What are the 5 generic strategies

CHAPTER 5 The Five Generic Competitive Strategiwes

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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.

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Learning Objectives

This chapter will help you understand:

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.

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

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

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

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This chapter describes the five generic competitive strategy options. Each of the five generic strategies represents a distinctly different approach to competing in the marketplace. Each of the five generic strategies represents a distinctly different approach to competing in the marketplace. 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.

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Why Do Strategies Differ?

A firm’s competitive strategy deals exclusively with the specifics of its efforts to position itself in the market-place, please customers, ward off competitive threats, and achieve a particular kind of competitive advantage.

Key factors that distinguish one strategy from another

Is the firm’s market target broad or narrow?

Is the competitive advantage being pursued linked to low costs or product differentiation?

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A company’s competitive strategy deals exclusively with the specifics of management’s game plan for competing successfully— its specific efforts to please customers, strengthen its market position, counter the maneuvers of rivals, respond to shifting market conditions, and achieve a particular kind of competitive advantage.

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

Whether a company’s market target is broad or narrow

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

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Types of Generic Competitive Strategies

Types GENERIC COMPETITIVE STRATEGIES
Broad, Low-cost Strategy Striving to achieve broad lower overall costs than rivals on comparable products that attract a broad spectrum of buyers, usually by underpricing rivals
Broad Differentiation Strategy Seeking to differentiate the firm’s product offering from its rivals’ with attributes that will appeal to a broad spectrum of buyers.
Focused Low-cost Strategy Concentrating on a narrow buyer segment (or market niche striving to meet these needs at lower costs than rivals (thereby being able to serve niche members at a lower price)
Focused Differentiation Strategy Concentrating on a narrow buyer segment (or market niche) by offering its members customized attributes that meet their specific tastes and requirements of niche members better than rivals
Best-cost (Hybrid) 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 firm to give customers more value for their money by underpricing rivals whose products have similar upscale, multifeatured attributes
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Five distinct competitive strategy approaches stand out:

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

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 low-cost strategy: concentrating on a narrow buyer segment and outcompeting rivals by serving niche members at a lower cost than rivals

A focused differentiation strategy: 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

A best-cost producer 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

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FIGURE 5.1 The Five Generic Competitive Strategies

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

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Figure 5.1 The Five Generic Competitive Strategies examines how each of the five strategies stake out a different market position.

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Low-Cost Strategies

Effective low-cost approaches

Pursue cost savings that are difficult to imitate

Avoid reducing product quality to unacceptable levels

Competitive advantages and risks

Greater total profits and increased market share gained from underpricing competitors

Larger profit margins when selling products at prices comparable to and competitive with rivals

Low pricing does not attract enough new buyers

Rival’s retaliatory price-cutting sets off a price war

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A low-cost producer’s basis for competitive advantage is lower overall costs than competitors. Successful low-cost leaders, who have the lowest industry costs, are exceptionally good at finding ways to drive costs out of their businesses and still provide a product or service that buyers find acceptable.

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The Two Major Avenues for Achieving a Cost Advantage

Low-cost advantage

Cumulative costs across the overall value chain must be lower than competitors’ cumulative costs.

Options for translating a low-cost advantage over rivals into attractive profit performance:

Perform value-chain activities more cost-effectively than rivals

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

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

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Cost-Efficient Management of Value Chain Activities (1 of 2)

Cost driver

A factor with a strong influence on a firm’s costs

Can be asset-based or activity-based

Securing a cost advantage

Use lower-cost inputs and hold minimal assets

Offer only “essential” product features or services

Offer only limited product lines

Use low-cost distribution channels

Use the most economical delivery methods

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A cost driver is a factor that has a strong influence on a firm’s costs. A low-cost advantage over rivals can translate into better profitability than rivals attain.

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FIGURE 5.2 Cost Drivers: The Keys to Driving Down Company Costs

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

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Figure 5.2 shows the most important cost drivers.

