Porter's Generic Strategies

Introduction

• A firm's profitability is largely determined by its position within its industry.
• Michael Porter identifies two main firm strengths: cost advantage and differentiation.
• Applying these strengths in a broad or narrow scope results in three generic strategies:
  • Cost Leadership
  • Differentiation
  • Focus
• These strategies are business unit level and not firm or industry dependent.

Generic Strategies

Cost Leadership Strategy

• Goal: Be the low-cost producer in the industry while maintaining quality.
• Approach:
  • Sell products at average industry prices to earn higher profits.
  • Sell below average industry prices to increase market share.
  • Maintain profitability in price wars.
• Methods to achieve cost advantages:
  • Improve process efficiencies.
  • Access to low-cost materials.
  • Optimal outsourcing and vertical integration.
  • Avoid unnecessary costs.
• Internal Strengths:
  • Access to significant capital for production.
  • Expertise in efficient product design and manufacturing.
  • Efficient distribution channels.
• Risks:
  • Competitors may also reduce costs.
  • Technological advancements by competitors.
  • Focused competitors could further reduce costs in niche markets.

Differentiation Strategy

• Goal: Develop unique products/services valued by customers.
• Benefits:
  • Ability to charge premium prices.
  • Less price sensitivity to supplier cost increases.
• Internal Strengths:
  • Access to leading scientific research.
  • Creative and skilled product development team.
  • Strong sales team.
  • Reputation for quality and innovation.
• Risks:
  • Imitation by competitors.
  • Changes in customer preferences.
  • Focus strategy competitors achieving greater differentiation.

Focus Strategy

• Goal: Concentrate on a narrow market segment to achieve cost advantage or differentiation.
• Benefits:
  • High customer loyalty.
  • Lower competition in narrow market.
• Challenges:
  • Lower volumes resulting in less bargaining power with suppliers.
  • Ability to pass costs to customers in differentiation focus.
• Risks:
  • Imitation and changes in target segments.
  • Broad-market leaders could adapt to compete.

Combining Strategies

• Combining strategies can lead to being "stuck in the middle" with no competitive advantage.
• Successful combination usually involves separate business units for different strategies.
• Some argue that customers may seek a mix of quality, style, convenience, and price.

Generic Strategies and Industry Forces

• Entry Barriers:
  • Cost leadership can deter new entrants by ability to cut prices.
  • Differentiation builds customer loyalty, discouraging new entrants.
  • Focus strategy develops core competencies that act as entry barriers.
• Buyer Power:
  • Cost leadership allows offering lower prices.
  • Differentiation reduces buyer power due to few alternatives.
  • Focus strategies can offer specialized products reducing buyer power.
• Supplier Power:
  • Better insulated under cost leadership.
  • Differentiation can pass supplier costs to customers.
  • Focused differentiation can pass costs to customers despite low volumes.
• Threat of Substitutes:
  • Cost leadership uses low price to defend.
  • Differentiation reduces substitute threat due to unique attributes.
  • Focus strategy protects with specialized products.
• Rivalry:
  • Cost leadership competes on price.
  • Differentiation relies on brand loyalty.
  • Focus strategies meet niche needs unmet by rivals.

Recommended Reading

• Porter, Michael E., Competitive Strategy: Techniques for Analyzing Industries and Competitors
  • Basis for modern business strategy.
  • Covers Porter's five forces, generic strategies, market signals, industry structure, and strategic decisions.