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The Five Generic Competitive Strategies – Which One to Employ?

Chapter 5 describes the five basic competitive strategy options—which of the five to employ is a company’s first and foremost choice in crafting overall strategy and beginning its quest for competitive advantage.

Lecture Outline

I. Introduction

1. By competitive strategy we mean the specifics of management’s game plan for competing successfully—how it plans to position the company in the marketplace, its specific efforts to please customers, and improve its competitive strength, and the type of competitive advantage it wants to establish.

2. A company achieves competitive advantage whenever it has some type of edge over rivals in attracting buyers and coping with competitive forces.

3. There are many routes to competitive advantage, but they all involve giving buyers what they perceive as superior value.

4. Delivering superior value—whatever form it takes—nearly always requires performing value chain activities differently than rivals and building competencies and resource capabilities that are not readily matched.

II. The Five Generic Competitive Strategies

1. There are countless variations in the competitive strategies that companies employ, mainly because each company’s strategic approach entails custom-designed actions to fit its own circumstances and industry environment.

2. The biggest and most important differences among competitive strategies boil down to:

a. Whether a company’s market target is broad or narrow

b. Whether the company is pursuing a competitive advantage linked to low costs or product differentiation

3. Five distinct competitive strategy approaches stand out:

a. A low-cost provider strategy: striving to achieve lower overall costs than rivals and appealing to a broad spectrum of customers, usually by under-pricing rivals.

b. A broad differentiation strategy: seeking to differentiate the company’s product/service offering from rivals’ in ways that will appeal to a broad spectrum of buyers. A focused (or market niche) strategy based on lower cost: concentrating on a narrow buyer segment and outcompeting rivals by serving niche members at a lower cost than rivals

c. A focused (or market niche) strategy based on differentiation: concentrating on a narrow buyer segment and outcompeting rivals by offering niche members customized attributes that meet their tastes and requirements better than rivals products

d. A best-cost provider strategy: giving customers more value for the money by incorporating good-to-excellent product attributes at a lower cost than rivals; the target is to have the lowest (best) costs and prices compared to rivals offering products with comparable attributes

4. See Figure 5.1 – The Five Generic Competitive Strategies—Each Stakes Out a Different Position in the Marketplace

III. Low-Cost Provider Strategies

1. 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.

2. In striving for a cost advantage over rivals, managers must take care to include features that buyers consider essential.

3. For maximum effectiveness, companies employing a low-cost provider strategy need to achieve their cost advantage in ways difficult for rivals to copy or match.

4. Core Concept: A low-cost leader’s basis for competitive advantage is lower overall costs than competitors. Successful low-cost leaders are exceptionally good at finding ways to drive costs out of their businesses.

5. A company has two options for translating a low-cost advantage over rivals into attractive profit performance:

a. Option 1: use the lower-cost edge to underprice competitors and attract price-sensitive buyers in great numbers to increase total profits

b. Option 2: maintain the present price, be content with the current market share, and use the lower-cost edge to earn higher profit margin on each unit sold

6. Illustration Capsule 5.1 describes how Wal-Mart managed its value chain to achieve a huge low-cost advantage over rival supermarket chains. This is its strategy for out-managing its rivals in efficiently performing various value chain activities to gain a low-cost leadership.

7. The Two Major Avenues for Achieving a Cost Advantage

a. To achieve a low-cost advantage over rivals, a firm’s cumulative costs across its overall value chain are lower than competitors’ cumulative costs. There are two ways to accomplish this:

i. Do a better job than rivals in performing value chain activities more cost effectively.

ii. Revamp the firm’s overall value chain to eliminate or bypass some cost-producing activities

b. Cost-Efficient Management of Value Chain Activities: Managers must launch a concerted, ongoing effort to ferret out cost-saving opportunities in every part of the value chain.

i. Striving to capture all available economies of sale

ii. Taking full advantage of learning/experience curve effects

iii. Trying to operate facilities at full capacity

iv. Improving supply chain efficiency

v. Using lower cost inputs wherever doing so will not entail too great a sacrifice in quality

vi. Using the company’s bargaining power vis-E0-vis suppliers to gain concessions

vii. Using communications systems and information technology to achieve operating efficiencies

viii. Employing advanced production technology and process design to improve overall efficiency

ix. Being alert to the cost advantages of outsourcing and vertical integration

x. Motivating employees through incentives and company culture

c. Core Concept: A cost driver is a factor that has a strong influence on a company’s costs.