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Cost-Cutting Methods (1 of 2)

Capturing all available economies of scale

Taking full advantage of experience and learning-curve effects

Operating facilities at full or near-full capacity

Improving supply chain efficiency

Substituting lower-cost inputs wherever there is little or no sacrifice in product quality or performance

Using the firm’s bargaining power vis-à-vis suppliers or others in the value chain system to gain concessions

Using online systems and sophisticated software to achieve operating efficiencies

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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.

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Cost-Cutting Methods (2 of 2)

Improving process design and employing advanced production technology

Being alert to the cost advantages of outsourcing or vertical integration

Motivating employees through incentives and company culture

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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.

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Revamping the Value Chain System to Lower Costs

Selling direct to consumers and bypassing the activities and costs of distributors and dealers by using a direct sales force and a company website

Streamlining operations to eliminate low value-added or unnecessary work steps and activities

Reduce materials-handling and shipping costs by having suppliers locate their plants or warehouses close to the firm’s own facilities

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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.

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Vanguard’s Path to Becoming the Low-Cost Leader in Investment Management

Describe Vanguard’s business segment.

How well are Vanguard’s competitive strengths matched to the five forces in its competitive environment?

Which of Vanguard’s value chain activities would be most easily overcome by rivals? most difficult to overcome?

Assume you have been tasked to revamp a rival’s value chain activities to better compete with Vanguard. In what order of expected payoff should you attempt to revamp its value chain activities?

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Illustration Capsule 5.1 shows how Vanguard managed its value chain to achieve a huge low-cost advantage over rival supermarket chains.

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The Keys to a Successful Low-Cost Strategy

Success in achieving a low-cost edge over rivals comes from out-managing rivals in finding ways to perform value chain activities faster, more accurately, and more cost-effectively by:

Spending aggressively on resources and capabilities that promise to drive costs out of the business

Carefully estimating the cost savings of new technologies before investing in them

Constantly reviewing cost-saving resources to ensure they remain competitively superior

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Success in achieving a low-cost edge over rivals comes from out-managing rivals in finding ways to perform value chain activities faster, more accurately, and more cost-effectively.

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

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When a Low-Cost Strategy Works Best

Price competition among rival sellers is vigorous.

Identical products are available from many sellers.

There are few ways to differentiate industry products.

Most buyers use the product in the same ways.

Buyers incur low costs in switching among sellers.

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A low-cost producer strategy becomes increasingly appealing and competitively powerful when the forces of competition are favorable to a particular competitor’s market position.

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Pitfalls to Avoid in Pursuing a Low-Cost Strategy

Engaging in overly aggressive price cutting that does not result in unit sales gains sufficient to recoup forgone profits

Relying on a cost advantage that is not sustainable because rival firms can easily copy or overcome it

Becoming so fixated on cost reduction such that the firm’s offerings lack the primary features that attract buyers

Having a rival discover a new lower-cost value chain approach or develop a cost-saving technological breakthrough

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Reducing price does not lead to higher total profits unless the added gains in unit sales are large enough to bring in a bigger total profit despite lower margins per unit sold.

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

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Broad Differentiation Strategies

Effective Differentiation Approaches

Carefully study buyer needs and behaviors, values, and willingness to pay for a unique product or service

Incorporate features that both appeal to buyers and create a sustainably distinctive product offering

Use higher prices to recoup differentiation costs

Advantages of Differentiation

Command premium prices for the firm’s products

Increased unit sales due to attractive differentiation

Brand loyalty that bonds buyers to the differentiating features of the firm’s products

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Differentiation enhances profitability whenever a company’s product can command a sufficiently higher price or produce sufficiently greater unit sales to more than cover the added costs of achieving the differentiation.

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.

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Cost-Efficient Management of Value Chain Activities (2 of 2)

A value driver can

Have a strong differentiating effect

Be based on physical as well as functional attributes of a firm’s products

Be the result of superior performance capabilities of the firm’s human capital

Have an effect on more than one of the firm’s value chain activities

Create a perception of value (brand loyalty) in buyers where there is little reason for it to exist

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A value driver is a factor that can have a strong differentiating effect.

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FIGURE 5.3 Value Drivers: The Keys to Creating a Differentiation Advantage

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

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Figure 5.3 contains a list of important value drivers.

