MODULE No.21 : Generic Competitive Strategies

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COMMERCE PAPER No.12 : Strategic Management

MODULE No.21 : Generic Competitive Strategies

Subject COMMERCE

Paper No and Title 12. STRATEGIC MANAGEMENT

Module No and Title 21. GENERIC COMPETITIVE STRATEGIES

Module Tag COM_P12_M21

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COMMERCE PAPER No.12 : Strategic Management

MODULE No.21 : Generic Competitive Strategies TABLE OF CONTENTS

1. Learning Outcomes 2. Introduction

3.Porter’s Competitive Strategies for Building Competitive Advantage 3.1 Cost leadership Strategy

3.1.1 Achieving Cost leadership

3.1.2 When Cost Leadership Strategy Works Best 3.1.3 Benefits Associated with Cost leadership Strategy 3.1.4 Risks faced under the Cost Leadership Strategy 3.2 Differentiation Strategy

3.1.1 Achieving Cost leadership

3.1.2 When Cost Leadership Strategy Works Best 3.1.3 Benefits Associated with Differentiation Strategy 3.1.4 Risks faced under the Differentiation Strategy 3.3Focus Strategy

3.1.1 Achieving Focus

3.1.2 When Focus Strategies Works Best 3.1.3 Benefits Associated with Focus Strategy 3.1.4 Risks faced under the Focus Strategy 4. Stuck in the Middle

5. Points of Concern regarding Generic Strategies

6. Summary

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COMMERCE PAPER No.12 : Strategic Management

MODULE No.21 : Generic Competitive Strategies 1. Learning Outcomes

After studying this module, you shall be able to

 Know about M.Porter’s three competitive strategies for attaining Competitive Advantage

 Understand their requirements, benefits, and risks

 Identify the competitive strategy being followed in a particular case

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COMMERCE PAPER No.12 : Strategic Management

MODULE No.21 : Generic Competitive Strategies 2. INTRODUCTION

Strategy formation plays a foundation role toward attaining long term competitive advantage for any organization. A successfully attained competitive advantage is one that can be sustained by the company for years, so that it can constantly reap the greater profits arising from this advantage as compared to competitors. This very advantage is an addition in the value provided to customers, without an addition in costs of generating this additional value.

Value is what buyers intend to pay, and superior value stems from offering lower prices than competitors for equivalent benefits or providing unique benefits that more than offset a higher price. However, to compete successfully in the long-run a firm must first choose an appropriate positioning. Porter has proposed 3 different approaches to gaining or strengthening competitive advantage: 1.Cost leadership, 2.Differentiation, and 3.Focus.

These three strategies are well tested for delivering higher profits than the industry averages, however the suitability of each strategy with a particular company varies according to changing dynamics from company to company, such as skills & expertise, assets & resources, infrastructural facilities, control processes and other managerial limitations.

The benefits arriving from the implementation of these strategies is highly contingent on the selection of the strategy. This decision can be taken in line with the company offerings, values, and proposed competitive advantage, which has to be acquired by the company. The strategy should also be as unique as possible, because that would make it impossible for competitors to replicate.

Figure 1: Types of Competitive Advantage

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COMMERCE PAPER No.12 : Strategic Management

MODULE No.21 : Generic Competitive Strategies 3. Porter’s Competitive Strategies For Building Competitive Advantage

Table 1: Distinctive Features of Generic Competitive Strategies

Type of Feature Low-Cost Leadership

Broad

Differentiation

Best-Cost Provider Focused Low-Cost and Focused Differentiation Strategic Target A broad cross section

of the market

A broad cross section of the market

Value-conscious buyers

A narrow market niche where buyer needs and preferences are distinctively different from the rest of the market Basis of Competitive

Advantage

Lower costs than competitors

An ability to offer buyers something different from competitors

Give customers more value for the money

Lower cost in serving the niche (focused low cost) or an ability to offer nich buyers something customized to their requirements and tastes (focused differentiation) Product Line A good basic product

with few frills (acceptable quality and limited selection)

Many product variations, wide selection, strong emphasis on the chosen differentiating features

Good to excellent attributes, several to many upscale features

Customized to fit the specialized needs of the target segment

Production Emphasis

A continuous search for cost reduction without sacrificing acceptable quality and essential features

Invent ways to create values for buyers;

strive for product superiority

Incorporate upscale features and attributes at low cost

Tailor-made for the niche

Marketing Emphasis

Try to make a virtue out of product features that lead to low cost

Build in whatever features buyers are willing to pay for

Charge a premium price to cover the extra costs of differentiating features

Underprice rival brands with comparable features

Communicate the focuser’s unique ability to satisfy the buyer’s specialized requirements

Sustaining the Strategy

Economical prices/good value.

