MODULE 4

Strategic Management

SESSION TOPIC 4: Competitive Advantage Through Functional Level Strategies

LEARNING OUTCOMES:
The following specific learning objectives are expected to be realized at the end of the session:
1. To explain how an enterprise can use functional-level strategies to increase its efficiency
2. To explain how an enterprise can use functionallevel strategies to increase its customer responsiveness

KEY POINT

Positioning strategy

CORE CONTENT
Introduction:
This module presents a comprehensive look at functional-level strategies: those aimed at improving the
effectiveness of a company’s operations and its ability to attain superior efficiency, quality, innovation, and customer
responsiveness.

Distinctive competencies shape the functional-level strategies that a company can pursue. Managers, through
their choices related to functional-level strategies, can build resources. and capabilities that enhance a company’s
distinctive competencies. Also, note that a company’s ability to attain superior efficiency, quality, innovation, and customer
responsiveness will determine if its product offering is differentiated from that of rivals, and if it has a low-cost structure.
Recall that companies that increase the value (utility) consumers get from their products through differentiation, while
simultaneously lowering their cost structure, create more value than their rivals—and this leads to a competitive
advantage, superior profitability, and profit growth.

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ACHIEVING SUPERIOR EFFICIENCY
A company is a device for transforming inputs (labor, land, capital, management, and technological knowhow) into
outputs (the goods and services produced). The simplest measure of efficiency is the quantity of inputs that it takes to
produce a given output; that is, efficiency = outputs/inputs. The more efficient a company, the fewer the inputs required to
produce a given output, and therefore the lower its cost structure. Put another way, an efficient company has higher
productivity, and therefore lower costs, than its rivals. Here are the steps that companies can take at the functional level to
increase their efficiency and thereby lower cost structure.

Efficiency and Economies of Scale

Economies of scale are unit cost reductions associated with a large scale of output. It is very important for
managers to understand how the cost structure of their enterprise varies with output because this understanding should
help to drive strategy. For example, if unit costs fall significantly as output is expanded—that is, if there are significant
economies of scale—a company may benefit by keeping prices down and increasing volume.
One source of economies of scale is the ability to spread fixed costs over a large production volume. Fixed costs
are costs that must be incurred to produce a product regardless of the level of output; examples are the costs of
purchasing machinery, setting up machinery for individual production runs, building facilities, advertising, and research
and development (R&D).
Another source of scale economies is the ability of companies producing in large volumes to achieve a greater
division of labor and specialization. Specialization is said to have a favorable impact on productivity, primarily because it
enables employees to become very skilled at performing a particular task.

The concept of scale economies

means that as company increases its
output, unit costs decrease. This
process comes to an end at an output
of Q1, where all scale economies are
exhausted. Indeed, at outputs of
greater than Q1, the company may
encounter diseconomies of scale,
which are the unit cost increases
associated with a large scale of
output. Larger enterprises have a
tendency to develop extensive
managerial hierarchies in which
dysfunctional political behavior is
commonplace. Information about
operating matters can accidentally and
deliberately be distorted by the
number of managerial layers through
which the information must travel to
reach top decision makers. The result
is poor decision making. Therefore, past a specific point—such as Q1—inefficiencies result from such developments, and
outweigh any additional gains from economies of scale. As output expands, unit costs begin to rise.

Efficiency and Learning Effects

Learning effects are cost savings that come from learning by doing. Labor, for example, learns by repetition how
to best carry out a task. Therefore, labor productivity increases over time, and unit costs decrease as individuals learn the
most efficient way to perform a particular task. Equally important, management in new manufacturing facilities typically
learns over time how best to run the new operation. Hence, production costs decline because of increasing labor
productivity and management efficiency. No matter how complex the task is, however, learning effects typically diminish in
importance after a period of time. Indeed, it has been suggested that they are most important during the start-up period of
a new process, and become trivial after 2 or 3 years. When changes occur to a company’s production system—as a result
of the use of new information technology, for example—the learning process must begin again.