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Managing the Value Chain to Create the Differentiating Attributes

Create product features and performance attributes that appeal to a wide range of buyers.

Improve customer service or add extra services.

Invest in production-related R&D activities.

Strive for innovation and technological advances.

Pursue continuous quality improvement.

Increase marketing and brand-building activities.

Seek out high-quality inputs.

Emphasize HRM activities that improve the skills, expertise, and knowledge of company personnel.

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Differentiation is not something hatched in marketing and advertising departments, nor is it limited to the catchalls of quality and service. Differentiation opportunities can exist in activities all along an industry’s value chain. The most systematic approach that managers can take, however, involves focusing on the value drivers, a set of factors—analogous to cost drivers—that are particularly effective in creating differentiation.

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Revamping the Value Chain System to Increase Differentiation

Approaches to enhancing differentiation through changes in the value chain system

Coordinating with downstream channel allies to enhance customer perceptions of value

Coordinating with suppliers to better address customer needs

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Just as pursuing a cost advantage can involve the entire value chain system, the same is true for a differentiation advantage.

Activities performed upstream by suppliers or downstream by distributors and retailers can have a meaningful effect on customers’ perceptions of a company’s offerings and its value proposition

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Delivering Superior Value via a Broad Differentiation Strategy

Broad Differentiation: Offering Customers Something That Rivals Cannot or Do Not
1. Incorporate product attributes and user features that lower the buyer’s overall costs of using the firm’s product
2. Incorporate tangible features (e.g., styling) that increase customer satisfaction with the product
3. Incorporate intangible features (e.g., buyer image) that enhance buyer satisfaction in noneconomic ways
4. Signal the value of the firm’s product offering to buyers (e.g., price, packaging, placement, advertising)
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Differentiation strategies depend on meeting customer needs in unique ways or creating new needs through activities such as innovation or persuasive advertising. The objective is to offer customers something that rivals can’t—at least in terms of the level of satisfaction. The four basic routes to achieving this aim are listed in the slide content.

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Differentiation: Signaling Value

Signaling value is important when:

The nature of differentiation is based on intangible features and is therefore subjective or hard to quantify by the buyer.

Buyers are making a first-time purchase and are unsure what their experience will be with the product.

Product or service repurchase by buyers is infrequent.

Buyers are unsophisticated.

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Differentiation can be based on tangible or intangible attributes. Easy-to-copy differentiating features cannot produce a sustainable competitive advantage.

The value of certain differentiating features is rather easy for buyers to detect, but in some instances, buyers may have trouble assessing what their experience with the product will be. Successful differentiators go to great lengths to make buyers knowledgeable about a product’s value and employ various signals of value.

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Successful Approaches to Sustainable Differentiation

Differentiation that is difficult for rivals to duplicate or imitate

Company reputation

Long-standing relationships with buyers

A unique product or service image

Differentiation that creates substantial switching costs that lock in buyers

Patent-protected product innovation

Relationship-based customer service

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The most successful approaches to differentiation are those that are difficult for rivals to duplicate. Indeed, this is the route to a sustainable competitive advantage.

While resourceful competitors can, in time, clone almost any tangible product attribute, socially complex intangible attributes such as company reputation, long-standing relationships with buyers, and image are much harder to imitate.

Differentiation that creates switching costs that lock in buyers also provides a route to sustainable advantage.

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When a Differentiation Strategy Works Best

Market Circumstances Favoring Differentiation

Buyer needs and uses for the product are diverse.

There are many ways that differentiation can have value to buyers.

Few rival firms are following a similar differentiation approach.

There is rapid change in the product’s technology and features.

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Differentiation strategies tend to work best in market circumstances where differentiation yields a longer-lasting and more profitable competitive edge that is based on a well-established brand image, patent-protected product innovation, complex technical superiority, a reputation for superior product quality and reliability, relationship-based customer service, and unique competitive capabilities.

