5 The Five Generic Competitive Strategies PDF

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CHAPTER 5

The Five Generic Competitive Strategies

Learning Objectives

© Roy Scott/Ikon Images/SuperStock

THIS CHAPTER WILL HELP YOU UNDERSTAND:

LO 1

What distinguishes each of the five generic strategies and why some of these strategies work better in certain kinds of competitive conditions than in others.

LO 2

The major avenues for achieving a competitive advantage based on lower costs.

LO 3

The major avenues to a competitive advantage based on differentiating a company’s product or service offering from the offerings of rivals.

LO 4

The attributes of a best-cost provider strategy—a hybrid of low-cost provider and differentiation strategies.

Strategy 101 is about choices: You can’t be all things to all people. Michael E. Porter—Professor, author, and cofounder of

requisite fit between what the environment needs and what the company does. Costas Markides—Professor and consultant

Monitor Consulting

Strategy is all about combining choices of what to do and what not to do into a system that creates the

A company can employ any of several basic approaches to competing successfully and gaining a competitive advantage over rivals, but they all involve delivering more value to customers than rivals or delivering value more efficiently than rivals (or both). More value for customers can mean a good product at a lower price, a superior product worth paying more for, or a best-value offering that represents an attractive combination of price, features, service, and other appealing attributes. Greater efficiency means delivering a given level of

I learnt the hard way about positioning in business, about catering to the right segments. Shaffi Mather—Social entrepreneur

value to customers at a lower cost to the company. But whatever approach to delivering value the company takes, it nearly always requires performing value chain activities differently than rivals and building competitively valuable resources and capabilities that rivals cannot readily match or trump. This chapter describes the five generic competitive strategy options. Which of the five to employ is a company’s first and foremost choice in crafting an overall strategy and beginning its quest for competitive advantage.

TYPES OF GENERIC COMPETITIVE STRATEGIES A company’s competitive strategy deals exclusively with the specifics of management’s game plan for competing successfully—its specific efforts to position itself in the marketplace, please customers, ward off competitive threats, and achieve a particular kind of competitive advantage. The chances are remote that any two companies— even companies in the same industry—will employ competitive strategies that are exactly alike in every detail. However, when one strips away the details to get at the real substance, the two biggest factors that distinguish one competitive strategy from another boil down to (1) whether a company’s market target is broad or narrow and (2) whether the company is pursuing a competitive advantage linked to lower costs or differentiation. These two factors give rise to five competitive strategy options, as shown in Figure 5.1 and listed next.1 1. A low-cost provider strategy—striving to achieve lower overall costs than rivals on comparable products that attract a broad spectrum of buyers, usually by underpricing rivals.

LO 1 What distinguishes each of the five generic strategies and why some of these strategies work better in certain kinds of competitive conditions than in others.

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FIGURE 5.1

Concepts and Techniques for Crafting and Executing Strategy

The Five Generic Competitive Strategies

Market Target

Type of Competitive Advantage Being Pursued

A Broad Cross-Section of Buyers

A Narrow Buyer Segment (or Market Niche)

Lower Cost

Differentiation

Overall Low-Cost Provider Strategy

Broad Differentiation Strategy

Best-Cost Provider Strategy Focused Low-Cost Strategy

Focused Differentiation Strategy

Source:This is an expanded version of a three-strategy classification discussed in Michael E. Porter, Competitive Strategy(New York: Free Press, 1980).

2. A broad differentiation strategy—seeking to differentiate the company’s product offering from rivals’ with attributes that will appeal to a broad spectrum of buyers. 3. A focused low-cost strategy—concentrating on the needs and requirements of a narrow buyer segment (or market niche) and striving to meet these needs at lower costs than rivals (thereby being able to serve niche members at a lower price). 4. A focused differentiation strategy—concentrating on a narrow buyer segment (or market niche) and outcompeting rivals by offering niche members customized attributes that meet their tastes and requirements better than rivals’ products. 5. A best-cost provider strategy—striving to incorporate upscale product attributes at a lower cost than rivals. Being the “best-cost” producer of an upscale, multifeatured product allows a company to give customers more value for their money by underpricing rivals whose products have similar upscale, multifeatured attributes. This competitive approach is a hybrid strategy that blends elements of the previous four options in a unique and often effective way. The remainder of this chapter explores the ins and outs of these five generic competitive strategies and how they differ.

