Value-Created

Competitive Advantage and Value Creation: Conceptual Foundations • 301

for a buyer of aluminum cans, for example, a soft-drink bottler such as Coca-Cola Enterprises, is $100 per thousand (i.e., B 5 $100). This represents the highest price the buyer is willing to pay for aluminum cans before switching to the best available alternative product, perhaps plastic containers. The difference between maximum willingness- to-pay and cost is the value-created, which in this case equals $70 (i.e., B 2 C 5 $70). Working our way down the right side of the diagram, we see that value-created of $70 equals the sum of consumer surplus and producer profit. If the seller of aluminum cans charges a price of $55 (i.e., P 5 $55), consumer surplus is $45 per thousand cans (i.e., B 2 P 5 $45), while producer profit margin is $25 per thousand (i.e., P 2 C 5 $25). The price P thus determines how much of the value-created sellers capture as profit and how much buyers capture as consumer surplus.

Value Creation and “Win–Win” Business Opportunities

No product can be viable without creating positive economic value. If B 2 C was negative, there would be no price that consumers would be willing to pay for the product that would cover the cost of the resources that are sacrificed to make the product. Bubblegum-flavored soda, vacuum tubes, and video cassette recorders are products that at one time created positive value, but because of changes in tastes and technology, they no longer create enough benefits to consumers to justify their production.

By contrast, when B 2 C is positive, a firm can profitably purchase inputs from suppliers, convert them into a finished product, and sell it to consumers. When B . C, it will always be possible for an entrepreneur to strike win–win deals with input suppliers and consumers, that is, deals that leave all parties better off than they would be if they did not deal with each other. In economics, win–win trade opportunities are called gains from trade. When B . C, clever entrepreneurs can exploit potential gains from trade.

Value Creation and Competitive Advantage

Although a positive B 2 C is necessary for a product to be economically viable, just because a firm sells a product whose B 2 C is positive is no guarantee that it will make a positive profit. In a market in which entry is easy and all firms create essentially the same economic value, competition between firms will dissipate profitability. Existing firms and new entrants will compete for consumers by bidding down their prices to the point at which all producers earn zero profit. In such markets, consumers capture all the economic value that the product creates.

It follows, then, that in order for a firm to earn positive profit in a competitive industry, the firm must create more economic value than its rivals. That is, the firm must generate a level of B 2 C that its competitors cannot replicate. This simple but powerful insight follows from our earlier discussion of the competitive implications of consumer surplus. To see why, imagine that two sellers are competing for your business. The seller whose product characteristics and price provides you the greatest amount of consumer surplus will win your business. The most aggressive consumer surplus “bid” that either seller would be prepared to offer is the one at which its profit is equal to zero, which occurs when it offers a price P that equals its cost C. At such a bid, a firm would hand over all of the value it creates to you in the form of consumer surplus. The firm with the advantage in this competition is the one that has the highest B 2 C. This is because that firm will be able to win your patronage by offering you a slightly more favorable consumer surplus “bid” than the most aggressive bid its rival is prepared to offer, while retaining the extra value it creates in the form of profit.5

302 • Chapter 9 • Strategic Positioning for Competitive Advantage

In one version of the above competitive scenario, all firms offer identical B. In this case, the “winning” firm must have lower C than its rivals. This reaffirms an idea introduced in Chapter 5, that successful firms in perfectly competitive industries must have lower costs than their rivals. This also holds true in concentrated markets when firms compete aggressively on the basis of price, such as in the Bertrand model also described in Chapter 5. The firm with the lowest cost can slightly undercut its rivals’ prices, capture the entire market, and more than cover its production costs.

In markets with homogeneous products, the firm offering the highest B 2 C captures the entire market. In most markets, different customers will make different tradeoffs between price and the attributes that drive B, so that one firm might create a higher B 2 C among one segment of consumers, while another firm may create a higher B 2 C among other segments. We saw this, for example, in the personal computer industry in the late 1990s in which Gateway probably created more economic value in the SOHO (small office/home office) segment of the market, while Dell created more economic value in most of the rest of the market. As Figure 9.6 shows, both Dell and Gateway consistently outperformed industry peers during the latter half of the 1990s. We will discuss the implications of this market segmentation later in the chapter.

Analyzing Value Creation

Understanding how a firm’s product creates economic value and whether it can continue to do so is a necessary first step in diagnosing a firm’s potential for achieving a competitive advantage in its market. Diagnosing the sources of value creation requires

FIGURE 9.6

Economic Profitability of Personal Computer Makers

This figure shows average economic profits (expressed as a percentage of invested capital) of selected personal computer makers over the period 1995–1999.

Source: 2000 Stern Stewart Performance 1000 database.