain

When executives choose strategies, an organization’s resources and capabilities should be examined alongside
consideration of its value chain. A value chain charts the path by which products and services are created and
eventually sold to customers (Porter, 1985). The term value chain reflects the fact that, as each step of this
path is completed, the product becomes more valuable than it was at the previous step (Table 4.10). Within the
lumber business, for example, value is added when a tree is transformed into usable wooden boards; the boards
created from a tree can be sold for more money than the price of the tree.

The Value Chain is used as an internal assessment tool to help a firm determine where it might be able to
achieve a competitive advantage. In which areas of the primary and secondary activities is the firm particularly
strong? Can that activity be leveraged to provide a competitive advantage over its rivals? Resources and/
or capabilities within that activity can be evaluated using the VRIO framework to determine what type
of competitive advantage they provide. For example, Netflix was the first firm to leverage its technology
development support activity to bring high quality movies to customers through streaming. Being the first
mover in this industry gave Netflix a foothold and reputation in this industry, and others have not been
able to catch up. When using this tool for internal assessment, each activity of the Value Chain should be
examined for its potential to achieve a competitive advantage. Conversely, weak activities in the Value Chain
are opportunities to improve organizational performance. The overall intent of the Value Chain is to produce a
profit margin for the firm.

Figure 4.12: The Value Chain

Figure 4.11: Adding Value within a Value Chain.

110 | Chapter 4: Evaluating the Internal Environment Chapter 4: Evaluating the Internal Environment | 111
Value chains include both primary and secondary activities. Primary activities are actions that are directly Sometimes competitive advantage is achieved from the support activities of a firm as opposed to the primary
involved in creating and distributing goods and services. Consider a simple illustrative example: doughnut activities. Superior technology development or human resource management can produce a temporary if not
shops. Doughnut shops transform basic commodity products such as flour, sugar, butter, and grease into a sustained competitive advantage. A strong research and development arm in a pharmaceutical company can
delectable treats. Value is added through this process because consumers are willing to pay much more for develop medications that are patented and cannot be imitated. Incentives to staff such as those provided by 3M
doughnuts than they would be willing to pay for the underlying ingredients. and Google to be creative and develop new products have resulted in a competitive advantage.

There are five primary activities. Inbound logistics refers to the arrival of raw materials. Although doughnuts
are seen by most consumers as notoriously unhealthy, the Doughnut Plant in New York City has carved out a
unique niche for itself by obtaining organic ingredients from a local farmer’s market. Operations refers to the
actual production process, while outbound logistics tracks the movement of a finished product to customers.
Referring back to Southwest Airlines, one of Southwest Airlines’ unique capabilities is moving passengers more Section Video
quickly than its rivals. This advantage in operations is based in part on Southwest’s reliance on one type of
airplane (which speeds maintenance) and its avoidance of advance seat assignments (which accelerates the
Strategic Management: Value Chain Analysis [04:41]
passenger boarding process).
The video for this lesson further discusses value chain analysis.
Attracting potential customers and convincing them to make purchases is the domain of marketing and sales.
You can view this video here: https://youtu.be/Tpb1fxt9YfU.
For example, people cannot help but notice Randy’s Donuts in Inglewood, California, because the building has
a giant doughnut on top of it. Finally, service refers to the extent to which a firm provides assistance to their
customers. Voodoo Donuts in Portland, Oregon, has developed a clever website (voodoodoughnut.com) that
helps customers understand their uniquely named products, such as the Voodoo Doll, the Texas Challenge, the
Memphis Mafia, and the Dirty Snowball.
Key Takeaway
Secondary activities are not directly involved in the evolution of a product, but instead provide important
underlying support for primary activities. Firm infrastructure refers to how the firm is organized and led by
executives. The effects of this organizing and leadership can be profound. For example, Ron Joyce’s leadership • The value chain provides a useful tool for managers to examine systematically where value may
of Canadian doughnut shop chain Tim Hortons was so successful that Canadians consume more doughnuts per be added to their organizations. This tool is useful in that it examines key elements in the
person than all other countries. In terms of resource-based theory, Joyce’s leadership was clearly a valuable and production of a good or service, as well as areas in which value may be added in support of those
rare resource that helped his firm prosper. primary activities.

Human resource management is also important. Human resource management involves the recruitment,
training, and compensation of employees. A recent research study used data from more than twelve thousand
organizations to demonstrate that the knowledge, skills, and abilities of a firm’s employees can act as a
strategic resource and strongly influence the firm’s performance (Crook et al., 2011). Certainly, the unique Exercises
level of dedication demonstrated by employees at Southwest Airlines has contributed to that firm’s excellent
performance over several decades.

Technology refers to the use of computerization and telecommunications to support primary activities. 1. If you were hired as a consultant for your university, what specific element of the value chain
Although doughnut making is not a high-tech business, technology plays a variety of roles for doughnut shops, would you seek to improve first?
such as allowing customers to pay using credit cards. 2. What local business in your town could be improved most dramatically by applying the value
chain? Would improvements of primary or support activities help to improve this firm most?
Procurement is the process of negotiating for and purchasing raw materials. Large doughnut chains such as Could knowledge of strategic supply chain management add further value to this firm?
Dunkin’ and Krispy Kreme can gain cost advantages over their smaller rivals by purchasing flour, sugar, and
other ingredients in bulk. Meanwhile, Southwest Airlines has gained an advantage over its rivals by using futures
contracts within its procurement process to minimize the effects of rising fuel prices.

112 | Chapter 4: Evaluating the Internal Environment Chapter 4: Evaluating the Internal Environment | 113

References
Exercises
Crook, T. R., Todd, S. Y., Combs, J. G., Woehr, D. J., & Ketchen, D. J. (2011). Does human capital matter? A meta-
analysis of the relationship between human capital and firm performance. Journal of Applied Psychology, 96(3),
443–456. 1. Divide your class into four or eight groups, depending on the size of the class. Each group should
search for a patent tied to a successful product, as well as a patent associated with a product
Porter, M. E. (1985). Competitive advantage: Creating and sustaining superior performance. Free Press. that was not a commercial hit. Were there resources tied to the successful organization that the
poor performer did not seem to attain?
2. This chapter discussed Southwest Airlines. Based on your reading of the chapter, how well has
Image Credits Southwest done in bundling together the resources recommended by resource-based theory?
What theoretical perspective best explains the competitive actions of most firms in the airline
industry?
Figure 4.11: Kindred Grey (2020). “Adding value within a value chain.” CC BY NC SA 4.0. Image of donut: Annie
Spratt (2016). “Stacked donuts.” Public Domain. Retrieved from: https://unsplash.com/photos/AjTclDIadpg
Adaptation of Figure 4.10 from Mastering Strategic Management (2015) (CC BY NC SA 4.0). Retrieved from
https://open.lib.umn.edu/app/uploads/sites/11/2015/04/9c5437a4d7bfd1ad4b0baa480978c7bd.jpg.

Figure 4.12: Kindred Grey (2020). “The value chain.” CC BY NC SA 4.0. Adaptation of Figure 4.11 from Mastering
Strategic Management (2015) (CC BY NC SA 4.0). Retrieved from
https://open.lib.umn.edu/app/uploads/sites/11/2015/04/b38d1270a489c447e16e30df24d931aa.jpg.

Video Credits

Melissa Schilling. (2020, May 25). Strategic management: Value chain analysis [Video]. YouTube.
https://youtu.be/Tpb1fxt9YfU.

4.6 Conclusion

This chapter explains key issues that executives face in managing resources to keep their firms competitive.
Resource-based theory argues that firms will perform better when they assemble resources that are valuable,
rare, difficult-to-imitate, and organized to capture value. When executives can successfully bundle
organizational resources into unique capabilities, the firm is more likely to enjoy lasting success. Different
forms of intellectual property—which include patents, trademarks, copyrights, and trade secrets—may also
serve as strategic resources for firms. Examining a firm’s resources can be aided by the value chain, a tool that
systematically examines primary and secondary activities in the creation of a good or service.

114 | Chapter 4: Evaluating the Internal Environment Chapter 4: Evaluating the Internal Environment | 115
 accomplishing its vision. The next chapter discusses how basic business level strategies are developed. The
Chapter 5: Synthesis of Strategic Issues and development of the firm’s strategic issue is discussed in greater detail later in this chapter.

Analysis
5.2 SWOT Framework
5.1 Introduction

5.2 SWOT Framework Chess master Bruce Pandolfini has noted the similarities between business and chess. In both arenas, you must
understand your own abilities as well as your flaws. You must also know your opponents, try to anticipate their
5.3 Strategic Issue Identification
moves, and deal with considerable uncertainty. A very popular management tool that incorporates the idea of
5.4 Conclusion understanding the elements internal and external to the firm is SWOT (strengths, weaknesses, opportunities, and
threats) analysis. Strengths and weaknesses are assessed by examining the firm, while opportunities and threats
refer to external events and trends. These ideas can be applied to individuals too. Below are examples of each
Learning Objectives element of SWOT analysis for organizations and for individuals who are seeking employment.

Table 5.1 SWOT

SWOT point Organizational Examples Individual Examples

After reading this chapter, you should be able to understand and articulate answers to the following
questions: Having high levels of cash flow gives firms Strong technical and language skills, as well as
Strengths discretion to purchase new equipment if they previous work experience, can help individuals rise
wish to. above the competition.
1. How is the SWOT framework developed and used for determining strategic issues and
Dubious leadership and CEO scandals have Poor communication skills keep many job seekers
strategies? Weaknesses
plagued some corporations in recent years. from being hired into sales and supervisory positions.
2. What is a strategic issue and how is it identified and expressed?
The high cost of gasoline creates opportunities The US economy is increasingly services based,
Opportunities for substitute products based on alternative suggesting that individuals can enjoy more
energy sources. opportunities in service firms.

Concerns about worldwide pollution are a threat

Threats A tight job market poses challenges to new graduates.
to petroleum-based products.

5.1 Introduction Porter’s Five Forces analysis examines the situation

faced by the competitors in an industry. Strategic
groups analysis narrows the focus by centering on
The last three chapters have dealt with assessing organizational performance, external analysis of the industry,
subsets of these competitors whose strategies are
and competitive environments of a firm, and analyzing the internal environment of an organization. What
similar. SWOT analysis takes an even narrower focus by
happens to all information that is obtained as a result of all these evaluations? The SWOT framework helps to
centering on an individual firm. Specifically, SWOT
pull the most important information into a format that can then be used in strategic management to determine
analysis is a tool that considers a firm’s strengths and
the strategic issue the firm needs to address and resolve by consolidating a summary of the other analyses
weaknesses along with the opportunities and threats
into one framework. The SWOT framework is also helpful in the next phase of strategic management, setting
that exist in the firm’s environment (Table 4.12).
strategies.
Executives using SWOT analysis compare these
A strategic issue is the primary matter faced by an organization that must be addressed for the organization to
internal and external factors to generate ideas about
survive, excel, or achieve a major strategic initiative. The strategic issue defines what the organization needs Figure 5.1: China’s huge population and growing wealth
how their firm might become more successful. In makes it an attractive opportunity for Subway and other
to address and resolve to move the organization forward toward success by analyzing the data and information
general, it is wise to focus on ideas that allow a firm to American restaurant chains.
from the internal and external assessments as presented in the SWOT. Once the strategic issue is defined,
leverage its strengths, steer clear of or resolve its
strategies can be developed that address and resolve the strategic issue and propel the organization toward
weaknesses, capitalize on opportunities, and protect itself against threats. For example, untapped overseas

116 | Chapter 5: Synthesis of Strategic Issues and Analysis Chapter 5: Synthesis of Strategic Issues and Analysis | 117

markets have presented potentially lucrative opportunities to Subway and other restaurant chains such as opportunities to work at a rehabilitation center or to pursue an advanced degree are available. Our hypothetical
McDonald’s and KFC. Meanwhile, Subway’s strengths include a well-established brand name and a simple student might be wise to pursue a job at the rehabilitation center, where her strength at helping others would
business format that can easily be adapted to other cultures. In considering the opportunities offered by be a powerful asset, rather than entering graduate school, where a lot of reading is required and her short
overseas markets and Subway’s strengths, it is not surprising that entering and expanding in different countries attention span could undermine her studies.
has been a key element of Subway’s strategy in recent years. Indeed, Subway in 2020 had operations in 111
nations.

The SWOT framework is developed by synthesizing the information developed from the external, competitive,
and internal assessments. The most important information from these assessments is pulled into the SWOT
framework. Once complete, the SWOT is helpful in determining the strategic issue facing the organization. Section Video
SWOT is also beneficial is developing the strategies for the firm.

SWOT analysis is helpful to executives, and it is used within most organizations. Important cautions need to Business strategy-SWOT analysis [03:08]
be offered about SWOT analysis, however. First, in laying out each of the four elements of SWOT, internal and The video for this lesson discusses SWOT analysis.
external factors should not be confused with each other. It is important not to list strengths as opportunities,
You can view this video here: https://youtu.be/9-NWhwskTO4.
for example, if executives are to succeed at matching internal and external concerns during the idea generation
process. Internal environment assessment tools such as VRIO and Value Chain Analysis can lead to
organizational strengths and weaknesses. Using external environment analysis tools like PESTEL and Porter’s
Five Forces help to determine opportunities and threats. Second, opportunities should not be confused with
strategic moves designed to capitalize on these opportunities. In the case of Subway, it would be a mistake to
Key Takeaway
list “entering new countries” as an opportunity. Instead, untapped markets are the opportunity presented to
Subway, and entering those markets is a way for Subway to exploit the opportunity. Finally, and perhaps most
important, the results of SWOT analysis should not be overemphasized. SWOT analysis is a relatively simple
• Executives using SWOT analysis compare internal strengths and weaknesses with external
tool for understanding a firm’s situation. As a result, SWOT is best viewed as a brainstorming technique for
opportunities and threats to generate ideas about how their firm might become more successful.
generating creative ideas, not as a rigorous method for selecting strategies. Thus the ideas produced by SWOT
Ideas that allow a firm to leverage its strengths, mitigate or resolve its weaknesses, capitalize on
analysis offer a starting point for executives’ efforts to craft strategies for their organization, not an ending
opportunities, and protect itself against threats are particularly helpful.
point. The SWOT framework is also very helpful in determining the strategic issue facing the firm that will need
to be addressed and resolved through the strategies that are developed.

Table 5.2 SWOT Analysis for Subway in 2020

Strengths Weaknesses
Exercises
• Healthy menu options • Limited menu items
• Economical pricing • High employee turnover
• Simple business format • No hamburgers or french fries
1. What do each of the letters in SWOT represent?
Opportunities Threats 2. What are your key strengths, and how might you build your own personal strategies for
success around them?
• Untapped international markets • Competitors offering more options
• Movement to more healthy eating • Long-term economic slow-down due to pandemic

In addition to organizations, individuals can benefit from applying SWOT analysis to their personal situation. A
college student who is approaching graduation, for example, could lay out her main strengths and weaknesses
and the opportunities and threats presented by the environment. Suppose, for instance, that this person enjoys
and is good at helping others (a strength) but also has a rather short attention span (a weakness). Meanwhile,

118 | Chapter 5: Synthesis of Strategic Issues and Analysis Chapter 5: Synthesis of Strategic Issues and Analysis | 119
Image Credits

Figure 5.1: Jonathan. “Nanjing Lu.” CC BY-NC-ND 2.0. Retrieved from https://flic.kr/p/7vi4uK.

Video Credits

365Careers. (2017, July 4). Business strategy-SWOT analysis [Video]. YouTube.

https://youtu.be/9-NWhwskTO4.

5.3 Strategic Issue Identification

So, what happens in strategic management once all the external and internal analysis is done and the SWOT
framework is complete? Is it time to start developing strategies? No, not yet. One more thing needs to happen:
defining the strategic issue or issues the firm needs to be sure to address. Figure 5.2: The Planning Team

What is a strategic issue? First, it is an issue, something that needs to be addressed and resolved. Second,
it is strategic. It is a long-term issue whose resolution will help move the organization toward its vision.
Resolving the strategic issue will have a major impact on the direction and success of the firm (Ambler, 2020). The strategic issue will change over time, as the external, competitive and internal dynamics change. For
The strategic issue is derived from the facts and data provided by the external and internal analysis and its organizations working through the strategic management process, defining the strategic issue may not be
synthesis through the SWOT framework. The business decision makers do not define the strategic issue(s) simple. The planning team members may interpret data differently or through the lens of their own perspective.
at the beginning of the strategic management process, through a hunch or guess, but after the analysis is The CFO may see the strategic issue in financial terms, the marketing director as a marketing issue, and the
completed. Once defined, the strategic issue helps drive the strategies that the organization develops and human resources director as an issue with manpower and training. One process organizations can use to
pursues. A strategic issue, when identified correctly and used effectively, becomes the strategic focus of determine the strategic issue is for planning team members to study the data from the analysis and each draft
the organization. In this process, more than one strategic issue may surface. Generally, decision makers will and share their idea of the strategic issue. The team then has a process to prioritize these, dropping some,
condense these into a single statement, or deal with less important strategic issues when establishing strategies combining some, until they arrive at a consensus on the wording of the strategic issue (Ambler, 2020).
or lower order goals.

The word “issue” often connotes a negative situation that a firm may be facing. For example, Southwest Airlines
was faced with much lower passenger volumes as a result of the COVID-19 pandemic that started in 2020.
However, the Subway example discussed at the beginning of this chapter demonstrates that the strategic issue
was framed as capitalizing on an opportunity—how to move into untapped international markets. Section Video
Ideally, the strategic issue is reduced to one concise sentence, so that it is easily captured and understood.
Amplifying information may be provided to further explain the situation and justify the choice of the strategic Strategic Issues [01:57]
issue. Often, the strategic issue starts with the word how. In the Southwest Airlines example, the strategic
The video for this lesson discusses Strategic Issues.
issue could be: “How does Southwest Airlines adjust to long-term, lower passenger volumes and remain the
preferred, low-cost leader in the industry?” For Subway, it may have been “How does Subway enter untapped You can view this video here: https://youtu.be/Zj_dxbJpCqo.

international markets?” Once defined, these companies would develop strategies that move their organization
towards its vision, while addressing the strategic issue.

