Generic Strategy: Types of Competitive Advantage
Basically, strategy is about two things: deciding where you want your business to go, and deciding how to get there. A more complete definition is based on competitive advantage, the object of most corporate strategy:
Competitive advantage grows out of value a firm is able to create for its buyers that exceeds the firm’s cost of creating it. Value is what buyers are willing 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. There are two basic types of competitive advantage: cost leadership and differentiation.
— Michael Porter, Competitive Advantage, 1985, p.3
The figure below defines the choices of “generic strategy” a firm can follow. A firm’s relative position within an industry is given by its choice of competitive advantage (cost leadership vs. differentiation) and its choice of competitive scope. Competitive scope distinguishes between firms targeting broad industry segments and firms focusing on a narrow segment. Generic strategies are useful because they characterize strategic positions at the simplest and broadest level. Porter maintains that achieving competitive advantage requires a firm to make a choice about the type and scope of its competitive advantage. There are different risks inherent in each generic strategy, but being “all things to all people” is a sure recipe for mediocrity – getting “stuck in the middle”.
Porter’s Generic Strategies (source: Porter, 1985, p.12)
References:
Porter, Michael, Competitive Advantage, The Free Press, NY, 1985.
Porter, Michael, “What is strategy?” Harvard Business Review v74, n6 (Nov-Dec, 1996):61 (18 pages).
Porter’s 5 Forces & Industry Structure
What is the basis for competitive advantage?
Industry structure and positioning within the industry are the basis for models of competitive strategy promoted by Michael Porter. The “Five Forces” diagram captures the main idea of Porter’s theory of competitive advantage. The Five Forces define the rules of competition in any industry. Competitive strategy must grow out of a sophisticated understanding of the rules of competition that determine an industry’s attractiveness. Porter claims, “The ultimate aim of competitive strategy is to cope with and, ideally, to change those rules in the firm’s behavior.” (1985, p. 4) The five forces determine industry profitability, and some industries may be more attractive than others. The crucial question in determining profitability is how much value firms can create for their buyers, and how much of this value will be captured or competed away. Industry structure determines who will capture the value. But a firm is not a complete prisoner of industry structure – firms can influence the five forces through their own strategies. The five-forces framework highlights what is important, and directs manager’s towards those aspects most important to long-term advantage. Be careful in using this tool: just composing a long list of forces in the competitive environment will not get you very far – it’s up to you to do the analysis and identify the few driving factors that really define the industry. Think of the Five Forces framework as sort of a checklist for getting started, and as a reminder of the many possible sources for what those few driving forces could be.
Porter’s 5 Forces – Elements of Industry Structure (source: Porter, 1985, p.6)
How is competitive advantage created?
At the most fundamental level, firms create competitive advantage by perceiving or discovering new and better ways to compete in an industry and bringing them to market, which is ultimately an act of innovation. Innovations shift competitive advantage when rivals either fail to perceive the new way of competing or are unwilling or unable to respond. There can be significant advantages to early movers responding to innovations, particularly in industries with significant economies of scale or when customers are more concerned about switching suppliers. The most typical causes of innovations that shift competitive advantage are the following:
new technologies
new or shifting buyer needs
the emergence of a new industry segment
shifting input costs or availability
changes in government regulations
How is competitive advantage implemented?
But besides watching industry trends, what can the firm do? At the level of strategy implementation, competitive advantage grows out of the way firms perform discrete activities – conceiving new ways to conduct activities, employing new procedures, new technologies, or different inputs. The “fit” of different strategic activities is also vital to lock out imitators. Porters “Value Chain” and “Activity Mapping” concepts help us think about how activities build competitive advantage.
The value chain is a systematic way of examining all the activities a firm performs and how they interact. It scrutinizes each of the activities of the firm (e.g. development, marketing, sales, operations, etc.) as a potential source of advantage. The value chain maps a firm into its strategically relevant activities in order to understand the behavior of costs and the existing and potential sources of differentiation. Differentiation results, fundamentally, from the way a firm’s product, associated services, and other activities affect its buyer’s activities. All the activities in the value chain contribute to buyer value, and the cumulative costs in the chain will determine the difference between the buyer value and producer cost.
A firm gains competitive advantage by performing these strategically important activities more cheaply or better than its competitors. One of the reasons the value chain framework is helpful is because it emphasizes that competitive advantage can come not just from great products or services, but from anywhere along the value chain. It’s also important to understand how a firm fits into the overall value system, which includes the value chains of its suppliers, channels, and buyers.
The Four P’s of the Marketing Mix
The phrase “the four p’s” is an easy way to remember and characterize the four most important marketing decision variables. The four P’s are price, product, promotion, and place:
“Price” variables:
Allowances and deals
Distribution and retailer markups
Discount structure
“Product”variables:
Quality
Models and sizes
Packaging
Brands
Service
“Promotion” variables:
Advertising
Sales promotion
Personal selling
Publicity
“Place” variables:
Channels of distribution
Outlet location
Sales territories
Warehousing system
Source: Kotler, 1997
Market-Oriented Strategic Planning
“Market-oriented strategic planning is the managerial process of developing and maintaining a viable fit between the organization’s objectives, skills, and resources and its changing market opportunities. The aim of strategic planning is to shape and reshape the company’s businesses and products so that they yield target profits and growth.” – Kotler, 1997
Three key ideas:
Manage the company’s business as an investment portfolio.
Assess the future profit potential of each business by consider the market growth rate and the company’s fit.
Develop a strategic game plan that makes sense in light of the company’s industry position, objectives, skills, and resources.
