4. Business-level strategy

Fit between organisation and environment

Organisations must find a good match between their internal capabilities and the external environment. Because both change continuously, this is difficult. Firms need to align strengths and weaknesses with opportunities and threats to achieve sustainable competitive advantage.

Three levels of strategy: corporate strategy (how the organisation as a whole is composed and in which businesses it wants to be active), business strategy (how a firm competes within a specific market or industry) and functional strategy (how functions such as marketing, production or HR use their resources as efficiently as possible to support the higher levels).

The business model

• Upstream industries: raw materials, growing and extraction industries that provide input; the start of the supply chain.
• Downstream industries: turning produced output into offerings and bringing them to customers; the end of the supply chain.
• Broad scope: many segments with a varied offering. Narrow scope: one or a few segments with a limited assortment. Variants: segment focus, product focus, broad scope and niche focus.

Positioning and environmental analysis

Positioning answers three questions: where will you compete (competitive scope), how will you compete (competitive advantage) and with which strategy, based on which advantage? The next step is analysing the environment with:

• Porter's five forces: threat of new entrants, threat of substitutes, bargaining power of suppliers, bargaining power of buyers and intensity of rivalry.
• PESTEL (in the lecture notes the E stands for ethical): political, economic, sociocultural, technological, ethical and legal factors.

Generic strategies

Resources: VRIO and VRIN

Resources that give a sustainable competitive position meet the VRIO criteria: Valuable, Rare, costly to Imitate and exploited by the Organisation. Barney (Reading 4.2) uses VRIN: valuable, rare, imperfectly imitable and non-substitutable.

Markets versus resources

With market adaptation firms mainly look at opportunities and needs in the market and adapt to them; this fits the Industrial Organization (IO) model. The drawback is less focus on what the organisation itself is good at. With resource leverage firms start from their own strong resources and capabilities (the Resource-Based View); the risk is missing important market changes or growth opportunities. A balance is needed, for example through SWOT.

This creates a paradox: firms must adapt to market changes (new technology, regulation, customer needs) while they have invested heavily in existing resources, processes and value chains that take time, money and risk to change. It can be managed by parallel processing (some units focus on markets and customers, others build internal resources such as technology or knowledge) and by juxtaposing (a dynamic equilibrium in which strong dynamic capabilities allow developing new resources while improving existing ones).

Readings

Reading 4.1 (Strategy from the outside in): successful organisations start with the market and the customer; the main goal is creating and keeping customer value. Market insight and marketing information help anticipate competitors, cooperate with partners and stimulate innovation. Many firms still think inside-out because they want to use existing resources, because of internal interests and because people hold on to existing ways of working. Market knowledge must be turned into action through four customer value imperatives: choosing which customers to serve, developing new value for customers, building and keeping strong customer relationships, and strengthening the brand. These must be supported by top management and the whole organisation.

Reading 4.2 (Barney, firm resources and sustained competitive advantage): firm resources include all assets, knowledge, processes and skills used to implement strategy (physical, human, organisational). A firm has a competitive advantage when it implements a value-creating strategy not simultaneously implemented by competitors, and a sustained competitive advantage when competitors also cannot easily copy it. With homogeneous resources firms cannot differentiate; advantage requires heterogeneous resources. Imitation is hard because of unique historical conditions, causal ambiguity and social complexity (culture, relationships, reputation).

Reading 4.3 (Ambrosini, Bowman and Collier): three levels of dynamic capabilities. Incremental dynamic capabilities give small, continuous improvements to the existing resource base. Renewing dynamic capabilities renew or replace resources when the environment changes. Regenerative dynamic capabilities change the way the organisation develops and uses its dynamic capabilities themselves, helping in highly turbulent environments.

Textbook deepening: De Wit, Ch. 4 (Business level strategy)

The sections below add the theory from the textbook chapter on business level strategy to the lecture notes above. The central issue is how firms create a (sustainable) competitive advantage in each business: accruing enough power to counterbalance buyers and suppliers, outperform rivals, discourage entrants and fend off substitutes.

Components of a business model (Figure 4.1)

A business model is the configuration of resources (input), activities (throughput) and product/service offerings (output) intended to create value for customers: "the way a firm conducts its business". Its three components are the product offering (value proposition), the activity system (value chain) and the resource base (stock of assets). Competitive advantage requires alignment between all three.

Why firms must focus: six problems of being unfocused

1. Low economies of scale: less specialisation means less efficient value chains and less leverage of the resource base.
2. Slow organizational learning: many products and markets slow the build-up of specific knowledge and capabilities.
3. Unclear brand image: companies that stand for everything stand out in nothing.
4. Unclear corporate image: a lack of internal identity; hard to explain why people work at the same company.
5. High organizational complexity: diverse products and customers increase complexity exponentially.
6. Limits to flexibility: procedures, routines, systems and tools force choices; being all things to all people is physically impossible.