All elements of strategy aim at contributing to a sustainable cost advantage – the key is to manage costs down, year after year, in every area of the business

Communicate the points of difference in credible ways

Stress consistent improvement and innovation to stay ahead of imitative competitors

Concentrate on a few key differentiating features; tout them to create a reputation and brand image

Unique expertise in managing costs down and product/service caliber up simultaneously

Remain totally dedicated to serving the niche better than other competitors;

don’t blunt the firm’s image and efforts by entering segments with substantially different buyer requirements or adding other product categories to widen market appeal

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MODULE No.21 : Generic Competitive Strategies

3.1 Cost Leadership Strategy

For a company that pursues the Low Cost leadership strategy, its only motive would be to bring down its costs as much as possible and offer the cheapest products amongst competitors. Such companies have the advantage of attracting customers whose primary agenda is price. Also, they gain the power of setting industry prices. This strategy is particularly helpful in case of economies of scale and in a price sensitive scenario.

The first step toward achieving the cost advantage is lowering one’s costs, but merely lowering costs and thrashing your competitors is not sufficient, for one must cleverly identify its cost drivers that are lower than competitors, and build strategies based on these very drivers to sustain the competitive advantage. They also are committed to squeezing unnecessary costs out of their operations.

Businesses that compete with a low-cost strategy often tend to produce basic, non-custom products and services for a mass market full of price-sensitive customers.

Companies employing this kind of leadership strategy must achieve their competitive advantage in ways that are difficult for competitors to copy or match. Sometimes however, competitors may easily replicate the costs of such a company. In such cases the strategy and the advantage are unsustainable.

3.1.1 Achieving Cost leadership

Central to the idea of achieving cost leadership is the understanding of the value chain for a product /service of an organization. Costs are distributed over the entire value chain, in activities that contribute to the making of the product. The basic objective in achieving cost leadership is to ensure that the total additive costs across this value chain is lower than that of competitors. For doing this, it is essential to analyze the cost drivers and then identify the areas for optimization of costs. There are two ways to accomplish this:

1. Efficiently managing and conducting internal operations comprising the value chain, and hence lowering costs compared to competitors

2. Revamping the firm’s value chain without affecting productivity, so that certain cost incurring activities can be weeded out.

Let's look at each of the two approaches to securing a cost advantage.

a) Cost-Efficient Management of Value Chain Activities

To achieve such cost effectiveness, a company would have to closely analyze and monitor all cost drivers that form the value chain of operations, and all workers must function together as a team for a common goal. All such opportunities of reducing costs must be explored and leveraged promptly. To determine these costs at different stages of the value chain, the following factors can be put to use—

 Economies or diseconomies of scale.

 key resource inputs that may drive costs

 Union versus non-union labor

 Bargaining ability vis-à-vis suppliers

 Geographic variables

 Links to other operations in the company or industry value chain

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 Learning and experience curve

 Sharing opportunities with other organizational or business units within the enterprise

 Indigenous vertical integration versus third party outsourcing

 Timing advantages like First Mover

 The percentage of capacity utilization

 Strategic choices and operating decisions.

A company’s costs can be driven up or down by a fairly wide assortment of managerial decisions:

 Increasing/decreasing the number of products or varieties offered

 Adding/Removing the service offerings to buyers

 Incorporating greater/lesser performance and quality parameters into the product

 Paying varying wages to employees compared to rival companies

 Increasing/decreasing the number of different forward channels used in distributing the firm’s product

 Lengthening/shortening delivery times to customers

 Using different incentives and drivers for motivating employees compared to others in the industry

 Raising/lowering the specifications for purchased materials

b) Reengineering the Value Chain to Curb or Eliminate Unnecessary Activities

Dramatic cost advantages can emerge from finding innovative ways to curb or certain cost- producing value chain operations. The most effective common ways to achieve this cost leadership include:

 Changing the product design to simple achievable forms

 Cutting down the extra offerings and come up with the basic product

 Moving on to a simple, less capital intensive and streamlined and technology friendly process, which is flexible at the same time.