The business strategic planning process:
Boston Consulting Group Growth-Share Matrix: “Invest in the stars, get rid of the dogs!” The framework promotes the importance of market growth rate and market share in determining the strategic importance of a product.
Alternative Views Of The Value Creation Process:
One traditional business approach ignores the impact of marketing research on product design. Under this framework, the first step is to make the product, and then the second step is to figure out how and to whom it will be sold. This is still a common problem in many companies today. A more sophisticated paradigm recognizes that the consumer demand should drive product design. Marketing research, segmentation, positioning, and conjoint analysis are all examples of this more sophisticated approach. The diagrams below illustrate the two paradigms.
Traditional physical process sequence:
The value creation and delivery sequence (McKinsey):
Market Segmentation, Targeting, and Positioning
“STP Marketing” is one way to characterize the modern strategic marketing approach. STP stands for Segmenting, Targeting, and Positioning. The idea is to use a more direct “rifle” approach instead of an undirected “shotgun” approach:
Additional Notes On Segmentation, Targeting And Positioning:
The following set of notes provides a brief outline some of the key ideas in this area.
Alternative approaches to marketing strategy:
Mass marketing: one product for all customers
Product-variety marketing: a variety of products for customers to choose from
Target marketing: targeted products for specific customer groups
Patterns of market segmentation:
Homogeneous preferences
Diffused preferences
Clustered preferences
Market segmentation procedure (one common approach) (Kotler, 1997):
Survey Stage: Exploratory interviews and focus groups, followed by questionnaires to assess:
Attributes and their importance ratings
Brand awareness
Product-usage patterns
Attitudes toward the product category
Demographics, etc.
Analysis Stage:
Factor analysis applied to remove highly correlated variables.
Cluster analysis applied to “create a specific number of maximally different segments”.
Profiling Stage: Each cluster is profiled in terms of its distinguishing attitudes, behavior, … Each cluster is a market segment.
Market targeting: 3 criteria for evaluating market segments:
Segment size and growth
Segment structural attractiveness (Porter’s 5 forces)
Company objectives and resources
Five patterns of target market selection (Abell) (p. 284):
Developing a positioning strategy:
“Positioning is the act of designing the company’s offer and image so that it occupies a distinct and valued place in the target customers’ minds.” (Kotler)
USP: Unique Selling Position. Promotion of a single benefit to the marketplace. Effective strategy (as opposed to touting multiple benefits).
Positioning strategies:
Attribute positioning
Benefit positioning
Use/application positioning
User positioning
Competitor positioning
Product category positioning
Quality/price positioning
Three steps:
Identify differences
Choose most important differences
Effectively signal differences to the target market
Economics: Differentiation premium pricing
Treacy and Wiersema: 3 strategies that lead to successful differentiation and market leadership:
Operational excellence
Customer intimacy
Product leadership
Differentiation:
Product differentiation:
Service differentiation:
Personnel differentiation:
Image differentiation:
Analyzing Industries and Competitors
Industries and competition play a central role in strategic analysis. The following notes reiterate these ideas from a marketing perspective.
Industry concept of competition – factors affecting industry structure and competition:
Number of sellers and degree of differentiation
Entry and mobility barriers
Exit and shrinkage barriers
Cost structures
Vertical integration
Global reach
Industry structure types:
Pure monopoly
Pure oligopoly
Differentiated oligopoly
Monopolistic competition
Pure competition
Market concept of competition: It may be important to consider competitors which make different products but which meet similar needs. This is different from an industry perspective when the view of competition is limited to those firms offering the same or very similar products.
Product segmentation
Market segmentation
Competitive intelligence: gathering data about competitors. Benchmarking.
True market orientation balances consumer and competitor considerations. Changing consumer needs and latent competitors are key factors and can be more devastating than existing competitor actions.
SWOT Checklist
Potential internal strengths
Potential internal weaknesses
Many product lines?
Obsolete, narrow product lines?
Broad market coverage?
Rising manufacturing costs?
Manufacturing competence?
Decline in R&D innovations?
Good marketing skills?
Poor marketing skills?
Good materials management systems?
Poor materials management systems?
R&D skills and leadership?
Loss of customer good will?
Information system competencies
Inadequate information systems?
Human resource competencies?
Inadequate human resources?
Brand name reputation?
Loss of brand name capital?
Portfolio management skills?
Growth without direction?
Cost of differentiation advantage?
Bad portfolio management?
New-venture management expertise?
Loss of corporate direction?
Appropriate management style?
Infighting among divisions?
Appropriate organizational structure?
Loss of corporate control?
Appropriate control systems?
Inappropriate organizational structure and control systems?
Ability to manage strategic change?
High conflict and politics?
Well-developed corporate strategy?
Poor financial management?
Good financial management?
Others?
Others?
Potential environmental opportunities
Potential environmental threats
Expand core business(es)?
Attacks on core business(es)?
Exploit new market segments?
Increases in domestic competition?
Widen new market segments?
Increases in foreign competition?
Extend cost or differentiation advantage?
Change in consumer taste?
Diversify into new growth businesses?
Fall in barriers to entry?
Expand into foreign markets?
Rise in new or substitute products?
Apply R&D skills in new areas?
Increase in industry rivalry?
Enter new related businesses?
New forms of industry competition?
Vertically integrate forward?
Potential for takeover?
Vertically integrate backward?
Existence for corporate raiders?
Enlarge corporate portfolio?
Increase in regional competition?
Overcome barriers to entry?
Changes in demographic factors?
Reduce rivalry among competitors?
Changes in economic factors?
Make profitable new acquisitions?
Downturn in economy?
Apply brand name capital in new areas?
Rising labor costs?
Seek fast market growth?
Slower market growth?
Others?
Others?
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