LOW-COST PROVIDER STRATEGIES Striving to achieve lower overall costs than rivals is an especially potent competitive approach in markets with many price-sensitive buyers. A company achieves low-cost leadership when it becomes the industry’s lowest-cost provider rather than just being one of perhaps several competitors with comparatively low costs. A low-cost provider’s foremost strategic objective is meaningfully lower costs than rivals—but not

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The Five Generic Competitive Strategies

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necessarily the absolutely lowest possible cost. In striving for a cost advantage over rivals, company managers must incorporate features and services that buyers consider LO 2 essential. A product offering that is too frills-free can be viewed by consumers as The major avenues offering little value regardless of its pricing. for achieving A company has two options for translating a low-cost advantage over rivals into a competitive attractive profit performance. Option 1 is to use the lower-cost edge to underprice advantage based on lower costs. competitors and attract price-sensitive buyers in great enough numbers to increase total profits. Option 2 is to maintain the present price, be content with the present market share, and use the lower-cost edge to earn a higher profit margin on each CORE CONCEPT unit sold, thereby raising the firm’s total profits and overall return on investment. A low-cost provider’s basis While many companies are inclined to exploit a low-cost advantage by using for competitive advantage option 1 (attacking rivals with lower prices), this strategy can backfire if rivals is lower overall costs than respond with retaliatory price cuts (in order to protect their customer base and competitors. Successful defend against a loss of sales). A rush to cut prices can often trigger a price war low-cost leaders, who have that lowers the profits of all price discounters. The bigger the risk that rivals will the lowest industry costs, respond with matching price cuts, the more appealing it becomes to employ the are exceptionally good at second option for using a low-cost advantage to achieve higher profitability. finding ways to drive costs

The Two Major Avenues for Achieving a Cost Advantage To achieve a low-cost edge over rivals, a firm’s cumulative costs across its overall value chain must be lower than competitors’ cumulative costs. There are two major avenues for accomplishing this:2 1. Perform value chain activities more cost-effectively than rivals. 2. Revamp the firm’s overall value chain to eliminate or bypass some costproducing activities.

out of their businesses and still provide a product or service that buyers find acceptable.

A low-cost advantage over rivals can translate into better profitability than rivals attain.

CORE CONCEPT For a A cost driver is a factor company to do a more cost-efficient job of managing its value chain than rivals, that has a strong influence managers must diligently search out cost-saving opportunities in every part of the on a company’s costs. value chain. No activity can escape cost-saving scrutiny, and all company personnel must be expected to use their talents and ingenuity to come up with innovative and effective ways to keep down costs. Particular attention must be paid to a set of factors known as cost drivers that have a strong effect on a company’s costs and can be used as levers to lower costs. Figure 5.2 shows the most important cost drivers. Cost-cutting approaches that demonstrate an effective use of the cost drivers include:

Cost-Efficient Management of Value Chain Activities

1. Capturing all available economies of scale. Economies of scale stem from an ability to lower unit costs by increasing the scale of operation. Economies of scale may be available at different points along the value chain. Often a large plant is more economical to operate than a small one, particularly if it can be operated round the clock robotically. Economies of scale may be available due to a large warehouse operation on the input side or a large distribution center on the output side. In global industries, selling a mostly standard product worldwide tends to lower unit costs as opposed to making separate products for each country market, an approach in which costs are typically higher due to an inability to reach the most economic scale of production for each country. There are economies of scale in advertising as well. For example, Anheuser-Busch could

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FIGURE 5.2

Concepts and Techniques for Crafting and Executing Strategy

Cost Drivers: The Keys to Driving Down Company Costs

Incentive systems and culture

Outsourcing or vertical integration

Economies of scale

Learning and experience

Capacity utilization COST DRIVERS

Bargaining power

Supply chain efficiencies

Communication systems and information technology

Production technology and design

Input costs

Source: Adapted from Michael E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York: Free Press, 1985).

afford to pay the $5 million cost of a 30-second Super Bowl ad in 2016 because the cost could be spread out over the hundreds of millions of units of Budweiser that the company sells. 2. Taking full advantage of experience and learning-curve effects. The cost of performing an activity can decline over time as the learning and experience of company personnel build. Learning and experience economies can stem from debugging and mastering newly introduced technologies, using the experiences and suggestions of workers to install more efficient plant layouts and assembly procedures, and the added speed and effectiveness that accrues from repeatedly picking sites for and building new plants, distribution centers, or retail outlets. 3. Operating facilities at full capacity. Whether a company is able to operate at or near full capacity has a big impact on unit costs when its value chain contains activities associated with substantial fixed costs. Higher rates of capacity utilization allow depreciation and other fixed costs to be spread over a larger unit volume, thereby lowering fixed costs per unit. The more capital-intensive the business and the higher the fixed costs as a percentage of total costs, the greater the unit-cost penalty for operating at less than full capacity. 4. Improving supply chain efficiency. Partnering with suppliers to streamline the ordering and purchasing process, to reduce inventory carrying costs via just-intime inventory practices, to economize on shipping and materials handling, and to