 Procuring lowest cost Raw material and parts without compromising on quality

 Using direct sales and marketing approaches that often help in cutting out the costs and margins of wholesalers and retailers (costs and margins in the wholesale and retail portions of the value chain often represent 50 percent of the price paid by final consumers)

 Localizing the facility close to suppliers, customers and other associated businesses.

 Carving out one’s own niche in the market by focusing on your own competitive advantages, product offerings and costs through identification of specific target groups.

 Reengineering core operational activities to identify non value adding centers in the business and thus removing them

 Staying up to date with technology, and hiring tech friendly personnel. Ensuring paper free smooth flow of information within and outside the organization. Leveraging the Digital media for communications and marketing.

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Striving to be the low-cost producer in an industry can be especially effective when:

 The market is composed of many price-sensitive buyers

 Price competition among rival sellers is especially vigorous

 The industry’s produce is essentially standardized or a commodity readily available from a host of sellers

 There are few ways to achieve product differentiation that have value to buyers

 Most buyers use the product in the same ways – with common user requirements

 There is lesser customer loyalty and the cost of switching from one seller to another is low. This often seen in the case of commodities or products that are highly standardized.

 Buyers are large and have significant power to bargain down prices

 Industry newcomers use introductory low prices to attract buyers and build a customer base

3.1.3Benefits Associated with Cost leadership Strategy

As suggested by Porter, a low-cost position provides a firm with some attractive defenses against the five competitive forces:

 In meeting the challenges of rival competitors, the low cost company is in the best position to compete on the basis of price, to use the appeal of lower price to grab sales (and market share) from rivals, to remain profitable in the face of strong price competition, and survive price wars and earn above average profits.

 In defending against the power of buyers, low costs provide a company with partial profit margin protection.

 In countering the bargaining leverage of powerful suppliers, organizations that possess a cost advantage are less affected in such a scenario as they can absorb the price increases to some extent.

 In countering the bargaining leverage of suppliers, the low cost producer is more insulated than competitors from powerful suppliers if the primary source of its cost advantage is greater internal efficiency.

 As concerns potential entrants, the low cost leader can use price cutting to make it harder for a new rival to win customers.

 In competing against substitutes, a low cost leader is better positioned to use low price as a defense against companies trying to gain market inroads with a substitute product or service.

3.1.4 Risks faced under the Cost Leadership Strategy

The risks faced under the cost leadership business strategy are several. Some of these are:

 Cost advantage is ephemeral. It does not remain for long as competitors can imitate the cost reduction techniques easily. Duplication of cost reduction techniques makes the position of the cost leader vulnerable from competitive threats.

 Getting carried away with overly aggressively price cutting and ending up with lower, rather than higher profitability.

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 Often, severe cost reduction can dilute customer focus

and limit experimentation with product attributes. This may create a situation where cost reduction is done for own sake and the interests of the customers are ignored.

 Technological shifts are a great threat to the cost leader as they may change the ground rules on which the industry operates. For instance, a technological development may lead to the creation of a cheaper process or product, which is adopted by newer competitors. The older players may be left with an obsolete technology that now proves to be costlier. In this way, technological breakthroughs can upset cost leadership strategies.

 Becoming too fixated on cost reduction. A low cost zealot risks getting left behind if buyers begin to opt for enhanced quality, innovative performance features, faster service, and other differentiating features.

3.2Differentiation Strategy

Differentiation strategies are an attractive competitive approach when buyer preferences are too diverse to be fully satisfied by a standardized product or when buyer requirements are too diverse to be fully satisfied by sellers with identical capabilities. A company following a differentiation strategy seeks to build customer loyalty by positioning its goods or services in a unique or different fashion.

A differentiation strategy should be pursued only after a careful study of buyers’ needs and behavior carefully to learn what they consider important, what they think as value, and what they are willing to pay for.

Companies that execute a differentiation strategy successfully can command premium prices for their products than competitors and services, increase their market share, and reap the benefits of customer loyalty and retention. The goal for a company pursuing a differentiation strategy is to create that kind of uniqueness in the minds of its customers.

The key to a successful differentiation strategy is to build it on a core competency, something a company is uniquely good at doing in comparison to its competitors. Differentiation enhances profitability whenever the extra price the product commands outweighs the added costs of achieving differentiation. The most appealing approaches to differentiation are those that are hard or expensive for rivals to duplicate.

