Strategy as Trade-Offs
Three of the most widely read books on competitive analysis in the 1980s were Michael Porter’s Competitive Strategy, Competitive Advantage, and Competitive Advantage of Nations. In his various books, Porter developed three generic strategies that, he argues, can be used singly or in combination to create a defendable position and to outperform competitors, whether they are within an industry or across nations. The strategies are (1) overall cost leadership, (2) differentiation, and (3) focus on a particular market niche.
Cost Leadership, Differentiation, and Scope
These strategies are termed generic because they can be applied to any size or form of business. We refer to them as trade-off strategies because Porter argues that a firm must choose to embrace one strategy or risk not having a strategy at all. Overall lower cost or cost leadership refers to the strategy where a firm’s competitive advantage is based on the bet that it can develop, manufacture, and distribute products more efficiently than competitors. Differentiation refers to competitive advantage based on superior products or service; superiority arises from factors other than low cost, such as customer service, product quality, or unique style. To put these strategies into context, you might think about Wal-Mart as pursuing a cost-leadership strategy and Harley Davidson as pursuing a differentiation strategy.
Porter suggests another factor affecting a company’s competitive position is its competitive scope. Competitive scope defines the breadth of a company’s target market. A company can have a broad (mass market) competitive scope or a narrow (niche market) competitive scope. A firm following the focus strategy concentrates on meeting the specialized needs of its customers. Products and services can be designed to meet the needs of buyers. One approach to focusing is to service either industrial buyers or consumers but not both.
Firms using a narrow focus strategy can also tailor advertising and promotional efforts to a particular market niche. Many automobile dealers advertise that they are the largest volume dealer for a specific geographic area. Other car dealers advertise that they have the highest customer satisfaction scores within their defined market or the most awards for their service department.
Another differentiation strategy is to design products specifically for a customer. Such customization may range from individually designing a product for a single customer to offering a menu from which customers can select options for the finished product. Tailor-made clothing and custom-built houses include the customer in all aspects of production, from product design to final acceptance, and involve customer input in all key decisions. However, providing such individualized attention to customers may not be feasible for firms with an industry-wide orientation. At the other end of the customization scale, customers buying a new car, even in the budget price category, can often choose not only the exterior and interior colors but also accessories such as navigation, rooftop racks, and upgraded tires.
By positioning itself in either broad scope or narrow scope and a low-cost strategy or differentiation strategy, an organization will fall into one of the following generic competitive strategies: cost leadership, cost focus, differentiation, and focused differentiation.
Example 5.2 Broad Scope
Amazon, an online retailer, is difficult to compete with due to its wide variety of product offerings and low cost products. Amazon has just about anything a person could want from apparel, electronics, and office products. If a person wants product choice, they will shop at Amazon. Companies such as Rent the Runway are forced to not compete on selection and scope, but rather by using another business level strategy.
Source: CNBC, Beating Bezos: Top online retailers like Rent the Runway are winning shoppers by offering what Amazon can’t, Sarah Cushing, 2018Fa
Example 5.3 Narrow Scope
In the face of continued fierce competition and increased uncertainty due to Coronavirus, McDonald’s keeps a narrow scope for its business-level strategy when compared to the greater restaurant industry. With its focus on fast food and its low-cost strategy, it has made itself the top family-friendly restaurant in the fast-food market. Despite a 3.4% decline in sales in the past two months due to the Coronavirus outbreak, the company has decided to keep most of its stores operating and to take measures to support its more than 35,000 franchised locations.
Source: Bloomberg, Leslie Patton, McDonald’s Withdraws Forecast After Covid-19 Bludgeons Sales, Siyuan Wang, 2020Sp
Cost Leadership/Low Cost
Cost leadership is a low-cost market strategy. Firms pursuing this type of strategy must be particularly efficient in engineering tasks, production operations, and physical distribution; they must also be able to minimize costs in marketing and research and development (R&D). A low-cost leader can gain significant market share enabling it to procure a more powerful position relative to both suppliers and competitors. A firm employing this strategy uses product price as its primary competitive edge, minimizing its cost to enable it to provide an acceptable product at the lowest possible price while still maintaining a positive margin. This strategy is particularly effective for organizations in industries where there is limited possibility of product differentiation and where buyers are very price sensitive as with commodities and similar products or services.
Overall cost leadership is not without potential problems. Two or more firms competing for cost leadership may engage in price wars (a race to the bottom) that drive profits to very low levels. Ideally, a firm using a cost-leader strategy will develop an advantage that others cannot easily copy. Cost leaders also must maintain their investment in state-of-the-art equipment or face the possible entry of more cost-effective competitors. Major changes in technology may drastically change production processes so that previous investments in production technology are no longer advantageous. Finally, firms may become so concerned with maintaining low costs that they overlook needed changes in the product, production, or marketing.
The cost-leadership strategy may be more difficult in a dynamic environment because some of the expenses that firms may seek to minimize are research and development costs or marketing research costs—expenses the firm may need to incur to remain competitive.
