HBR-Creating-Competitive-Advantage

9-798-062REV:FEBRUARY25,2006________________________________________________________________________________________________________________ProfessorsPankajGhemawatandJanW.Rivkinpreparedthisnoteasthebasisforclassdiscussion.ItisbasedinpartonearliernotesbyPankajGhemawat,TarunKhanna,andAnitaMcGahan.Copyright©1998PresidentandFellowsofHarvardCollege.Toordercopiesorrequestpermissiontoreproducematerials,call1-800-545-7685,writeHarvardBusinessSchoolPublishing,Boston,MA02163,orgoto—electronic,mechanical,photocopying,recording,orotherwise—withoutthepermissionofHarvardBusinessSchool.PANKAJGHEMAWATJANW.RIVKINCreatingCompetitiveAdvantageSomecompaniesgeneratefargreaterprofitsthanothers.ThepharmaceuticalmakerSchering-Ploughproducedaneconomicprofitofmorethan$10billionduringtheperiod1984-2002.Thatis,theaccountingprofititgeneratedexceededitscostofequitycapitalbythatamount.Overthesameperiod,U.S.Steelproducedaneconomiclossofnearly$500million;itscostofcapitalexceededitsaccountingprofitbyawidemargin.Suchlargedifferencesineconomicperformancearecommonplace.Understandingtheirrootsiscrucialforstrategists.Differencesinindustrystructureshedsomelightonsuchdifferencesinperformance.1Toacertainextent,Schering-PloughhasgeneratedmoreeconomicprofitthanU.S.Steelbecausethepharmaceuticalindustryisstructurallymoreattractivethanthesteelindustry.Rivalryinthepharmaceuticalmarketismutedbyfactorssuchaspatentprotection,productdifferentiation,andexpandingdemand;incontrast,rivalryinthesteelindustryisfierce—fueledbyexcesscapacity,limiteddifferencesacrossproducts,andslowgrowth.Manypharmaceuticalusershesitatetoswitchamongproductsorbrands,whilesteelcustomersareusuallywillingtoswitchamongproducerstogetabetterprice.Manypharmaceuticalsaremadefromcommoditieswithlittlelaborinput,whileunionsexercisesuchpowerinthesteelindustrythatlaborcostsoftenaccountforaquarteroftotalrevenue.Suchcontrastsinindustry-levelcompetitiveforcesareonereasonthattheprofitlevelsoffirmsindifferentindustriesdiffer.Figure1shows,foreachofmanyindustries,thespreadbetweentheindustry’sreturnonequityanditscostofequity(theverticalaxis)andtheaverageequityintheindustry(thehorizontalaxis)fortheperiod1984-2002.Reflectingdifferencesinindustry-levelcompetitiveforces,thepharmaceuticalindustryhasbeenamongthegreatestgeneratorsofeconomicprofit,whilethesteelindustryasawholehasproducedlosses.Thetypicalpharmaceuticalmakerisfarmoreprofitablethanthetypicalsteelproducer.2Schering-Plough,however,isnota“typicalpharmaceuticalmaker,”norisU.S.Steela“typicalsteelproducer.”AsFigures2aand2billustrate,industryaveragescanmasklargedifferencesineconomicprofitwithinindustries.Schering-Ploughwasfarmoreeffectiveatproducingeconomicprofitsthanweremanydrugmakersduringthe1984-2002period,whileU.S.Steelperformedfarworsethanmanyothersteelproducers.Indeed,recentresearchindicatesthatintra-industrydifferencesinprofitabilitylikethoseshowninFigures2aand2bmaybelargerthandifferencesacrossindustriessuchasthoseinFigure1.3Industry-leveleffectsappeartoaccountfor10-20%ofthevariationinbusinessprofitabilitywhilestablewithin-industryeffectsaccountfor30-45%.(Mostoftheremaindercanbeassignedtoeffectsthatfluctuatefromyeartoyear.)FortheexclusiveuseofS.Steinberg,2015.ThisdocumentisauthorizedforuseonlybySamanthaSteinberginStrategicManagementHonorstaughtbyDr.NileshKhare,atOHIOSTATEUNIVERSITYfromJanuary2015toMay2015.798-062CreatingCompetitiveAdvantage2Figure1EconomicProfitsofU.S.IndustryGroups,1984-2002Source:Compustat,ValueLine,MarakonAssociatesanalysisFigure2aEconomicProfitsinthePharmaceuticalIndustry,1984-2002Source:Compustat,ValueLine,MarakonAssociatesanalysisAvg.Spread(1984-2002)Avg.Equity($B)(1984-2002)(20%)(10%)0%10%20%30%40%02004006008001,0001,2001,4001,6001,8002,000TeleServiceSemiconductAirTransportTextileSteelRailroadPaper&For.ForEl/Ent.ForTelecomPowerEntertainToiletry&CosmeticSoftDrinksPharmaceuticalMedSuppliesComputerSoftwareTobaccoPublishingFinancialServicesBankRetailStorePetro-IntegergratedAerospace/DefenseComputers&PeripheralsAutoPartsBuildingMaterialsInsuranceProperty&CasualtyAuto&TruckAvg.Spread(1984-2002)Avg.Equity($B)(1984-2002)(20%)(10%)0%10%20%30%40%02004006008001,0001,2001,4001,6001,8002,000TeleServiceSemiconductAirTransportTextileSteelRailroadPaper&For.ForEl/Ent.ForTelecomPowerEntertainToiletry&CosmeticSoftDrinksPharmaceuticalMedSuppliesComputerSoftwareTobaccoPublishingFinancialServicesBankRetailStorePetro-IntegergratedAerospace/DefenseComputers&PeripheralsAutoPartsBuildingMaterialsInsuranceProperty&CasualtyAuto&TruckAvg.Spread(1984-2002)Avg.Equity($B)(1984-2002)(80%)(60%)(40%)(20%)0%20%40%05101520253035404550Merck&CoSchering-PloughBristolMyersSquibbPfizerIncWyethLilly(Eli)&CoBarrLaboratoriesIncNovartisAG-ADRKingPharmaceuticalsIncAlbanyMolecularReshIncCovanceIncMylanLaboratoriesWatsonPharmaceuticalsIncForestLaboratories-ClAPharmaceuticalProdDevIncNovo-NordiskA/S-ADRIdecPharmaceuticalsCorpPerrigo