Basic Competitive Strategies

Business strategy focuses on improving the competitive position of a company’s or business unit’s products or services within the specific industry or market segment that the company or business unit serves.

Competitive strategy raises the following questions:

❖ Should we compete on the basis of lower cost (and thus price) or should we differentiate our products or services on some basis other than cost, such as quality or service?

❖ Should we compete head to head with our major competitors for the biggest but most sought-after share of the market, or should we focus on a niche in which we can satisfy less sought-after but also profitable segment of the market?

Michael Porter proposes two “generic” competitive strategies for outperforming corporations in a particular industry: lower cost and differentiation. They are called generic because they can be pursued by any type or size of business firm, even by not-for-profit organization.

Lower cost strategy is the ability of a company or a business unit to design, to produce, and to market a comparable product more efficiently than its competitors.

Differentiation strategy is the ability of a company to provide unique and superior value to the buyer in terms of product quality, special features, or after-sale services.

M. Porter further proposes that a firm’s competitive advantage in an industry is determined by its competitive scope, that is, the breadth of the company’s or business unit’s target market.

Simply put, a company’s business or business unit can choose a broad target (that is, aim at the middle of the mass target) or a narrow target (that is, aimed at a market niche).

Combining these two types of target markets with the two competitive strategies results in the four variations of generic strategies (see image on next page).

When the lower cost and differentiation strategies have a broad mass market target, they are simply called cost leadership and differentiation. When they are focused on a market niche (narrow target), they are called cost focus and differentiation focus.

1. COST LEADERSHIP

It is a low-cost competitive strategy that aims at the broad mass target (that is, aim at the middle of the mass market) and requires an aggressive construction of efficient-scale facilities and bright pursuit of cost and overhead control. The cost leader being able to produce product at lower cost can charge a lower price than its competitors and still can make a satisfactory profit.

Companies that have successfully used cost leadership strategy include Timex and Casio (watches), Walmart (discount retailing), McDonald (fast food restaurant), Dell (computer) Hyundai (automobile), Southwest Airlines and Ryanair (airline).

Because the cost leader is able to charge a lower price because of its lower cost, it can still make the same level of profit. Also, if rivalry increases and companies start to compete on price, cost leader is able to withstand competitor than other companies because of its lower cost.

Having a lower-cost position also gives a company or business unit a defense against rivals. Their lower cost allows it to continue to earn profits during times of heavy competition.

Its high market share means that it will have high bargaining power relative to its suppliers (because it buys in large quantities). Its low price will also serve as a barrier to entry because few new entrants will be able to match the leader’s cost advantage.

Risk of Cost Leadership

Cost leadership strategy is not risk free.

Low-cost leaders’ manufacturing equipment could become obsolete because of competitor’s technological innovation. These innovations may allow rivals to produce at costs lower than those of the original cost leader, or to provide additional differentiated features without increasing the products price to customers.

There can also be failure in detecting significant changes in customer’s needs, that is, companies fail to understand customer’s perception of competitive levels of differentiation.

Imitation is another risk of cost leadership strategy. Using their own core competencies, competitors sometimes learn how to successfully imitate the cost leader’s strategy. When this happens, the cost leader must increase the value of its goods or service it provides to customers. Commonly, the value is increased by selling the current product at an even lower price of by adding differentiated features that create value for customers while maintaining price.

2. DIFFERENTIATION

Differentiation strategy is an integrated set of actions taken to produce goods or services (at an acceptable cost) that customers perceive as being different in ways that are important to them.

It is the ability to provide company’s product or service certain characteristic, uniqueness, or superiority in value over its competitor’s product. The uniqueness or superiority in value will place the company’s products more preferable over its competitors.

Differentiation can be in terms of product quality, brand, image, special features, after-sale service, and advanced technology.

A good’s or service’s unique attributes, rather than its purchase price, provide the value for which customers are willing to pay. Because of the value attached to a product, the company or business unit may then charge a premium for its products. But because of client’s brand loyalty, it will lower customer’s sensitivity to price.

A firm using differentiation strategy seeks to be different from its competitors on as many dimensions as possible. The less similarity between a firm’s goods or services and those of competitors, the more buffered it is from rival’s action.

Examples of companies that have successfully used the differentiation strategy are Toyota’s Lexus, Ralph Lauren’s product lines, and Caterpillar’s heavy equipment, Walt Disney (entertainment), BMW (automobile), Nike (athletic shoes), Apple (computer and mobile phones), Coach, Inc. (luxury goods).