Example 5.4 Broad Cost Leadership
As a leader in the super market industry for more than two decades, Walmart’s broad cost leadership strategy is based on providing low-prices and a wide range of products. By selling its British subsidiary, Asda, launching a $98/year paid membership program, Walmart+, and investing heavily in redesigning 1,000 stores, Walmart hopes to focus its operations in the interest of keeping current and attracting new customers. Critics argue, however, such moves may be not be a positive sign. The sale of Asda was at a $8B loss from the original purchase price, despite initial success with Walmart+ it is fighting an uphill battle against Amazon, and store remodels are long overdue. Whether these changes will signal a comeback from Walmart remains to be determined.
Source: Forbes, Walmart Still Needs To Get Better At These 3 Things, Zhizhang Zeng 2020Fa
A cost-focus strategy is a low-cost, narrowly focused market strategy. Firms employing this strategy may focus on a particular buyer segment or a particular geographic segment and must locate a niche market that wants or needs an efficient product and is willing to forgo extras to pay a lower price for the product. A company’s costs can be reduced by providing little or no service, providing a low-cost method of distribution, or producing a no-frills product.
Example 5.5 Narrow Cost Leadership
Traditionally, realtor’s collect a commission as a percentage of the final selling price of the property, which is typically 5-6% of the selling price of the property, and comes from the proceeds of the seller. This fee covers all of the realtor’s services but remains relatively opaque in the overall process of buying and selling real estate. Flat fee realty service was introduced in recent years to compete with traditional realtors with a fixed fee instead of a percentage commission. This allows the seller access to the ubiquitous multiple-listing service (MLS) for a flat fee ranging from $49 to $500. MLS is how buyers know the property is for sale, but it is open only to licensed realtors. By paying a flat fee, the seller can access the MLS and sell the property themselves.
Source: MoneyWise, Ben Mizes, Why You’re Paying Realtors Too Much Commission — and What You Can Do About It, Siyuan Wang, 2020Sp
A differentiation strategy involves marketing a unique product in a market; because this type of strategy involves a unique product, price is not the significant factor. In fact, consumers may be willing to pay a high price for a product that they perceive as different. The product difference may be based on product design, method of distribution, or any aspect of the product (other than price) that is significant to the consumer. A company choosing this strategy must develop and maintain a product perceived as different enough from the competitors’ products to warrant the asking price.
Example 5.6 Broad Differentiation
CEO of ViacomCBS, Bob Bakish states on the company’s fourth-quarter earnings call that they created a new strategy in streaming to maximize the value of their content by reaching the largest addressable audience. It helps the company to differentiate its product in the overall media market.
Source: Nasdaq, ViacomCBS’ Streaming Strategy Leaves a Lot of Questions, 2020Wi
Example 5.7 Narrow Differentiation
Boeing has made a $20 million investment into Virgin Galactic as it looks to increase its presence in space tourism. This market serves the ultra-wealthy, and is growing rapidly as other players such as Bezos’ Blue Origin and Musk’s SpaceX look to expand space exploration operations. Boeing’s investment serves as a strategic play to enter the space tourism market and broaden its technological innovation.
Source: Investor’s Business Daily, Boeing Teams Up With This Billionaire As Rivals Eye Space Tourism, Michael Crennen, 2019Fa
Several studies have shown that a differentiation strategy is more likely to generate higher profits than a cost-leadership strategy, because differentiation creates stronger entry barriers. However, a cost-leadership strategy is more likely to generate increases in market share.
Example 5.8 Using Brand to Differentiate
Increasing market share, brand loyalty, and consumer trust are integral to maintaining and increasing profitability. Nike is an example of a company that invests a significant amount of money and resources into developing strong connections with their customers through product personalization, loyalty apps, and state-of-the-art retail shopping experiences. Nike also differentiates their brand through advocacy initiatives, most recently advocating for social justice through the Colin Kaepernick saga in the NFL. This brand differentiation strategy appeals to customers for reasons other than the expertise in footwear and sportswear.
Source: Forbes, How Foot Locker, Nike, North Face And Starbucks Created A Culture Of Customer Loyalty, 2018Fa
A differentiation-focus strategy is the marketing of a differentiated product to a narrow market, often involving a unique product and a unique market. This strategy is viable for a company that can convince consumers that its narrow focus allows it to provide better goods and services than its competitors.
Example 5.9 Private-label Product
Amazon is now finding new ways to entice potential consumers. With new retail stores Amazon is now giving customers a new way to experience their private label products. Although shopping with Amazon and buying their private label products is not something foreign to current customers, the idea of being able to hold, feel, and try these products is something customers are willing to participate in. For example, Wag, Amazon’s private label dog food is being displayed at these new stores alongside popular reviews in order to give the customer a cohesive experience.
Source: Forbes, Amazon Tries To Find A Home For Its Private Label Products With New ‘4-Star’ Store, 2018Fa
Differentiation does not allow a firm to ignore costs; it makes a firm’s products less susceptible to cost pressures from competitors because customers see the product as unique and are willing to pay extra to have the product with the desirable features. Differentiation can be achieved through real product features or through advertising that causes the customer to perceive that the product is unique.
