Write a 2-4 page executive memo to the CEO of ConAgra arguing for or against a stock market valuation focus at the current time (contemporaneous with the case). Note that you are not making a case for including stock price among the CEO's concerns -- you are arguing for him to make this his primary focus or not at the present time of the case. Be sure to include at least a brief discussion of the supply chain in this assessment/recommendation.
Creating Competitive Advantage 9-798-062 R E V : F E B R U A R Y 2 5 , 2 0 0 6 ________________________________________________________________________________________________________________ Professors Pankaj Ghemawat and Jan W. Rivkin prepared this note as the basis for class discussion. It is based in part on earlier notes by Pankaj Ghemawat, Tarun Khanna, and Anita McGahan. Copyright © 1998 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School. P A N K A J G H E M A W A T J A N W . R I V K I N Creating Competitive Advantage Some companies generate far greater profits than others. The pharmaceutical maker Schering- Plough produced an economic profit of more than $10 billion during the period 1984-2002. That is, the accounting profit it generated exceeded its cost of equity capital by that amount. Over the same period, U.S. Steel produced an economic loss of nearly $500 million; its cost of capital exceeded its accounting profit by a wide margin. Such large differences in economic performance are commonplace. Understanding their roots is crucial for strategists. Differences in industry structure shed some light on such differences in performance.1 To a certain extent, Schering-Plough has generated more economic profit than U.S. Steel because the pharmaceutical industry is structurally more attractive than the steel industry. Rivalry in the pharmaceutical market is muted by factors such as patent protection, product differentiation, and expanding demand; in contrast, rivalry in the steel industry is fierce—fueled by excess capacity, limited differences across products, and slow growth. Many pharmaceutical users hesitate to switch among products or brands, while steel customers are usually willing to switch among producers to get a better price. Many pharmaceuticals are made from commodities with little labor input, while unions exercise such power in the steel industry that labor costs often account for a quarter of total revenue. Such contrasts in industry-level competitive forces are one reason that the profit levels of firms in different industries differ. Figure 1 shows, for each of many industries, the spread between the industry’s return on equity and its cost of equity (the vertical axis) and the average equity in the industry (the horizontal axis) for the period 1984-2002. Reflecting differences in industry-level competitive forces, the pharmaceutical industry has been among the greatest generators of economic profit, while the steel industry as a whole has produced losses. The typical pharmaceutical maker is far more profitable than the typical steel producer.2 Schering-Plough, however, is not a “typical pharmaceutical maker,” nor is U.S. Steel a “typical steel producer.” As Figures 2a and 2b illustrate, industry averages can mask large differences in economic profit within industries. Schering-Plough was far more effective at producing economic profits than were many drug makers during the 1984-2002 period, while U.S. Steel performed far worse than many other steel producers. Indeed, recent research indicates that intra-industry differences in profitability like those shown in Figures 2a and 2b may be larger than differences across industries such as those in Figure 1.3 Industry-level effects appear to account for 10-20% of the variation in business profitability while stable within-industry effects account for 30-45%. (Most of the remainder can be assigned to effects that fluctuate from year to year.) For the exclusive use of M. CONTA, 2021. This document is authorized for use only by MUHAMMED CONTA in MGMT-6025 Strategic Perspectives of Global Management FA 2021 taught by MICHAEL FORTUNATO, Williams College from Aug 2021 to Feb 2022. 798-062 Creating Competitive Advantage 2 Figure 1 Economic Profits of U.S. Industry Groups, 1984-2002 Source: Compustat, Value Line, Marakon Associates analysis Figure 2a Economic Profits in the Pharmaceutical Industry, 1984-2002 Source: Compustat, Value Line, Marakon Associates analysis Avg. Spread (1984-2002) Avg. Equity ($B) (1984-2002) (20%) (10%) 0% 10% 20% 30% 40% 0 200 400 600 800 1,000 1,200 1,400 1,600 1,800 2,000 Tele Service Semiconduct Air Transport Textile Steel Railroad Paper & For. For El/Ent. For Telecom Power Entertain Toiletry & Cosmetic Soft Drinks Pharmaceutical Med Supplies Computer Software Tobacco Publishing Financial Services Bank Retail Store Petro-Integergrated Aerospace/ Defense Computers & Peripherals Auto Parts Building Materials Insurance Property & Casualty Auto & Truck Avg. Spread (1984-2002) Avg. Equity ($B) (1984-2002) (20%) (10%) 0% 10% 20% 30% 40% 0 200 400 600 800 1,000 1,200 1,400 1,600 1,800 2,000 Tele Service Semiconduct Air Transport Textile Steel Railroad Paper & For. For El/Ent. For Telecom Power Entertain Toiletry & Cosmetic Soft Drinks Pharmaceutical Med Supplies Computer Software Tobacco Publishing Financial Services Bank Retail Store Petro-Integergrated Aerospace/ Defense Computers & Peripherals Auto Parts Building Materials Insurance Property & Casualty Auto & Truck Avg. Spread (1984-2002) Avg. Equity ($B) (1984-2002) (80%) (60%) (40%) (20%) 0% 20% 40% 0 5 10 15 20 25 30 35 40 45 50 Merck & Co Schering-Plough Bristol Myers Squibb Pfizer Inc Wyeth Lilly (Eli) & Co Barr Laboratories Inc Novartis AG - ADR King Pharmaceuticals Inc Albany Molecular Resh Inc Covance Inc Mylan Laboratories Watson Pharmaceuticals Inc Forest Laboratories -Cl A Pharmaceutical Prod Dev Inc Novo-Nordisk A/S -ADR Idec Pharmaceuticals Corp Perrigo Co Ivax Corp Andrx Corp Medicis Pharmaceut Cp -Cl A Genzyme Corp Parexel International Corp Aventis Sa -ADR Chiron Corp Protein Design Labs Inc Sicor Inc Gilead Sciences Inc Enzon Pharmaceuticals Inc Abgenix Inc Cephalon Inc Neurocrine Biosciences Inc Tularik Inc Medimmune Inc Medarex Inc Celgene Corp Nektar Therapeutics Quintiles Transnational Corp Icn Pharmaceuticals Inc Avg. Spread (1984-2002) Avg. Equity ($B) (1984-2002) (80%) (60%) (40%) (20%) 0% 20% 40% 0 5 10 15 20 25 30 35 40 45 50 Merck & Co Schering-Plough Bristol Myers Squibb Pfizer Inc Wyeth Lilly (Eli) & Co Barr Laboratories Inc Novartis AG - ADR King Pharmaceuticals Inc Albany Molecular Resh Inc Covance Inc Mylan Laboratories Watson Pharmaceuticals Inc Forest Laboratories -Cl A Pharmaceutical Prod Dev Inc Novo-Nordisk A/S -ADR Idec Pharmaceuticals Corp Perrigo Co Ivax Corp Andrx Corp Medicis Pharmaceut Cp -Cl A Genzyme Corp Parexel International Corp Aventis Sa -ADR Chiron Corp Protein Design Labs Inc Sicor Inc Gilead Sciences Inc Enzon Pharmaceuticals Inc Abgenix Inc Cephalon Inc Neurocrine Biosciences Inc Tularik Inc Medimmune Inc Medarex Inc Celgene Corp Nektar Therapeutics Quintiles Transnational Corp Icn Pharmaceuticals Inc For the exclusive use of M. CONTA, 2021. This document is authorized for use only by MUHAMMED CONTA in MGMT-6025 Strategic Perspectives of Global Management FA 2021 taught by MICHAEL FORTUNATO, Williams College from Aug 2021 to Feb 2022. Creating Competitive Advantage 798-062 3 Figure 2b Economic Profits in the Steel Industry, 1984-2002 Source: Compustat, Value Line, Marakon Associates analysis In light of this, strategists need a systematic way to understand and analyze within-industry differences in performance. Toward that end, this note uses the notion of competitive advantage. A firm is said to have a competitive advantage over its rivals if it has driven a wide wedge between the willingness to pay it generates among buyers and the costs it incurs—indeed, a wider wedge than its competitors have achieved.4 A firm with a competitive advantage is positioned to earn superior profits within its industry. In examining the logic of how firms create competitive advantage, this note emphasizes two themes. First, to create an advantage, a firm must configure itself to do something unique and valuable. The firm must ensure that, were it to disappear, someone in its network of suppliers, customers, and complementors would miss it and no one could replace it perfectly.5 The first section of the note uses the concept of “added value” to make this point more precisely. Second, competitive advantage usually comes from the full range of a firm’s activities— from production to finance, from marketing to logistics—acting in harmony. The essence of creating advantage is finding an integrated set of choices that distinguishes a firm from its rivals. The second section of the note shows how managers can analyze the full range of activities to understand the sources of competitive advantage. As a preface to the main discussion, it is important to address a few possible misconceptions. Creating vs. sustaining competitive advantage. The note separates the challenge of creating competitive advantage at a point in time from the problem of sustaining advantage over time. In reality, the two issues are married: the choices that establish a firm’s advantage also influence whether the advantage can be sustained. For instance, in launching its personal financial software “Quicken,” Intuit chose to offer customers outstanding post-sale assistance over the telephone. Customers valued the help from trained operators, and customer service became a tool for creating competitive advantage. Moreover, customer service helped Intuit sustain its advantage over rivals such as Microsoft. Competitors found it hard to match Intuit’s service operations and its reputation Avg. Spread (1984-2002) Avg. Equity ($B) (1984-2002) Worthington Industries Gibraltar Steel Corp Nucor Corp Steel Technologies Commercial Metals Quanex Corp Carpenter Technology Cleveland-Cliffs Inc United States Steel Corp AK Steel Holding Corp Ampco-Pittsburgh Corp Dofasco Inc Ryerson Tull Inc (14%) (12%) (10%) (8%) (6%) (4%) (2%) 0% 2% 4% 6% 0 1 2 3 4 5 6 7 8 Avg. Spread (1984-2002) Avg. Equity ($B) (1984-2002) Worthington Industries Gibraltar Steel Corp Nucor Corp Steel Technologies Commercial Metals Quanex Corp Carpenter Technology Cleveland-Cliffs Inc United States Steel Corp AK Steel Holding Corp Ampco-Pittsburgh Corp Dofasco Inc Ryerson Tull Inc (14%) (12%) (10%) (8%) (6%) (4%) (2%) 0% 2% 4% 6% 0 1 2 3 4 5 6 7 8 For the exclusive use of M. CONTA, 2021. This document is authorized for use only by MUHAMMED CONTA in MGMT-6025 Strategic Perspectives of Global Management FA 2021 taught by MICHAEL FORTUNATO, Williams College from Aug 2021 to Feb 2022. 798-062 Creating Competitive Advantage 4 for excellent support. In addition, Intuit used information from its service operations to generate a stream of ideas for improving its product.6 Despite the connections between creating and sustaining advantage, we find it important to