Porter_generic_strategies

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Porter generic strategies

Michael Porter has described a category scheme consisting of three general types of strategies that are commonly used by businesses to achieve and maintain competitive advantage. These three generic strategies are defined along two dimensions: strategic scope and strategic strength. Strategic scope is a demand-side dimension (Porter was originally an engineer, then an economist before he specialized in strategy) and looks at the size and composition of the market you intend to target. Strategic strength is a supply-side dimension and looks at the strength or core competency of the firm. In particular he identified two competencies that he felt were most important: product differentiation and product cost (efficiency). He originally ranked each of the three dimensions (level of differentiation, relative product cost, and scope of target market) as either low, medium, or high, and juxtaposed them in a three dimensional matrix. That is, the category scheme was displayed as a 3 by 3 by 3 cube. But most of the 27 combinations were not viable.

In his 1980 classic Competitive Strategy: Techniques for Analysing Industries and Competitors, Porter simplifies the scheme by reducing it down to the three best strategies. They are cost leadership, differentiation, and market segmentation (or focus). Market segmentation is narrow in scope while both cost leadership and differentiation are relatively broad in market scope.

Empirical research on the profit impact of marketing strategy indicated that firms with a high market share were often quite profitable, but so were many firms with low market share. The least profitable firms were those with moderate market share. This was sometimes referred to as the hole in the middle problem. Porter?s explanation of this is that firms with high market share were successful because they pursued a cost leadership strategy and firms with low market share were successful because they used market segmentation to focus on a small but profitable market niche. Firms in the middle were less profitable because they did not have a viable generic strategy.

Combining multiple strategies is successful in only one case. Combining a market segmentation strategy with a product differentiation strategy is an effective way of matching your firm?s product strategy (supply side) to the characteristics of your target market segments (demand side). But combinations like cost leadership with product differentiation are hard (but not impossible) to implement due to the potential for conflict between cost minimization and the additional cost of value-added differentiation.

Since that time, some commentators have made a distinction between cost leadership, that is, low cost strategies, and best cost strategies. They claim that a low cost strategy is rarely able to provide a sustainable competitive advantage. In most cases firms end up in price wars. Instead, they claim a best cost strategy is preferred. This involves providing the best value for a relatively low price.

Cost Leadership Strategy

This strategy emphasizes efficiency. By producing high volumes of standardized products, the firm hopes to take advantage of economies of scale and experience curve effects. The product is often a basic no-frills product that is produced at a relatively low cost and made available to a very large customer base. Maintaining this strategy requires a continuous search for cost reductions in all aspects of the business. The associated distribution strategy is to obtain the most extensive distribution possible. Promotional strategy often involves trying to make a virtue out of low cost product features.

To be successful, this strategy usually requires a considerable market share advantage or preferential access to raw materials, components, labour, or some other important input. Without one or more of these advantages, the strategy can easily be mimicked by competitors. Successful implementation also benefits from:

process engineering skills

products designed for ease of manufacture

sustained access to inexpensive capital

close supervision of labour

tight cost control

incentives based on quantitative targets.

always ensure that the costs are kept at the minimum possible level.

Examples include retailers such as Wal-Mart and KwikSave as well as IT firms such as Dell and Lenovo.

When a firm designs, produces and markets a product more efficiently than competitors such firm has implemented a cost leadership strategy (Allen et al. 2006, p.25,). Cost reduction strategies across the activity cost chain will represent low cost leadership (Tehrani 2003, p.610, Beheshti 2004, p. 118). Attempts to reduce costs will spread through the whole business process from manufacturing to the final stage of selling the product. Any processes that do not contribute towards minimization of cost base should be outsourced to other organisations with the view of maintaining a low cost base (Akan et al. 2006, p.48). Low costs will permit a firm to sell relatively standardised products that offer features acceptable to many customers at the lowest competitive price and such low prices will gain competitive advantage and increase market share (Porter 1980 cited by Srivannboon 2006, p.88; Porter 1979;1987;1986, Bauer and Colgan 2001; Hyatt 2001; Anon 1988; Davidson 2001; Cross 1999 cited by Allen and Helms 2006, p.435). These writings explain that cost efficiency gained in the whole process will enable a firm to mark up a price lower than competition which ultimately results in high sales since competition could not match such a low cost base. If the low cost base could be maintained for longer periods of time it will ensure consistent increase in market share and stable profits hence consequent in superior performance. However all writings direct us to the understanding that sustainability of the competitive advantage reached through low cost strategy will depend on the ability of a competitor to match or develop a lower cost base than the existing cost leader in the market.

A firm attempts to maintain a low cost base by controlling production costs, increasing their capacity utilization, controlling material supply or product distribution and minimizing other costs including R&D and advertising (Prajogo 2007,p.70). Mass production, mass distribution, economies of scale, technology, product design, learning curve benefit, work force dedicated for low cost production, reduced sales force, less spending on marketing will further help a firm to main a low cost base (Freeman 2003, p.86; Trogovicky et al. 2005, p.18). Decision makers in a cost leadership firm will be compelled to closely scrutinise the cost efficiency of the processes of the firm. Maintaining the low cost base will become the primary determinant of the cost leadership strategy. For low cost leadership to be effective a firm should have a large market share (Robinson and Chiang 2000, p.857; Hyatt 2001 cited by Allen and Helms 2006, p.435). New entrants or firms with a smaller market share may not benefit from such strategy since mass production, mass distribution and economies of scale will not make an impact on such firms. Low cost leadership becomes a viable strategy only for larger firms. Market leaders may strengthen their positioning by advantages attained through scale and experience in a low cost leadership strategy. But is their any superiority in low cost strategy than other strategic typologies? Can a firm that adopts a low cost strategy out perform another firm with a different competitive strategy? If firms costs are low enough it may be profitable even in a highly competitive scenario hence it becomes a defensive mechanism against competitors (Kim et al. 2004, p.21). Further they mention that such low cost may act as entry barriers since new entrants require huge capital to produce goods or services at the same or lesser price than a cost leader. As discussed in the academic frame work of competitive advantage raising barriers for competition will consequent in sustainable competitive advantage and in consolidation with the above writings we may establish the fact that low cost competitive strategy may generate a sustainable competitive advantage. However, this is not true in all cases.