Differentiation may lead to customer brand loyalty and result in reduced price elasticity. It may also lead to higher profit margins and reduce the need to be a low-cost producer. Since customers see the product as different from competing products and they like the product features, customers are willing to pay a premium for these features. As long as the firm can increase the selling price by more than the marginal cost of adding the features, the profit margin is increased. Firms must be able to charge more for their differentiated product than it costs them to make it distinct, or else they may be better off making generic, undifferentiated products. Firms must remain sensitive to cost differences. They must carefully monitor the incremental costs of differentiating their product and make certain the difference is reflected in the price.
Example 5.10 Best Cost Provider Success
Costco didn’t need Covid to get ahead, 65% annual returns are double that of the S&P 500 and it has been out-performing the larger market for more than ten years. The pandemic, however, has strengthened their market position. Its business model positions the company to focus on narrow product niches where it can offer good quality products and a competitive price. The “stock the pantry” attitude that marked the early days of the pandemic sent a surge of customers to Costco and, while April sales volume was down in comparison, their growing e-commerce sector has more than offset the closure of its optical, hearing aids, and food courts.
Source: Forbes , Costco Sells Its Way Into Attractive Rating, Chenbo Tang, 2020Fa
Firms pursuing a differentiation strategy are vulnerable to different competitive threats than firms pursuing a cost-leader strategy. Customers may sacrifice features, service, or image for cost savings. Price-sensitive customers may be willing to forgo desirable features in favor of a less costly alternative. This can be seen in the growth in popularity of store brands and private labels. Often, the same firms that produce name-brand products produce the private-label products. The two products may be physically identical, but stores are able to sell the private-label products for a lower price because very little money was put into advertising to differentiate the private-label product.
Imitation may also reduce the perceived differences between products when competitors copy product features. Thus, for firms to be able to recover the cost of marketing research or R&D, they may need to add a product feature that is not easily copied by a competitor.
A final risk for firms pursuing a differentiation strategy is changing consumer tastes. The feature that customers like and find attractive about a product this year may not make the product popular next year. Changes in customer tastes are especially obvious in the fashion industry. For example, although Ralph Lauren’s Polo has been a very successful brand of apparel, some younger consumers have shifted to Tommy Hilfiger and other youth-oriented brands.
For a variety of reasons, including the differences between intended versus realized strategies discussed in an earlier section, none of these competitive strategies is guaranteed to achieve success. Some companies that have successfully implemented one of Porter’s generic strategies have found that they could not sustain the strategy. Several risks associated with these strategies are based on evolved market conditions (buyer perceptions, competitors, etc.).
Straddling Positions or Stuck in the Middle?
Can forms of competitive advantage be combined? That is, can a firm straddle strategies so that it is simultaneously the low-cost leader and a differentiator? Porter asserts that a successful strategy requires a firm to stake out a market position aggressively and that different strategies involve distinctly different approaches to competing and operating the business. Some research suggests that straddling strategies — also known as a Best Cost Provider strategy — is a recipe for below-average profitability compared to the industry. Porter also argues that straddling strategies is an indication that the firm’s managers have not made necessary choices about the business and its strategy. A straddling strategy may be especially dangerous for narrow scope firms that have been successful in the past, but then start neglecting their focus.
Example 5.11 Stuck in the Middle
Apple is now offering a cheaper version of the iPhone in an attempt to rejuvenate slowing iPhone sales; the phone is tentatively referred to as iPhone SE. Historically, Apple’s brand image has been known for its state-of-the-art minimalist technology that comes with a hefty price tag. However, after several quarters of lackluster iPhone sales, the company is offering a much cheaper version to accompany the higher-end model to reach a new customer base. No longer will Apple be solely focused on a differentiation strategy.
Source: A new smaller, cheaper iPhone could boost sales in early 2020, top Apple analyst Kuo predicts, Michael Crennen, 2019Fa
An organization pursuing a differentiation strategy seeks competitive advantage by offering products or services that are unique from those offered by rivals, either through design, brand image, technology, features, or customer service. Alternatively, an organization pursuing a cost-leadership strategy attempts to gain competitive advantage based on being the overall low-cost provider of a product or service. To be “all things to all people” can mean becoming “stuck in the middle” with no distinct competitive advantage. The difference between being “stuck in the middle” and successfully pursuing a combination best cost provider strategy merits discussion. Although Porter describes the dangers of not being successful in either cost control or differentiation, some firms have been able to succeed using combination strategies and research suggests that, in some limited cases, it is possible to be a cost leader while maintaining a differentiated product.
Some industries may actually call for such combination strategies. Trends suggest that highly complex environments do not have the luxury of choosing exclusively one strategy over another. The hospital industry may represent such an environment, as hospitals must compete on a variety of fronts. Combination (i.e., more complicated) strategies are both feasible and necessary to compete successfully. For instance, reimbursement to diagnosis-related groups, and the continual lowering of reimbursement ceilings have forced hospitals to compete on the basis of cost. At the same time, many of them jockey for position with differentiation based on such features as technology and birthing rooms. Thus, many hospitals may need to adopt some form of hybrid strategy to compete successfully.
- Walters, B. A., & Bhuian, S. (2004). Complexity absorption and performance: A structural analysis of acute-care hospitals. Journal of Management, 30, 97–121. ↵