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Efficiency and the Experience Curve
The experience curve refers to the systematic lowering of the cost structure, and consequent unit cost
reductions, that have been observed to occur over the life of a product. According to the experience-curve concept, per-
unit production costs for a product typically decline by some characteristic amount each time accumulated output of the
product is doubled (accumulated output is the total output of a product since its introduction). The strategic significance of
the experience curve is clear: increasing a company’s product volume and market share will lower its cost structure
relative to its rivals.

Company B has a cost advantage over Company A because of its lower cost structure, and because it is farther down the
experience curve. Managers should not become complacent about efficiency-based cost advantages derived from
experience effects. First, because neither learning effects nor economies of scale are sustained forever, the experience
curve is likely to bottom out at some point; it must do so by definition. Over time, other companies can lower their cost
structures and match the cost leader. Second, cost advantages gained from experience effects can be made obsolete by
the development of new technologies.

Efficiency, Flexible Production Systems, and Mass Customization

Central to the concept of economies of scale is the idea that a lower cost structure, through the mass production
of a standardized output, is the best way to achieve high efficiency. The tradeoff implicit in this idea is between unit costs
and product variety. Producing greater product variety from a factory implies shorter production runs, which implies an
inability to realize economies of scale, and thus higher costs.
This view of production efficiency has been challenged by the rise of flexible production technologies. The term
flexible production technology covers a range of technologies designed to reduce setup times for complex equipment,
increase the use of individual machines through better scheduling, and improve quality control at all stages of the
manufacturing process. Flexible production technologies allow the company to produce a wider variety of end products at
a unit cost that at one time could be achieved only through the mass production of a standardized output. Research
suggests that the adoption of flexible production technologies may increase efficiency and lower unit costs relative to what
can be achieved by the mass production of a standardized output, while at the same time enabling the company to
customize its product offering to a much greater extent than was once thought possible. The term mass customization
has been coined to describe the company’s ability to use flexible manufacturing technology to reconcile two goals that
were once thought to be incompatible: low cost and differentiation through product customization

Marketing and Efficiency

The marketing strategy that a company adopts can have a major impact on efficiency and cost structure.
Marketing strategy refers to the position that a company takes with regard to market segmentation, pricing, promotion,
advertising, product design, and distribution. Some of the steps leading to greater efficiency are fairly obvious. For

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example, moving down the experience curve to achieve a lower cost structure can be facilitated by aggressive pricing,
promotions, and advertising—all of which are the task of the marketing function. Other aspects of marketing strategy have
a less obvious—but no less important impact—on efficiency. One important aspect is the relationship of customer
defection rates, cost structure, and unit costs. Customer defection (or “churn rates”) are the percentage of a
company’s customers who defect every year to competitors. Defection rates are determined by customer loyalty, which in
turn is a function of the ability of a company to satisfy its customers. Because acquiring a new customer often entails one-
time fixed costs, there is a direct relationship between defection rates and costs. The longer a company retains a
customer, the greater the volume of customer-generated unit sales that can be set against these fixed costs, and the
lower the average unit cost of each sale. Thus, lowering customer defection rates allows a company to achieve a lower
cost structure.
A central component of developing a strategy to reduce defection rates is to identify customers who have
defected, find out why they defected, and act on that information so that other customers do not defect for similar reasons
in the future. To take these measures, the marketing function must have information systems capable of tracking
customer defections.