Industries, markets and businesses

Statisticians use fixed product-based industry categories (SIC codes); strategists like to redefine industries. Swatch could see itself in the watch industry (product and production) or in the fashion industry (design and marketing activities). Porter draws industry columns left-right as a value system, from upstream to downstream industries. Market definition depends on substitution: London-Paris air transport may be a segment of a broader London-Paris transport market, or even a "London-Paris meeting market" if teleconferencing substitutes for travel. Example of a business: the charter business within the airline industry serving tourist markets. There is no single best way to define business boundaries (Abell).

Segmentation criteria (Figure 4.3) fall into three categories: buyer attributes/demographics (geography, age, education: objective and easily available, but only indirectly linked to needs: "not all Canadians need hockey sticks"), buying criteria/needs (price, purpose, style) and buyer behaviour/actions (adoption, purchase location, use). The latter two define segments directly, but the information is hard to gather. Reconceptualising segments is often where a unique approach is found.

Firms must focus in two ways: selecting a limited number of businesses (corporate configuration, Ch. 5, using five forces analysis to judge attractiveness) and focusing within each business on selected segments and product offerings. Positioning is focusing the overall business model to serve the needs of a targeted group of buyers in a way that distinguishes the firm from rivals; it covers "where to compete" (competitive scope) and "how to compete" (competitive advantage) (Porter). Using the same advantage for too many dissimilar products and customers makes a firm unfocused.

Six bases of competitive advantage

The factors that create value in the eyes of the customer are called value drivers; choosing which ones to base the value proposition on is a matter of positioning. Porter reduces all forms to lower cost and differentiation, which require fundamentally different business models; trying both risks being "stuck in the middle". Treacy and Wiersema likewise warn against a "mix-and-match" approach: operational excellence requires a "lean and mean" value chain with simple service; product leadership requires innovation and creative collaboration between marketing and R&D; customer intimacy requires flexibility and empowerment of employees close to the customer. Other researchers (Baden-Fuller and Stopford) argue there is an endless variety of advantages beyond these generic categories; finding a new type (peer-to-peer lending, Airbnb, Uber) may be the best way to a unique position.

The value chain (Porter, 1985)

A value chain is an integrated set of value creation processes leading to the supply of product or service offerings. Value chains differ between industries and within them (bricks-and-mortar vs online bookstores; hub-and-spoke vs no-frills airlines such as Southwest and easyJet; Dell's online mass customisation vs HP and Lenovo).

The strength of a value chain usually lies not in a few specialised activities but in the extraordinary configuration of the entire chain, which multiplies distinctness and raises the barrier to imitation (Porter, 1996; Amit and Zott). The difference between the value created and the cost of the activities is the margin.

The resource base

The resource base includes all means at the disposal of the organization for value-adding activities (also called assets: Dierickx and Cool, Itami). Research under the resource-based view (Penrose, Wernerfelt, Barney) has produced no generally accepted classification, but the following distinctions are common (Figure 4.7):

• Tangible resources ("hardware"): physically observable means such as land, buildings, materials and money; usually purchased, easier to transfer and price, and placed on the balance sheet.
• Intangible resources ("software"): cannot be touched, largely carried by people; can be purchased (big data) or developed internally. They split into:
• Relational resources: means derived from interaction with the environment, i.e. relationships with buyers, suppliers, competitors and governments ("it's not what you know, but whom you know") and reputation.
• Competences: the firm's fitness to perform in a field, consisting of knowledge (rules: know-how, know-what, know-where, know-when; and insights: know-why), capabilities (the potential to carry out activities; a skill is a narrow task ability, a capability combines skills, e.g. market research, advertising and production skills combined into new product development) and attitude (the organization's mindset, disposition or will, e.g. quality-driven or competitively aggressive).

Durand: a firm has a competence when knowledge, capabilities and attitude are aligned (Honda's engines, Walmart's inventory control, Amazon's service). Prahalad and Hamel use "core competences" more technologically. Practical problems: resources are hard to categorise (human resources are both tangible and intangible; intangibles can be made tangible by codifying them in patents, programs or contracts) and, more importantly, hard to identify, because knowledge is tacit, capabilities are embedded in routines (Nelson and Winter) and attitudes feel like common sense. Comparing resources with rivals is even harder.

Sustaining competitive advantage

A competitive advantage is sustainable if it cannot be copied, substituted or eroded by rivals and is not made redundant by environmental developments (Porter). It depends on two factors:

• Competitive defendability: advantages based on a few distinct elements are easy to imitate; a distinct business model with an entirely different configuration raises barriers (traditional airlines failed to imitate Southwest, Ryanair and easyJet). Many argue the best defence is not building walls but "running faster": upgrading resources, value chain and offering faster than rivals.
• Environmental consonance: changing customer needs, channels, regulation, technologies and entrants can undermine the fit (Rumelt).

These two pose opposite demands: defendability suggests staying true to fundamental strengths, consonance requires continual adaptation. This is the root of the paradox of markets and resources.