3.2.1 Achieving Differentiation

The key to achieving differentiation is to create value for the customer that is unmatched by the competitors at that price at which the differentiator organization offers its products/services. This is done through incorporating features and attributes in the products/services valued by the customers. Differentiation opportunities can exist in activities all along an industry's value chain;

possibilities include the following:

 Purchasing and procurement activities that spill over to affect the performance or quality of the end product.

 Product R&D activities that aim at improved product designs and performance features, expanded end uses and applications, more frequent first-on-the market victories, wider product variety and selection, added user safety, greater recycling capability, or enhanced environmental protection.

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permit custom order manufacture at an efficient cost; make production methods safer for the environment; or improve product quality, reliability, and appearance.

 Manufacturing activities that reduce defects, prevent premature product failure, extend product life, allow better warranty coverages, improve economy of use, result in more end-user convenience, or enhance product appearance.

 Outbound logistics and distribution activities that allow for fewer warehouse and on the- shelf stock outs, quicker delivery to customers, more accurate order filling, and/or lower shipping costs.

 Marketing, sales and customer service activities that result in superior technical assistance to buyers, faster maintenance and repair services, better credit terms or greater customer convenience.

3.2.2WhenDifferentiation Strategy Works Best

A differentiation business strategy is suitable for special conditions primarily related to the markets and customers. Generally, one would expect customers to go for a product/service that has a lower price and offer comparable utility.

But normally, markets and customers are not homogeneous; there are several market niches and customer groups that demand special treatment by organizations. Products/services cannot always be uniform. The major conditions under which differentiation business strategies could be employed are given below:

 The market is too large to be catered to by a few organizations offering standardised product/service.

 The customer needs and preferences are too diversified to be satisfied by a standardised product/service.

 It is possible for the organization to charge a premium price for differentiation that is valued by the customer.

 The nature of the product/service is such that brand loyalty is possible to generate and sustain.

 There is ample scope for increasing the sale of the product/service on the basis of differentiated features and premium pricing.

3.2.3Benefits Associated with Differentiated Strategy

Differentiation offers a buffer against the strategies of rivals when it results in enhanced buyer loyalty to a company’s brand or model and greater willingness to pay a little more for it. In addition, successful differentiation provides the following benefits in the context of the Porter’s five forces model.

 Organizations distinguish themselves successfully on the basis of differentiation, thereby lessening competitive rivalry. Customer brand loyalty too acts as a safeguard against competition. Brand loyal customers are also generally less price-insensitive.

 Powerful suppliers can negotiate price increases that the organization can absorb to some extent as it has brand loyal customers, who are typically less sensitive to price increases.

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 Powerful buyers do not usually negotiate price

decrease as they have fewer options with regard to suppliers and generally have no cause of compliant, as they get the special features and attributes demanded. Owing to its nature, differentiation is an market- and customer-focussed strategy.

 Differentiation is an expensive proposition. Newer entrants are not normally in a position to offer similar differentiation as a comparable price. In his manner, differentiation acts as a formidable entry barrier to new entrants.

For similar reasons, as in the case of new entrants, substitute product/service suppliers too pose a negligible threat to established differentiator organizations

3.2.4Risks faced under the Differentiated Strategy

The risks faced by under the differentiated business strategy are several. Some of these are:

 In a growing market, as is the case with the most industries in India, products tend to become commodities. Long-term perceives uniqueness-the basis for differentiation-is difficult to sustain. There is imminent threat from competitors who can imitate the differentiation strategy. In this sense, the first-mover advantages associated with the differentiation strategy are limited.

 In the case of several differentiators adopting similar differentiation strategies, the basis for distinctiveness is gradually lessened and ultimately lost.

 Differentiation fails to work if its basis is something that is not valued by the customer.

This often happens in case where unnecessary features are added for differentiation. Such things also occur when over-differentiation is done, carrying little tangible benefit for the customer.

 Price premiums too have a limit. Charging too high a price for differentiated features may cause the customer to forgo the additional advantage from a product/service on the basis of her own cost-benefit analysis.

 Failure on the part of the organization to communicate adequately the benefit arising out of differentiation or over-relying on the intrinsic product attributes not readily apparent to a customer, may cause the differentiation strategy to fail.

3.3 Focus Strategies

A focus strategy recognizes that not all markets are homogeneous. In fact, in any given market, there are many different customer segments, each having different needs, wants, and characteristics. Thus, rather than attempting to serve the total market, a focusing firm specializes in serving a specific target segment or niche.