MATERIALS MANAGEMENT, JUST-IN-TIME SYSTEMS, AND EFFICIENCY

The contribution of materials management (logistics) to boosting the efficiency of a company can be just as
dramatic as the contribution of production and marketing. Materials management encompasses the activities necessary to
get inputs and components to a production facility (including the costs of purchasing inputs), through the production
process, and out through a distribution system to the end-user. Improving the efficiency of the materials-management
function typically requires the adoption of a just-in-time (JIT) inventory system, which is designed to economize on
inventory holding costs by scheduling components to arrive at a manufacturing plant just in time to enter the production
process, or to have goods arrive at a retail store only when stock is almost depleted. The major cost saving comes from
increasing inventory turnover, which reduces inventory holding costs, such as warehousing and storage costs.
The drawback of JIT systems is that they leave a company without a buffer stock of inventory. Although buffer
stocks are expensive to store, they can help a company prepare for shortages on inputs brought about by disruption
among suppliers (for instance, a labor dispute at a key supplier), and can help a company respond quickly to increases in
demand. However, there are ways around these limitations. For example, to reduce the risks linked to dependence on just
one supplier for an important input, a company might decide to source inputs from multiple suppliers.

R&D Strategy and Efficiency

The role of superior research and development (R&D) in helping a company achieve a greater efficiency and a
lower cost structure is twofold. First, the R&D function can boost efficiency by designing products that are easy to
manufacture. By cutting down on the number of parts that make up a product, R&D can dramatically decrease the
required assembly time, which results in higher employee productivity, lower costs, and higher profitability.
Pioneering process innovations is the second way in which the R&D function can help a company achieve a lower
cost structure. A process innovation is a new, unique way that production processes can operate to improve their
efficiency. Process innovations have often been a major source of competitive advantage.

Human Resource Strategy and Efficiency

Employee productivity is one of the key determinants of an enterprise’s efficiency, cost structure, and profitability.
Productive manufacturing employees can lower the cost of goods sold as a percentage of revenues, a productive sales
force can increase sales revenues for a given level of expenses, and productive employees in the company’s R&D
function can boost the percentage of revenues generated from new products for a given level of R&D expenses. Thus,
productive employees lower the costs of generating revenues, increase the return on sales, and, by extension, boost the
company’s return on invested capital. The challenge for a company’s human resource function is to devise ways to
increase employee productivity. Among its choices are using certain hiring strategies, training employees, organizing the
workforce into self-managing teams, and linking pay to performance.

 Hiring Strategy Many companies that are well known for their productive employees devote considerable
attention to hiring. Southwest Airlines hires people who have a positive attitude and who work well in teams
because it believes that people who have a positive attitude will work hard and interact well with customers,
therefore helping to create customer loyalty. The people a company hires should have attributes that match the
strategic objectives of the company.

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  Employee Training Employees are a major input into the production process. Those who are highly skilled can
perform tasks faster and more accurately, and are more likely to learn the complex tasks associated with many
modern production methods than individuals with lesser skills. Training upgrades employee skill levels, bringing
the company productivity-related efficiency gains from learning and experimentation.

 Self-Managing Teams The use of self-managing teams, whose members coordinate their own activities and
make their own hiring, training, work, and reward decisions, has been spreading rapidly. The typical team
comprises 5 to 15 employees who produce an entire product or undertake an entire task. Team members learn all
team tasks and rotate from job to job. Because a more flexible workforce is one result, team members can fill in
for absent coworkers and take over managerial duties such as scheduling work and vacation, ordering materials,
and hiring new members. The greater responsibility thrust on team members and the empowerment it implies are
seen as motivators. (Empowerment is the process of giving lower-level employees decision-making power.)
People often respond well to being given greater autonomy and responsibility. Performance bonuses linked to
team production and quality targets work as an additional motivator.

 Pay for Performance It is hardly surprising that linking pay to performance can help increase employee
productivity, but the issue is not quite so simple as just introducing incentive pay systems. It is also important to
define what kind of job performance is to be rewarded and how. Some of the most efficient companies in the
world, mindful that cooperation among employees is necessary to realize productivity gains, link pay to group or
team (rather than individual) performance

Information Systems and Efficiency

The impact of information systems on productivity is wide ranging and potentially affects all other activities of a
company. The theory behind Internet-based retailers such as Amazon.com is that replacing physical stores and their
supporting personnel with an online virtual store and automated ordering and checkout processes allows a company to
take significant costs out of the retailing system. Cost savings can also be realized by using Web-based information
systems to automate many internal company activities, from managing expense reimbursements to benefits planning and
hiring processes, thereby reducing the need for internal support personnel.