120 | Chapter 5: Synthesis of Strategic Issues and Analysis Chapter 5: Synthesis of Strategic Issues and Analysis | 121

5.4 Conclusion
Key Takeaway
In the analysis stage of the strategic management process, the final phase is to apply the SWOT framework
to consolidate a “snapshot” of the internal and external analysis conducted and identify the key strategic
• It is important to define the strategic issue of an organization using the information and data
issue(s). The SWOT pulls together the important information from the external and internal analysis and
from the external and internal analysis and the SWOT framework. The strategic issue sets the
the organizational performance assessment and displays it in an organized framework. The strengths and
strategic focus for the development of strategies. The strategies will address and attempt to
weaknesses are internal to the organization, and the opportunities and threats are external to the firm.
resolve the strategic issue and move the organization toward accomplishing its vision.
The information and data from the assessments and SWOT are then used to formulate the strategic issue(s).
What needs to be addressed and resolved to move the organization forward toward success and its vision?
Strategies are then developed that address the resolution of the strategic issue and advance the organization,
as discussed in the next chapter.
Exercises

1. Suppose internal and external analysis data from Apple show an upcoming slump in sales of
desktop and laptop computers and tablets for years to come. What might the strategic issue for
Apple be?
2. You are a college senior preparing to graduate in six months. The COVID-19 pandemic has
caused massive furloughs and layoffs nationwide. What might be your strategic issue?

References

Ambler, T. E. (2020). Strategic issues: The pivotal process for strategic success. The Center for Simplified
Strategic Planning, Inc. https://www.cssp.com/CD0799/ProcessForStrategicSuccess/.

Image Credits

Figure 5.2: Morillo, Christina. “People on conference room.” Pexels license. Retrieved from
https://www.pexels.com/photo/people-on-conference-room-1181427/.

Video Credits

Gregg Learning. (2018, June 9). Strategic issues [Video]. YouTube. https://youtu.be/Zj_dxbJpCqo.

122 | Chapter 5: Synthesis of Strategic Issues and Analysis Chapter 5: Synthesis of Strategic Issues and Analysis | 123
 terms of the product lines, but the key point is to evaluate the business-level based on to whom the strategy
Chapter 6: Selecting Business-Level Strategies appeals. In this way, a firm can target a broad audience with a single or a few products.

There are two primary decisions in a generic business strategy. Will the intent of the strategy be on a broad or
6.1 Introduction focused target audience, and simultaneously, does the firm organize around a cost or differentiation approach?
If selecting a broad cost leadership or broad differentiation strategy, the target market for the product or
6.2 Understanding Business-Level Strategy through “Generic Strategies”
service is broad, meaning most people who buy within that industry. If the strategy is focused, that target

6.3 Cost Leadership market is narrow, a niche market, and not meant for most people in the industry. A strategy of broad cost
leadership offers the lowest price in the market for that product or service. It appeals particularly to price
6.4 Differentiation sensitive customers. Firms pursuing a broad differentiation strategy offer something unique that differentiates
their product or service from others. Typically this uniqueness adds cost and value to the product or service,
6.5 Focused Cost Leadership and Focused Differentiation
allowing the company to charge more. If the strategy is focused cost leadership, then the firm attempts
6.6 Best-Cost Strategy to provide the lowest cost to a narrow, niche target market. Focused differentiation provides unique or
differentiated products or services to a narrow, niche target market. The fifth generic business-level strategy
6.7 Stuck in the Middle is called best cost, where the firm attempts to offer a hybrid of both lower cost and differentiated products
or services, combining the two basic strategies. A firm pursuing this strategy must be careful to perform both
6.8 Conclusion
strategies well, or risk not performing either well, and therefore becoming “stuck in the middle,” and losing
customers to the competition.

Learning Objectives Once a firm establishes its overall generic business-level strategy, the strategic management process helps
the firm to continuously improve upon that strategy. The organizational performance, external, and internal
assessments, and the development of the strategic issue(s) through the SWOT analysis are then used to plot
After reading this chapter, you should be able to understand and articulate answers to the following strategies for the firm to achieve its vision through its business-level strategy.
questions:

1. Why is an examination of generic strategies valuable?

2. What are the four main generic strategies?
3. What is a best-cost strategy?
4. What does it mean to be “stuck in the middle”? The Competition Takes Aim at Target

On January 13, 2011, Target Corporation

announced its intentions to operate stores
outside the United States for the first time. The
6.1 Introduction plan called for Target to enter Canada by
purchasing existing leases from a Canadian
retailer and then opening 100 to 150 stores in
Within the strategic management framework, an organization must define and continue to improve its generic, 2013 and 2014 (Target, 2011). The chain already
business-level strategy. A generic, business-level strategy is also called its generic competitive strategy, Figure 6.1: Inside of a Target store
included more than 1,700 stores in forty-nine
because it defines how a firm competes head-to-head against similar products and services in the marketplace. states. Given the close physical and cultural
According to Michael Porter, a firm may pursue one of five generic/competitive business-level strategies. ties between the United States and Canada, entering the Canadian market seemed to be a logical
These are broad cost leadership, broad differentiation, focused cost leadership, focused differentiation, and move for Target.
best cost strategies. An important point of distinction is that business level strategies are viewed from the
perspective of which consumer(s) are being targeted. It may be tempting to view business-level strategies in

124 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 125

References
In addition to making its initial move beyond the United States, Target had several other sources of
pride. The company claimed that 96% of American consumers recognized its signature logo, Fortune Magazine. (2020). World’s most admired companies.
surpassing the percentages enjoyed by famous brands such as Apple and Nike. In 2020, Fortune https://fortune.com/worlds-most-admired-companies/2020/search/?ordering=asc.
magazine ranked Target twenty-second on its list of the “World’s Most Admired Companies.” But
not all had been well with Target (Fortune, 2020). They pulled out of Canada in 2015 after just two Peterson, H. (2015, January 15). 5 reasons Target failed in Canada. Business Insider.
years and $2 billion in losses. Concern also surrounded Target’s possible vulnerability to https://www.businessinsider.com/why-target-canada-failed-2015-1.
competition within the retail industry (Peterson, 2015). Since its creation in the early 1960s, Target
Target fact card. (2007, January). https://web.archive.org/web/20071128161431/http://sites.target.com/
executives had carved out a lucrative position for the firm. Target offers relatively low prices on
images/corporate/about/pdfs/corp_factcard_101107.pdf.
brand name consumer staples such as cleaning supplies and paper products, but it also offers chic
clothing and household goods. This unique combination helps Target to appeal to fairly affluent Target. (2011, January 13). Target Corporation to acquire interest in Canadian real estate from Zellers Inc., a
customers. Perhaps the most tangible reflection of Target’s upscale position among large retailers subsidiary of Hudson’s Bay Company, for $1.825 billion [Press release]. https://investors.target.com/news-
is the tendency of some customers to jokingly pronounce its name as if it were a French boutique: releases/news-release-details/target-corporation-acquire-interest-canadian-real-estate-zellers.
“Tar-zhay.”

Target’s lucrative position was far from guaranteed, however. Indeed, a variety of competitors
seemed to be taking aim at Target. Retail chains such as Kohl’s and Old Navy offered fashionable Image Credits
clothing at prices similar to Target’s. Discounters like T.J. Maxx, Marshalls, and Ross offered
designer clothing and chic household goods for prices that often were lower than Target’s.
Figure 6.1: Lovable98158. “A picture of the grocery section of a local Target.” CC BY-SA 4.0. Retrieved from
Closeout stores such as Big Lots offered a limited selection of electronics, apparel, and household
https://commons.wikimedia.org/wiki/File:Target_Store.jpg . Image edited to crop ceiling out.
goods but at deeply discounted prices. All these stores threatened to steal business from Target.

Walmart was perhaps Target’s most worrisome competitor. After some struggles in the 2000s, the
mammoth retailer’s performance was strong enough that it ranked consistently above Target on
Fortune’s list of the “World’s Most Admired Companies” (eighteenth vs. twenty-second in 2020). 6.2 Understanding Business-Level Strategy through “Generic Strategies”
Walmart also was much bigger than Target. The resulting economies of scale meant that Walmart
could undercut Target’s prices anytime it desired. Just such a scenario had unfolded before. A few
years ago, Walmart’s victory in a price war over Kmart led the latter into bankruptcy.
Why Examine Generic Strategies?
One important difference between Kmart and Target is that Target is viewed by consumers as
offering relatively high-quality goods. But this difference might not protect Target. Although
Walmart’s products tended to lack the chic appeal of Target’s, Walmart had begun offering better Business-level strategy addresses the question of how a firm will compete in a particular industry (Table 6.1).
products during the recession of the late 2000s in an effort to expand its customer base. If Walmart This seems to be a simple question on the surface, but it is actually quite complex. The reason is that there
executives chose to match Target’s quality while charging lower prices, Target could find itself are a great many possible answers to the question. Consider, for example, the restaurants in your town or city.
without a unique appeal for customers. As 2020 continued, a big question loomed: could Target Chances are that you live fairly close to some combination of McDonald’s, Subway, Chili’s, Applebee’s, Panera
maintain its unique appeal to customers or would the competitive arrows launched by Walmart and Bread Company, dozens of other national brands, and a variety of locally based eateries that have just one
others force Target’s executives to quiver? location. Each of these restaurants competes using a business model that is at least somewhat unique. When an
executive in the restaurant industry analyzes her company and her rivals, she needs to avoid getting distracted
by all the nuances of different firm’s business-level strategies and losing sight of the big picture.

The solution is to think about business-level strategy in terms of generic strategies. A generic business-
level strategy is a general way of positioning a firm within an industry. Focusing on generic strategies allows
executives to concentrate on the core elements of firms’ business-level strategies. The most popular set of
generic strategies is based on the work of Professor Michael Porter of the Harvard Business School and
subsequent researchers that have built on Porter’s initial ideas (Porter, 1980; Williamson & Zeng, 2009).

126 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 127
 Firms compete on two general dimensions—the source of competitive advantage (cost or differentiation) and the
scope of operations (broad or narrow). Four possible generic business-level strategies emerge from these decisions.
An example of each generic business-level strategy from the retail industry is illustrated below.

Table 6.1 Business-Level Strategies

Competitive Advantage: Cost

Broad Target Market: Walmart’s cost leadership strategy depends on attracting a large customer base and keeping prices
low by buying massive quantities of goods from suppliers.

Narrow Target Market: In using a focused cost leadership, Dollar General does not offer a full array of consumer goods,
but those that it does offer are priced to move.

Competitive Advantage: Differentiation

Broad Target Market: Nordstrom builds its differentiation strategy around offering designer merchandise and providing
exceptional service.

Narrow Target Market: Anthropologie follows a focused differentiation strategy by selling unique (and pricey) women’s
apparel, accessories, and home furnishings.

According to Porter, two competitive dimensions are the keys to business-level strategy. The first dimension
is a firm’s source of competitive advantage. This dimension involves whether a firm tries to gain an edge on
rivals by keeping costs down or by offering something unique in the market. The second dimension is a firms’
scope of operations. This dimension involves whether a firm tries to target customers in general or whether
it seeks to attract just a narrow segment of customers. Four generic business-level strategies emerge from
these decisions: (1) broad cost leadership, (2) broad differentiation, (3) focused cost leadership, and (4) focused
differentiation. In rare cases, firms are able to offer both low prices and unique features that customers find
desirable. These firms are following a best-cost strategy. Firms that are not able to offer low prices or appealing
unique features are referred to as “stuck in the middle.”
Figure 6.2: Analyzing generic strategies enhances the understanding of how firms compete at the
business level.
Understanding the differences that underlie generic strategies is important because different generic
strategies offer different value propositions to customers. A firm focusing on cost leadership will have a
different value chain configuration than a firm whose strategy focuses on differentiation. For example,
marketing and sales for a differentiation strategy often requires extensive effort while some firms that follow
cost leadership such as Waffle House are successful with limited marketing efforts. This chapter presents
Limitations of Generic Strategies
each generic strategy and the “recipe” generally associated with success when using that strategy. When firms
follow these recipes, the result can be a strategy that leads to superior performance. But when firms fail to Examining business-level strategy in terms of generic strategies has limitations. Firms that follow a particular
follow logical actions associated with each strategy, the result may be a value proposition configuration that is generic strategy tend to share certain features. For example, one way that cost leaders generally keep costs
expensive to implement and that does not satisfy enough customers to be viable. low is by not spending much on advertising. Not every cost leader, however, follows this path. While cost
leaders such as Waffle House spend very little on advertising, Walmart spends considerable money on print
and television advertising despite following a cost leadership strategy. Thus a firm may not match every
characteristic that its generic strategy entails. Indeed, depending on the nature of a firm’s industry, tweaking
the recipe of a generic strategy may be essential to cooking up success.

128 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 129

Williamson, P. J. & Zeng, M. (2009). Value-for-money strategies for recessionary times. Harvard Business
Review, 87(3), 66–74. https://hbr.org/2009/03/value-for-money-strategies-for-recessionary-times.

Section Video Video Credits

Five Competitive Strategies [02:50]

Gregg Learning. (2018, June 11). Five competitive strategies [Video]. YouTube.
The video for this lesson explains the five generic strategies and why some work better in some https://www.youtube.com/watch?v=xUW6_Nbe8d0&feature=emb_logo.
industries or conditions than others.

You can view this video here:

https://www.youtube.com/watch?v=xUW6_Nbe8d0&feature=emb_logo
6.3 Cost Leadership

Firms that compete based on price and target a broad target market are following a broad cost leadership
strategy. Several examples of firms pursuing a broad cost leadership strategy are illustrated below.
Key Takeaway
Table 6.2 Cost Leadership

Examples of Firms Pursuing a Broad Cost Leadership Strategy

• Business-level strategies examine how firms compete in a given industry. Firms derive such Despite its name, Dunkin’ Donuts makes more money selling inexpensive coffee than it does from selling donuts. The
strategies by executives making decisions about whether their source of competitive advantage coffee is often advertised as costing under a dollar, making Dunkin’ Donuts a low-priced alternative to Starbucks.
is based on price or differentiation and whether their scope of operations targets a broad or Supercuts’s website makes clear their longstanding cost leadership strategy by noting, “A Supercut is a haircut that has
narrow market. kept people looking their best, while keeping money in their pockets, since 1975.”

Payless ShoeSource is a discount retailer that sells inexpensive shoes for men, women, and children. However, they filed
for bankruptcy in 2020 and closed all their stores, only operating their overseas stores. Super Shoes survives as a low
cost leader.

Little Debbie snack cakes began when O. D. McKee started selling treats for five cents each in the early 1930s. Little
Debbie cakes cost a lot more than five cents today, but they remain cheaper than similar offerings from Entenmann’s,
Exercises Tastykake, and other snack cake rivals.

1. What are examples of each generic business-level strategy in the apparel industry? The Nature of the Cost Leadership Strategy
2. What are the limitations of examining firms in terms of generic strategies?
3. Create a new framework to examine generic strategies using different dimensions than the two
It is tempting to think of cost leaders as companies that sell inferior, poor-quality goods and services for rock-
offered by Porter’s framework. What does your approach offer that Porter’s does not?
bottom prices. This is not necessarily true, but some companies get this reputation. K-Mart, for example, had
been a successful discount department store with a cost leadership strategy. As Walmart competed head to
head with K-Mart, however, and offered higher quality products at the same or lower prices than its rivals, K-
Mart was doomed. Its reputation for cheap, inferior products and its inability to win a price war with Walmart
pushed K-Mart into bankruptcy.
References
In contrast to firms such as K-Mart, cost leaders can be very successful. A firm following a cost leadership
Porter, M. E. (1980). Competitive strategy: Techniques for analyzing industries and competitors. Free Press. strategy offers products or services with acceptable quality and features to a broad set of customers at a low
price (Table 6.2). Super Shoes, for example, sells name-brand shoes at inexpensive prices. Little Debbie snack

130 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 131
cakes offer another example. The brand was started in the 1930s when O. D. McKee began selling sugary treats Using a cost leadership strategy offers firms important advantages and disadvantages. Below, table 6.3 illustrates
for five cents. Most consumers today would view the quality of Little Debbie cakes as a step below similar a few examples in relation to entertainment and leisure.
offerings from Entenmann’s, but enough people believe that they offer acceptable quality that the brand is still
Table 6.3 Executing a Low-Cost Strategy
around eight decades after its creation.
Advantages
Perhaps the most famous cost leader is Walmart, which has used a cost leadership strategy to become the
High profits can be enjoyed if a cost leader has a high market share. An example is Kampgrounds of America, a chain of
largest company in the world. The firm’s advertising slogans such as “Always Low Prices” and “Save Money. Live nearly 500 low cost camping franchises in the United States.
Better” communicate Walmart’s emphasis on price slashing to potential customers. Meanwhile, Walmart has
Low-cost firms such as many municipal golf courses can withstand price wars because high-priced competitors will not
the broadest customer base of any firm in the United States. Approximately one hundred million Americans want to compete directly with a more efficient rival.
visit a Walmart in a typical week (Zimmerman & Hudson, 2006). Incredibly, this means that roughly one-third Disadvantages
of Americans are frequent Walmart customers. This huge customer base includes people from all demographic
If perceptions of quality become too low, business will suffer.
and social groups within society.
Large volumes of sales are a must because margins are slim.
Cost leaders tend to share some important characteristics. The ability to charge low prices and still make a The need to keep expenses low might lead cost leaders to be late in detecting key environment trends.
profit is challenging. Cost leaders manage to do so by emphasizing efficiency. At Waffle House restaurants,
Low-cost firms’ emphasis on efficiency makes it difficult for them to change quickly if needed.
for example, customers are served cheap eats quickly to keep booths available for later customers. As part
of the effort to be efficient, most cost leaders spend little on advertising, market research, or research and
Beyond existing competitors, a cost leadership strategy also creates benefits relative to potential new entrants.
development. Waffle House, for example, limits its advertising to billboards along highways. Meanwhile, the
Specifically, the presence of a cost leader in an industry tends to discourage new firms from entering the
simplicity of Waffle House’s menu requires little research and development.
business because a new firm would struggle to attract customers by undercutting the cost leaders’ prices. Thus,
Many cost leaders rely on economies of scale to achieve efficiency. Economies of scale are created when the a cost leadership strategy helps create barriers to entry that protect the firm—and its existing rivals—from new
costs of offering goods and services decreases as a firm is able to sell more items. This occurs because expenses competition.
are distributed across a greater number of items. Walmart spent approximately $3.5 billion on advertising in
In many settings, cost leaders attract a large market
2019 (Guttmann, 2019). This is a huge number, but Walmart is so large that its advertising expenses equal just
share because a large portion of potential customers
a tiny fraction of its sales. Also, cost leaders are often large companies, which allows them to demand price
find paying low prices for goods and services of
concessions from their suppliers. Walmart is notorious for squeezing suppliers such as Procter & Gamble to sell
acceptable quality to be very appealing. This is
goods to Walmart for lower and lower prices over time. The firm passes some of these savings to customers in
certainly true for Walmart, for example. The need for
the form of reduced prices in its stores.
efficiency means that cost leaders’ profit margins are
often slimmer than the margins enjoyed by other firms.
However, cost leaders’ ability to make a little bit of
Advantages and Disadvantages of Cost Leadership profit from each of a large number of customers means
that the total profits of cost leaders can be substantial.

