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strategies, a critique of their validity and some ideas on how to relate generic
strategies to industrial analysis and how to write a good Porter’s generic strategies
analysis for a given company. WE will be discussing this in class so it is useful if you
have all read this by Monday 4th February 2008
Introduction
Porter’s generic strategies framework constitutes a major contribution to the
development of the strategic management literature. Generic strategies were
first presented in two books by Professor Michael Porter of the Harvard
Business School (Porter, 1980, 1985). Porter (1980, 1985) suggested that some
of the most basic choices faced by companies are essentially the scope of the
markets that the company would serve and how the company would compete in
the selected markets. Competitive strategies focus on ways in which a company
can achieve the most advantageous position that it possibly can in its industry
(Pearson, 1999). The profit of a company is essentially the difference between
its revenues and costs. Therefore high profitability can be achieved through
achieving the lowest costs or the highest prices vis-à-vis the competition. Porter
used the terms ‘cost leadership’ and ‘differentiation’, wherein the latter is the
way in which companies can earn a price premium.
Cost leadership
The companies that attempt to become the lowest-cost producers in an industry
can be referred to as those following a cost leadership strategy. The company
with the lowest costs would earn the highest profits in the event when the
competing products are essentially undifferentiated, and selling at a standard
market price. Companies following this strategy place emphasis on cost
reduction in every activity in the value chain. It is important to note that a
company might be a cost leader but that does not necessarily imply that the
company’s products would have a low price. In certain instances, the company
can for instance charge an average price while following the low cost leadership
strategy and reinvest the extra profits into the business (Lynch, 2003). Examples
of companies following a cost leadership strategy include RyanAir, and easyJet,
in airlines, and ASDA and Tesco, in superstores. [Zimbabwean examples
include Express Stores, Fashion Discount, Number one stores, and Nick’s
Government schools, mission schools and state universities also pursue a cost
leadership strategy. Consider how this influences the final product. ]
The risk of following the cost leadership strategy is that the company’s focus on
reducing costs, even sometimes at the expense of other vital factors, may
become so dominant that the company loses vision of why it embarked on one
such strategy in the first place.
What other negative consequences can arise from this strategy?
Differentiation
When a company differentiates its products, it is often able to charge a premium
price for its products or services in the market. Some general examples of
differentiation include better service levels to customers, better product
performance etc. in comparison with the existing competitors. Porter (1980) has
argued that for a company employing a differentiation strategy, there would be
extra costs that the company would have to incur. Such extra costs may include
high advertising spending to promote a differentiated brand image for the
product, which in fact can be considered as a cost and an investment.
McDonalds , for example, is differentiated by its very brand name and brand
images of Big Mac and Ronald McDonald. [In Zimbabwe Barbours, Meikles,
Greaterman’s, Clicks all have opted for differentiation. The same strategy is
also applicable to the private schools ]
Differentiation has many advantages for the firm which makes use of the
strategy. Some problematic areas include the difficulty on part of the firm to
estimate if the extra costs entailed in differentiation can actually be recovered
from the customer through premium pricing. Moreover, successful
differentiation strategy of a firm may attract competitors to enter the company’s
market segment and copy the differentiated product (Lynch, 2003). This is the
major reason why there is such a big pre occupation with intellectual property
rights (IPRs) as these confer considerable competitive advantage and permit
their owners to leverage earnings from them. Consider the case of software
from Microsoft. The end user license agreement for much of the software is
annually renewable meaning that the client is forced to buy the same thing over
and over. Consider also the rise of the phenomenon of piracy as a consequence
of others wanting to cash in on the successful brand “microsoft”
Focus
Porter initially presented focus as one of the three generic strategies, but later
identified focus as a moderator of the two strategies. Companies employ this
strategy by focusing on the areas in a market where there is the least amount of
competition (Pearson, 1999). Organisations can make use of the focus strategy
by focusing on a specific niche in the market and offering specialised products
for that niche. This is why the focus strategy is also sometimes referred to as the
niche strategy (Lynch, 2003). Therefore, competitive advantage can be achieved
only in the company’s target segments by employing the focus strategy. The
company can make use of the cost leadership or differentiation approach with
regard to the focus strategy. In that, a company using the cost focus approach
would aim for a cost advantage in its target segment only. If a company is using
the differentiation focus approach, it would aim for differentiation in its target
segment only, and not the overall market.