d. See Figure 5.2 – Cost Drivers: The Keys to Driving Down Company Costs

8. Revamping the Value Chain to Curb or Eliminate Unnecessary Activities: Dramatic costs advantages can emerge from finding innovative ways to eliminate or bypass cost-producing value chain activities. The primary ways companies can achieve a cost advantage by reconfiguring their value chains include:

a. Selling direct to consumers and bypassing the activities and costs of distributors and dealers

b. Coordinating with suppliers to bypass the need to perform certain value chain activities, speed up their performance, or otherwise increase overall efficiency

c. Reducing materials handling and shipping costs by having suppliers locate their plants or warehouses close to the company’s own facilities

d. See Illustration Capsule 5.1 – How Wal-Mart Managed Its Value Chain to Achieve a Huge Low-Cost Advantage over Rival Supermarket Chains

i. Discussion Question: Which parts of the value chain does Wal-Mart target in order to achieve a low-cost advantage over its rivals?

ii. Answer: Wal-Mart has an extensive real-time information sharing network with vendors to make the supply chain much more efficient. It targets purchasing, store delivery, procurement practices that leverage the company’s relative buying power, investment in a large fleet of trucks for distribution of inventory, optimization of the product mix, use of security systems, preferred real estate rental and leasing rates, and lowering labor costs. Together, these initiatives give the company a 22 percent advantage over rival supermarket chains.

e. Examples of Companies That Revamped Their Value Chains to Reduce Costs: Nucor Corporation drastically revamped the value chain process for manufacturing steel products by using relatively inexpensive electric arc furnaces

i. One example of accruing significant cost advantages from creating altogether new value chain systems can be found in the beef-packing industry.

ii. Southwest Airlines has reconfigured the traditional value chain of commercial airlines to lower costs and thereby offer dramatically lower fares to passengers. Dell Computer has proved a pioneer in redesigning its value chain architecture in assembling and marketing personal computers.

9. The Keys to Success in Achieving Low-Cost Leadership

a. To succeed with a low-cost provider strategy, company managers have to scrutinize each cost creating activity and determine what drives its cost.

b. Success in achieving a low-cost edge over rivals comes from outmanaging rivals in figuring out how to perform value chain activities most cost effectively and eliminating or curbing nonessential value chain activities.

c. While low-cost providers are champions of frugality, they are usually aggressive in investing in resources and capabilities that promise to drive costs out of the business.

d. Wal-Mart is one of the foremost practitioners of low-cost leadership. Other companies noted for their successful use of low-cost provider strategies include Visio, Briggs & Stratton, Bic, Stride Rite, Poulan, General Electric, and Whirlpool.

10. When a Low-Cost Provider Strategy Works Best

a. A competitive strategy predicated on low-cost leadership is particularly powerful when:

i. Price competition among rival sellers is especially vigorous

ii. The products of rival sellers are essentially identical and suppliers are readily available from any of several eager sellers

iii. There are a few ways to achieve product differentiation that have value to buyers

iv. Most buyers use the product in the same ways

v. Buyers incur low costs in switching their purchases from one seller to another

vi. Buyers are large and have significant power to bargain down prices

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

b. A low cost provider is in the best position to win the business of price-sensitive buyers, set the floor on market price, and still earn a profit.

11. The Pitfalls of a Low-Cost Provider Strategy

a. Perhaps the biggest pitfall of a low-cost provider strategy is getting carried away with overly aggressive price cutting and ending up with lower, rather than higher, profitability.

i. A low-cost/low-price advantage results in superior profitability only if prices are cut by less than the size of the cost advantage or the added value gains in unit sales are large enough to bring in bigger total profit despite lower margins per unit sold.

b. A second big pitfall is not emphasizing avenues of cost advantages that can be kept proprietary or that relegate rivals to playing catch-up.

c. A third pitfall is becoming too fixated on cost reduction.

i. Even if these mistakes are avoided, a low-cost competitive approach still carries risk.

d. A low-cost provider’s product offering must always contain enough attributes to be attractive to prospective buyers—low price, by itself, is not always appealing to buyers.

IV. Broad Differentiation Strategies

1. Differentiation strategies are attractive whenever buyers’ needs and preferences are too diverse to be fully satisfied by a standardized product or by sellers with identical capabilities.

2. Core Concept: The essence of a broad differentiation strategy is to offer unique product attributes that a wide range of buyers find appealing and worth paying for.

3. Successful differentiation allows a firm to:

a. Command a premium price for its product

b. Increase unit sales

c. Gain buyer loyalty to its brand

4. Differentiation enhances profitability whenever the extra price the product commands outweighs the added costs of achieving the differentiation.

5. Types of Differentiation Themes

a. Companies can pursue differentiation from many angles.

b. The most appealing approaches to differentiation are those that are hard or expensive for rivals to duplicate.

c. Easy to copy differentiating features cannot produce sustainable competitive advantage; differentiation based on competencies and capabilities tend to be more sustainable.