The principal idea of this strategy is to select one or more market segments, identify customers’

special needs, wants, and interests, and approach them with a good or service designed to excel in meeting these needs, wants, and interests. Focus strategies build on differences among market segments. For instance, most markets contains a population of customers who are willing and able to pay for premium goods and services, giving small companies the opportunity to follow a focus strategy aimed at the premium segment of the market.

A focus strategy is ideally suited to many small businesses, which often lack the resources to reach the overall market.

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groups are the demographic characteristics (age, gender,

income, occupation, etc.), geographic segmentation (rural/urban or Northern India/Southern India) or life-style (traditional/modern).

The most successful focusers build a competitive edge by concentrating on specific market niches and serving them more effectively and efficiently than any other competitor can. Essentially, this strategy depends on creating value for the customer either by being the lowest-cost producer or by differentiating the product or service in a unique fashion, but doing it in a narrow target segment. Focused low-cost and differentiation strategies are discussed below:

a)

A

Focused Low-Cost Strategy

A focused strategy based on low cost aims at securing a competitive advantage by serving buyers in the target market niche at a lower cost and lower price than rival competitors. This strategy has considerable attraction when a firm can lower costs significantly by limiting its customer base to a well-defined buyer segment.

The avenues to achieving a cost advantage over rivals also serving the target market niche are the same as for low-cost leadership-outmanage rivals in keeping the costs of value chain activities contained to a bare minimum and search for innovative ways to reconfigure the firm's value chain and bypass or reduce certain value chain activities.

The only real difference between a low-cost provider strategy and a focused low-cost strategy is the size of the buyer group that a company is trying to appeal to-the former involves a product offering that appeals broadly to most all buyer groups and market segments whereas the latter at just meeting the needs of buyers in a narrow market segment.

b) A Focused Differentiation Strategy

A focused strategy keyed to differentiation aims at securing a competitive advantage with a product offering carefully designed to appeal to the unique preferences and needs of a narrow, well-defined group of buyers (as opposed to a broad differentiation strategy aimed at many buyer groups and market segments).

Successful use of a focused differentiation strategy depends on the existence of a buyer segment that is looking for special product attributes or seller capabilities and on a firm's ability to stand apart from rivals competing in the same target market niche. Companies like Chanel, Gucci and Rolls-Royce employ successful differentiation-based focused strategies targeted at upscale buyers wanting products and services with world-class attributes.

Indeed, most markets contain a buyer segment willing to pay a big price premium for the very finest items available, thus opening the strategic window for some competitors to pursue differentiation-based focused strategies aimed at the very top of the market pyramid.

3.3.1Achieving Focus

A focus strategy is essentially concerned with identifying a narrow target in terms of markets and customers. The organization seeking to adopt a focus strategy has to locate a niche in the market where the cost leaders and differentiators are not operating.

There might be several reasons why niches exist. One of the major reasons is that cost leaders and differentiators, in an attempt to cover broad target, tend to leave out segments of the market

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which require very special attention. In doing so, cost leaders and differentiators may not be able to generalize their

product/service to serve a broader segment. So they feel it is more profitable to neglect niches.

For example, in the tyre market, replacement of truck tyres constitutes the largest segment of the market while that of tyres for aircraft would be miniscule. Not all tyre companies may feel that it is worthwhile to consider this niche. Some tyre companies however, may feel that they have the necessary expertise to do so, and they can afford to do it. What emerges is a focused differentiation strategy for specialized tyres for aircraft.

Most product and service categories offer scope for niche marketing. Indeed, there will be always be a small number of buyers willing to pay a higher price for getting some type of special treatment. At the other end of the spectrum, there will always be buyers willing to forgo perceived frills and additional attributes and features as long as the price paid is lower.

3.3.2 When Focus Strategy Works Best

A focused strategy based either on low cost or differentiation becomes increasingly attractive as more of the following conditions are met:

 The target market niche is big enough to be profitable and offers a good growth potential

 The niche is not crucial to the success of major competitors

 The focusing firm has the capabilities and resources to serve the targeted niche effectively

 The focuser can defend itself against challengers based on the customer goodwill it has built up and its superior ability to server buyers comprising the niche

 When it is costly or difficult for multi-segment competitors to meet the specialized needs of the target market niche

 When no other rival is attempting to specialize in the same target segment

 When a firm doesn’t have the resources or capabilities to go after a bigger piece of the total market

 When the industry has many different niches and segments, allowing a focuser to pick an attractive niche suited to its resource strengths and capabilities.