This strategy provides the company the possibility to charge a premium price
for superior quality (differentiation focus) or by offering a low price product to
a small and specialised group of buyers (cost focus). Ferrari and Rolls-Royce
are classic examples of niche players in the automobile industry. Both these
companies have a niche of premium products available at a premium price.
Moreover, they have a small percentage of the worldwide market, which is a
trait characteristic of niche players. The downside of the focus strategy,
however, is that the niche characteristically is small and may not be significant
or large enough to justify a company’s attention. The focus on costs can be
difficult in industries where economies of scale play an important role. There is
the evident danger that the niche may disappear over time, as the business
environment and customer preferences change over time.
Competitive rivalry
If the competition in the industry in which the company operates is fierce, the
advantage of a cost leadership strategy would be that the firm would be able to
compete on price. However, cost leadership strategy is not the most desirable
strategy in this event, as competitors may put intense price pressures, such that
all companies would end up reducing their prices drastically. Differentiation
would be a viable strategy in this case as there is a likelihood that the loyal
customers would stay with the company. It would also be hard for competitors
to cope with the specialised needs of customers who are part of a niche segment
in the market.
Barriers to Entry
A company employing any one of the three strategies would find it easy to
create barriers for new entrants. The learning curve of cost leaders in an
industry, along with the economies of scale through experience curve effects,
would often make it impossible for potential entrants to compete on price, as the
more mature firm can further lower prices without comprising its profitability.
High customer loyalty towards a company’s brands, which is true for the
differentiation strategy, can play a vital role in discouraging potential entrants.
Customers often choose to be with a niche player because of a certain core
competence that only that particular player is providing in the market. Also
companies that make use of the focus strategy over time often develop a
thorough understanding of their customers’ needs, which is a very difficult task
for a potential entrant. In this way, focus can act as an entry barrier also.
Threat of substitutes
It is the differentiation and differentiation-focused strategies that effectively
reduce the threat of substitutes. Threat of substitutes is reduced in case of the
differentiation strategy due to customer loyalty to the unique aspects of a
particular product or service, which no substitute product can offer in the
customer’s mind. In case of the later strategy, the very nature of the company’s
products and core competence of the firm reduce the threat of substitutes.
Buyer Power
The power of buyers changes in accordance with the three generic strategies.
Cost leaders have the unique ability to offer lower price options to large and
powerful buyers. However, the scenario differs for companies making use of the
differentiation and focus strategies. Buyers in case of these two strategies would
have less power as there are few alternatives available to them.
Supplier Power
Suppliers can exercise their power primarily in case of differentiation and
focus/niche strategies. Companies making use of these strategies have the
ability to pass the price increases of suppliers to their final customers, through
the premium pricing strategy.
Conclusion
Porter’s generic strategies framework suggests that a company can maximize
performance by striving to be the cost leader in an industry, by differentiating its
products or services from those of other companies, and by focusing on a
narrow target in the market. A company that attempts to combine cost
leadership and differentiation strategies would invariably be stuck in the middle,
which according to Porter is not a desirable notion. It is seen that each of the
generic strategies has advantages and inherent risks that should be analysed
carefully with respect to the company and its competitors. It is noted that in
practice, most successful companies make use of a combination of low cost and
differentiation strategies, which is true even in the context of online business.
It is seen that Porter’s generic strategies can be effective in defending against
competitive forces in the industry. Key sources of information for conducting a
generic strategies analysis include company and competitor websites, annual
reports, advertising, and journal articles, trade publications and reputable
magazine articles. Porter’s generic strategies have certain limitations which
include shades of grey in the distinction between differentiation and cost,
compared to the black and white approach suggested by Porter. Also, analysts
must use the generic strategies analysis as only a part of a broader strategic
analysis. Use of other strategic models and tools like PESTEL, SWOT etc. is
recommended for a more holistic analysis.
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