Risk of Differentiation

Firms must be able to produce differentiated products at competitive cost to reduce pressure on the price that customers pay. Because if not, customers might decide that the price difference between differentiator and cost leader is too significant. In this instance, a firm may be offering differentiated features that exceed target customer needs. The firm then becomes vulnerable to competitors that are able to offer customer a combination of features and price that is more consistent with their needs.

Also, differentiation may no longer provide value for which customers are willing to pay. A differentiated product become less valuable if imitation by rivals causes customers to perceive that competitors offer essentially the same good or service at a lower price.

Finally, learning can narrow customer’s perception of the value of a firm’s differentiated features. For instance, customers having positive experience with generic tissue brand may decide that the differentiated features of Kleenex product are not worth the extra cost. To counter the risk, firms must continue to meaningfully differentiate their product for customers at a price that they are willing to pay.

An example of company that has used this strategy is Coach Inc., maker of high quality luxurious accessories and gift for men and women. They have reacted to the decline of luxury goods in 2009 due to the financial crisis by releasing an inexpensive line of products which they call “Poppy.” The cost of these products is 20% lower than the average price of regular (Coach) item.

3. COST FOCUS

It is a low-cost competitive strategy that focuses on a particular buyer group or geographic market and attempts to serve only this niche, others not included. In using cost focus, the company or business unit seeks a cost advantage in its target segment.

A company, which uses this strategy, produces goods and services that serve the needs of a particular competitive segment. For instance, particular industry segment that can be targeted by focus strategy includes:

a. Particular buyer group (youth, senior citizen)
b. Different segment of a product line (products for professional painters, do-it-yourself group) c. Different geographic market (Northern Italy, Southern Italy)

A good example for this strategy is Potlatch Corp., a manufacturer of toilet tissue. Rather compete directly against Procter & Gamble’s Charmin, Potlach makes the house brands for grocery store chains. It matches the quality of well-known brands but keeps cost low by eliminating advertising
and promotion expenses. As a result, Potlach makes 92% of private level bathrooms and one-third of all bathroom tissues sold in Western US grocery stores.

Another sound example for cost focus is IKEA. Based in Sweden, IKEA is a global furniture retailer with locations in 24 countries and sales revenues of 21.1 billion Euros. It uses the focused cost leadership strategy. Its target customers are the young buyers desiring style at low cost. The firm offers home furnishings that combine good design, function, and acceptable quality with low prices. According to the firm, “low cost is always in focus. This applies to every phase of our activities.”

IKEA emphasizes several activities to keep its cost low. First, instead of relying primarily on third party manufacturers, the firm’s engineers design low-cost modular furniture ready for assembly by customers. Second, to eliminate the need for sales associate or decorators, IKEA positions the products in its stores so that customers can view different combinations (complete with sofas, chairs, tables, etc.) in a single room setting, which helps customers imagine how a grouping of furniture will look in the home. Third practice that helps keep IKEA’s cost low is requiring customers to transport their own purchases rather than providing delivery service.

Although it is a cost leader, IKEA also offers some differentiated features that appeal to its target customers, including its unique furniture design, in-store playrooms for children, wheelchair for customer use and extended hours.

Thus IKEA’s focused cost leadership strategy also includes some differentiated features with its low-cost products.

This strategy is based on the belief that a company can serve efficiently a specific market than its competitor if it focuses its effort on this market.

4. FOCUS DIFFERENTIATION

Like cost focus, this strategy also concentrates on a particular market segment. In using this focus differentiation, the business or unit or company must seek differentiation on a particular buyer group, product line segment, or geographic market.

This strategy is important on the belief that a company can serve efficiently a target segment than its competitors if it focuses on this narrow strategic target segment.

This is the strategy successfully followed by Midamar Corp., a distributor of halal foods in the US. They serve clients like McDonalds, Pizza Hut, KFC and many more.

Another example is Orphagenix, a small biotech pharmaceutical company that avoids head-to-head competition with big companies like AstraZenica and Merck by developing “orphan” drugs to target diseases that affect fewer than 200,000 people such as sickle cell anemia and spinal muscular atrophy that big drug makers are overlooking.

Risk of FOCUS strategy

In general, a firm encounters the same risk faced by those pursuing the cost leadership and differentiation strategy on an industry wide basis.