3.3.3Benefits Associated with Focus Strategy

A focuser’s specialized competencies and capabilities in serving the target market niche provide a basis for defending against the five competitive forces.

 The focussed organization is protected from competition to the extent that the other organizations having a broader target, do not possess the competitive ability to cater to the niche markets. In other words, a focussed organization provides products/services that the other organizations cannot provide or would not find it profitable to provide.

 The focussed organizations buy in small quantities and so powerful suppliers may not evince much interest. But price increments to a certain limit can be absorbed and passed on to the loyal customers.

 Powerful buyers are less likely to shift loyalties as they might not find others willing to cater to the niche markets as the focused organizations do.

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achieve in serving a niche market acts as a powerful barrier to substitute products/services that might be available in the market.

 For the same reason as above, the competence of the focussed organization acts as an effective entry barrier to potential entrants to the niche markets.

3.3.4Risks faced under the Focus Strategy

There are several risks associated with the focus strategies. Basically these arise from the small size of the focused organizations and their dependence on the niche markets.

 First of all, serving niche markets requires the development of distinctive competencies to serve those markets. The development of such distinctive competencies may be a long- drawn and difficult process.

 Being focussed means commitment to a narrow market segment. Once committed, it may be difficult for the focussed organization to move to other segments of the markets.

 Major risk lies in the cost configuration for the focussed organization. Typically, the costs for the focussed organization are higher as the markets are limited and the volume of production and sales small.

 Niches are often transient. They may disappear owing to technology or market factors.

For instance, a new technology may make the process of niche products easier. Or there might be a shift in the customers’ needs and preferences causing them to move to other products. Sometimes, the rising costs of niche products may cause the customers to move to the lower-priced products of cost-leaders.

 Niches may become attractive enough for the big players to shift their attention to them.

The rising competition in the markets for cost and differentiator organizations may cause them to look at niche markets with greater interest, thereby posing a threat to the focussed organizations.

 Finally, rivals in the market may sometimes out-focus the focussed organizations by devising ways to serve the niche markets in a better manner.

That the risks to a focused organization are real can be seen from the fact that several organizations in competitive industries find it worthwhile to focus on narrower segments.

A wider choice of products, greater variety in services, the rising trend to customize products/services to cater to niche markets are evident today in the Indian markets.

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Table 2: Benefits associated with Generic Strategies

Industry

Force

Generic Strategies

Cost Leadership Differentiation Focus Competitive Rivalry

Better able to compete on price.

Brand loyalty to keep customers from rivals.

Rivals cannot meet differentiation-focused

customer needs.

Supplier Power Better insulated from powerful suppliers.

Better able to pass on supplier price increases to

customers.

Suppliers may not show much interest

because of low volumes. Also a focused firm is better able to absorb and pass

on supplier price increases to the loyal

customers.

Buyer Power

Ability to offer lower price to powerful buyers.

Large buyers have less power to negotiate because

of few close alternatives.

Large buyers have less power to negotiate

because of few alternatives.

Entry Barriers

Ability to cut price in retaliation deters potential entrants.

Customer loyalty can discourage potential

entrants.

Focusing develops core competencies that can act as an entry barrier.

Threat of Substitutes Can use low price to defend against

substitutes.

Customer’s become attached to differentiating attributes,

reducing threat of substitutes.

Specialized products&

core competency protect against

substitutes.

Table 3: Risks associated with Generic Strategies

Risks of Cost Leadership Risks of Differentiation Risks of Focus

Cost Leadership is not sustained

competitors imitate

technology changes

other bases for code leadership erode

Differentiation is not sustained

competitors imitate

bases for differentiation become less important to buyers

The focus strategy is imitated

The target segment becomes structurally unattractive

structure erodes

demand disappears

Proximity in differentiation is lost Cost proximity is lost Broadly-targeted competitors overwhelm the segment

the segment’s

differences from other segments narrow

the advantages of a broad line increase

Cost focusers achieve even cost in segments

Differentiation focusers achieve even greater differentiation in segments

New focusers sub-segment the industry

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MODULE No.21 : Generic Competitive Strategies 4. Stuck in the Middle

The three generic strategies each provide defenses against forces in the economic environment.

The firms that develop one of these strategies will earn higher than average returns in their industries.

