Download Southwest Airlines Integrated Low Cost/Differentiation Strategy

Chapter 4
Business-level Strategies
Diane M. Sullivan, Ph.D. 2014
Sections modified from Hitt, Ireland, and Hoskisson, Copyright © 2008 Cengage
Sections modified from Gentner (2009)
The Strategic Management Process

After collecting
information about the
internal and external
environment, firms
can select their
business-level
strategy
Insert figure 1.1 graphic
Business-level Strategy

Definition: integrated and coordinated set of commitments and
actions the firm uses to gain a competitive advantage by
exploiting core competencies in specific product markets

In selecting a business-level strategy, a firm must determine

Who are the customer groups to be served

What needs those customers have that the firm seeks to satisfy

How those needs can be satisfied (e.g., can the firm use core competencies
to satisfy customer needs)
Five Business-level Strategies
Cost Leadership Strategy

Definition: An integrated set of actions designed to produce or
deliver goods or services at the lowest cost, relative to
competitors with features that are acceptable to customers

Using a cost leadership strategy, a firm


Produces no-frills, standardized products for typical customers

Focuses on efficiency so costs are lower than competitors’ costs

Generally offers lower cost products with competitive levels of
differentiation
Examples: Big Lots Inc., Wal-Mart
Value Creating Activities Common to a
Cost Leadership Business-Level Strategy
Support
Activities
Cost Effective
MIS Systems
Simplified Planning
Practices to Reduce
Planning Costs
Consistent Policies to
Reduce Turnover Costs
Easy-to-Use Manufacturing
Technologies
Systems and Procedures to find the
Lowest Cost Producers to Purchase
Raw Materials
Relatively Few
Management Layers to
Reduce Overhead
Effective Training Programs
to Improve Worker
Efficiency and Effectiveness
Investments in Technology in order
to Reduce Costs Associated with
Manufacturing Processes
Frequent Evaluation Processes to
Monitor Suppliers’ Performances
Efficient Plant Delivery Schedule
Scale to Minimize
that Reduces
Highly Efficient
Manufacturing
Costs
Systems to Link
Costs
Suppliers’
Selection of Low
Products with the Timing of Asset
Cost Transport
Firm’s Production
Purchases
Carriers
Processes
Located in Close
Proximity with
Suppliers
Policy Choice of
Plant Technology
Efficient Order
Sizes
Organizational
Learning
Interrelationships
with Sister Units
Primary Activities
Small, Highly
Trained Sales
Force
National Scale
Advertising
Effective Product
Installations to
Reduce Frequency
and Severity
of Recalls
Risks of Cost Leadership Strategy

Competitive risks associated with the cost leadership
strategy include

Cost reduction processes become obsolete due to competitor
innovations

Cost reduction processes come at the expense of necessary
levels of differentiation

The strategy is imitated too easily
Differentiation Strategy

Definition: integrated set of actions designed by a firm to
produce or deliver goods or services (at an acceptable cost) that
customers perceive as being different in ways that are
important to them

Firms using differentiation strategy

Provide products with different, valued features sold at a premium price


Hinges on customers valuing differentiated features more than they value low
price

Firms should differentiate offerings on as many dimensions as possible

The less similarity to competitors’ products, the more buffered a firm is
from competition
Examples: Tiffany Jewelry, Apple, Lexus
Value Creating Activities Common to a
Differentiation Business-Level Strategy
Support
Activities
Highly Developed Information
Systems to better understand
customers’ purchasing preferences
A companywide
emphasis on producing
high quality products
Compensation programs
Extensive use of subjective
intended to encourage worker
rather than objective
creativity and productivity
performance measures
Coordination among R&D,
product development and
marketing
Investments in technologies that will
allow the firm to consistently produce
highly differentiated products
Systems and procedures used to find
the highest quality raw materials
Superior
handling of
incoming raw
materials to
minimize
damage and
improve the
quality of the
final product
Consistent
manufacturing of
attractive
products
Rapid responses
to customers
unique
manufacturing
specifications
Superior
personnel
training
Strong
capability in
basic research
Purchase of highest quality
replacement parts
Accurate and
responsive order
processing
procedures
Rapid and timely
product deliveries
to customers
Primary Activities
Strong Coordination among
functions in R&D,
Marketing and
Product
Development
Extensive
personal
relationships
with buyers
Premium
Pricing
Complete field
stocking of
replacement parts
Risks of Differentiation Strategy