Each generic strategy offers advantages that firms can potentially leverage to enhance their success as well In some settings, the need for high sales volume is a Figure 6.3: Challenging a cost leader in a price war may end
up destroying a company.
as disadvantages that may undermine their success. In the case of cost leadership, one advantage is that cost critical disadvantage of a cost leadership strategy.
leaders’ emphasis on efficiency makes them well positioned to withstand price competition from rivals (Table Highly fragmented markets and markets that involve a
6.3). Kmart’s ill-fated attempt to engage Walmart in a price war ended in disaster, in part because Walmart was lot of brand loyalty may not offer much of an opportunity to attract a large segment of customers. In both the
so efficient in its operations that it could live with smaller profit margins far more easily than Kmart could. soft drink and cigarette industries, for example, customers appear to be willing to pay a little extra to enjoy the
brand of their choice. Lower-end brands of soda and cigarettes appeal to a minority of consumers, but famous
brands such as Coca-Cola, Pepsi, Marlboro, and Camel still dominate these markets. A related concern is that
achieving a high sales volume usually requires significant upfront investments in production and/or
distribution capacity. Not every firm is willing and able to make such investments.

132 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 133

Due to the need for cost leaders to have high volumes and slim margins, a focused cost leadership strategy
is difficult to achieve. By definition, a focused approach is directed at a narrow, niche segment of the market.
Exercises
This means lower volumes, therefore contrary to the normal cost leadership strategy. An example would be an
Hispanic grocery store in Northern Virginia serving the niche market of Hispanics living there, that uses a cost
leadership strategy to compete against the other Hispanic grocery stores.
1. What are three industries in which a cost leadership strategy would be difficult to implement?
Cost leaders tend to keep their costs low by minimizing advertising, market research, and research and 2. What is your favorite cost leadership restaurant?
development, but this approach can prove to be expensive in the long run. A relative lack of market research 3. Name three examples of firms conducting a cost leadership strategy that use no advertising.
can lead cost leaders to be less skilled than other firms at detecting important environmental changes. Should they start advertising? Why or why not?
Meanwhile, downplaying research and development can slow cost leaders’ ability to respond to changes once
they are detected. Lagging rivals in terms of detecting and reacting to external shifts can prove to be a deadly
combination that leaves cost leaders out of touch with the market and out of answers.

References

Guttmann, A. (2019, August 9). Walmart: advertising spending 2014-2019. Statista.

Section Video https://www.statista.com/statistics/622029/walmart-ad-spend/.

Zimmerman, A., & Hudson, K. (2006). Managing Wal-Mart: How US-store chief hopes to fix Wal-Mart. Wall
Low Cost Strategy [03:20] Street Journal. https://www.wsj.com/articles/SB114462756022321371.
The video for this lesson describes the competitive approach of low cost strategy.

You can view this video here:

https://www.youtube.com/watch?v=-C0MQzIb7Y4&feature=emb_logo. Image Credits

Figure 6.3: Skirvin, Ben. “Closed Sign.” CC BY-NC 2.0. Retrieved from https://flic.kr/p/8ScoFg.

Key Takeaway
Video Credits

• Cost leadership is an effective business-level strategy to the extent that a firm offers low prices, Gregg Learning. (2018, June 12). Low cost strategy [Video]. YouTube.
provides satisfactory quality, and attracts enough customers to be profitable. https://www.youtube.com/watch?v=-C0MQzIb7Y4&feature=emb_logo.

134 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 135
 lesser brands, but having equipment that you can count on to keep you warm and dry is worth a price premium
6.4 Differentiation
in the minds of most campers.

Successful use of a differentiation strategy depends on not only offering unique features but also
Firms that compete on uniqueness and target a broad market are following a differentiation strategy. Several
communicating the value of these features to potential customers. As a result, advertising in general and brand
examples of firms pursuing a differentiation strategy are illustrated below.
building in particular are important to this strategy. Few goods are more basic and generic than table salt. This
Table 6.4 Differentiation would seemingly make creating a differentiated brand in the salt business next to impossible. Through clever
marketing, however, Morton Salt has done so. Morton has differentiated its salt by building a brand around its
Examples of Firms Pursuing a Differentiation Strategy
iconic umbrella girl and its trademark slogan of “When it rains, it pours.” Would the typical consumer be able to
Although salt is a commodity, Morton has differentiated its salt by building a brand around its iconic umbrella girl and its tell the difference between Morton Salt and cheaper generic salt in a blind taste test? Not a chance. Yet Morton
trademark slogan of “When it rains, it pours.”
succeeds in convincing customers to pay a little extra for its salt through its brand-building efforts.
FedEx’s former slogan “When it absolutely, positively has to be there overnight” highlights the commitment to very
speedy delivery that differentiates them from competitors such as UPS and the US Postal Service. FedEx and Nike are two other companies that have done well at communicating to customers that they
provide differentiated offerings. FedEx’s former slogan “When it absolutely, positively has to be there overnight”
Offerings such as Hot Wheels cars and the Barbie line of dolls highlight toy maker Mattel’s differentiation strategy. Both highlights the commitment to speedy delivery that sets the firm apart from competitors such as UPS and the
are updated regularly to reflect current trends and tastes.
US Postal Service. Nike differentiates its athletic shoes and apparel through its iconic “swoosh” logo as well as
Nike differentiates its athletic shoes through its iconic “swoosh” as well as an intense emphasis on product innovation an intense emphasis on product innovation through research and development.
through research and development. Nike also differentiates their athletic brand through their marketing strategy of
highlighting social justice issues regardless of potential public controversy.

The Walt Disney Company has developed incomparable customer service standards (“the happiest place on earth”) and
numerous well-known characters such as Mickey Mouse, the Little Mermaid, and Captain Jack Sparrow that help
differentiate their movies, theme parks, and merchandise.

Developing a Differentiation Strategy at Express Oil Change

The Nature of the Differentiation Strategy Express Oil Change and Service Centers is a
chain of auto repair shops that stretches from
A famous cliché contends that “you get what you pay for.” This Florida to Texas. Based in Birmingham,
saying captures the essence of a differentiation strategy. A firm Alabama, the firm has more than 170 company-
following a differentiation strategy attempts to convince owned and franchised locations under its
customers to pay a premium price for its goods or services by brand. Express Oil Change tries to provide a
providing unique and desirable features (Table 6.4). The message unique level of service, and the firm is content
that such a firm conveys to customers is that you will pay a little to let rivals offer cheaper prices. We asked an
bit more for our offerings, but you will receive a good value Express Oil Change executive about his firm
overall because our offerings provide something special. (Ketchen & Short, 2010).

Question:
In terms of the two competitive dimensions described by Michael
Porter, using a differentiation strategy means that a firm is The auto repair and maintenance business is a
Figure 6.5: Express Oil Change sets itself apart through
competing based on uniqueness rather than price and is seeking pretty competitive space. How is Express Oil superior service and great locations.
to attract a broad market (Porter, 1980). Coleman camping Change being positioned relative to other
Figure 6.4: Coleman’s patented stove captures the equipment offers a good example. If camping equipment such as firms, such as Super Lube, American LubeFast, and Jiffy Lube?
essence of a differentiation strategy, since buyers
are willing to pay a premium for its reliability. sleeping bags, lanterns, and stoves fail during a camping trip, the
result will be, well, unhappy campers. Coleman’s sleeping bags,
lanterns, and stoves are renowned for their reliability and durability. Cheaper brands are much more likely to
have problems. Lovers of the outdoors must pay more to purchase Coleman’s goods than they would to obtain

136 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 137

A differentiation strategy offers important advantages and disadvantages for firms that adopt it. Below we
illustrate a few examples in relation to an often differentiated product—women’s handbags.

Don Larose, Senior Vice President of Franchise Development: Table 6.5 Executing a Differentiation Strategy

Advantages
Every good business sector is competitive. The key to our success is to be more convenient and
provide a better overall experience for the customer. Express Oil Change and Service Centers Buyer loyalty is common among handbag buyers. Many individuals enjoy seeing—and being seen with—a designer logo on
the products they buy such as the iconic C that is shown on Coach bags.
outperform the industry significantly in terms of customer transactions per day and store sales, for
Chanel enjoys strong margins because their well-known name allows them to charge a premium for their handbags.
a host of reasons.
Disadvantages
In terms of customer convenience, Express Oil Change is faster than most of our competitors—we
do a ten-minute oil change while the customer stays in the car. Mothers with kids in car seats Less expensive bags from retailers such as Target provide enough of a trendy look to satisfy many price-sensitive buyers.
These individuals will choose to save their money by avoiding expensive bags from top-end designers.
especially enjoy this feature. We also do mechanical work that other quick lube businesses don’t do.
Imitations may steal customers, such as is common with knock-off handbags sold by street vendors.
We change and rotate tires, do brake repairs, air conditioning, tune ups, and others. There is no
appointment necessary for many mechanical services like tire rotation and balancing, and checking
brakes. So, overall, we are more convenient than most of our competitors.

In terms of staffing our stores, full-time workers are all that we employ. Full-time workers are Advantages and Disadvantages of Differentiation
better trained and typically have less turnover. They therefore have more experience and do better
quality work.
Each generic strategy offers advantages that firms can potentially leverage to enjoy strong performance, as
We think incentives are very important. We use a payroll system that provides incentives to the well as disadvantages that may damage their performance. In the case of differentiation, a key advantage is that
store staff on how many cars are serviced each day and on the total sales of the store, rather than effective differentiation creates an ability to obtain premium prices from customers (Table 6.5). This enables a
on increasing the average transactions by selling the customer items they did not come in for, firm to enjoy strong profit margins. Coca-Cola, for example, currently enjoys a profit margin of approximately
which is what most of the industry does. We don’t sell customers things they don’t yet need, like air 33%, meaning that about 33 cents of every dollar it collects from customers is profit. In comparison, Walmart’s
filters and radiator flushes. We focus on building trust, by acting with integrity, to get the customer cost leadership strategy delivered a margin of under 4% in 2010.
to come back and build the daily car count. This philosophy is not a slogan for us. It is how we
operate with every customer, in every store, every day. In turn, strong margins mean that the firm does not need to attract huge numbers of customers to have a good
overall level of profit. Luckily for Coca-Cola, the firm does attract a great many buyers. Overall, the firm made
The placement of our outlets is another key factor. We place our stores in A-caliber retail locations.
a profit of just under $9.0 billion on sales of just over $37.3 billion in 2019. Interestingly, Walmart’s profits were
These are lots that may cost more than our competitors are willing or able to pay. We get what we
only 2.4 times higher ($22.0 billion) than Coca-Cola’s while its sales volume ($514.4 billion) was 13.8 times higher
pay for though; we have approximately 41% higher sales per store than the industry average.
than Coca-Cola’s (Walmart, 2019; Coca Cola, 2019). This comparison of profit margins and overall profit levels
Question: illustrates why a differentiation strategy is so attractive to many firms.
What is the strangest interaction you’ve ever had with a potential franchisee?
To the extent that differentiation remains in place over time, buyer loyalty may be created. Loyal customers
Larose: are very desirable because they are not price sensitive. In other words, buyer loyalty makes a customer unlikely
I once had a franchisee candidate in New Jersey respond to a request by us for proof of his liquid to switch to another firm’s products if that firm tries to steal the customer away through lower prices. Many
assets by bringing to the interview about $100,000 in cash to the meeting. He had it in a bag, with soda drinkers are fiercely loyal to Coca-Cola’s products. Coca-Cola’s headquarters are in Atlanta, and loyalty
bundles of it wrapped in blue tape. Usually, folks just bring in a copy of a bank or stock statement. to the firm is especially strong in Georgia and surrounding states. Pepsi and other brands have a hard time
Not sure why he had so much cash on hand, literally, and I didn’t want to know. He didn’t become a convincing loyal Coca-Cola fans to buy their beverages, even when offering deep discounts. This helps keep
franchisee. Coca-Cola’s profits high because the firm does not have to match any promotions that its rivals launch to keep
its customers.

Meanwhile, Pepsi also has attracted a large set of brand-loyal customers that Coca-Cola struggles to steal. This
enhances Pepsi’s profits. In contrast, store-brand sodas such as Sam’s Choice, which is sold at Walmart, seldom
attract loyalty. As a result, they must be offered at very low prices to move from store shelves into shopping
carts.

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Beyond existing competitors, a differentiation strategy also creates benefits relative to potential new entrants.
Specifically, the brand loyalty that customers feel to a differentiated product makes it difficult for a new entrant
to lure these customers to adopt its product. A new soda brand, for example, would struggle to take customers
away from Coca-Cola or Pepsi. Thus, a differentiation strategy helps create barriers to entry that protect the
firm and its industry from new competition. Section Video
The big risk when using a differentiation strategy is that customers will not be willing to pay extra to obtain the
unique features that a firm is trying to build its strategy around. Department store Dillard’s stopped carrying Differentiation Strategy [04:28]
men’s sportswear made by Nautica because the seafaring theme of Nautica’s brand had lost much of its cache The video for this lesson discusses differentiation strategies.
among many men (Kapner, 2007). Because Nautica’s uniqueness had eroded, Dillard’s believed that space in its
You can view this video here:
stores that Nautica had been occupying could be better allocated to other brands.
https://www.youtube.com/watch?v=NshI_qoaf7g&feature=emb_logo.
In some cases, customers may simply prefer a cheaper alternative. For example, products that imitate the look
and feel of offerings from Ray-Ban, Gucci, and Patagonia are attractive to many value-conscious consumers.
Firms such as these must work hard at product development and marketing to ensure that enough customers
are willing to pay a premium for their goods rather than settling for knockoffs.
Key Takeaway
In other cases, customers desire the unique features that a firm offers,
but competitors are able to imitate the features well enough that they
are no longer unique. If this happens, customers have no reason to pay
• Differentiation can be an effective business-level strategy to the extent that a firm offers unique
a premium for the firm’s offerings. IBM experienced the pain of this
features that convince customers to pay a premium for their goods and services. As with other
scenario when executives tried to follow a differentiation strategy in
business-level strategies, there are advantages and disadvantages in pursuing a differentiation
the personal computer market. The strategy had worked for IBM in
strategy.
other areas. Specifically, IBM had enjoyed a great deal of success in the
mainframe computer market by providing superior service and
charging customers a premium for their mainframes. A business owner
who relied on a mainframe to run her company could not afford to have
her mainframe out of operation for long. Meanwhile, few businesses Exercises
had the skills to fix their own mainframes. IBM’s message to customers
was that they would pay more for IBM’s products but that this was a
good investment because when a mainframe needed repairs, IBM
1. What are two industries in which a differentiation strategy would be difficult to implement?
would provide faster and better service than its competitors could. The Figure 6.6: Firms following a
2. What is an example of a differentiated business near your college or university?
customer would thus be open for business again very quickly after a differentiation strategy must “watch” out
for counterfeit goods such as the faux 3. Name three ways businesses that provide entertainment that might better differentiate their
mainframe failure. Rolexes shown here. services. How might they do this?
This positioning failed when IBM used it in the personal computer
market. Rivals such as Dell were able to offer service that was just as good as IBM’s while also charging lower
prices for personal computers than IBM charged. From a customer’s perspective, a person would be foolish to
pay more for an IBM personal computer since IBM did not offer anything unique. IBM steadily lost market share
as a result. IBM’s struggles led it to sell its personal computer business to Lenovo. The firm is still successful, References
however, within the mainframe market where its offerings remain differentiated.

Kapner, S. (2007, November 1). Nautica brand losing ground. CNNMoney.

http://money.cnn.com/2007/10/31/news/companies/Kapner_Nautica.fortune/index.htm.

140 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 141

Ketchen, D. J., & Short, J. C. (2010). The franchise player: An interview with Don Larose. Journal of Applied 6.5 Focused Cost Leadership and Focused Differentiation
Management and Entrepreneurship, 15(4), 94–101.

Porter, M. E. (1980). Competitive strategy: Techniques for analyzing industries and competitors. Free Press.
Companies that use a cost leadership strategy and those that use a differentiation strategy share one important
The Coca Cola Company. (2019). Form 10K. https://investors.coca-colacompany.com/filings-reports/annual- characteristic: both groups try to be attractive to customers in general. These efforts to appeal to broad
filings-10-k. markets can be contrasted with strategies that involve targeting a relatively narrow niche of potential
customers. These latter strategies are known as focus strategies (Porter, 1980).
Walmart. (2019). Earnings release.
https://s2.q4cdn.com/056532643/files/doc_financials/2019/Q4/Q4FY19-Earnings-Release-Final.pdf.

The Nature of the Focus Cost Leadership Strategy

Image Credits
Focused cost leadership is the first of two focus strategies.
A focused cost leadership strategy requires competing
Figure 6.4: Tullis, B.W. – US Patent Office. “Patent drawing for Coleman Model 520 stove – No. 236098.” Public based on price to target a narrow market (Table 6.6). A firm
Domain. Retrieved from https://en.wikipedia.org/wiki/G.I._pocket_stove#/media/ that follows this strategy does not necessarily charge the
File:Patent_Drawing_for_Coleman_Model_520_Stove.jpg lowest prices in the industry. Instead, it charges low prices
relative to other firms that compete within the target
Figure 6.5: Dystopos. “Express Oil Change.” CC BY-NC 2.0. Cropped. Retrieved from
market. Redbox, for example, uses vending machines placed
https://flic.kr/p/8FYBk.
outside grocery stores and other retail outlets to rent DVDs
Figure 6.6: Nino, Gerald. “Counterfeit Rolex watches seized by US CBP.” Public Domain. Retrieved from of movies for $1. There are ways to view movies even
https://commons.wikimedia.org/wiki/File:Patent_Drawing_for_Coleman_Model_520_Stove.jpg. cheaper, such as through the flat-fee streaming video
subscriptions offered by Netflix. But among firms that rent
actual DVDs, Redbox offers unparalleled levels of low price
and high convenience.
Video Credits
Firms that compete based on price and target a narrow
market are following a focused cost leadership strategy.
Gregg Learning. (2018, June 13). Differentiation strategy [Video]. YouTube.
Several examples of firms pursuing a focused cost leadership
https://www.youtube.com/watch?v=NshI_qoaf7g&feature=emb_logo.
Figure 6.7: Redbox machines are available nationwide. strategy are illustrated below.