The implication is that firms that do not develop one of the basic strategies will earn lower than average returns in their industries. Porter calls this being “stuck in the middle.” Becoming “stuck in the middle” is usually a recipe for below-average performance. The in-between firms lose all the high-margin business. They cannot compete well for high-volume business from customers who demand low prices, for the high-margin business of the differentiated firms, nor for the low- cost or focus-differentiated businesses.

The high returns are earned by the industry-wide firms with large market shares (the low cost and differentiated firms) and the firms that are focused with small market shares. Those firms in between, in terms of market share, earn lower than average returns. This idea is illustrated by a U-shaped relationship between market share and profitability (Figure 2). Market-leading firms within overall cost leadership are the largest, while differentiation or focus strategy are the smallest, and stuck in the middle least profitable firms are medium sized.

Figure 2. Generic strategies and Porter’s U-shaped relationship between market share and ROI

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MODULE No.21 : Generic Competitive Strategies 5. Points of Concern regarding Generic Strategies

At the conceptual level, Porter’s theory of generic strategy can be condensed into two propositions: (1) there are only three generic and comprehensive strategies, and (2) success depends upon using only one of the three generic strategies. Although generic strategy is valuable to many organizations and has provided a real contribution to business literature, several questions arise.

First, the generics are viewed as separate and completely distinct from one another (each strategy is mutually exclusive).

Second, the framework fails to show techniques that could be employed to shift from one strategy to another.

Third, although Porter’s generic strategies are based on earlier work, they lack theoretical or empirical substantiation.

And fourth, Porter, along with others, believes that competing simultaneously with low cost and differentiation is inconsistent. This means that when a business emphasizes differentiation, it cannot maintain low cost at the same time. Also, a business that keeps costs low cannot produce significantly differentiated outputs.

The fact is that many empirical and theoretical studies demonstrate that a dual emphasis on low costs and differentiation can result in high performance. This may occur, for example, when the firm pioneers a proprietary innovation (whether a product, service or process), which enables it to reduce cost and at the same time differentiate successfully. With the appropriate barriers erected, it may be possible to exploit such an innovation for a considerable period of time.

Similarly, cost leadership and differentiation may also be pursued together when costs are largely determined by market share, and control of a considerable share enables the firm to use the extra margin to differentiate, and still remain the cost leader. The same may be possible if there are interrelationships between industries that a competitor may be able to exploit while others are not.

The successes of Anheuser-Busch, General Electric, Coca-Cola, and Pepsi-Cola support this scenario. All of these companies have differentiated their outputs through offering high-quality products while simultaneously maintaining low per-unit cost operations.

The crux of this debate is that there exists no reason to imply that a low-cost base should necessarily be coupled with lower prices, or that a differentiated product should be coupled with premium prices. The low-cost base could simply be used to earn higher margins or, indeed, a differentiated product could be priced low enough to achieve a higher volume of sales.

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COMMERCE PAPER No.12 : Strategic Management

MODULE No.21 : Generic Competitive Strategies 6. Summary

 A generic strategy is a simple typology that captures the essential economic forces at work in a market (the demand side) and in an industry (the supply side). Porter suggested that there are three generic strategies to choose from, and each business unit can have its own strategy.

 According to Porter, a business can strive to supply a product or service more cost- effectively than its competitors (cost leadership), it can strive to add value to the product or service through differentiation and command higher prices (differentiation), or it can narrow its focus to a special product market segment which it can monopolize (focus).

 Each of the three generic competitive strategies positions the company differently in its market and competitive environment. Each establishes a central theme for how the company will endeavour to outcompete rivals.

 Not following any of these strategies characterizes a firm as being ‘stuck in the middle’.

The choice of generic strategy should be based on the firm’s business unit’s strengths and weaknesses, and a comparison of those with the strengths and weaknesses of competitors.

 The strategic positioning the firms adopt by being primarily cost leaders, differentiators or focusers is open to risks. No organization can make the assumption that the benefits derived out of any one business strategies are for all times to come.

 It is necessary to continually evaluate one’s positioning and take appropriate strategic actions to protect one from threats that may arise. Indeed, the purpose of managing as organization strategically is to be alive to the changes taking place in the environment.

 A choice of which generic strategy to employ spills over to affect several aspects of how the business will be operated and the manner in which value chain activities must be managed.

 Deciding which generic strategy to employ is perhaps the most important strategic commitment a company makes-it tends to drive the rest of the strategic actions a company decides to undertake.

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