Further in consideration of factors mentioned above that facilitate a firm in maintaining a low cost base; some factors such as technology which may be developed through innovation (mentioned as creative accumulation in Schumpeterian innovation) and some may even be resources developed by a firm such as long term healthy relationships build with distributors to maintain cost effective distribution channels or supply chains (inimitable, unique, valuable non transferable resource mentioned in RBV). Similarly economies of scale may be an ultimate result of a commitment made by a firm such as capital investments for expansions (as discussed in the commitment approach). Also raising barriers for competition by virtue of the low cost base that enables the low prices will result in strong strategic positioning in the market (discussed in the IO structural approach). These significant strengths align with the four perspectives of sustainable competitive advantage mentioned in the early parts of this literature review. Low cost leadership could be considered as a competitive strategy that will create a sustainable competitive advantage.

However, low cost leadership is attached to a disadvantage which is less customer loyalty (Vokurka and Davis 2004, p. 490, Cross 1999 cited by Allen and Helms 2006, p.436). Relatively low prices will result in creating a negative attitude towards the quality of the product in the mindset of the customers (Priem 2007, p.220). Customer?s impression regarding such products will enhance the tendency to shift towards a product which might be higher in price but projects an image of quality. Considering analytical in depth view regarding the low cost strategy, it reflects capability to generate a competitive advantage but development and maintenance of a low cost base becomes a vital, decisive task.

Differentiation Strategy

Differentiation is aimed at the broad market that involves the creation of a product or services that is perceived throughout its industry as unique. The company or business unit may then charge a premium for its product. This specialty can be associated with design, brand image, technology, features, dealers, network, or customers service. Differentiation is a viable strategy for earning above average returns in a specific business because the resulting brand loyalty lowers customers' sensitivity to price. Increased costs can usually be passed on to the buyers. Buyers loyalty can also serve as an entry barrier-new firms must develop their own distinctive competence to differentiate their products in some way in order to compete successfully. Examples of the successful use of a differentiation strategy are Hero Honda, Asian Paints, HLL, Nike athletic shoes, Perstorp BioProducts, Apple Computer, and Mercedes-Benz automobiles. Research does suggest that a differentiation strategy is more likely to generate higher profits than is a low cost strategy because differentiation creates a better entry barrier. A low-cost strategy is more likely, however, to generate increases in market share. This may or may not be true.

Variants on the Differentiation Strategy

The shareholder value model holds that the timing of the use of specialized knowledge can create a differentiation advantage as long as the knowledge remains unique William E. Fruhan, Jr., "The NPV Model of Strategy - The Shareholder Value Model," in Financial Strategy: Studies in the Creation, Transer, and Destruction of Shareholder Value (Homewood, IL: Richard D. Irwin, 1979. This model suggests that customers buy products or services from an organization to have access to its unique knowledge. The advantage is static, rather than dynamic, because the purchase is a one-time event.

The unlimited resources model utilizes a large base of resources that allows an organization to outlast competitors by practicing a differentiation strategy. An organization with greater resources can manage risk and sustain losses more easily than one with fewer resources. This deep-pocket strategy provides a short-term advantage only. If a firm lacks the capacity for continual innovation, it will not sustain its competitive position over time.

Focus Strategy

The firm focuses on a few target markets (also called a segmentation strategy or niche strategy). It is hoped that by focusing your marketing efforts on one or two narrow market segments and tailoring your marketing mix to these specialized markets, you can better meet the needs of that target market. The firm typically looks to gain a competitive advantage through product innovation and/or brand marketing rather than efficiency. It is most suitable for relatively small firms but can be used by any company. A focus strategy should target market segments that are less vulnerable to substitutes or where a competition is weakest to earn above-average return on investment.

Examples of firm using a focus strategy include Southwest Airlines, with provides short-haul point-to-point flights in contrast to the hub-and-spoke model of mainstream carriers, and Family Dollar, which targets poor urban American families who can not drive to Wal-Marts in the suburbs because they do not own a car.

Recent developments

Michael Treacy and Fred Wiersema (1993) have modified Porter's three strategies to describe three basic "value disciplines" that can create customer value and provide a competitive advantage. They are operational excellence, product leadership, and customer intimacy.

Criticisms of generic strategies

Several commentators have questioned the use of generic strategies claiming they lack specificity, lack flexibility, and are limiting.

In particular, Miller (1992) questions the notion of being "caught in the middle". He claims that there is a viable middle ground between strategies. Many companies, for example, have entered a market as a niche player and gradually expanded. According to Baden-Fuller and Stopford (1992) the most successful companies are the ones that can resolve what they call "the dilemma of opposites".

A popular post-Porter model was presented by W. Chan Kim and Renée Mauborgne in their 1999 Harvard Business Review article "Creating New Market Space". In this article they described a "value innovation" model in which companies must look outside their present paradigms to find new value propositions. Their approach fundamentally goes against Porter's concept that a firm must focus either on cost leadership or on differentiation. They later went on to publish their ideas in the book Blue Ocean Strategy.

An up-to-date critique of generic strategies and their limitations, including Porter, appears in Bowman, C. (2008) Generic strategies: a substitute for thinking?

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