Risks

Customers decide that differences between differentiated and
cost leader’s product not worth a higher price

Competitors offer similar products at a lower cost

Too high a price premium

Counterfeiters offer a cheap “knockoff” of a differentiated
good or service (e.g., easily imitated)

Too much differentiation
Focus Strategies

Definition: The focus strategy is an integrated set of actions taken to produce
goods or services that serve the needs of a particular competitive segment

Firms choose a focus strategy to serve the needs of a specific customer
segment or industry segment


Examples

A particular buyer group (such as youths or senior citizens)

A different segment of a product line (such as products for professional painters or the
do-it-yourself group), or

A different geographic market (such as East or West in the U.S).
2 types of focus strategies:

Focused cost leadership strategy


Example: IKEA
Focused differentiation strategy

Example: Babies R Us
Risks of Focus Strategies

Competitive risks of focus strategies

A competitor is able to focus on an even more narrowly
defined market segment

Industry-wide competitors decide to focus on specific
customer segments—imitation

The differences are reduced between the needs of a specific
market segment and those of the rest of the industry
Integrated Cost Leadership/Differentiation Strategy

Using this strategy, firms



Provide relatively low cost products with valued
differentiated features
Use primary and support activities to produce differentiated
products at relatively low costs
Risk of this strategy

A firm produces products that lack sufficient low cost or
differentiation
Integrated Low Cost/Differentiation Strategy
Southwest Airlines
Low Cost
Use a single aircraft model
(Boeing 737)
Use secondary airports
Fly short routes
No meals
25 minute turnaround time
Differentiation
Focus on customer
satisfaction
High level of employee
dedication
Focus on making the
flying experience fun
No reserved seats
No travel agent reservations
14
Integrated Low Cost/Differentiation Strategy
The Challenge: the integrated strategy is risky
Potential Pitfalls
• The firm may become “Stuck-in-the-Middle”
lacking an expertise with either type of generic
strategy
• When a firm’s products are too expensive to
compete with low cost producer and too
undifferentiated to provide the value offered by
the differentiated producer
Applying Chapters 3 & 4 to CapSim

What capabilities does your strategy require?

What are the benefits & limitations of those capabilities?

What resources are required to develop those capabilities?

Can you obtain an economic payback from developing those capabilities?

Timing your Capabilities:
– When will they be required?
– How long to develop?
– How temporal are they?

Capabilities & The Competition:
– What capabilities do your competitors have?
– What are they going to have?
– What do they believe they have?
– How will you counter them?
Broad Cost Leader

A broad cost leader will attempt to be the low-cost producer in every segment
served

Strive for good profit margins on all sales while keeping prices low for pricesensitive customers.

Firm Profile:
– Capacity improvements are unlikely to be undertaken (may run overtime instead)
unless at 200% capacity
– Pursue automation to increase margins in all segments (more automation in
slower moving segments versus faster moving segments)
– Low R&D spending, while still keeping pace with the market preferences
– Low labor and material costs
– Prices lower than average
– Spends moderately on promotion and sales
– Investments will be financed primarily via bonds and stock issues as needed
– When cash allows, establish a dividend policy and begin to retire stock
– Focus on Market Share, Profits, ROE and Stock Price
Cost Leader with Low-end Focus

A low-tech focused cost leader will seek to minimize costs through efficiency
and expertise.

Products will be concentrated in the Traditional and Low-end segments

Firm Profile:

Multiple product lines in low-end segments (Traditional and Low-end)

Few or no products in other segments (allow products to migrate)

Low R&D spending, while still keeping reasonable pace with the market

Low labor and material costs

Invests in automation (only after products positioned into their “forever”
segments) will help manage labor costs and make it most efficient to run a second
shift (which is preferred to capacity expansions)

Prices will be lower than average

Spends moderately on promotion and sales

Investments will be financed primarily via bonds and stock issues as needed

When cash allows, establish a dividend policy and begin to retire stock

Focus on Stock Price, ROE, ROS, and Profits
Cost Leader with Product-life Cycle Focus

A product life-cycle focused cost leader will seek to minimize costs
through efficiency and expertise

Products will be allowed to age and change in appeal from High End, to
Traditional, and eventually Low End buyers (then they are retired)

Firm Profile:

Minimum presence in “specialty” segments (Size & Performance)

