How Companies Build Sustainable Advantages and Add Value for Users

Many companies want to add value to users. This is true if the company makes expensive products that users will think closely about before buying. Some examples range from furniture to engagement rings to travel. One company that spend a lot of time thinking about value is Ikea.

When IKEA opened its second store, it had few competitive advantages. It had long-term fixed contracts with suppliers and had a stock of goods in large warehouses. Competitive advantage stemmed from preemption, i.e. the sunk costs of the supply contracts and warehouses would deter new entrants. These supplier contracts also translated into bargaining power, meaning IKEA was able to secure furniture at cheaper prices than smaller competitors. By the end of the time period of the case, IKEA’s competitive advantage stems from economies of scale, economies of scope, accumulated investments and pre-emptive investments. IKEA is able to spread out the large fixed costs of R&D and design over many units. It also spreads out the fixed costs of building and running its service trading offices and highly automated distribution centers. By buying production capacity, it has moved the variable costs of buying from furniture suppliers to the fixed cost of capacity. These activities increase the Minimum Efficient Scale any competitor needs to match IKEA’s cost.

By selling a vast range of home furniture in a single location and offering matching furniture, IKEA creates economies of scope: a customer is willing to pay more for a bundle of items than for the items separately. The vast product range also reduces IKEA’s cost as the knowledge gained from building one type of furniture improves another type of furniture. These economies of scope also enable IKEA to spread marketing costs (like catalog costs) over 9,500 products. IKEA blocked off key resources from competitors by copyrighting its catalog. By suing STOR, IKEA established a credible threat to its competitors that it would take legal action against companies copying its store layout and experience. IKEA has also incurred large sunk costs in long-term supplier contracts, production capacity and branding/advertising. This means that competitors and potential entrants know that IKEA has incurred fixed costs for remaining in business, and would be incentivised to retaliate if competitors competed with IKEA directly. IKEA’s accumulated investments in human-centered design, reduction of costs through iterative design, and advertising approach mean that it has spent many years accumulating and reaping the benefits of lower costs and a higher customer willingness to pay. Any new entrant would not have these experiences and the resulting cost and WTP gains, and thus, would be deterred from entering the industry.

To evaluate how well IKEA is protected from the threat of imitation, we considered both the threat of substitution4 and barriers to entry.5 IKEA is well protected from the threat of imitation as a result of the high barriers to entry they have generated and the credible threat to imitators they have demonstrated. In a buyer need dimension analysis performed to assess threat of substitution, IKEA performs well in comparison to potential substitutes. The barriers to entry that IKEA has established most significantly are an absolute cost advantage and economies of scale. IKEA’s absolute cost advantage comes from redesigning products and packaging to cut prices over time rather than allowing them to increase through inflation. As a result, IKEA’s experience curve in engineering low cost furniture would be very difficult to replicate. IKEA’s experience curve applies beyond furniture to a wide range of products sold and to the food and services they provide in their restaurants, meaning they benefit not only from economies of scale but also of scope: they are low-cost production experts on a wide range of products.

IKEA’s bargaining power is high because of their massive market share relative to competitors and the supplier market (see Exhibit 1a). When suppliers have tried to increase their power through boycotts and special reports, IKEA has reduced supplier power by vertically integrating (e.g. creating their own designs) and outsourcing to new suppliers. IKEA also embedded their buyer power into a social contract that suppliers would be reluctant to violate: when the worth of the Polish zloty collapsed, IKEA’s CEO saved their Polish manufacturers from default by paying them more than their contracts required. IKEA also benefits from systemic complementarity, which makes it harder for competitors to imitate them long-term.6 For example, IKEA’s designers are specialized in low-cost engineering, which is consistent with its cash and carry model, and is also consistent with the “IKEA Concept” store standardization.

To conduct a threat of substitution analysis, we compared IKEA to the three closest substitutes (large home furniture retailers, smaller local furniture retailers, and general retailers) across three buyer need dimensions: price, quality, and shopping experience. IKEA achieves high marks (3 or greater) on all three dimensions; no other competitor is able to achieve high marks on more than two dimensions. Finally, in addition to their experience curve, cost advantage, and bargaining power, IKEA has demonstrated that imitation is subject to legal action. A year after STOR’s first location opened, IKEA filed a lawsuit against the company and eventually won. This credible threat to imitators further protects IKEA: any potential imitator knows that threat of litigation is not “cheap talk.”

IKEA has very effectively addressed the threat of vertical competition. First, consider IKEA’s focus on designing their furniture to a target price. This method directly improves the firm’s added value as willingness to pay and revenue remain relatively high, but costs drop substantially compared to competitors. The added value is appropriated to both IKEA and its customers, leading to differentiation from competitors and greater customer satisfaction. In terms of supplier structure, IKEA maintains a favorable position by establishing a fragmented global network of unconventional suppliers. For example, by leveraging excess capacity at a shirt factory in Poland for cushion covers, IKEA guards against the potential for increased supplier bargaining power as well as the threat of vertical integration (VI) from these suppliers due to their narrow production focus and fragmentation. Lastly, IKEA has engaged in tapered integration with their purchase of Swedwood, giving them the knowledge to reduce costs with suppliers and signaling a credible threat of VI themselves.