The paradox of markets and resources: the Bally example

SWOT suggests matching strengths and weaknesses with opportunities and threats, but the two sides can pull in opposite directions. Bally, world leader in pinball machines in the 1990s, faced a shift to video games (Nintendo, Sega, Sony). The demand for market adaptation pushed it to follow customer preferences and find a defensible market position, requiring agility in changing offering, value chain and resource base. The demand for resource leveraging pushed it to exploit years of investment in electromechanical manufacturing, since building new competences takes time, money and risk; the danger is "to excel at something of increasing irrelevance". Bally's synthesis: redirecting its resources to slot machines, a fast-growing market where its electromechanical and game-making expertise fitted.

The outside-in perspective in more detail

Successful firms are externally oriented and market-driven (Day; Jaworski and Kohli): markets are leading, resources are following. Strategy begins with analysing the environment for attractive opportunities, then defending the position by adapting to changes. Also called the positioning approach (Mintzberg et al.). Positioning is not short-term opportunism: superior positions are hard to attain but give sustained profitability. Porter argues that niche and differentiation positions can be profitable even if another firm has the lowest cost; others (Buzzell and Gale, PIMS) stress the value of market leadership (economies of scale, customer risk aversion, bargaining power, ability to block entrants). Managers need to know "what makes the market tick" (the rules of the game), anticipate and even initiate changes. The resource base is only a limiting condition; market-driven firms are often first to see which resources are needed, giving a first mover advantage, and can use alliances to access resources. Example: Riot Games (League of Legends), "Player Experience First", free-to-play model.

The inside-out perspective in more detail

Strategies should be built around a company's strengths: resources are leading, markets following; market positioning is vital but tactical. Proponents stress competences over tangible assets: resource-based view (Wernerfelt, Barney), competence-based view (Prahalad and Hamel) and capabilities-based view (Stalk et al.; Teece, Pisano and Shuen). Competences are not "plug-and-play" components for sale, but must be built through hard work and experience, so rivals need a long time to catch up. The nightmare scenario is a firm that flexibly follows every market shift and builds an eclectic set of non-distinctive competences. The shadow side: competences are hard to unlearn; core competences can become core rigidities (Leonard-Barton), like a concert pianist who cannot switch to saxophone. Firms should therefore first try to find or create a market that suits their competences. Example: Dyson, applying its technological know-how (cyclones, motors, airflow) to vacuum cleaners, hand dryers, fans and electric cars.

Managing the paradox: dynamic capabilities as the basis of juxtaposing

In parallel processing (spatial separation) sales analyses client demands, competitors and industry dynamics to position the firm, while R&D leverages resources to create unique value propositions; the paradox is managed one level up, in the boardroom. In juxtaposing, managers with higher positions accommodate both demands at the same time using dynamic capabilities: "the distinct skills, processes, procedures, organizational structures, decision rules and disciplines that form the basis of a company's ability to sense, seize and reconfigure capabilities" (Teece, Pisano and Shuen). Juxtaposing is the continuous creation of a dynamic equilibrium: firms keep upgrading competences against imitators and defending market positions, while developing new capabilities for a changing environment, on a project basis, within one unit or at a higher level.

Business level strategy in international perspective

No national preferences have been found yet (perhaps because the resource-based view emerged only in the 1980s). Possible influences:

• Mobility barriers: where government regulation (import quotas, licences, subsidies), union resistance, customer loyalty or powerful families protect incumbents, market positions are harder to obtain than resources, favouring outside-in thinking; in dynamic economies positions are easily challenged unless based on distinctive resources.
• Resource mobility: where dominant industries use simple, abundant resources, market positions matter more; where industries use complex bundles of resources developed over many years, resources are emphasised (Peng).
• Industry level: primary sector industries lean to inside-out, the tertiary (service) sector to outside-in; engineering and heavy industries (few marketers) tend inside-out, B2C industries outside-in.
• Personal level: education shapes preference; marketers lean outside-in, HR and R&D people inside-out. Strategists should be aware of their own bias.

Readings in the book's framing

Reading 4.1 (Day and Moorman) gives three lessons from winning companies: they take an outside-in approach, they use market insight ("deep and integrated knowledge that reveals patterns and identifies opportunities", more than data) and every part of the firm focuses on achieving, sustaining and profiting from customer value. Reading 4.2 (Barney) rests on two assumptions of the resource-based view: resource heterogeneity (firms have different resources) and resource immobility (resources cannot easily be transferred or copied). Reading 4.3 (Ambrosini, Bowman and Collier) bridges the perspectives with dynamic capabilities; the three levels relate to managers' perceptions of environmental dynamism. Incremental and renewing dynamic capabilities are usually what the literature calls dynamic capabilities; regenerative capabilities change the way the firm changes its resource base and may come from inside or from outside (new leadership, external change agents). Key works in the dynamic capabilities stream: Teece, Pisano and Shuen (1997), Eisenhardt and Martin (2000), Teece (2007) and McGrath's The End of Competitive Advantage (2013).