Table 6.6 Focused Cost Leadership

Example of Firms Pursuing a Focused Cost Leadership Strategy

Redbox rents DVDs and video games through vending machines for only $1.

Papa Murphy’s targets its inexpensive take-and-bake pizzas at value-conscious families. Because the pizzas are baked at
home rather than in the store, Papa Murphy’s is permitted to accept food stamps. This allows the firm to attract
customers that might not otherwise be able to afford a restaurant-quality pizza.

Claire’s nearly 3,000+ locations target young women with inexpensive jewelry, accessories, and ear piercings. The
strategy has worked: Claire’s has over three thousand locations and has stores in 95% of US shopping malls.

Providing indoor seating creates expenses for fast food restaurants. Checkers Drive In keeps its costs low by not offering
indoor seating. Checkers targets drive-thru customers and offers them big burgers at rock-bottom prices.

Another important point is that the nature of the narrow target market varies across firms that use a focused
cost leadership strategy. In some cases, the target market is defined by demographics. Claire’s, for example,

142 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 143
seeks to appeal to young women by selling inexpensive jewelry, accessories, and ear piercings. Claire’s use of proverbial “next level” by firms using a focused differentiation strategy. Thus the unique features provided by
a focused cost leadership strategy has been very successful; the firm has more than three thousand locations firms following a focused differentiation strategy are often specialized.
and has stores in 95% of US shopping malls.
When it comes to uniqueness, few offerings can top Kopi Luwak coffee beans. High-quality coffee beans often
In other cases, the target market is defined by the sales channel used to reach customers. Most pizza shops sell for $10 to $15 a pound. In contrast, Kopi Luwak coffee beans sell for hundreds of dollars per pound (Cat’s
offer sit-down service, delivery, or both. In contrast, Papa Murphy’s sells pizzas that customers cook at home. Ass Coffee, n.d.). This price is driven by the rarity of the beans and their rather bizarre nature. As noted in an
Because these inexpensive pizzas are baked at home rather than in the store, the law allows Papa Murphy’s to article in the New York Times, these beans are found in the droppings of the civet, a nocturnal, furry, long-tailed
accept food stamps as payment. This allows Papa Murphy’s to attract customers that might not otherwise be catlike animal that prowls Southeast Asia’s coffee-growing lands for the tastiest, ripest coffee cherries. The
able to afford a prepared pizza. In contrast to most fast-food restaurants, Checkers Drive In is a drive-through- civet eventually excretes the hard, indigestible innards of the fruit—essentially, incipient coffee beans—though
only operation. To serve customers quickly, each store has two drive-thru lanes: one on either side of the only after they have been fermented in the animal’s stomach acids and enzymes to produce a brew described
building. Checkers saves money in a variety of ways by not offering indoor seating to its customers—Checkers’s as smooth, chocolaty and devoid of any bitter aftertaste (Onishi, 2010).
buildings are cheaper to construct, its utility costs are lower, and fewer employees are needed. These savings
Although many consumers consider Kopi Luwak to be disgusting, a relatively small group of coffee enthusiasts
allow the firm to offer large burgers at very low prices and still remain profitable.
has embraced the coffee, making it a profitable product. This illustrates the essence of a focused differentiation
strategy—effectively serving the specialized needs of a niche market can create great riches.

The Nature of the Focused Differentiation Strategy Larger niches are served by Whole Foods Market and Mercedes-Benz. Although most grocery stores devote
a section of their shelves to natural and organic products, Whole Foods Market works to sell such products
exclusively. For customers, the large selection of organic goods comes at a steep price. Indeed, the
Focused differentiation is the second of the two focused strategies. A focused differentiation strategy requires
supermarket’s reputation for high prices has led to a wry nickname—”Whole Paycheck”—but a sizable number
offering unique features that fulfill the demands of a narrow market (Table 6.7). As with a focused low-cost
of consumers are willing to pay a premium to feel better about the food they buy.
strategy, narrow markets are defined in different ways in different settings. Some firms using a focused
differentiation strategy concentrate their efforts on a particular sales channel, such as selling over the internet
only. Others target particular demographic groups. One example is Breezes Resorts, a company that caters to
couples without children. The firm operates seven tropical resorts where vacationers are guaranteed that they
will not be annoyed by loud and disruptive children.

Firms that compete based on uniqueness and target a narrow market are following a focused differentiation
strategy. Several examples of firms pursuing a focused differentiation strategy are illustrated below.

Table 6.7 Focused Differentiation

Examples of Firms Pursuing a Focused Differentiation Strategy

Whole Foods Market focuses on selling natural and organic products. The supermarket’s reputation for high prices has
led to a wry nickname—”Whole Paycheck”—but a sizable number of consumers are willing to pay a premium in order to
feel better about the food they are buying. Amazon, a broad cost leader, owns Whole Foods.

At Build-A-Bear Workshop, customers enjoy an interactive process of designing and assembling teddy bears.
Build-A-Bear customers are willing to pay a premium price because they receive a unique, hands-on experience rather
than simply buying a stuffed toy.

You can buy a cinnamon roll cheaper elsewhere, but Cinnabon’s pricey pastries are so delicious that sugar-obsessed
snackers line up to buy them. Perhaps in a nod to Cinnabon’s strategy, the brand is owned by a parent company named Figure 6.8: Janis Joplin’s musical tribute to Mercedes-Benz underscores the allure of the brand.
Focus Brands.

The dedication of Mercedes-Benz to cutting-edge technology, styling, and safety innovations has made the firm’s
vehicles prized by those who are wealthy enough to afford them.

The dedication of Mercedes-Benz to cutting-edge technology, styling, and safety innovations has made the
While a differentiation strategy involves offering unique features that appeal to a variety of customers, the
firm’s vehicles prized by those who are rich enough to afford them. This appeal has existed for many decades. In
need to satisfy the desires of a narrow market means that the pursuit of uniqueness is often taken to the
1970, acid-rocker Janis Joplin recorded a song called “Mercedes Benz” that highlighted the automaker’s allure.

144 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 145

Since then Mercedes-Benz has used the song in several television commercials. Here is Joplin’s song “Mercedes
Benz:” https://youtu.be/-H7YULkiLIA
Question:

You have been active in Japan. Do the preferences of Japanese customers differ from those of
Americans?

Loprinzi:

Developing a Focused Differentiation Strategy at Augustino LoPrinzi Yes. The Japanese want only high-end instruments. Aesthetics are very important to the Japanese
Guitars and Ukuleles along with high-quality materials and workmanship. The US market seems to care in general less
about ornamentation and more about quality workmanship, tone, and playability.

Question:
Augustino LoPrinzi Guitars and Ukuleles in Clearwater, Florida, builds high-end custom
instruments. The founder of the company, Augustino LoPrinzi, has been a builder of custom guitars How do you stay ahead in your industry?
for five decades. While a reasonably good mass-produced guitar can be purchased elsewhere for a Loprinzi:
few hundred dollars, LoPrinzi’s handmade models start at $1,100, and some sell for more than
Always try to stay abreast on what the music industry is doing. We do this by reading several music
$10,000. The firm’s customers have included professional musicians such as Dan Fogelberg, Leo
industry publications, talking with suppliers, and keeping an eye on the trends going on in other
Kottke, Herb Ohta (Ohta-San), Lyle Ritz, Andrés Segovia, and B. J. Thomas. Their instruments can be
countries because usually they come full circle. Also, for the past several years by following the
found at http://www.augustinoloprinzi.com. We asked Augustino about his firm (Short, 2007).
internet forums and such has been extremely beneficial.
Question:

Were there other entrepreneurial opportunities you considered before you began making guitars?

Augustino Loprinzi:

I originally thought of pursuing a career in commercial art, but I found my true love was in classical
guitar building. I was trained by my father to be a barber from a very young age, and after my term
Advantages and Disadvantages of the Focused Strategies
in the service, I opened a barbershop.

Question: Each generic strategy offers advantages that firms can potentially leverage to enhance their success as well
as disadvantages that may undermine their success. In the case of focus differentiation, one advantage is that
What is the most expensive guitar you’ve ever sold?
very high prices can be charged. Indeed, these firms often price their wares far above what is charged by firms
Loprinzi: following a differentiation strategy (Table 6.8). Recreational Equipment Inc. (REI), for example, commands a
$17,500. hefty premium for its outdoor sporting goods and clothes that feature name brands, such as The North Face
and Marmot. Nat Nast’s focused differentiation strategy centers on selling men’s silk camp shirts with a 1950s
Question:
retro flair. These shirts retail for more than $100. Focused cost leaders such as Checkers Drive In do not charge
How old were you when you started your first business in the guitar industry? high prices like REI and Nat Nast do, but their low cost structures enable them to enjoy healthy profit margins.
Loprinzi:
A second advantage of using a focus strategy is that firms often develop tremendous expertise about the goods
I was in my early twenties. and services that they offer. In markets such as camping equipment where product knowledge is important,
Question: rivals and new entrants may find it difficult to compete with firms following a focus strategy.

How did you get your break with more famous customers?

Loprinzi:

I think word of mouth had a lot to do with it.

146 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 147
Using one of the focus strategies offers firms important advantages and disadvantages. Below we illustrate a few Finally, damaging attacks may come not only from larger firms but also from smaller ones that adopt an even
examples in relation to an industry where many different types of focus exist—sporting goods. narrower focus. A sporting goods store that sells camping, hiking, kayaking, and skiing goods, for example,
might lose business to a store that focuses solely on ski apparel because the latter can provide more guidance
Table 6.8 Executing a Focus Strategy
about how skiers can stay warm and avoid broken bones.
Advantages

High prices can be charged. Recreational Equipment Incorporated (REI), for example, commands a premium for their
outdoor sporting goods and clothes that feature name brands such as The North Face and Marmot.

Firms using a focused strategy often develop great expertise about the good or service being sold. Thus, customers may
gravitate toward a specialty camping shop in order to learn how to best take advantage of limited vacation time.

Disadvantages Strategy at the Movies

Limited demands exist for specialized goods and services, so every potential sale counts.

The area of focus may be taken over by others or even disappear over time. Many gun stores went out of business after Zoolander
large retailers such as Walmart started carrying an array of firearms.
One man’s trash is another man’s fashion? That’s what fashion mogul Jacobim Mugatu was counting
Other firms may provide an even narrower focus. An outdoor sporting goods store, for example, might lose business to a
store that focuses solely on ski apparel because the latter can provide more guidance about how skiers can stay warm
on in the comedy Zoolander. In his continued effort to be the most cutting-edge designer in the
and avoid broken bones. fashion industry, Mugatu developed a new line of clothing inspired “by the streetwalkers and hobos
that surround us.” His new product line, Derelicte, characterized by dresses made of burlap and
In terms of disadvantages, the limited demand available within a niche can cause problems. First, a firm could parking cones and pants made of garbage bags and tin cans, was developed for customers who
find its growth ambitions stymied. Once its target market is being well served, expansion to other markets valued the uniqueness of his…eclectic design. Emphasizing unique products is typical of a company
might be the only way to expand, and this often requires developing a new set of skills. Also, the niche could following a differentiation strategy; however, Mugatu targeted a very specific set of customers. Few
disappear or be taken over by larger competitors. Many gun stores have struggled and even gone out of people would probably be enticed to wear garbage for the sake of fashion. By catering to a niche
business since Walmart and sporting goods stores such as Academy Sports and Bass Pro Shops have started target market, Mugatu went from a simple differentiation strategy to a focused differentiation.
carrying an impressive array of firearms. Mugatu’s Derelicte campaign in Zoolander is one illustration of how a particular firm might develop
a focused differentiation strategy.

Section Video

Focused Strategy [03:47]

The video for this lesson explains that focused strategies concentrate on a narrow segment of the
total market.

You can view this video here:

https://www.youtube.com/watch?v=cSMD6MoNeBo&feature=emb_logo.

Figure 6.9: In contrast to tacky Hawaiian souvenirs, the

quality of Kamaka ukuleles makes them a favorite of ukulele
phenom Jake Shimabukuro and others who are willing to pay
$1,000 or more for a high-end instrument.

148 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 149

Figure 6.9: Surfsupusa. “Jake Shimabukuro performing in Joshua Tree, California in 2007.” Public Domain.
Retrieved from https://upload.wikimedia.org/wikipedia/commons/f/fc/Jake_Shimabukuro.jpg.
Key Takeaway

• Focus strategies can be effective business-level strategies to the extent that a firm can match Music Credits
their goods and services to specific niche markets. As with the other business-level strategies,
there are advantages and disadvantages to focus strategies. Columbia Records. (1971). Mercedes Benz – Janis Joplin. All Rights Reserved. Provided to YouTube by Sony
Music Entertainment. https://youtu.be/-H7YULkiLIA.

Exercises Video Credits

Gregg Learning. (2018, June 14). Focused strategy [Video]. YouTube.

1. What are three different demographics that firms might target to establish a focus strategy? https://www.youtube.com/watch?v=cSMD6MoNeBo&feature=emb_logo.
2. What is an example of a business that you think is focused in too narrow a fashion to be
successful? How might it change to be more successful?

References

Cat’s Ass Coffee. http://www.catsasscoffee.com.

Onishi, N. (2010, April). From dung to coffee brew with no aftertaste. New York Times.
http://www.nytimes.com/2010/04/18/world/asia/18civetcoffee.html?pagewanted=all.

Porter, M. E. (1980). Competitive strategy: Techniques for analyzing industries and competitors. Free Press.

Short, J. C. (2007). A touch of the masters’ hands: An interview with Augustino and Donna Loprinzi. Journal of
Applied Management and Entrepreneurship, 12, 103–109.

Image Credits

Figure 6.7: Everett, Valerie. “A big mac and saving private ryan please.” CC BY-SA 2.0. Retrieved from
https://flic.kr/p/4ozURH.

Figure 6.8: Navigator84. “Mercedes-Benz E-Class V212 facelift photographed in Guangzhou, Guangdong
province, China.” CC BY-SA 4.0. Retrieved from https://commons.wikimedia.org/w/
index.php?curid=84685638.

150 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 151
6.6 Best-Cost Strategy

Firms that charge relatively low prices and offer substantial differentiation are following a best-cost strategy. This
strategy is difficult to execute, but it is also potentially very rewarding. Several examples of firms pursuing a best- Developing a Best-Cost Strategy at Plain Ivey Jane
cost strategy are illustrated below.

Table 6.9 Best-Cost Strategy According to government statistics, women are

60% less likely than men to become
Examples of Firms Pursuing a Best-Cost Strategy
entrepreneurs. Meanwhile, succeeding within
Southwest Airlines provides low cost flights to vacation destinations such as San Antonio, San Diego, and Orlando. While
many airlines make passengers feel like cattle loaded onto a truck, Southwest creates fun by, for example, getting the specialty fashion retailing market is
children excited about visiting Sea World when they see this custom Shamu plane design. notoriously difficult. These trends do not
Target offers extremely competitive prices, but the firm also differentiates itself from other discount retailers by worry Sarah Reeves, a young entrepreneur and
carrying products from trendy designers such as Michael Graves, Isaac Mizrahi, Fiorruci, and Universal Thread. 2007 graduate of Auburn University who is
Chipotle Mexican Grill relies on organic ingredients to create very tasty burritos that are sold at prices comparable to rapidly becoming a key player within the
those of fast-food restaurants. When noon arrives, many hungry people prefer to spend their lunch dollars on a
top-shelf burrito rather than a greasy burger combo meal. Austin, Texas, retail scene by offering high-end
fashion at low prices.
Pabst Blue Ribbon is offered at an extremely low price and its taste (or lack thereof) is comparable to other inexpensive
beers. PBR enjoys brand loyalty, however, due to its high name recognition. The frequent appearance of PBR’s Sarah describes Plain Ivey Jane as “the go-to Figure 6.10: The success recent college graduates have as
well-known logo on signs, t-shirts, and other merchandise has helped make PBR an enduring favorite among beer
entrepreneurs have may inspire other recent graduates
consumers with light wallets. place for women who want to elevate their
to become entrepreneurs.
wardrobes. We offer high end designer names
at a discount, and the new overstocked apparel is handpicked from over 70 different brands to offer
exactly what Austin needs at a price every girl can afford. To pair with your fabulous new wardrobe,
The Challenge of Following a Best-Cost Strategy Plain Ivey Jane carries accessories from undiscovered local artisans.” We asked Reeves to discuss
her firm (Ketchen & Short).
Some executives are not content to have their firms compete based on offering low prices or unique features. Question:
They want it all! Firms that charge relatively low prices and offer substantial differentiation are following a
Can you tell us a little about your Plain Ivey Jane concept?
best-cost strategy (Table 6.9). This strategy is difficult to execute in part because creating unique features and
communicating to customers why these features are useful generally raises a firm’s costs of doing business. Sarah Reeves, Owner:
Product development and advertising can both be quite expensive. However, firms that manage to implement Plain Ivey Jane sells overstock from Anthropologie, Urban Outfitters, Bloomingdales, and other
an effective best-cost strategy are often very successful. high-end and small designers. Although I buy from the same designers as the big and famous
retailers, our dresses and accessories are sold at a fraction of their prices.
Target appears to be following a best-cost strategy. The firm charges prices that are relatively low among
retailers while at the same time attracting trend-conscious consumers by carrying products from famous Question:
designers, such as Michael Graves, Isaac Mizrahi, Fiorucci, Universal Thread, and others. This is a lucrative What differentiates your boutique from competitors?
position for Target, but the position is under attack from all sides. Cost leader Walmart charges lower prices
Reeves:
than Target. This makes Walmart a constant threat to steal the thriftiest of Target’s customers. Focus
differentiators such as Anthropologie that specialize in trendy clothing and home furnishings can take business I’m one of the lowest-priced retailers in the shopping district that people in Austin call the Second
from Target in those areas. Deep discounters such as T. J. Maxx and Marshalls offer another viable alternative Street area. My niche in the fashion retailing business is that my merchandise is overstock from
to shoppers because they offer designer clothes and furnishings at closeout prices. A firm such as Target that great brands. There’s maybe one other business in Austin that sells overstock. What makes my
uses a best-cost strategy also opens itself up to a wider variety of potentially lethal rivals. concept different is that it has the feel of a high-end retail store versus a basement feel of the
typical discount retailer.

152 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 153

Table 6.10 Driving toward a Best-Cost Strategy

Driving toward a Best-Cost Strategy by Reducing Overhead

Question:
For about the same price as a Subway or Jimmy John’s sandwich, Counter Culture in Austin, Texas, provides vegan
Do have a lot of regular customers? offerings such as their Garbanzo “Tuna” sandwich.