Low R&D spending (very little repositioning & new product every 2 years in
high-end segment)

Low material costs

Low labor costs

Invests in automation early in the product’s life-cycle

Prices are lower than average

Spends moderately on promotion and sales

Investments financed through bonds and stock offerings as needed

When cash allows, establish a dividend policy and begin to retire stock

Focus on Stock Price, ROE, ROS and Profits
Broad Differentiator

A broad differentiator will seek to create maximum awareness and brand equity in
every segment

It wants to be well known as a maker of high quality/highly desirable products

Firm Profile:

High R&D spending to keep products fresh and at pace with market

Maintains presence in all market segments

Capacity will be expanded as higher demand is generated, avoiding overtime

Modest investments in automation after products well positioned but never at expense
of repositioning

Spends heavily on advertising and sales to create maximum awareness and
accessibility

Prices are above average

Investments are financed via stock issues and cash from operations as well as bonds as
needed

When cash allows, establish a dividend policy and begin to retire stock

Focus on Market Share, Profits, ROA and Stock Price
Differentiator with High-end Focus

A high-tech differentiator seeks to be known as the top producer of the best
performing state-of-the-art products in the High-end, Performance and Size
segments

Firm Profile:

Multiple product lines in high-tech segments (High-end, Performance, & Size) achieved
via harvesting Traditional and Low-end products and new products

High promotion & sales investments to create maximum awareness & accessibility

High R&D expenditures to continually introduce new product lines and keep existing
products fresh and with pace of the market

Capacity will be expanded as higher demand is generated, avoiding overtime

Price is above average

Modest investments in automation after products well positioned but never at expense of
repositioning

Investments are financed via stock issues and cash from operations and bonds as needed

When cash allows, establish a dividend policy and begin to retire stock

Focus on ROA, Asset Turnover, and ROS
Differentiator with Product Life-cycle Focus

A product life-cycle focused differentiator seeks to be known as the top producer of
the best performing state-of-the-art products in High-end, Traditional & Low-end
segments

Products will be repositioned into the segments, allowed to drift into the appropriate
segments and/or newly created into the segments

Firm Profile:

Minimum presence in Size & Performance segments (reposition them to Traditional)

High promotion and sales investments to create maximum awareness and accessibility

High R&D expenditures to continually introduce new product lines and keep existing
products fresh and with pace of the market

Price is above average

Capacity will be expanded as higher demand is generated, avoiding overtime

Modest investments in automation after products well positioned but never at expense of
repositioning

Investments are financed via stock issues and cash from operations as well as bonds as
needed

When cash allows, establish a dividend policy and begin to retire stock

Focus on Stock Price, ROS, Asset Turnover, and ROA
Integrated Strategy

A broad cost leader will attempt to be the
low-cost producer in every segment of
the market. It will have good profit
margins on all sales while keeping prices
low for price-sensitive customers.
 Firm Profile:

A broad differentiator will seek to
create maximum awareness and
brand equity. It wants to be well
known as a maker of high
quality/highly desirable products.
 Firm Profile:
– More likely to reposition products than
–
introduce new ones to the market
– Capacity improvements are unlikely to
–
be undertaken (may run overtime
instead)
–
– Automation may be pursued to increase
margins
– Investments will be financed with debt
–
and/or stock issues
–
– Tends to spend less on promotion and
sales
– Focus on Market Share, Profits, and
ACHIEVES
Stock Price
BOTH
High R&D spending to keep
products fresh
Maintains a presence in all market
segments
Spends heavily on advertising and
sales to create maximum
awareness and accessibility
Prices tend to be higher
Focus on Market Share, Profits,
and Stock Price
CapSim Business-level Strategies:
Investments & Tradeoffs
Segments
R&D & Marketing
Automation & Capacity
Cost Approaches
Broad Cost Leader
T, L, H, P, S
Cost Leader with low-tech
focus
T and/or L with > 1
product in each segment
Cost leader with product
life-cycle focus
HTL
Below
Avg.
Invest
Above
Avg.
Invest
Differentiation Approaches
Broad Differentiator
T, L, H, P, S
Differentiator with hightech focus
H, P, and/or S with > 1
product in segment(s)
Differentiator with product
life-cycle focus
HTL
Above
Avg.
Invest
Integrated Approaches
Successful integrated
?????
Stuck-in-the-middle
?????
Below
Avg.
Invest