Infrastructure and Efficiency

A company’s infrastructure—that is, its structure, culture, style of strategic leadership, and control system—
determines the context within which all other value creation activities take place. It follows that improving infrastructure
can help a company increase efficiency and lower its cost structure. Above all, an appropriate infrastructure can help
foster a companywide commitment to efficiency, and promote cooperation among different functions in pursuit of
efficiency goals Achieving superior efficiency requires a companywide commitment to this goal that must be articulated by
general and functional managers. A further leadership task is to facilitate the cross-functional cooperation needed to
achieve superior efficiency.

ACHIEVING SUPERIOR QUALITY

High-quality products are reliable, do well the job for which they were designed, and are perceived by consumers to have
superior attributes.

Attaining Superior Reliability

The principal tool that most managers now use to increase the reliability of their product offering is the Six Sigma quality
improvement methodology. The Six Sigma methodology is a direct descendant of the total quality management (TQM)
philosophy that was widely adopted, first by Japanese companies and then by American companies, during the 1980s
and early 1990s. The TQM concept was developed by a number of American management consultants, including W.
Edwards Deming, Joseph Juran, and A. V. Feigenbaum. The philosophy underlying TQM, as articulated by Deming, is
based on the following five-step chain reaction:
1. Improved quality means that costs decrease because of less rework, fewer mistakes, fewer delays, and better use
of time and materials.
2. As a result, productivity improves.
3. Better quality leads to higher market share and allows the company to raise prices.
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4. Higher prices increase the company’s profitability and allow it to stay in business.
5. Thus, the company creates more jobs

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Implementing Reliability Improvement Methodologies
What needs to be stressed first,
however, is that improvement in product
reliability is a cross-functional process. Its
implementation requires close cooperation
among all functions in the pursuit of the common
goal of improving quality; it is a process that
works across functions
Implementing quality improvement
methodologies requires organization-wide
commitment and substantial cooperation among
functions. R&D must cooperate with production
to design products that are easy to manufacture;
marketing must cooperate with production and
R&D so that customer problems identified by
marketing can be acted on; and human resource
management must cooperate with all the other
functions of the company in order to devise
suitable quality-training programs.
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Improving Quality as Excellence
Products can also be differentiated by attributes that collectively define product excellence. These attributes
include the form, features, performance, durability, and styling of a product. In addition, a company can create quality as
excellence by emphasizing attributes of the service associated with the product, such as ordering ease, prompt delivery,
easy installation, the availability of customer training and consulting, and maintenance services.

ACHIEVING SUPERIOR INNOVATION

In many ways, innovation is the most important source of competitive advantage. This is because innovation can result in
new products that better satisfy customer needs, can improve the quality (attributes) of existing products, or can reduce
the costs of making products that customers want.

The High Failure Rate of Innovation

Although promoting innovation can be a source of competitive advantage, the failure rate of innovative new
products is high. Research evidence suggests that only 10 to 20% of major R&D projects give rise to commercial
products.

Five explanations for failure

1. Many new products fail because the demand for innovations is inherently uncertain.
2. New products often fail because the technology is poorly commercialized.
3. New products may fail because of poor positioning strategy.
4. Many new-product introductions fail because companies often make the mistake of marketing a technology for
which there is not enough demand.
5. Companies fail when products are slowly marketed.

Reducing Innovation Failures

One of the most important things that managers can do to reduce the high failure rate associated with innovation
is to make sure that there is tight integration between R&D, production, and marketing. Tight cross-functional integration
can help a company ensure that:
1. Product development projects are driven by customer needs.
2. New products are designed for ease of manufacture.
3. Development costs are not allowed to spiral out of control.
4. The time it takes to develop a product and bring it to market is minimized.
5. Close integration between R&D and marketing is achieved to ensure that product development projects are driven
by the needs of customers.
ACHIEVING SUPERIOR RESPONSIVENESS TO CUSTOMERS

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To achieve superior responsiveness to customers, a company must give customers what they want, when they want it,
and at a price they are willing to pay—so long as the company’s long-term profitability is not compromised in the process.