Reeves: PBJ’s offer unique sandwiches with organic peanut butter at the heart of many of their creations. The traditional PB and J
is a staple nationwide, but customers will travel far to get the “Hot Hood” with Challah bread, black cherry jam, jalapeño,
Yes. Once people find out what I offer, they’re in here all the time. I see the same group of people applewood-smoked bacon, and PBJ’s peanut butter for only $5.50.

every few months, but getting in new faces is the challenge. I think a lot of people walk by and Owners Kahala and Kat founded Ninja Plate Lunch in Portland, Oregon, to offer large portions of delectable Hawaiian
foods such as pulled pork for only around $5.
assume that our clothes are expensive, but nothing could be further from the truth.
In the smash hit graphic novel Tales of Garcón: The Franchise Players, the Tapas Taxi takes the concept of a cheap taxi
Question: ride to a new level by also offering passengers a variety of “tapas.” These Spanish snacks are top shelf, of course!

Were you fearful of starting your own business so young?

Reeves:

No, I figured this was a great time since I had nothing to lose. I thought getting it out of my system Pursuing the Best-Cost Strategy through a Low-Overhead Business Model
now was a good idea, and it was a good time since I was able to get a great deal on my lease. With
the downturn in the economy, the time was right for my lower-priced strategy. One route toward a best-cost strategy is for a firm to adopt a business model whose fixed costs and overhead
Question: are very low relative to the costs that competitors are absorbing (Table 6.10). The internet has helped make this
possible for some firms. Amazon, for example, can charge low prices in part because it does not have to endure
What would you say is the biggest key to success for a small business?
the expenses that firms such as Walmart and Target do in operating many hundreds of stores. Meanwhile,
Reeves: Amazon offers an unmatched variety of goods. This combination has made Amazon the unquestioned leader in
Flexibility. Rolling with the punches and definitely the ability to follow up with people. I thought e-commerce.
that people who owned their own business must know what they are doing, but many people don’t.
Another example is Netflix. This firm is able to offer customers a far greater variety of movies and charge lower
At this point, I prefer to do everything myself. At least I can blame myself when things go wrong.
prices than video rental stores by conducting all its business over the internet and via mail. Netflix’s best-cost
Another key is networking with other small-business owners. A lot of the other boutique owners strategy has been so successful that $10,000 invested in the firm’s stock in May 2006 was worth more than
nearby have become close friends. I learn what works for them and what might possibly apply to $1,050,000 in May 2020, fourteen years later (Forbes, 2020).
my concept.
Moving toward a best-cost strategy by dramatically reducing expenses is also possible for firms that cannot
rely on the internet as a sales channel. Owning a restaurant requires significant overhead costs, such as rent
and utilities. Some talented chefs are escaping these costs by taking their food to the streets. Food trucks that
Many firms would like to use a best cost strategy but struggle to meet the strategy’s dual requirements of charging serve high-end specialty dishes at very economical prices are becoming a popular trend in cities around the
low prices and providing differentiation features. One way to help make the best cost strategy a reality is to use a country. In Portland, Oregon, a food truck called the Viking Soul Food offers Norwegian food at low prices.
business model that slashes fixed costs. Amazon.com, for example, can charge low prices in part because it does Another Portland food truck is The Good and Evil Wrap Company, whose unique and inexpensive wraps center
not have to absorb the overhead involved in operating stores. Similarly, some talented chefs are pursuing a best on specialty foods. Beyond keeping costs low, the mobility of food trucks offers important advantages over a
cost strategy by operating food trucks and thereby avoiding the overhead required to run a restaurant such as traditional restaurant. Some food trucks set up outside big-city nightclubs, for example, to sell party goers a
rent and utilities. Several examples are illustrated below. late-night snack before they head home.

154 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 155
 Section Video

Best-Cost Provider Strategy [03:29]

The video for this lesson discusses companies that use best-cost strategies.

You can view this video here:

https://www.youtube.com/watch?v=zOaMXfFHzwQ&feature=emb_logo.

Key Takeaway

• A best-cost strategy can be an effective business-level strategy to the extent that a firm offers
differentiated goods and services at relatively low prices.
Figure 6.11: Hey Cupcake! in Austin, Texas, is a low-overhead bakery that has become a delicious
success.

Exercises
A best cost strategy offers some important advantages and disadvantages.

Table 6.11 Executing a Best Cost Strategy

1. What is an example of an industry in which you think a best-cost strategy could be successful?
Advantages Disadvantages
How would you differentiate a company to achieve success in this industry?
Best cost can attract both the cost-conscientious
Trying to achieve best cost can result in not having low enough 2. What is an example of a firm following a best-cost strategy near your college or university?
buyer and one looking for better quality than the low
prices to attract the cost-conscious buyer.
cost leader.

Neither achieving a low enough price nor sufficient

Best cost can also result in the best value for the
differentiation can result in accomplishing neither, and getting
buyer.
“stuck in the middle.”
References

Ketchen, D. J., & Short, J. C. Forthcoming. The discount diva: An interview with Sarah Reeves. Journal of Applied
Management and Entrepreneurship.

Forbes. (n.d.). Netflix (NFLX). [Infographic]. https://www.forbes.com/companies/netflix/#bf246018541f.

156 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 157

Image Credits roast beef sandwiches are neither cheaper than other fast-food sandwiches nor standouts in taste. Firms that
are stuck in the middle generally perform poorly because they lack a clear market or competitive pricing.

Figure 6.10: Mentadgt. “Two Women Looking and Pointing at Macbook Laptop.” Pexels license. Retrieved from
https://www.pexels.com/photo/two-women-looking-and-pointing-at-macbook-laptop-1569076.
Doing Everything Means Doing Nothing Well
Figure 6.11: Bench, Evan. “Hey Cupcake!” CC BY 2.0. Retrieved from https://flic.kr/p/5W7uPu.

Michael Porter has noted that strategy is as much about executives deciding what a firm is not going to do as
it is about deciding what the firm is going to do (Porter, 1996). In other words, a firm’s business-level strategy
Video Credits should not involve trying to serve the varied needs of different segments of customers in an industry. No firm
could possibly pull this off.

Gregg Learning. (2018, June 15). Best-Cost provider strategy [Video]. YouTube. The fable, The Miller, His Son, and Their Ass, told by the
https://www.youtube.com/watch?v=zOaMXfFHzwQ&feature=emb_logo. ancient Greek storyteller Aesop helps illustrate this
idea. In this tale, a miller and his son were driving their
ass (donkey) to market for sale. They soon encountered
a group of girls who mocked them for walking instead
6.7 Stuck in the Middle of riding. The father then told his son to ride the
animal. Not long after, father and son overheard a man
A firm is said to be stuck in the middle if it does not offer features that are unique enough to convince customers claim that young people had no respect for the elderly.
to buy its offerings and its prices are too high to effectively compete based on price. Firms that are stuck in the On hearing this opinion, the father told the boy to
middle generally perform poorly because they lack a clear market or competitive pricing. Several examples of dismount the animal and he began to ride. They
such firms are illustrated below. progressed a short distance farther and met a
company of women and children. Several of the women
Table 6.12 Stuck in the Middle suggested that it was both ridiculous and lazy for the
Examples of Firms that are Stuck in the Middle father to ride while the young son was forced to walk
alone; once again the two changed positions. Another
Arby’s signature roast beef sandwiches are neither cheaper than other fast food nor are they standouts in taste.
bystander suggested that they could not believe that
Sears and their famous catalog once dominated US retailing, but the failure to cultivate customers among newer Figure 6.12: This illustration from 1887 captures the lesson of
generations and prices that are higher than those of rivals have severely wounded the company. Sears filed for the man was the owner of the beast, judging from the
Aesop’s fable “The Miller, His Son, and Their Ass”—a lesson
bankruptcy in 2018. that executives need to follow. way it was weighed down. In fact, it would make more
Electronics retailer Circuit City found itself squeezed by the superior service offered by rival Best Buy and the cheaper sense for the man and his son to carry the ass. On
prices charged on electronics by Walmart and Target. Headquartered in Richmond, Virginia, the firm went bankrupt in hearing this, the father and his son tied the animal’s legs together and carried it on a pole. As they crossed a
2009 after sixty years in business.
bridge near town, the townspeople began to gather and laugh at the unorthodox sight. The noise and the chaos
Kmart’s “Blue Light Specials” that alert shoppers to a deeply discounted item reflect the firm’s long-running effort to be
a cost leader. But emerging on the losing end of a price war with Walmart sent the firm into bankruptcy. Struggling to frightened the beast, leading it to thrash around until it tumbled into the river. With tongue in cheek, we note
survive, it has closed most of its stores. that the moral of the story is that if you try to please everyone, you may lose your ass (Short & Ketchen, 2005).

Stuck in the Middle: Neither Inexpensive nor Differentiated Getting Outmaneuvered by Competitors

Some firms fail to effectively pursue one of the generic strategies. A firm is said to be stuck in the middle if it In many cases, firms become stuck in the middle not because executives fail to arrive at a well-defined strategy
does not offer features that are unique enough to convince customers to buy its offerings, and its prices are too but because firms are simply outmaneuvered by their rivals. After six decades as an electronics retailer, Circuit
high to compete effectively based on price (Table 6.11). Arby’s appears to be a good example. Arby’s signature City went out of business in 2009. The firm had simply lost its appeal to customers. Rival electronics retailer

158 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 159
Best Buy offered comparable prices to Circuit City’s prices, but the former offered much better customer Blockbuster was stuck in the middle—its prices were higher than those of Redbox and Netflix, and Netflix’s
service. Meanwhile, the service offered by discount retailers such as Walmart and Target on electronics was no service was superior. Once individuals lacked a compelling reason to be Blockbuster customers, the firm’s fate
better than Circuit City’s, but their prices were better. was sealed. As of 2020 Blockbuster operated one store!

The results were predictable—customers who made electronics purchases based on the service they received
went to Best Buy, and value-driven buyers patronized Walmart and Target. Circuit City’s demise was probably Key Takeaway
inevitable because it lacked a competitive advantage within the electronics business. Although Target was on
the winning end of this battle, Target executives need to worry that their firm could become stuck in the middle
between Walmart’s better prices on one side and the trendiness of specialty shops on the other.
• When executing a business-level strategy, a firm must not become stuck in the middle between
IBM’s personal computer business offers another example. IBM tried to position its personal computers via viable generic business-level strategies by neither offering unique features nor competitive
a differentiation strategy. In particular, IBM’s personal computers were offered at high prices, and the firm pricing.
promised to offer excellent service to customers in return. Unfortunately for IBM, rivals such as Dell were able
to provide equal levels of service while selling computers at lower prices. Nothing made IBM’s computers stand
out from the crowd, and the firm eventually exited the business.

Exercises

1. What is an example of a firm that you would consider to be “stuck in the middle”? What would
your advice be to the executives in charge of this firm?
2. Research a company that has gone bankrupt or otherwise stopped operations in the past decade
because their strategy was “stuck in the middle” of otherwise viable generic business-level
strategies. Could its demise have been prevented?

References

Porter, M. E. (1996). What is strategy? Harvard Business Review, reprint 96608.

Figure 6.13: Netflix and Redbox have left video rental stores such as Movie Gallery and Blockbuster stuck Short, J. C., & Ketchen, D. J. (2005). Using classic literature to teach timeless truths: An illustration using
in the middle. Blockbuster filed for bankruptcy in late 2010. Aesop’s fables to teach strategic management. Journal of Management Education, 29(6), 816–832.

At its peak in the mid-2000’s, Blockbuster operated approximately 9,000 video rental stores. By 2010, the
Image Credits
firm filed for bankruptcy. This rapid demise can be traced to the firm becoming outmaneuvered by Netflix.
When Netflix began offering inexpensive DVD rentals through the mail, customers defected in droves from Figure 6.12: Crane, Walter. “Illustration for ‘The Man That Pleased None.'” Public Domain. Retrieved from
Blockbuster and other video rental stores such as Movie Gallery. Netflix customers were delighted by the https://upload.wikimedia.org/wikipedia/commons/a/a5/Can%27t_please_everyone2.jpg.
firm’s low prices, vast selection, the convenience of not having to visit a store to select and return videos, and
Figure 6.13: Stu pendousmat. “A Blockbuster location in Moncton.” CC BY-SA 3.0. Retrieved from
were among the first to transition to streaming movies. The low price strategy of RedBox also hurt the firm.
https://upload.wikimedia.org/wikipedia/commons/3/35/BlockbusterMoncton.JPG.

160 | Chapter 6: Selecting Business-Level Strategies Chapter 6: Selecting Business-Level Strategies | 161

6.8 Conclusion Chapter 7: Innovation Strategies

This chapter explains generic business-level strategies that executives select to keep their firms competitive.
7.1 Introduction
Executives must select their firm’s source of competitive advantage by choosing to compete based on low-cost
versus more expensive features that differentiate their firm from competitors. In addition, targeting either a 7.2 Entrepreneurial Orientation
narrow or broad market helps firms further understand their customer base. Based on these choices, firms
will follow broad cost leadership, broad differentiation, focused cost leadership, or focused differentiation 7.3 Why Innovate?
strategies. Another potentially viable business strategy, best cost, exists when firms offer relatively low prices
7.4 Types of Innovation
while still managing to differentiate their goods or services on some important value-added aspects. All firms
pursuing a best cost strategy can fall victim to being “stuck in the middle” by not offering unique features or 7.5 Implementing Innovation
competitive prices.
7.6 Responding to Innovation in the Market

7.7 Conclusion
Exercises

Learning Objectives
1. Divide your class into four or eight groups, depending on the size of the class. Each group should
select a different industry. Find examples of each generic business-level strategy for your
industry. Discuss which strategy seems to be the most successful in your selected industry.
After reading this chapter, you should be able to understand and articulate answers to the following
2. This chapter discussed Target and other retailers. If you were assigned to turn around a
questions:
struggling retailer such as Kmart, what actions would you take to revive the company?
1. What is Entrepreneurial Orientation?
2. Why should companies innovate?
3. What are the four types of innovation?
4. What are the four stages of the product life cycle and crossing the chasm?
5. What are the ways firms might cooperate with their competitors?

7.1 Introduction

A firm’s philosophy toward innovation greatly impacts the business-level/competitive strategies that it
pursues. Having an entrepreneurial orientation stimulates a firm toward innovation, improving its products and
services and launching new product lines. Innovation can open new markets for a company, and being the first
mover to launch a new product or service can be an advantage over competitors, but not always. There are
four types of innovation that depend on if existing or new markets are reached or if existing or new technology
is used. Firms may also find it advantageous to cooperate at certain levels, such as through a joint venture,
strategic alliance, merger, acquisition co-location, or co-opetition.

Innovation is important in strategic management. A firm must be improving its products and services or

162 | Chapter 6: Selecting Business-Level Strategies Chapter 7: Innovation Strategies | 163

developing new ones to stay competitive. Business level strategy will not be able to sustain any competitive Entrepreneurship within an organization is called intrapreneurship. Companies often grow by offering new
advantage by sitting still. As firms implement corporate and international strategies, discussed in the next two services or launching new products. Rather than acquire another company that provides that product or
chapters, cooperative and co-opetition measures help companies obtain resources and capabilities needed to service, they develop it themselves. This is a method of strategy implementation called internal development.
innovate and enter new markets. To maximize opportunities for intrapreneurship, companies need employees with a high entrepreneurial
orientation.

Thinking and behaving entrepreneurially can help a person’s career as well. Some enterprising individuals
7.2 Entrepreneurial Orientation successfully navigate through the environments of their respective organizations and maximize their own
career prospects by identifying and seizing new opportunities (Table 7.1) (Certo et al., 2009).

A famous Nike slogan encourages people to “just do it!” For people and organizations that have developed an
entrepreneurial orientation (EO), “just do it!” is a way of life. While often associated with starting new ventures,
an EO can be very valuable to established organizations as well. Below we describe each of the three
characteristics associated with an EO: innovativeness, proactiveness, and risk-taking.
Section Video
An additional two characteristics were later added—competitive aggressiveness and autonomy. However, these
two dimensions of EO have been subject to much debate and are omitted for the purposes of this text.
The relationship between entrepreneurial orientation and organizational performance [01:02]
Table 7.1 Understanding Entrepreneurial Orientation The video for this lesson discusses the relationship between entrepreneurial orientation and
Term Definition Example organizational performance.
3M has built its business around its mission statement: to solve You can view this video here: https://youtu.be/Iru7IBqc3Vk.
The tendency to pursue unsolved problems innovatively. 3M employs over 7,000
novel ideas, creative researchers and more than 118,000 patents as of 2019, adding more
Innovativeness
processes, and than 4,000 patents annually. 3M’s innovativeness has led it to
experimentation. develop thousands of products (such as Post-it notes and Scotch
tape) that are sold in almost 200 countries.
In the 1730s, Richard Cantillon used the French term entrepreneur, or literally “undertaker,” referring to those
The tendency to anticipate
Proactive Communications Inc. lives up to its name by focusing on who undertake self-employment while also accepting an uncertain return. In subsequent years, entrepreneurs
and act on future
emerging and unusual opportunities. The firm embraces contracts
Proactiveness opportunities rather than have also been referred to as innovators of new ideas (Thomas Edison), individuals who find and promote new
in war zones and natural disaster areas that are often avoided by
rely solely on existing
other telecommunications firms. combinations of factors of production (Bill Gates’ bundling of Microsoft’s products), and those who exploit
products and services.
opportunistic ideas to expand small enterprises (Mark Zuckerberg at Facebook). The common elements of these
The tendency to take bold Richard Brandson’s launching of Virgin Galactic—a company that
Risk Taking actions rather than being plans to offer suborbital space flights to commercial conceptions of entrepreneurs are that they do something new and that some individuals can make something
cautious. passengers—reflects his love of high-risk, high-reward ventures.
out of opportunities that others cannot.

Entrepreneurial orientation (EO) is a key concept when executives are crafting strategies in the hopes of
doing something new and exploiting opportunities that other organizations cannot exploit. EO refers to the
The Value of Thinking and Acting Entrepreneurially processes, practices, and decision-making styles of organizations that act entrepreneurially (Lumpkin & Dess,
1996). Any organization’s level of EO can be understood by examining how it stacks up relative to three
When asked to think of an entrepreneur, people typically offer examples such as Elon Musk, Oprah Winfrey, dimensions: (1) innovativeness, (2) proactiveness, (3) and risk taking. These dimensions are also relevant to
Jeff Bezos, Kylie Jenner, and Mark Zuckerberg —individuals who have started their own successful businesses individuals.
from the bottom up that generated a lasting impact on society. But entrepreneurial thinking and doing are not
limited to those who begin in their garage with a new idea, financed by family members or personal savings.
Some people in large organizations are filled with passion for a new idea, spend their time championing a new
product or service, work with key players in the organization to build a constituency, and then find ways to
acquire the needed resources to bring the idea to fruition.

