Leaders and managers are faced with difficult decisions every day. Even process-level decisions must be made with the firm’s overall strategy in mind. The difficulty is that business strategy is a topic that is often described in complex or unclear terms, leaving the reader still incapable of making strategically sound decisions.
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Transitioning from my formal background in economics to my career in business, I was challenged to teach strategy to many firms without numbing the audience with mindless economic graphs of the demand curve and strategic progressions. As a result, I have developed a series of easier-to-read diagrams that more simply and clearly explain business strategies. By asking a series of logical questions, we can understand how strategies arise, how they work, and their implications. This article is designed to give the reader more clarity about the topic of business strategy to help guide everyday leadership and management decisions.
What is an advantage?
Webster’s defines an advantage as “a superiority of position or condition” or a “benefit resulting from some course of action.”
What is a competitive advantage in business?
Having a product or service offering that is different than competitor offerings in such a way that customers perceive it to be more valuable.
How do customers perceive value?
The value equation: Value = Benefit–Price
Given the logic of the value equation, value is the extra benefit that is derived from the product or service above and beyond the price point.
In which ways can a business maximize its value offering?
Option A: maximize benefit. By leading in marketing and product or service innovation, a firm can understand customer needs and problems, and then innovate to fulfill those needs and offer solutions more effectively than competitors.
Providing additional benefit to customers often requires additional costs to the seller. These additional costs can be offset through higher pricing if the seller is truly offering additional benefit to the customer. But if the improvement is not valued by customers, it is not a true benefit, and it is not an advantage.
A benefit advantage arises when the offering is such that it is perceived as being better than other competitive offerings.
Option B: minimize price. By first focusing on initiatives and innovations that reduce the business’ cost structure, a lower price can be offered to the customer.
Note that offering lower prices without first reducing cost structure is not a true sustainable advantage because it does not necessarily lead to increased profit. Instead, this error reduces margins and possibly instigates a price war.
When is an advantage achieved?
An advantage is only achieved when the strategic firm’s offering leads its industry in terms of benefit provision or price (which is warranted by having the lowest cost structure in the industry).
The graph below shows Strategic Option A, a benefit advantage
In this benefit advantage graph, we observe that Firm A has achieved a benefit advantage over its competitor. Again, note that in many cases, Firm A’s cost structure would rise to some extent as a result of providing the additional benefit, but if the additional benefit is a truly valuable differentiating factor in the eyes of customers, then Firm A’s price can be raised by as much, or more than, the increase in costs.
The graph below shows Strategic Option B, a cost advantage
In this graph, we observe that Firm A has successfully achieved a cost advantage. Note that the advantage is measured by the customer in terms of the reduced price, but it is the reduction in Firm A’s cost structure that has enabled the firm to offer such low prices in a sustainable way. Without a uniquely configured value chain that enables Firm A to achieve the lowest cost structure in its industry, a price cut would merely represent a reduction in margins (i.e., profit). Price adjustments that happen without cost structure precedence should only be made when the firm understands its demand curve, as well as the elasticity of that demand. Only then will the firm understand the degree to which a price cut would increase sales volume and the level of profit that would result.
How does a business achieve an advantage?
An advantage is achieved by listening to and understanding market needs and developing a strategic plan that maximizes the value offering to the market by either maximizing benefit or minimizing cost structure to offer minimized prices. With the strategic pathway rationally determined, the strategic firm sets out to achieve its desired advantage by innovating to improve its processes.
We typically think of innovation as the function that develops product and services, but innovation is more than that. Robert Price said in a speech about leadership and innovation that “innovation is problem solving—using technology or know-how, sometimes new but more often old, to find a better, cheaper, faster way to meet some need better than ever before.”
Innovation is not only about improving products and services, but also processes. With a clear strategy for maximizing the value proposition, the firm’s focus must be turned toward its processes. Processes must be improved and shaped in such a way that they contribute to either increasing the benefit that is offered to customers, or reducing cost structure to offer customers lower prices.
Can benefit and cost be treated in isolation?
No, benefit and cost cannot be treated in isolation. Value propositions are intuitively measured by the customer, based on both the level of benefit, and price. Buyers will seek the product or service that offers them the most benefit for its given price point, or the product or service that offers the lowest price for its given level of benefit.
Another way to say this is that if buyers perceive your product or service offering to have the same level of benefit to buyers as your competitors’ product or service, then they will choose the cheapest option. Likewise, if buyers perceive your product or service offering to have the same price as your competitors’ offering, or if price is not the most relevant factor to the buyer (i.e., the product or service is not elastic), then they will choose the offering with the highest perceived benefit.
For this reason, firms that have chosen to strive for a benefit advantage in their market must still be concerned with executing their operations in an efficient way. To do this, they may apply cost-reduction tools and techniques.
Firms that have chosen to compete using a cost advantage will also be concerned with the efficiency of their execution but will achieve their cost advantage only if they go beyond simple cost-reduction methods. They must innovate a unique process configuration that results in the industry’s lowest cost structure. By doing this, those who only use cost-reduction tools and techniques cannot imitate this cost structure and cannot compete based on price without price-cutting and reducing their own margins. Given its low price offering, the cost advantage provider must be concerned with offering an adequate level of benefit that will meet cost-sensitive customers’ needs.
What is the consequence of not selecting a clear, strategic path?
Failing to select and pursue a clear strategic pathway leads to what Michael Porter identified as being “stuck in the middle.” This means that the firm never gains any advantage because it has not committed to one path or the other. A firm that is stuck in the middle loses price-sensitive customers to firms that have focused on pursuing a cost advantage and have configured their organizations to be capable of offering the industry’s lowest prices. Benefit-sensitive customers buy from firms that have done proper marketing and specialize in offering the most benefit. A firm that is stuck in the middle only gains business from buyers who have not done their homework and buy without knowing their options. This firm gets business from customers due to the asymmetry of information, or severe and potentially detrimental price cuts, not from an advantage in its value proposition.
Because firms that are stuck in the middle have not selected a strategic path, they try to be all things to all people. They have not profiled their ideal customer, and so they are stuck with price-cutting and negating their own margins to try to win business. These firms offer a level of benefit that is above a cost-advantage provider and below a benefit provider, and their costs are higher than a cost advantage provider. Due to this situation, a firm that is stuck in the middle cuts prices to match that of a cost-advantage provider and wins business because it typically offers a higher level of benefit.
The flaw in this approach is that the firm absorbs the costs of offering more benefit than the cost-advantage provider and is forced to offer equally low prices. Logically, this means that the firm that is stuck in the middle experiences lower margins, and therefore lower profit, than if they were to select a clear strategic path.
Going forward
Make strategy a required competency for your organization’s leaders and managers. Start rationalizing your business decisions strategically and economically, considering the effects on the value offering to the customer and the profit to your firm. When everybody understands and agrees on the firm’s strategy for offering value, the people in your business can begin cooperatively shaping its processes and pulling the firm in the direction of your desired strategic path.
Comments
Strategy made simple
Angelo
Thank you for a good article. It´s not easy to simplify concepts. Congratulations
Fred Hermann
Unique Value Proposition
Thanks for the good article. The last two paras are key to continued business success.
The common consumer can chart Walmart Vs Target or Amazon Vs BestBuy in making informed decisions.
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