6. Managing the Value Chain to Create the Differentiating Attributes

a. Differentiation opportunities can often be found in uniqueness drivers; possibilities include the following:

i. Striving to create superior product features, design, and performance.

ii. Improving customer service or adding additional service.

iii. Pursuing production R&D activities

iv. Striving for innovation and technological advances

v. Pursuing continuous quality improvement

vi. Increasing the intensity of marketing and sales activity

vii. Seeking out high-quality inputs

viii. Improving employee skill, knowledge, and experience through human resource management activity

b. Core Concept: A uniqueness driver is a factor that can have a strong differentiating effect.

c. See Figure 5.2 – Uniqueness Drivers: The Keys to Creating Differentiation Advantage

7. Revamping the Value Chain to Increase Differentiation

a. Differentiation opportunities can exist in activities all along an industry’s value chain; possibilities include the following:

i. Coordinating with channel allies to enhance customer perception of value

ii. Coordinating with suppliers to better address customer needs

b. Managers need keen understanding of the sources of differentiation and the activities that drive uniqueness to devise a sound differentiation strategy and evaluate various differentiation approaches.

8. Delivering Superior Value via a Broad Differentiation Strategy

a. While it is easy enough to grasp that a successful differentiation strategy must entail creating buyer value in ways unmatched by rivals, the big question is which of four basic differentiating approaches to take in delivering unique buyer value.

b. One route is to incorporate product attributes and user features that lower the buyer’s overall costs of using the product.

c. A second route is to incorporate tangible features that raise product performance.

d. A third route is to incorporate intangible features that enhance buyer satisfaction in noneconomic or intangible ways.

e. A fourth route is to signal the value of the company’s product offering - high price, packaging, ad content

f. A differentiator’s basis for competitive advantage is either a product/service offering whose attributes differ significantly from the offering of rivals, or a set of capabilities for delivering customer value that rivals do not have.

9. When a Differentiation Strategy Works Best

a. Differentiation strategies tend to work best in market circumstance where:

b. Buyer needs and uses of the product are diverse

c. There are many ways to differentiate the product or service and many buyers perceive these differences as having value

d. Few rival firms are following a similar differentiation approach

e. Technological change is fast-paced and competition revolves around rapidly evolving product features

10. The Pitfalls of a Differentiation Strategy

a. Differentiation strategies can fail for any of several reasons.

b. Any differentiating feature that works well is a magnet to imitators, and attempts at differentiation are doomed to fail if competitors can quickly copy most or all of the appealing product attributes a company comes up with.

c. A second pitfall is that the company’s differentiation strategy produces an unenthusiastic reception because buyers see little value in the unique attributes of a company’s product.

d. The third big pitfall of a differentiation strategy is overspending on efforts to differentiate the company’s product offering, thus eroding profitability

e. Other common pitfalls and mistakes in pursuing differentiation may include:

i. Being timid and not striving to open up meaningful gaps in quality or service or performance features vis-à-vis the products of rivals—tiny differences between rivals’ product offerings may not be visible or important to buyers

ii. Adding so many frills and extra features that the product exceeds the needs and use patterns of most buyers.

iii. Charging too high a price premium

f. A low-cost provider strategy can defeat a differentiation strategy when buyers are satisfied with a basic product and do not think extra attributes are worth a higher price.

V. Focused (or Market Niche) Strategies

1. What sets focused strategies apart from low-cost leadership or broad differentiation strategies is concentrated attention on a narrow piece of the total market.

2. The target segment or niche can be defined by:

a. Geographic uniqueness

b. Specialized requirements in using the product

c. Special product attributes that appeal only to niche members

3. A Focused Low-Cost Strategy

a. 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.

b. This strategy has considerable attraction when a firm can lower costs significantly by limiting its customer base to a well-defined buyer segment.

c. Focused low-cost strategies are fairly common.

4. A Focused Differentiation Strategy

a. A focused strategy based on differentiation aims at securing a competitive advantage by offering niche members a product they perceive is better suited to their own unique tastes and preferences.

b. 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.

c. See Illustration Capsule 5.4 – Progressive Insurance’s Focused Differentiation Strategy in Auto Insurance

5. When a Focused Low-Cost or Focused Differentiation Strategy is Attractive

a. A focused strategy aimed at securing a competitive edge based either on low cost or differentiation becomes increasingly attractive as more of the following conditions are met:

b. See Illustration Capsule 5.2 – Vizio’s Focused Low-Cost Strategy

i. Discussion Question: Discuss the advantages this organization achieves from its focused low-cost provider strategy.

ii. Answer: Through utilization of this type of strategy, Visio is able to capitalize on the market segment that is comprised of price-conscious buyers who want a quality picture for a reasonable price. Through its relationship with its major supplier and its focus on a single product category sold through limited distribution channels, it allows its customers deep price discounts.