164 | Chapter 7: Innovation Strategies Chapter 7: Innovation Strategies | 165

Entrepreneurial orientation (EO) is measured at both the organizational Proactiveness

and the individual levels. The characteristics of an entrepreneurial
company noted in Table 7.1 also apply to individuals. Those individuals
who are less risk averse, innovative thinkers, and competitive tend to have Proactiveness is the tendency to anticipate and act on future needs rather than reacting to events after they
a higher EO and greater success at starting a business. Online EO unfold. A proactive organization is one that adopts an opportunity-seeking perspective. Such organizations act
assessment tools exist for those wishing to determine their EO. It is in advance of shifting market demand and are often either the first to enter new markets or “fast followers” that
important to note that EO is not only related to high tech start-ups. improve on the initial efforts of first movers.
Starting a lawn care business or a beauty shop are very valid and
Consider Proactive Communications, an aptly named small firm in Killeen, Texas. From its beginnings in 2001,
necessary entrepreneurial ventures, and will have a better chance of
this firm has provided communications in hostile environments, such as Iraq and areas impacted by Hurricane
success if an entrepreneur possesses a higher EO.
Katrina. Being proactive in this case means being willing to don a military helmet or sleep outdoors—activities
often avoided by other telecommunications firms. By embracing opportunities that others fear, Proactive’s
executives have carved out a lucrative niche in a world that is technologically, environmentally, and politically
Innovativeness turbulent (Choi, 2008).

Innovativeness is the tendency to pursue creativity and experimentation.

Some innovations build on existing skills to create incremental Risk Taking
Figure 7.1: As a college student, Michael
improvements, while more radical innovations require brand-new skills Dell demonstrated an entrepreneurial
and may make existing skills obsolete. Either way, innovativeness is aimed orientation by starting a
computer-upgrading business in his Risk taking refers to the tendency to engage in bold rather than cautious actions. Starbucks, for example, made
at developing new products, services, and processes. Those organizations dorm room. He later founded Dell Inc. a risky move when it introduced a new instant coffee called VIA Ready Brew. Instant coffee has long been viewed
that are successful in their innovation efforts tend to enjoy stronger
by many coffee drinkers as a bland drink, but Starbucks decided that the opportunity to distribute its product
performance than those that do not.
in a different format was worth the risk of associating its brand name with instant coffee.

Known for efficient service, FedEx has introduced its

Although a common belief about entrepreneurs is that they are chronic risk takers, research suggests that
Smart Package, which allows both shippers and
entrepreneurs do not perceive their actions as risky; most take action only after using planning and forecasting
recipients to monitor package location, temperature,
to reduce uncertainty (Simon et al., 2000). However, uncertainty seldom can be fully eliminated. A few years
and humidity. This type of innovation is a welcome
ago, Jeroen van der Veer, CEO of Royal Dutch Shell PLC, entered a risky energy deal in Russia’s Far East. At the
addition to FedEx’s lineup for those in the business of
time, van der Veer conceded that it was too early to know whether the move would be successful (Certo et
shipping delicate goods, such as human organs. How
al., 2008). Just six months later, however, customers in Japan, Korea, and the United States had purchased all
do firms generate these types of new ideas that meet
the natural gas expected to be produced there for the next twenty years. If political instabilities in Russia and
customers’ complex needs? Perennial innovators 3M
challenges in pipeline construction do not dampen returns, Shell stands to post a hefty profit from its 27.5%
and Google have found a few possible answers. 3M
stake in the venture.
sends nine thousand of its technical personnel in
thirty-four countries into customers’ workplaces to
experience firsthand the kinds of problems customers
Figure 7.2: Ben & Jerry’s displays innovativeness by developing encounter each day. Google’s two most popular Building an Entrepreneurial Orientation
a series of offbeat and creative flavors over time.
features of its Gmail, thread sorting and unlimited e-
mail archiving, were first suggested by an engineer who was fed up with his own e-mail woes. Both 3M and Steps can be taken by executives to develop a stronger entrepreneurial orientation throughout an organization
Google allow employees to use a portion of their work time on projects of their own choosing with the goal of and by individuals to become more entrepreneurial themselves. For executives, it is important to design
creating new innovations for the company. This latter example illustrates how multiple EO dimensions—in this organizational systems and policies to reflect the three dimensions of EO. As an example, how an organization’s
case, autonomy and innovativeness—can reinforce one another. compensation systems encourage or discourage these dimensions should be considered. Is taking sensible
risks rewarded through raises and bonuses, regardless of whether the risks pay off, for example, or does the
compensation system penalize risk taking? Other organizational characteristics such as corporate debt level

166 | Chapter 7: Innovation Strategies Chapter 7: Innovation Strategies | 167

may influence EO. Do corporate debt levels help or impede innovativeness? Is debt structured in such a way as
to encourage risk taking? These are key questions for executives to consider.
Exercises
Examination of some performance measures can assist executives in assessing EO within their organizations.
To understand how the organization develops and reinforces autonomy, for example, top executives can
administer employee satisfaction surveys and monitor employee turnover rates. Organizations that effectively 1. Can you name three firms that have suffered because of lack of an entrepreneurial orientation?
develop autonomy should foster a work environment with high levels of employee satisfaction and low levels 2. Identify examples of each dimension of entrepreneurial orientation other than the examples
of turnover. Innovativeness can be gauged by considering how many new products or services the organization offered in this section.
has developed in the last year and how many patents the firm has obtained. 3. How does developing an entrepreneurial orientation have implications for your future career
choices?
Similarly, individuals should consider whether their attitudes and behaviors are consistent with the three
4. How could you apply the dimensions of entrepreneurial orientation to a job search?
dimensions of EO. Is an employee making decisions that focus on competitors? Does the employee provide
executives with new ideas for products or processes that might create value for the organization? Is the
employee making proactive as opposed to reactive decisions? Each of these questions will aid employees in
understanding how they can help to support EO within their organizations.

References

Certo, S. T., Connelly, B., & Tihanyi, L. (2008). Managers and their not-so-rational decisions. Business Horizons,
51(2), 113–119.
Section Video
Certo, S. T., Moss, T. W., & Short, J. C. (2009). Entrepreneurial orientation: An applied perspective. Business
Horizons, 52, 319–324.
Entrepreneurial Orientation [02:39]

The video for this lesson explains the importance of entrepreneurial orientation. Choi, A. S. (2008, April 16). PCI builds telecommunications in Iraq. Bloomberg Businessweek.
https://www.bloomberg.com/news/articles/2008-04-15/pci-builds-telecommunications-in-iraq.
You can view this video here: https://youtu.be/L6MqD5Hhs2U.
Lumpkin, G. T., & Dess, G. G. (1996). Clarifying the entrepreneurial orientation construct and linking it to
performance. Academy of Management Review, 21, 135–172.

Simon, M., Houghton, S. M., & Aquino, K. (2000). Cognitive biases, risk perception, and venture formation: How
Key Takeaway individuals decide to start companies. Journal of Business Venturing, 14, 113–134.

• Building an entrepreneurial orientation can be valuable to organizations and individuals alike in Image Credits
identifying and seizing new opportunities. Entrepreneurial orientation consists of three
dimensions: (1) innovativeness, (2) proactiveness, and (3) risk taking.
Figure 7.1: Ilan Costica. Michael Dell speaking at Oracle OpenWorld, San Francisco. CC BY-SA 3.0. Retrieved
from https://en.wikipedia.org/wiki/File:Michael_Dell_at_Oracle_OpenWorld.JPG.

Figure 7.2: Lam, Willis. “September 6th is National Coffee Ice Cream Day.” CC-BY SA 2.0. Retrieved from
https://commons.wikimedia.org/wiki/
File:Ben_and_Jerry%27s_2_Coffee_3_Buzz_Ice_Cream_(30650663798).jpg.

168 | Chapter 7: Innovation Strategies Chapter 7: Innovation Strategies | 169

Video Credits This proverb is especially meaningful in today’s business world. It is easy for executives to become paralyzed
by the dizzying array of competitive and cooperative moves available to them. Given the fast-paced nature
of most industries today, hesitation can lead to disaster. Some observers have suggested that competition in
The Oxford Review. (2018, December 16). The relationship between entrepreneurial orientation and many settings has transformed into hyper-competition, which involves very rapid and unpredictable moves
organisational performance [Video]. YouTube. https://youtu.be/Iru7IBqc3Vk. and countermoves that can undermine competitive advantages. Under such conditions, it is often better to
make a reasonable move quickly rather than hoping to uncover the perfect move through extensive and time-
Tarlan Golkar. (2020, April 28). Entrepreneurial orientation [Video]. YouTube. https://youtu.be/L6MqD5Hhs2U.
consuming analysis.

The importance of continuous learning also contributes to the value of adopting a “get moving” mentality.
Success in business often depends on executives learning from a series of competitive and cooperative moves,
7.3 Why Innovate? not on selecting ideal moves. In some circumstances, advantages can be created by taking decisive action, even
if the decision is based on incomplete information.

Innovate to Capture Markets

Blue Ocean Strategy
Innovation can be a key strategy to stay ahead of the competition. Firms who sit still, perhaps satisfied
with their success, will find themselves outsmarted and left behind, with the competition winning over their
It is best to win without fighting. – Sun-Tzu, The Art of War
customers. An innovation strategy coupled with an entrepreneurial orientation will help keep customers
buying. A blue ocean strategy involves creating a new, untapped market rather than competing with rivals in an existing
market (Kim & Mauborgne, 2004). This strategy follows the approach recommended by the ancient master of
Automobile manufacturers have used this strategy of innovation for years. Every year, a new innovation of
strategy Sun-Tzu in the quote above. Instead of trying to outmaneuver its competition, a firm using a blue
nearly all car models comes out in the fall season. The new year’s model may look a little sleeker, have some
ocean strategy tries to make the competition irrelevant (Table 7.2). Baseball legend Wee Willie Keeler offered
safety improvements, or be connected to the internet. These innovations entice consumers to sell their existing
a similar idea when asked how to become a better hitter: “Hit ’em where they ain’t.” In other words, hit the
car to have the latest look or technology. Cell phone manufacturers do the same thing, coming out with a new
baseball where there are no fielders rather than trying to overwhelm the fielders with a ball hit directly at them.
model almost annually, with more memory, a faster processor, a better camera, etc. Where would Apple be
today if they stopped with the iPhone 7? Drug manufacturers are always innovating by doing research to find Nintendo openly acknowledges following a blue ocean strategy in its efforts to invent new markets. Perrin
the next medication to slow Alzheimers or cure skin cancer. Kaplan, Nintendo’s former vice president of marketing and corporate affairs for Nintendo of America noted in
an interview, “We’re making games that are expanding our base of consumers in Japan and America. Yes, those
Innovation is usually the strategy of new startup IT
who’ve always played games are still playing, but we’ve got people who’ve never played to start loving it with
companies. A new software program is developed or a
titles like Nintendogs, Animal Crossing and Brain Games. These games are blue ocean in action” (Rosmarin,
new way to do interactive video games can meet a need
2006). Other examples of companies creating new markets include FedEx’s invention of the fast-shipping
or provide a service that consumers want. It is the
business and eBay’s invention of online auctions.
innovation strategy that propels the organization
forward. This is not to discount the need for a Firms that create blue oceans experience a temporary competitive advantage. How long “temporary
business-level/competitive strategy such as focused competitive advantage lasts” in a blue ocean strategy depends on the particular combination of internal and
differentiation, as the firm still needs to determine external factors that create the opportunity in the first place. Needless to say, the more successful a company
their business-level strategy and optimize it. Often a is with a blue ocean strategy, the more attention they will receive from potential competitors who want to get
differentiation strategy, broad or focused, can be used into a position to benefit from those same advantages.
for a new, innovative product or service and priced
Figure 7.3: Apple’s iPhone has continued to boast new features It’s a big ocean out there! When pursuing a blue ocean strategy, executives try to create and exploit vast untapped
since its initial release in 2007. high, because the competitors are few or none.
markets rather than competing directly with rivals. See several examples of firms following a blue ocean strategy
below.

Joseph Addison, an eighteenth century poet, is often credited with coining the phrase “He who hesitates is lost.”

170 | Chapter 7: Innovation Strategies Chapter 7: Innovation Strategies | 171

 Table 7.2 Blue Ocean Strategy
Image Credits
Examples of Firms Following a Blue Ocean Strategy

The interactive features of Nintendo’s Wii transformed playing video games from a hobby for the hardcore gamers into a
treasured family event. Figure 7.3: Fotois.com. “iPhone 4S Unbox.” CC BY 2.0. Retrieved from https://flic.kr/p/avJQdj.

Coffee shops were once the domain of old men, insomniacs, and chain-smoking urban hipsters. By reinventing coffee
shops, Starbucks made the $4 latte a must-have item for college students, business people, and soccer moms.

At a time when cars were only for the wealthy, Henry Ford envisioned cars that were affordable to the typical American.
Ford priced his vehicles so that his assembly line workers could afford them. 7.4 Types of Innovation
eBay’s invention of online auctions extended the auction experience—and the chance to buy that rare Elvis plate—to
anyone with internet access.

Golf can be frustrating to even skilled players. Callaway’s creation of the Big Bertha club with an oversized head made
golf appealing to a whole new set of weekend warriors.
Being a First Mover: Advantages and Disadvantages
A classy, affordable wine for novice wine drinkers? Casella wines (maker of Yellow Tail) steered clear of wine snobs and
sommeliers and instead created fun and simple tastes for the masses.
The idea of first mover advantage borrows from military strategy. For example, Confederate general Nathan
Beford Forrest’s attack plan was simply stated as “git thar fustest with the mostest.”

When confronted by a poisonous snake, should you strike first or wait for the serpent to make a move? Each
Key Takeaway
option has advantages and disadvantages. In business, being a first mover might allow a firm to “rattle its rivals,
but a first move might also attract the “venom” of skeptical customers. Below are examples of successful—and not
so successful—first movers.
• Firms must continually innovate to stay ahead of the competition. Blue ocean strategy is one way
that innovation can capture new markets. Table 7.3 First Mover Advantage

First Move Successes First Move Failures

At a time when using most personal computers

Netscape’s web browser was a first mover that was popular in
required memorizing obscure commands, Apple
the 1990s, but nearly extinct by 2002 with the advent of
pioneered a user-friendly interface. The firm gained a
Exercises reputation as an innovator that persists today.
Microsoft’s competitive offering—Internet Explorer.

Following World War II, Japan’s economy laid in ruin.

Ibuka Masaru used this backdrop to build a company Not all of Apple’s first moves were triumphs. The firm’s
1. Find a key trend from the general environment and develop a blue ocean strategy that might that would be the first in Japan to create tape disastrous attempt to pioneer the personal digital assistant
recorders and transistors radios. The company he market through its “Newton” created a loss of around
capitalize on that trend. pioneered—Sony—has now been a fierce electronics one-hundred million dollars.
competitor for over a half century.

A famous cliché contends that “the early bird gets the worm.” Applied to the business world, the cliché suggests
that certain benefits are available to a first mover into a market that will not be available to later entrants. A
References first-mover advantage exists when making the initial move into a market allows a firm to establish a dominant
position that other firms struggle to overcome (Table 7.3). For example, Apple’s creation of a user-friendly, small
computer in the early 1980s helped fuel a reputation for creativity and innovation that persists today. Kentucky
Kim, W. C., & Mauborgne, R. (2004, October). Blue ocean strategy. Harvard Business Review, 76–85. Fried Chicken (KFC) was able to develop a strong bond with Chinese officials by being the first Western
restaurant chain to enter China. Today, KFC is the leading Western fast-food chain in this rapidly growing
Rosmarin, R. (2006, February 7). Nintendo’s new look. Forbes. Retrieved from
market. Genentech’s early development of biotechnology allowed it to overcome many of the pharmaceutical
http://www.forbes.com/2006/02/07/xbox-ps3-revolution-cx_rr_0207nintendo.html.
industry’s traditional entry barriers such as financial capital and distribution networks and become a profitable
firm. Decisions to be first movers helped all three of these firms to be successful in their respective industries
(Ketchen et al., 2004).

172 | Chapter 7: Innovation Strategies Chapter 7: Innovation Strategies | 173

On the other hand, a first mover cannot be sure that customers will embrace its offering, making a first move Figure 7.4 illustrates the four types of innovation.
inherently risky. Apple’s attempt to pioneer the personal digital assistant market, through its Newton, was a
Incremental innovation can be described as making
financial disaster. The first mover also bears the costs of developing the product and educating customers.
improvements on an existing product or service. The
Others may learn from the first mover’s successes and failures, allowing them to cheaply copy or improve the
improvements are based on using existing technology
product. Sony, Samsung, and others have built on Apple’s knowledge and creation of Airpods to offer competing
and are directed at the existing market. In the
products. In many industries, knowledge diffusion and public-information requirements make such imitation
automobile industry, the improvements made each
increasingly easy.
year to the newest model of car are incremental
One caution is that first movers must be willing to commit sufficient resources to follow through on their innovations. No new markets are formed, and existing
pioneering efforts. RCA and Westinghouse were the first firms to develop active-matrix LCD display technology technology is used to make the car better. Some other
for flat computer screens, but their executives did not provide the resources needed to sustain the products examples of incremental innovation are presented in
spawned by this technology. Today, these firms are not even players in this important business segment that Table 7.4
supplies screens for notebook computers, camcorders, medical instruments, and many other products.
Incremental innovation occurs when the innovation
To date, the evidence is mixed regarding whether being a first mover leads to success. One research study of uses existing technology to improve a product or service
1,226 businesses over a fifty-five-year period found that first movers typically enjoy an advantage over rivals for that addresses the existing market.
about a decade, but other studies have suggested that first moving offers little or no advantages.

Perhaps the best question that executives can ask themselves when deciding whether to be a first mover is, how
Figure 7.4: Types of Innovation
will this move provide my firm with a sustainable competitive advantage? First moves that build on strategic
Table 7.4 Incremental Innovation
resources such as patented technology are difficult for rivals to imitate and thus are likely to succeed. For
example, Pfizer enjoyed a monopoly in the erectile dysfunction market for five years with its patented drug Incremental Innovation Examples
Viagra before two rival products (Cialis and Levitra) were developed by other pharmaceutical firms. Despite Each new version of Apple’s iPhone that comes out is typically incremental innovation. iPhone features such as the
facing stiff competition, Viagra continues to raise about $1.9 billion in sales for Pfizer annually. camera and processor are tweaked to make an improvement over the previous model.