Focusing on the Customer

A company cannot be responsive to its customers’ needs unless it knows what those needs are. Thus, the first step to
building superior responsiveness to customers is to motivate the entire company to focus on the customer.

 Demonstrating Leadership Customer focus must begin at the top of the organization. A commitment to superior
responsiveness to customers brings attitudinal changes throughout a company that can only be built through
strong leadership. A mission statement that puts customers first is one way to send a clear message to
employees about the desired focus. Another avenue is top management’s own actions. For example, Tom
Monaghan, the founder of Domino’s Pizza, stayed close to the customer by eating Domino’s pizza regularly,
visiting as many stores as possible every week, running some deliveries himself, and insisting that other top
managers do the same.

 Shaping Employee Attitudes Leadership alone is not enough to attain a superior customer focus. All employees
must see the customer as the focus of their activity, and be trained to focus on the customer—whether their
function is marketing, manufacturing, R&D, or accounting. The objective should be to make employees think of
themselves as customers—to put themselves in customers’ shoes. From that perspective, employees become
better able to identify ways to improve the quality of a customer’s experience with the company.
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 Knowing Customer Needs “Know thy
customer” is one of the keys to
achieving superior responsiveness to
customers. Knowing the customer not
only requires that employees think like
customers themselves; it also
demands that they listen to what
customers have to say. This involves
bringing in customers’ opinions by
soliciting feedback from customers on the company’s goods and services, and by building information systems
that communicate the feedback to the relevant people.

Satisfying Customer Needs

Once customer focus is an integral part of the company, the next requirement is to satisfy the customer needs that have
been identified.

 Customization Customization means varying the features of a good or service to tailor it to the unique needs or
tastes of groups of customers, or—in the extreme case—individual customers. Although extensive customization
can raise costs, the development of flexible manufacturing technologies has made it possible to customize
products to a greater extent than was feasible 10 to 15 years ago, without experiencing a prohibitive rise in cost
structure (particularly when flexible manufacturing technologies are linked with Web-based information systems).

 Response Time To gain a competitive advantage, a company must often respond to customer demands very
quickly, whether the transaction is a furniture manufacturer’s delivery of a product once it has been ordered, a
bank’s processing of a loan application, an automobile manufacturer’s delivery of a spare part for a car that broke
down, or the wait in a supermarket checkout line. We live in a fast-paced society, where time is a valuable
commodity. Companies that can satisfy customer demands for rapid response build brand loyalty, differentiate
their products, and can charge higher prices for products.

IN-TEXT ACTIVITY
Positioning strategy
It is the specific set of options a company adopts for a product based upon four main dimensions of marketing: price,
distribution, promotion and advertising, and product features. Apart from poor design, another reason for the failure of
Windows Mobile phones was poor positioning strategy. They were targeted at business users, whereas Apple developed
a mass market by targeting the iPhone at retail consumers.

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SESSION SUMMARY
A company can increase efficiency through a number of steps: exploiting economies of scale and learning effects;
adopting flexible manufacturing technologies; reducing customer defection rates; implementing just-in-time systems;
getting the R&D function to design products that are easy to manufacture; upgrading the skills of employees through
training; introducing self-managing teams; linking pay to performance; building a companywide commitment to efficiency
through strong leadership; and designing structures that facilitate cooperation among different functions in pursuit of
efficiency goals.

SELF-ASSESSMENT
Case study:
Is it ethical for Wal-Mart to pay its employees minimum wage and to oppose unionization, given that the organization also
works its people very hard? Are Wal-Mart’s employment and compensation practices for lower-level employees ethical?

REFERENCES
Refer to the references listed in the syllabus of the subject.

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