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The Five Generic Competitive Strategies

ferret out other cost-saving opportunities is a much-used approach to cost reduction. A company with a distinctive competence in cost-efficient supply chain management, such as BASF (the world’s leading chemical company), can sometimes achieve a sizable cost advantage over less adept rivals. Substituting lower-cost inputs wherever there is little or no sacrifice in product quality or performance. If the costs of certain raw materials and parts are “too high,” a company can switch to using lower-cost items or maybe even design the high-cost components out of the product altogether. Using the company’s bargaining power vis-à-vis suppliers or others in the value chain system to gain concessions. Home Depot, for example, has sufficient bargaining clout with suppliers to win price discounts on large-volume purchases. Using online systems and sophisticated software to achieve operating efficiencies. For example, sharing data and production schedules with suppliers, coupled with the use of enterprise resource planning (ERP) and manufacturing execution system (MES) software, can reduce parts inventories, trim production times, and lower labor requirements. Improving process design and employing advanced production technology. Often production costs can be cut by (1) using design for manufacture (DFM) procedures and computer-assisted design (CAD) techniques that enable more integrated and efficient production methods, (2) investing in highly automated robotic production technology, and (3) shifting to a mass-customization production process. Dell’s highly automated PC assembly plant in Austin, Texas, is a prime example of the use of advanced product and process technologies. Many companies are ardent users of total quality management (TQM) systems, business process reengineering, Six Sigma methodology, and other business process management techniques that aim at boosting efficiency and reducing costs. Being alert to the cost advantages of outsourcing or vertical integration. Outsourcing the performance of certain value chain activities can be more economical than performing them in-house if outside specialists, by virtue of their expertise and volume, can perform the activities at lower cost. On the other hand, there can be times when integrating into the activities of either suppliers or distributionchannel allies can lower costs through greater production efficiencies, reduced transaction costs, or a better bargaining position. Motivating employees through incentives and company culture. A company’s incentive system can encourage not only greater worker productivity but also cost-saving innovations that come from worker suggestions. The culture of a company can also spur worker pride in productivity and continuous improvement. Companies that are well known for their cost-reducing incentive systems and culture include Nucor Steel, which characterizes itself as a company of “20,000 teammates,” Southwest Airlines, and Walmart.

Revamping of the Value Chain System to Lower Costs Dramatic cost advantages can often emerge from redesigning the company’s value chain system in ways that eliminate costly work steps and entirely bypass certain cost-producing value chain activities. Such value chain revamping can include: ∙ Selling direct to consumers and bypassing the activities and costs of distributors and dealers. To circumvent the need for distributors and dealers, a company can (1) create its own direct sales force (which adds the costs of maintaining and

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supporting a sales force but which may well be cheaper than using independent distributors and dealers to access buyers) and/or (2) conduct sales operations at the company’s website (incurring costs for website operations and shipping may be a substantially cheaper way to make sales than going through distributor–dealer channels). Costs in the wholesale and retail portions of the value chain frequently represent 35 to 50 percent of the final price consumers pay, so establishing a direct sales force or selling online may offer big cost savings. ∙ Streamlining operations by eliminating low-value-added or unnecessary work steps and activities. At Walmart, some items supplied by manufacturers are delivered directly to retail stores rather than being routed through Walmart’s distribution centers and delivered by Walmart trucks. In other instances, Walmart unloads incoming shipments from manufacturers’ trucks arriving at its distribution centers and loads them directly onto outgoing Walmart trucks headed to particular stores without ever moving the goods into the distribution center. Many supermarket chains have greatly reduced in-store meat butchering and cutting activities by shifting to meats that are cut and packaged at the meatpacking plant and then delivered to their stores in ready-to-sell form. ∙ Reducing materials handling and shipping costs by having suppliers locate their plants or warehouses close to the company’s own facilities. Having suppliers locate their plants or warehouses close to a company’s own plant facilitates justin-time deliveries of parts and components to the exact workstation where they will be used in assembling the company’s product. This not only lowers incoming shipping costs but also curbs or eliminates the company’s need to build and operate storerooms for incoming parts and components and to have plant personnel move the inventories to the workstations as needed for assembly. Illustration Capsule 5.1 describes the path that Amazon.com, Inc. has followed on the way to becoming not only the largest online retailer (as measured by revenues) but also the lowest-cost provider in the industry.

Examples of Companies That Revamped Their Value Chains to Reduce Costs Nucor Corporation, the most profitable steel producer in the United States and one of the largest steel producers worldwide, drastically revamped the value chain process for manufacturing steel products by using relatively inexpensive electric arc furnaces and continuous casting processes. Using electric arc furnaces to melt recycled scrap steel eliminated many of the steps used by traditional steel mills that made their steel products from iron ore, coke, limestone, and other ingredients using costly coke ovens, basic oxygen blast furnaces, ingot casters, and multiple types of finishing facilities—plus Nucor’s value chain system required far fewer employees. As a consequence, Nucor produces steel with a far lower capital investment, a far smaller workforce, and far lower operating costs than traditional steel mills. Nucor’s strategy to replace the traditional steelmaking value chain with its simpler, quicker value chain approach has made it one of the world’s lowest-cost producers of steel, allowing it to take a huge amount of market share away from traditional steel companies and earn attractive profits. (Nucor reported a profit in 188 out of 192 quarters during 1966–2014—a remarkable feat in a mature and cyclical industry notorious for roller-coaster bottom-line performance.) Southwest Airlines has achieved considerable cost savings by reconfiguring the traditional value chain of commercial airlines, thereby permitting it to offer travelers dramatically lower fares. Its mastery of fast turnarounds at the gates (about 25 minutes

ILLUSTRATION CAPSULE 5.1

Amazon’s Path to Becoming the Low-Cost Provider in E-commerce

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