When Gillette went from a single razor blade to a double blade, to now up to six blades, no new markets were created, as
In contrast, E-Trade Group’s creation of the portable mortgage seemed doomed to fail because it did not the same consumers are buying the blades. There was no new technology involved, so this is incremental innovation.
leverage strategic resources. This innovation allowed customers to keep an existing mortgage when they Residential washers and dryers have been transitioning from top-loading to side-loading, and can handle larger loads.
move to a new home. Bigger banks could easily copy the portable mortgage if it gained customer acceptance, This incremental innovation used existing technology and created no new markets, but stimulated demand for more
purchasers at higher prices.
undermining E-Trade’s ability to profit from its first move.

Incremental Innovation Disruptive Innovation

Some firms have the opportunity to shake up their industry by introducing a disruptive innovation—an
Innovation can be classified into four types:
innovation that conflicts with, and threatens to replace, traditional approaches to competing within an industry

1. Incremental Innovation (Table 7.5). Disruptive innovation occurs when a new product or service engages the existing market with a new

2. Disruptive Innovation technology. The iPad has proved to be a disruptive innovation since its introduction by Apple in 2010. Many

3. Architectural Innovation individuals quickly abandoned clunky laptop computers in favor of the sleek tablet format offered by the iPad.

4. Radical Innovation And as a first mover, Apple was able to claim a large share of the market.

Disruptive innovations occur when firms introduce offerings that are so unique and superior that they threaten
The type of innovation is dependent on two factors:
to replace traditional approaches. Existing markets are disrupted by new technology. Sometimes a disruption
is so significant that it may create a “blue ocean” by finding a new market while disrupting an existing one, but
1. Market – does the innovation create a new market, or address the existing market?
this is not typically the case. A number of disruptive innovations are illustrated below.
2. Technology – does the innovation use a new technology or an existing technology?

174 | Chapter 7: Innovation Strategies Chapter 7: Innovation Strategies | 175

 Table 7.5 Shaking the Market with Disruptive Innovations Table 7.6 Architectural Innovation

Disruptive Innovation Examples Architectural Innovation Examples

Tablet computers disrupted laptop sales due to their versatility and portability. Reading books can be awkward on Peloton, maker of home exercise bicycles, packages the already existent bicycle, internet, and communications
traditional computers, but user-friendly devices such as iPad, Nook, and Kindle are popular platforms for aggressive technologies to create new consumers who otherwise would not buy an exercise bike.
textbook publishers.
Some firms have leveraged solar cell technology to produce small outdoor ground lighting. This created a whole new
Many stores that relied on compact disc sales went under when downloadable digital media disrupted the music group of consumers who decorate their yards with these environmentally friendly lights.
industry. Years earlier, CDs supplanted vinyl albums and cassette tapes due to their superior durability and quality.
Music subscriptions such as Spotify and Apple Music are new technologies that are replacing downloads. What new Copiers used to be large and expensive machines purchased only for large offices. Canon and others reconfigured these
technology will replace subscriptions? copiers to be small and usable on desktops, creating a whole new market of people buying personal copier/printers.

Digital cameras disrupted the photography industry by offering instant gratification and eliminating the cost of getting
film developed. Excellent cameras on cell phones have since disrupted the digital camera industry.

The emergence of personal computers disrupted the dominance of mainframes and made it possible for everyone to
have a computer in their home. Radical Innovation
LED lights are a newer technology that have been disrupting and replacing incandescent lights by selling to the existing
market.
When new products or services are developed using new technology that open up new markets, the result
is called radical innovation. The airplane is a good example of a radical innovation. It used an entirely new
The iPad story is unusual because most disruptive innovations are not overnight sensations. Typically, a small
aeronautical technology to open up a whole new market for people traveling. Traveling across the country was
group of customers embrace a disruptive innovation as early adopters and then a critical mass of customers
unthinkable for most people, when it would take weeks to go from New York to San Francisco by car or train.
builds over time. An example is digital cameras. Few photographers embraced digital cameras initially because
Table 7.6 provides more examples of radical innovation.
they took pictures slowly and offered poor picture quality relative to traditional film cameras. As digital cameras
improved, they gradually won over almost everyone that takes pictures. Executives who are deciding whether Innovation that uses new technology to reach new consumers is radical innovation. Firms who are successful
to pursue a disruptive innovation must first make sure that their firm can sustain itself during an initial period with a new product of service using radical innovation may then employ a strategy of incremental innovation to
of slow growth. continually improve the product or service and generate more sales.

Table 7.7 Radical Innovation

Radical Innovation Examples

Architectural Innovation
Pharmaceutical researchers often produce a new product that is radical innovation. They come up with a new
combination of chemicals to treat a medical condition that attracts new buyers. Aricept,a new medication co-marketed
by Eisai and Pfizer that helps treat the symptoms of Alzheimer’s disease, has opened new markets.
Architectural innovation occurs when new products or services use existing technology to create new markets
and/or new consumers that did not purchase that item before. For example, the smart watch used existing Apple’s Airpods can be considered a radical innovation. Apple developed an earpiece that could use wireless technology
to receive Bluetooth signals. Now we see people with Airpods in their ears when before they would not have been using
cell phone technology and was repackaged into a watch. This opened up a new market of purchasers by wired earphones nearly as much.
repackaging an existing technology. Typically, firms alter the architecture of the product to create a new The Magnetic Resonance Imaging (MRI) machine uses electro-magnetic forces instead of x-rays to produce images
product that opens up sales to new markets. Table 7.5 provides more examples. internal to the body. This new technology generated a brand new market for hospitals to buy these machines for new
diagnostic capabilities.
Firms can innovate by using and adapting existing technology to create new products or services that address
new markets and consumers. This type of innovation is called Architectural Innovation, since the architecture of
a product is changed to create a new product to reach new markets.
Footholds

Footholds are useful for rock climbers looking for sure footing to ascend a difficult mountain, as well as firms
hoping to gain positions in new markets. In business, a foothold is a small position that a firm intentionally
establishes within a market in which it does not yet compete. Examples of the use of footholds are illustrated
below.

176 | Chapter 7: Innovation Strategies Chapter 7: Innovation Strategies | 177

Table 7.8 Footholds

Exercises
Foothold Examples

Swedish furniture seller IKEA opens just a single store when entering a new country, such as their first store in Japan.
This foothold is used as a showcase to establish IKEA’s brand; more stores are opened once brand recognition is
gained in the country. 1. Provide an example of a product that, if invented, would work as a disruptive innovation. How
Pharmaceutical giant Merck obtained a foothold by purchasing SmartCells Inc.,—a company developing a possible widespread would be the appeal of this product?
new diabetes treatment.
2. How would you propose to develop a new foothold if your goal was to compete in the fashion
The foothold concept also applies to warfare. Many armies establish new positions in geographic territories that they industry?
have not previously occupied. The Allied Forces used Normandy, France, as their foothold to advance on German
forces during World War II.

Similarly, some organizations find it valuable to establish footholds in certain markets. Within the context of
business, a foothold is a small position that a firm intentionally establishes within a market in which it does
not yet compete (Upson et al., 2012). Swedish furniture seller IKEA is a firm that relies on footholds. When References
IKEA enters a new country, it opens just one store. This store is then used as a showcase to establish IKEA’s
brand. Once IKEA gains brand recognition in a country, more stores are established (Hambrick & Fredrickson,
Hambrick, D. C., & Fredrickson, J. W. (2005). Are you sure you have a strategy? Academy of Management
2005).
Executive, 19, 51–62.
Pharmaceutical giants such as Merck often obtain footholds in emerging areas of medicine. In December 2010,
Johnson, S. (2010, September 25) The genius of the tinkerer. Wall Street Journal.
for example, Merck purchased SmartCells Inc., a company that was developing a possible new treatment for
http://online.wsj.com/article/SB10001424052748703989304575503730101860838.html.
diabetes. In May 2011, Merck acquired an equity stake in BeiGene Ltd., a Chinese firm that was developing novel
cancer treatments and detection methods. Competitive moves such as these offer Merck relatively low-cost Ketchen, D. J., Snow, C., & Street, V. (2004). Improving firm performance by matching strategic decision
platforms from which it can expand if clinical studies reveal that the treatments are effective. making processes to competitive dynamics. Academy of Management Executive, 19(4), 29–43.

Monster Mini Golf, KISS Mini Golf to rock Las Vegas this fall [Press release]. (2011, April 28). Monster Mini Golf
Key Takeaway website: https://monsterminigolf.com/locations/kiss-las-vegas/?apppush.

Rosmarin, R. (2006, February 7). Nintendo’s new look. Forbes.

http://www.forbes.com/2006/02/07/xbox-ps3-revolution-cx_rr_0207nintendo.html.
• Being the first mover can provide a firm a competitive advantage, but competitors who wait may
be the ultimate winners. Turisas. (n.d.). http://www.turisas.com/site/.
• There are four types of innovation that firms employ to increase their strength in the
Upson, J., Ketchen, D. J., Connelly, B., & Ranft, A. (2012). Competitor analysis and foothold moves. Academy of
marketplace.
Management Journal 55(1), 93-110.

Image Credits

Figure 7.4: Kindred Grey (2020). “Interaction of market and technology.” CC BY-SA 4.0. Retrieved from
https://commons.wikimedia.org/wiki/File:Interaction_of_market_and_technology.png.

178 | Chapter 7: Innovation Strategies Chapter 7: Innovation Strategies | 179

 incremental innovation strategy are Apple’s iPhone and car manufacturers, such as Ford and Toyota. In essence,
7.5 Implementing Innovation
the new model starts the product life cycle all over again. Figure 7.6 illustrates this concept.

Product Life Cycle and Crossing the Chasm

When innovation creates a new product, it typically goes through four stages within the marketplace. This is
true whether it is a high-tech product like a new video game system or a more mundane product like a laundry
detergent. The four stages are:

1. Introduction: The product is launched, with the hopes that it catches on. Sales are low.
2. Growth: The product catches on, and sales increase with time. Competitors jump in, but the rivalry among
competitors is not really strong yet, and there are plenty of sales for all.
3. Maturity: Sales begin to level out, growth slows, and competition increases. Shake-out occurs, with some
competitors leaving the market or being acquired by others.
4. Decline: Sales start declining. More consolidation occurs, with firms looking for exit strategies. A few
firms remain.

Figure 7.6: Product Life Cycle Extension

Profits generated during the product life cycle also usually follow a traditional pattern. During the research and
development phase of the product, the firm is investing funds into the product, generating a negative profit.
Losses continue during the introduction phase, when sales are low and marketing expenses are high. Firms
tend to recoup their investment in R&D and marketing during the growth phase, with maximum profits at the
beginning of the maturity phase. Once competition heats up in the maturity phase, price competition kicks in,
and lower prices mean lower profits. Figure 7.7 illustrates the profits during the four phases of the product life
cycle.

Figure 7.5: Product Life Cycle

Figure 7.5 illustrates these four stages over time. To prevent the decline of their product after the maturity
stage, firms will often “relaunch” their product with a new and improved model. Innovation again plays a role,
making improvements to the product, so that consumers will purchase the latest model. Prime examples of

180 | Chapter 7: Innovation Strategies Chapter 7: Innovation Strategies | 181

Figure 7.8: Technology Adoption Life Cycle

Making Cooperative Moves

Figure 7.7: Profits During the Product Life Cycle
Franklin Roosevelt once quipped, “Competition has been shown to be useful up to a certain point and no further,
but cooperation, which is the thing we must strive for today, begins where competition leaves off.” We illustrate
four commonly used cooperative moves used by firms below.
Another phenomenon that occurs in the innovation process with new technology is called “crossing the chasm.”
Table 7.9 Making Cooperative Moves
When a new technology is launched, often there are technology innovators/enthusiasts who will purchase the
new technology to check it out. A few more, called early adopters, will also want to try out the new product. Joint ventures involve two or more organizations that contribute to the creation of a new entity. For
example, Hong Kong Disneyland is a joint venture between the government of Hong Kong and the Walt
But how does the firm get the product into the mainstream market? How do they get it to catch on? This can Joint Disney Company. While the park consists of Disney mainstays such as Main Street, USA, Fantasyland,
Ventures Adventureland, and Tomorrowland, the park also incorporates elements of Chinese culture such as
often be challenging. Can the product make the leap to the mainstream? This is called “crossing the chasm,” and adherence to the rules of Feng Shui—a set of aesthetic design principles believed to promote positive
often requires a different marketing approach. energy.

Strategic alliances are cooperative arrangements governed by contract between two or more
Figure 7.6 illustrates this concept, breaking down the market into customer segments. Innovators and early Strategic organizations that do not involve creating new entities. For example, a strategic alliance between Merck
adopters make up about 15% of the market. Firms must determine a business strategy for each segment of Alliances and PAREXEL International Corporation was formed with the goal of collaborating on biotechnology
efforts known as biosimilars—a term used to describe subsequent versions of innovative drugs.
the market. If they cannot convince the early majority to buy their product, the product fails. Google Glass
Mergers and Acquisitions combine two organizations into one. Mergers typically occur between
is an example of a product that did not cross the chasm. Eyeglasses connected to the internet were quite an Mergers and like-size firms. Sprint and T-Mobile merged to create a stronger force in the wireless communications
innovative product, projecting internet sites in front of the eyes, or allowing the wearer to take pictures. Its true Acquisitions industry. Acquisitions usually are done by larger companies acquiring smaller ones, as when Google
acquired Fitbit.
usefulness, however, was questionable, and aside from some early adopters, it failed.

Where is the electric car in this technology adoption life cycle? The purchase of electric cars has certainly In addition to competitive moves, firms can benefit from cooperating with one another. Cooperative moves
been growing. Have they crossed the chasm? In 2019, approximately 2.2% of all car sales were electric plug-in such as forming joint ventures and strategic alliances may allow firms to enjoy successes that might not
vehicles (Coran, 2019). Electric vehicles still need to cross the chasm. The lack of charging stations across the otherwise be reached (Table 7.9). This is because cooperation enables firms to share rather than duplicate
nation and concern for running out of battery are limiting factors preventing the electric vehicle from selling resources and to learn from one another’s strengths. Firms that enter cooperative relationships take on risks,
to the early majority. however, including the loss of control over operations, possible transfer of valuable secrets to other firms, and
possibly being taken advantage of by partners (Ketchen et al., 2004).

182 | Chapter 7: Innovation Strategies Chapter 7: Innovation Strategies | 183

Joint Ventures Mergers and Acquisitions

A joint venture is a cooperative arrangement that involves two or more organizations with each contributing Another way for firms to cooperate to the advantage of both firms and their stockholders is through mergers.
to the creation of a new entity. The partners in a joint venture share decision-making authority, control of the Two firms decide to combine into one entity, often gaining strength in the market. The merger of T-Mobile
operation, and any profits that the joint venture earns. and Sprint is a prime example. As the number three and four players in the wireless communications industry,
combining forces makes the new firm a much stronger competitor against AT&T and Verizon. Sometimes both
Sometimes two firms create a joint venture to deal with a shared opportunity. A joint venture was created
firms’ identities remain in the name of the new company, such as with the merger of Exxon and Mobil oil
between Merck and Sun Pharmaceutical Industries Ltd., an Indian pharmaceutical company. The purpose of the
companies to ExxonMobil. At other times, only one of the firm’s names remains, or a new name is selected for
joint venture was to create and sell generic drugs in developing countries. In a press release, a top executive at
the merged companies.
Sun stressed that each side has important strengths to contribute: “This joint venture reinforces [Sun’s] strategy
of partnering to launch products using our highly innovative delivery technologies around the world. Merck has Whereas mergers typically occur with like-size companies, acquisitions are usually done by the larger firm
an unrivaled reputation as a world leading, innovative, research-driven pharmaceutical company” (Merck, 2011). acquiring the smaller firm. The end result is basically the same, with two companies combining into one.
Both firms contributed executives to the new organization, reflecting the shared decision making and control Sometimes the acquired firm is absorbed into the acquiring company, but sometime it retains its identity.
involved in joint ventures. Besides combining the strengths of both organizations with the intent of having a stronger performing
company, mergers and acquisitions reduce the number of competitors in the industry.
In other cases, a joint venture is designed to counter a shared threat. Brewers SABMiller and Molson Coors
Brewing Company created a joint venture called MillerCoors that combines the firms’ beer operations in the Mergers and acquisitions are not without risk, however. According to a Harvard Business Review report, the
United States. Miller and Coors found it useful to join their US forces to better compete against their giant failure rate of mergers and acquisitions is between 70% – 90% (Lakelet Capital, 2019). Often, the enthusiasm
rival Anheuser-Busch, while the two parent companies still remain separate. The joint venture controls a wide of the perceived benefits of the merger overshadow the challenges of adapting two organizational cultures
array of brands, including Miller Lite, Coors Light, Blue Moon Belgian White, Coors Banquet, Foster’s, Henry into one, the total costs of the venture, and/or dealing with different technical systems. Also, an acquisition
Weinhard’s, Icehouse, Keystone Premium, Leinenkugel’s, Killian’s Irish Red, Miller Genuine Draft, Miller High is a quick way to increase firm revenues, a metric that may incentivize CEOs to acquire another firm without
Life, Milwaukee’s Best, Molson Canadian, Peroni Nastro Azzurro, Pilsner Urquell, and Red Dog. This diverse adequate due diligence, creating an agency problem, which is discussed in Chapter 11 on ethics.
portfolio makes MillerCoors a more potent adversary for Anheuser-Busch than either Miller or Coors would be
on their own.

Internal Development
Strategic Alliances
Another method to expand a firm is through internal development. If a firm wants to add a new product
or service line, rather than acquire that expertise by buying a company, the firm can develop that capability
A strategic alliance is a cooperative arrangement between two or more organizations that does not involve themselves. Although this is more of a competitive rather than a cooperative move, this is where a firm’s
the creation of a new entity. For example, Twitter formed a strategic alliance with Yahoo! Japan. The alliance strength of entrepreneurial orientation (EO) comes into play, and when intrapreneurship is important. Instead
involved relevant Tweets appearing within various functions offered by Yahoo! Japan (Rao, 2011). The alliance of acquiring Fitbit, Google could have developed this wearable technology internally by hiring those with the
simply involves the two firms collaborating through a contractual relationship as opposed to creating a new expertise and paying for the research and development for product development to enter this market.
entity together.