c. The target niche is big enough to be profitable and offers good growth potential

d. Industry leaders do not see that having a presence in the niche is crucial to their own success

e. It is costly or difficult for multi-segment competitors to put capabilities in place to meet specialized needs of the target market niche and at the same time satisfy the expectations of their mainstream customers

f. The industry has many different niches and segments

g. Few, if any, other rivals are attempting to specialize in the same target segment

h. The focuser has a reservoir of customer goodwill and loyalty

i. See Illustration Capsule 5.3 – Progressive Insurance’s Focused
Differentiation Strategy in Auto Insurance

i. Discussion Question: How does Progressive’s choice of strategy differentiate it from other insurance companies in the marketplace?

ii. Answer: Progressive’s choice of a focused differentiation strategy is one that caters to the more high-risk driver. Such drivers are not overly welcomed in the more traditional insurance companies of today. This company also has teams of roving claim adjusters to settle claims on the spot and offers motorcycle coverage as well as luxury car insurance. These are significantly different offerings from those of the more traditional insurance carriers that have been predominate within the industry.

6. The Risks of a Focused Low-Cost or Focused Differentiation Strategy

a. Focusing carries several risks such as:

i. The chance that competitors will find effective ways to match the focused firm’s capabilities in serving the target niche

ii. The potential for the preferences and needs of niche members to shift over time toward the product attributes desired by the majority of buyers

iii. The segment may become so attractive it is soon inundated with competitors, intensifying rivalry and splintering segment profits

VI. Best-Cost Provider Strategies

1. Core Concept: Best-cost strategies are a hybrid of low-cost provider and differentiation strategies that aim at providing desired quality/features/performance/service attributes while beating rivals on price.

2. Best-cost provider strategies aim at giving customers more value for the money. The objective is to deliver superior value to buyers by satisfying their expectations on key quality/service/features/ performance attributes and beating their expectations on price.

3. A company achieves best-cost status from an ability to incorporate attractive attributes at a lower cost than rivals.

4. Best-cost provider strategies stake out a middle ground between pursuing a low-cost advantage and a differentiation advantage and between appealing to the broader market as a whole and a narrow market niche.

5. From a competitive positioning standpoint, best-cost strategies are a hybrid, balancing a strategic emphasis on low cost against a strategic emphasis on differentiation.

6. The competitive advantage of a best-cost provider is lower costs than rivals in incorporating good-to-excellent attributes, putting the company in a position to underprice rivals whose products have similar appealing attributes.

7. When a Best-Cost Provider Strategy Works Best

a. A best-cost provider strategy is very appealing in markets where product differentiation is the norm and there are an attractively large numbers of value-conscious buyers who prefer midrange products to cheap, basic products or expensive top-of-the-line products.

b. See Illustration Capsule 5.3 – Toyota’s Best-Cost Producer Strategy for Its Lexus Line

i. Discussion Question: Discuss how Toyota has been able to achieve its low-cost leadership status in the industry.

ii. Answer: Toyota has achieved low-cost leadership status because it has developed considerable skills in efficient supply chain management and low-cost assembly capabilities and because its models are so well-positioned in the low-to-medium end of the price spectrum. These are enhanced by Toyota’s strong emphasis in quality.

8. The Big Risk of a Best-Cost Provider Strategy

a. The danger of a best-cost provider strategy is that a company using it will get squeezed between the strategies of firms using low-cost and differentiation strategies.

b. To be successful, a best-cost provider must offer buyers significantly better product attributes in order to justify a price above what low-cost leaders are charging.

VII. The Contrasting Features of the Five Generic Competitive Strategies: A Summary

1. Deciding which generic competitive strategy should serve as the framework for hanging the rest of the company’s strategy is not a trivial matter.

2. Each of the five generic competitive strategies positions the company differently in its market and competitive environment.

3. Each establishes a central theme for how the company will endeavor to outcompete rivals.

4. Each creates some boundaries or guidelines for maneuvering as market circumstances unfold and as ideas for improving the strategy are debated.

5. Each points to different ways of experimenting and tinkering with the basic strategy.

6. 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.

7. Each entails differences in terms of product line, production emphasis, marketing emphasis, and means for sustaining the strategy.

8. See Table 5.1 – Distinguishing Features of the Five Generic Strategies

9. One of the big dangers here is that managers will opt for “stuck in the middle” strategies that represent compromises between lower costs and greater differentiation and between broad and narrow market appeal.

10. Only if a company makes a strong and unwavering commitment to one of the five generic competitive strategies does it stand much chance of achieving sustainable competitive advantage that such strategies can deliver if properly executed.

11. A company’s competitive strategy is unlikely to succeed unless it is predicated on leveraging a competitively valuable collection of resources and capabilities that match the strategy.