The pharmaceutical industry is the location of many strategic

alliances. In another example, Merck and PAREXEL International
Corporation engaged in a strategic alliance. Within this alliance, Figure 7.9: ExxonMobil, a merger of Exxon and
the two companies collaborate on biotechnology efforts known Mobil oil companies
as biosimilars. This alliance could be quite important to Merck
because the global market for biosimilars has been predicted to rise significantly (PRWeb, 2011).

184 | Chapter 7: Innovation Strategies Chapter 7: Innovation Strategies | 185

from https://web.archive.org/web/20110608025556/http://www.merck.com/licensing/our-partnership/
sun-partnership.html.
Key Takeaways
PRWeb, Global biosimilars market to reach US$4.8 billion by 2015, according to a new report by Global
Industry Analysts, Inc. [Press release]. 2011, February 15. PRWeb website. Retrieved from
• New products and services typically follow a predictable product life cycle, and must be able to http://www.prweb.com/releases/biosimilars/human_growth _hormone/prweb8131268.htm.
“cross the chasm” to attract buyers beyond the early adopters.
Rao, L. 2011, June 14. Twitter announces “strategic alliance” with Yahoo Japan [Blog post]. Techcrunch website.
• Sometimes it is advantageous for a firm to make a cooperative move with a competitor, with
Retrieved from http://www.techcrunch.com/2011/06/14/twitter-announces-firehose-partnership-with-
strategies such as a joint venture, strategic alliance, merger, or acquisition. Internal development
yahoo-japan.
is also a method to add innovative capability.

Ritson, M. (2009, October). Should you launch a fighter brand? Harvard Business Review, 65–81.

Exercises Image Credits

Figure 7.5: Kindred Grey (2020). “Product Life Cycle.” CC BY-SA 4.0. Retrieved from
1. What are examples of firms that “relaunch” their products once in the maturity stage of the https://commons.wikimedia.org/wiki/File:Product_Life_Cycle.png. Adapted from https://marketing-
product life cycle? insider.eu/wp-content/uploads/2017/07/Characteristics-of-the-Product-Life-Cycle-Stages-and-their-
2. Why might local restaurants not be in the position to respond to large franchises or chains? Marketing-Implications.png.
What can local restaurants do to avoid being ruined by chain restaurants?
3. How could a family jewelry store use one of the cooperative moves mentioned in this section?? Figure 7.6: Kindred Grey (2020). “Product Extension and the product life cycle.” CC BY-SA 4.0. Retrieved from
What type of organization might be a good cooperative partner for a family jewelry store? https://commons.wikimedia.org/wiki/File:Product_Extension_and_the_product_life_cycle.png. Adapted
4. What are some reasons why a merger between Ford and Volkswagen might fail? from https://marketing-insider.eu/wp-content/uploads/2017/07/Characteristics-of-the-Product-Life-
Cycle-Stages-and-their-Marketing-Implications.png.

Figure 7.7: Kindred Grey (2020). “Difference between profits and sales.” CC BY-SA 4.0. Retrieved from
https://commons.wikimedia.org/wiki/File:Difference_between_profits_and_sales.png. Adapted from
https://marketing-insider.eu/wp-content/uploads/2017/07/Characteristics-of-the-Product-Life-Cycle-
References Stages-and-their-Marketing-Implications.png.

Figure 7.8: Kindred Grey (2020). “Technology adoption life cycle – breaking the chasm.” CC BY-SA 4.0.
Coran, M. (2019, December 6). 2019 was the year electric cars grew up. Quartz. https://qz.com/1762465/
Retrieved from https://commons.wikimedia.org/wiki/File:Technology_adoption_life_cycle_-
2019-was-the-year-electric-cars-grew-
_breaking_the_chasm.png. Adapted from http://www.themarketingstudent.com/wp-content/uploads/
up/#:~:text=Electric%20vehicles%20(EVs)%20grabbed%202.2,new%20models%20hit%20the%20road.
2017/04/chasm-adoption-lifecycle.jpeg.
Ketchen, D. J., Snow, C., & Street, V. (2004). Improving firm performance by matching strategic decision
Figure 7.9: Unknown Author. “ExxonMobil logo.” Public Domain, Trademarked logo. Retrieved from
making processes to competitive dynamics. Academy of Management Executive, 19(4) 29-43.
https://commons.wikimedia.org/wiki/File:ExxonMobil_Logo.svg.
Lakelet Capital. (2019, June 15). Reasons shy mergers & acquisitions fail and succeed.
https://lakeletcapital.com/reasons-why-mergers-acquisitions-fail-and-
succeed/#:~:text=According%20to%20collated%20research%20and,70%20percent%20and%2090%20percen
t.

Merck & Co., Inc., and Sun Pharma establish joint venture to develop and commercialize novel formulations
and combinations of medicines in emerging markets [Press release]. 2011, April 11. Merck website. Retrieved

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7.6 Responding to Innovation in the Market Responding to a Disruptive Innovation

When a rival introduces a disruptive innovation that conflicts with the industry’s current competitive practices,
Executives in many markets must cope with a rapid-fire barrage of attacks from rivals, such as head-to-head
such as the emergence of online stock trading, executives choose from among three main responses. First,
advertising campaigns, price cuts, and attempts to grab key customers. If a firm is going to respond to a
executives may believe that the innovation will not replace established offerings entirely and thus, may choose
competitor’s move, doing so quickly is important. If there is a long delay between an attack and a response, this
to focus on their traditional modes of business while ignoring the disruption. For example, many traditional
generally provides the attacker with an edge. For example, PepsiCo made the mistake of waiting fifteen months
bookstores such as Barnes & Noble did not consider book sales on Amazon to be a competitive threat until
to copy Coca-Cola’s introduction of Vanilla Coke. In the interim, Vanilla Coke carved out a significant market
Amazon began to take market share from them. Second, a firm can counter the challenge by attacking along a
niche.
different dimension. For example, Apple responded to the direct sales of cheap computers by Dell and Gateway
In contrast, fast responses tend to prevent such an edge. Pepsi’s announcement of a mid-calorie cola by adding power and versatility to its products. The third possible response is to simply match the competitor’s
introduction was quickly followed by a similar announcement by Coke, signaling that Coke would not allow move. Merrill Lynch, for example, confronted online trading by forming its own Internet-based unit. Here the
this niche to be dominated by its longtime rival. Thus, as former General Electric CEO Jack Welch noted in firm risks cannibalizing its traditional business, but executives may find that their response attracts an entirely
his autobiography, success in most competitive rivalries “is less a function of grandiose predictions than it is a new segment of customers.
result of being able to respond rapidly to real changes as they occur. That’s why strategy has to be dynamic and
anticipatory.”

Fighting Brands: Get Ready to Rumble

So…We Meet Again
A firm’s success can be undermined when a competitor tries to lure away its customers by charging lower
prices for its goods or services. Such a scenario is especially scary if the quality of the competitor’s offerings is
Multi-point competition adds complexity to decisions about whether to respond to a rival’s moves. With multi- reasonably comparable to the firm’s. One possible response would be for the firm to lower its prices to prevent
point competition, a firm faces the same rival in more than one market. Cigarette makers R. J. Reynolds (RJR) customers from abandoning it. This can be effective in the short term, but it creates a long-term problem.
and Philip Morris, for example, square off not only in the United States, but also in many countries around Specifically, the firm will have trouble increasing its prices back to their original level in the future because
the world. When a firm has one or more multi-point competitors, executives must realize that a competitive charging lower prices for a time will devalue the firm’s brand and make customers question why they should
move in a market can have effects not only within that market, but also within others. When RJR started using accept price increases.
lower-priced cigarette brands in the United States to gain customers, Philip Morris responded in two ways. The
first response was cutting prices in the United States to protect its market share. This started a price war that The creation of a fighting brand is a move that can prevent this problem. A fighting brand is a lower-end brand

ultimately hurt both companies. Second, Philip Morris started building market share in Eastern Europe where that a firm introduces to try to protect the firm’s market share without damaging the firm’s existing brands.

RJR had been establishing a strong position. This combination of moves forced RJR to protect its market share In the late 1980s, General Motors (GM) was troubled by the extent to which the sales of small, inexpensive

in the United States and neglect Eastern Europe. Japanese cars were growing in the United States. GM wanted to recapture lost sales, but it did not want to
harm its existing brands, such as Chevrolet, Buick, and Cadillac, by putting their names on low-end cars. GM’s
If rivals are able to establish mutual forbearance, then multi-point competition can help them be successful. solution was to sell small, inexpensive cars under a new brand: Geo.
Mutual forbearance occurs when rivals do not act aggressively because each recognizes that the other can
retaliate in multiple markets. Southwest Airlines and United Airlines compete in some, but not all markets. Interestingly, several of Geo’s models were produced in joint ventures between GM and the same Japanese

United announced plans to form a new division that would move into some of Southwest’s other routes. automakers that the Geo brand was created to fight. A sedan called the Prizm was built side by side with the

Southwest CEO Herb Kelleher publicly threatened to retaliate in several shared markets. United then backed Toyota Corolla by the New United Motor Manufacturing Incorporated (NUMMI), a factory co-owned by GM and

down, and Southwest had no reason to attack. The result was better performance for both firms. Similarly, Toyota. The two cars were virtually identical except for minor cosmetic differences. A smaller car (the Metro)

in hindsight, both RJR and Philip Morris probably would have been more profitable had RJR not tried to steal and a compact sport utility vehicle (the Tracker) were produced by a joint venture between GM and Suzuki. By

market share in the first place. Thus, recognizing and acting on potential forbearance can lead to better 1998, the US car market revolved around higher-quality vehicles, and the low-end Geo brand was discontinued.

performance through firms not competing away their profits, while failure to do so can be costly.

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Some fighting brands are rather short lived. Merck’s Co-location

failed attempt to protect market share in Germany by
creating a fighting brand is an example. Zocor, a
treatment for high cholesterol, was set to lose its Co-location occurs when goods and services offered under different brands are located close to one another.

German patent in 2003. Merck tried to keep its high In many cities, for example, theaters and art galleries are clustered together in one neighborhood. Auto malls

profit margin for Zocor intact until the patent expired that contain several different car dealerships are found in many areas. Restaurants and hotels are often located

as well as preparing for the inevitable competition with near one another as well. “Big Box Stores” like Target. Staples, Best Buy, Lowes, etc., are almost always found

generic drugmakers by creating a lower-priced brand, clustered together with other retailers. By providing customers with a variety of choices, a set of co-located

Zocor MSD. Once the patent expired, however, the new firms can attract a bigger set of customers collectively than the sum that could be attracted to individual

brand was not priced low enough to keep customers locations. If a desired play is sold out, a restaurant overcrowded, or a hotel overbooked, many customers simply

from switching to generics. Merck soon abandoned the patronize another firm in the area.

Zocor MSD brand (Ritson, 2009).

Because of these benefits, savvy executives in some firms co-locate their own brands. The industry that Brinker
Figure 7.10: The Geo brand was known for its low price and
Two major airlines experienced similar futility. In International competes within is revealed by its stock ticker symbol: EAT. This firm often sites outlets of the
good gas mileage, not for its styling.
response to the growing success of discount airlines multiple restaurant chains it owns on the same street. Marriott’s Courtyard and Fairfield Inn often sit side by

such as Southwest, AirTran, Jet Blue, and Frontier, both United Airlines and Delta Airlines created fighting side. Yum! Brands takes this clustering strategy one step further by locating more than one of its brands—A&W,

brands. United launched Ted in 2004 and discontinued it in 2009. Delta’s Song had an even shorter existence. It Long John Silver’s, Taco Bell, Kentucky Fried Chicken, and Pizza Hut—within a single store.

started in 2003 and ended in 2006. Southwest’s acquisition of AirTran in 2011 created a large airline that may
make United and Delta lament that they were not able to make their own discount brands successful.
Co-opetition
Despite these missteps, the use of fighting brands is a time-tested competitive move. For example, very
successful fighting brands were launched forty years apart by Anheuser-Busch and Intel. After Anheuser-Busch
increased the prices charged by its existing brands in the mid-1950s (Budweiser and Michelob), smaller brewers Although competition and cooperation are usually
started gaining market share. In response, Anheuser-Busch created a lower-priced brand: Busch. The new viewed as separate processes, the concept of co-
brand won back the market share that had been lost and remains an important part of Anheuser-Busch’s brand opetition highlights a complex interaction that is
portfolio today. In the late 1990s, silicon chipmaker Advanced Micro Devices (AMD) started undercutting the becoming increasingly popular in many industries.
prices charged by industry leader Intel. Intel responded by creating the Celeron brand of silicon chips, a brand Ray Noorda, the founder of software firm Novell,
that has preserved Intel’s market share without undermining profits. Wise strategic moves such as the creation coined the term to refer to a blending of competition
of the Celeron brand help explain why Intel ranks thirty-second on Fortune magazine’s list of the “World’s Most and cooperation between two firms. For example,
Admired Corporations.” Meanwhile, Anheuser-Busch is the second most admired beverage firm, ranking behind drug manufacturers Merck and Roche are rivals in Figure 7.11: Yum! Co-located brands
Coca-Cola. some markets, but the firms are working together to
develop tests to detect cancer and to promote a hepatitis treatment. NEC, a Japanese electronics company, has
Table 7.10 Co-location and Co-opetition
three different relationships with Hewlett-Packard Co.: customer, supplier, and competitor. Some units of each
Co-location refers to a situation when goods and services offered under different brands are located company work cooperatively with the other company, while other units are direct competitors. NEC and
very close to each other. Noting one common example of co-location, a comedian once joked that La
Co-location Hewlett-Packard could be described as “frienemies”—part friends and part enemies.
Quinta was Spanish for “Next to Denny’s.” Both hotels and restaurants are often co-located alongside
freeway exits to allow numerous choices for road-weary travelers.
Toyota and General Motors provide a well-known example of co-opetition. In terms of cooperation, Toyota and
Co-opetition is a term that refers to the blending of competition and cooperation between two firms.
Toyota and General Motors’ creation of jointly owned New United Motor Manufacturing incorporated GM vehicles were produced side by side for many years at the jointly owned New United Motor Manufacturing
Co-opetition
(NUMMI) allowed for collaboration on automobile designs while Toyota and GM continued to compete
for market share worldwide. The NUMMI experience also inspired the comedy Gung Ho.
Incorporated (NUMMI) in Fremont, California. While Honda and Nissan used wholly owned plants to begin
producing cars in the United States, NUMMI offered Toyota a lower-risk means of entering the US market.
This entry mode was desirable to Toyota because its top executives were not confident that Japanese-style
management would work in the United States. Meanwhile, the venture offered GM the chance to learn
Japanese management and production techniques—skills that were later used in GM’s facilities. NUMMI offered
both companies economies of scale in manufacturing and the chance to collaborate on automobile designs.

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Meanwhile, Toyota and GM compete for market share around the world. In recent years, the firms have been
the world’s two largest automakers, and they have traded the top spot over time.
Exercises
In their book titled, not surprisingly, Co-opetition, A. M. Brandenberger and B. J. Nalebuff suggest that
cooperation is generally best suited for “creating a pie,” while competition is best suited for “dividing it up”
(Brandenberger & Nalebuff, 1996). In other words, firms tend to cooperate in activities located far in the 1. Divide your class into four or eight groups, depending on the size of the class. Each group should
value chain from customers, while competition generally occurs close to customers. The NUMMI example select a different industry. Find examples of competitive and cooperative moves that you would
illustrates this tendency—GM and Toyota worked together on design and manufacturing but worked separately recommend if hired as a consultant for a firm in that industry.
on distribution, sales, and marketing. Similarly, a research study focused on Scandinavian firms found that, 2. What types of cooperative moves could your college or university use to partner with local,
in the mining equipment industry, firms cooperated in material development, but they competed in product national, and international businesses? What benefits and risks would be created by making
development and marketing. In the brewing industry, firms worked together on the return of used bottles but these moves?
not in distribution (Bengtsson & Kock, 2000). 3. If a new alternative fuel was found in the auto industry, what are two ways existing car
manufacturers might respond to this disruptive innovation?
4. How might a firm such as Apple computers use a fighting brand?

Section Video
References
Innovation Strategy [04:16]

The video for this lesson explains innovation strategy. Bengtsson, M., & Kock, S. (2000). “Coopetition” in business networks—to cooperate and compete
You can view this video here: https://youtu.be/B-tY6citUHw. simultaneously. Industrial Marketing Management, 29(5), 411–426.

Brandenberger, A. M., & Nalebuff, B. J. (1996). Co-opetition. New York, NY: Doubleday.

Ritson, M. (2009, October). Should you launch a fighter brand? Harvard Business Review, 65–81.

Key Takeaway
Image Credits
• Cooperating with other firms is sometimes a more lucrative and beneficial approach than
directly attacking competing firms. Figure 7.10: Rutger van der Maar (2014). “Geo Prizm.” CC BY 2.0. Retrieved from
https://flic.kr/p/ooQzaF.

Figure 7.11: Cantnot. “Older design of Taco Bell restaurant currently in use, adjacent to sister Yum Brands
restaurant KFC, near Burlington.” Public Domain. Retrieved from
https://en.wikipedia.org/wiki/File:TBOldDesign.JPG.

Video Credits

Kuczmarski Innovation. (2016, May 17). Innovation strategy [Video]. YouTube.

https://youtu.be/B-tY6citUHw.

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7.7 Conclusion

This chapter explains how innovation impacts strategy development. An entrepreneurial orientation helps a
firm develop and implement new innovations. Being the first mover can present advantages, but is not without
the risk of competitors learning from the first mover and eventually beating them. Executives may also choose
a more conservative route by establishing a foothold within an area that can serve as a launching point or
by avoiding existing competitors overall by using a blue ocean strategy. There are four types of innovation:
incremental, disruptive, architectural, and radical. New products typically follow a predictable product life cycle
with four stages: introduction, growth, maturity, and decline. Firms often use incremental innovation to re-
launch products with improved features, starting the product life cycle over again. New products and services
must “cross the chasm” to get them into the mainstream. Firms may cooperate with competitors through joint
ventures, strategic alliances, mergers, and acquisitions, or through co-location and co-opetition. Executives
may also react to competitive attacks by using fighting brands. All of these efforts by firms are part of the
strategic management process that executives must respond to if they want their companies to be successful.

Exercises

1. Divide your class into four or eight groups, depending on the size of the class. Each group should
think of one example for each of the four types of innovation: Incremental, Architectural, Radical,
and Disruptive. Report out to the class.
2. Divide your class into four or eight groups, depending on the size of the class. Each group should
think of one product or service that launched but did not “cross the chasm.” Report out to the
class.

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