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Pitfalls to Avoid in Pursuing a Differentiation Strategy

Relying on product attributes easily copied by rivals

Introducing product attributes that do not evoke an enthusiastic buyer response

Eroding profitability by overspending on efforts to differentiate the firm’s product offering

Offering only trivial improvements in quality, service, or performance features vis-à-vis the products of rivals

Over-differentiating the product quality, features, or service levels exceeds the needs of most buyers

Charging too high a price premium

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Any differentiating feature that works well is a magnet for imitators. This is why a firm must seek out sources of value creation that are time-consuming or burdensome for rivals to match if it hopes to use differentiation to win a sustainable competitive edge. Overdifferentiating and overcharging are fatal strategy mistakes.

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Focused (or Market Niche) Strategies

Focused Strategy Approaches

Focused Low-Cost Strategy

Focused Market Niche Strategy

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

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Clinícas del Azúcar’s Focused Low-Cost Strategy

Which uniqueness drivers are responsible for the success of Clinícas del Azúcar?

Which competitive conditions would mitigate against successful entry of the Clinícas del Azúcar into the U.S. diabetes care market?

What part do customer expectations about patient-doctor relationships play in the delivery of health care in the United States?

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Illustration Capsule 5.2 describes how Clinícas del Azúcar’s focus on lowering the costs of diabetes care is allowing to address a major health issue in Mexico.

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When a Focused Low-Cost or Focused Differentiation Strategy Is Attractive

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

Industry leaders chose not to compete in the niche; focusers avoid competing against strong competitors.

It is costly or difficult for multi-segment competitors to meet the specialized needs of niche buyers.

The industry has many different niches and segments.

Rivals have little or no entry interest in the target segment.

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A focused strategy aimed at securing a competitive edge based on either low costs or differentiation becomes increasingly attractive as more of the following favorable conditions listed in the slide are met.

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

Competitors will find ways to match the focused firm’s capabilities in serving the target niche.

The specialized preferences and needs of niche members shift over time toward the product attributes desired by the majority of buyers.

As attractiveness of the segment increases, it draws in more competitors, intensifying rivalry and splintering segment profits.

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There are several inherent risks related to increased attractiveness of the focuser’s segment, changes in competitor capabilities and changes in the characteristics of the segment’s customers.

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Canada Goose’s Focused Differentiation Strategy

Which decisions did CEO Dani Reiss make that launched Canada Goods on its chosen strategic path?

Which uniqueness drivers are responsible for the success of Canada Goose?

Which of Canada Goose’s uniqueness drivers are competitors likely to attempt to copy first?

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Illustration Capsule 5.3 describes how Canada Goose has been gaining attention with its focused differentiation strategy.

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Best-Cost (Hybrid) Strategies

Differentiation: Providing desired quality, features, performance, service attributes

Low Cost Producer: Charging a lower price than rivals with similar caliber product offerings

Best-Cost Hybrid Approach

Value-Conscious Buyer

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Best-cost strategies are a hybrid of low cost and differentiation strategies, incorporating features of both simultaneously. They may target either a broad or narrow (focused) base of value-conscious customers.

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When a Best-Cost Strategy Works Best

Product differentiation is the market norm.

There are a large number of value-conscious buyers who prefer mid-range products.

There is competitive space near the middle of the market for a competitor with either a medium-quality product at a below-average price or a high-quality product at an average or slightly higher price.

Economic conditions have caused more buyers to become value-conscious.

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The target market for a best-cost strategy is value-conscious middle-market buyers who are looking for appealing extras and functionality at a comparatively low price, regardless of whether they represent a broad or more focused segment of the market.

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T he Risk of a Best-Cost Strategy

Best-Cost Strategy

Low-Cost Producers

High-End Differentiators

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A company’s biggest vulnerability in employing a best-cost strategy is getting squeezed between the strategies of firms using low-cost and high-end differentiation strategies.

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Trader Joe’s Focused Best-Cost Strategy

How can higher product quality lower product costs?

In which stages of an industry life cycle are low-cost leadership, differentiation, focused niche, and best-cost provider strategies most appropriate?

Could the lower-selling prices of its groceries versus its competitors be used as a proxy for measuring the strength of its focused best-cost strategy?

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Illustration Capsule 5.4 describes how Trader Joe’s has applied the principles of a focused best-cost strategy to thrive in the competitive grocery store industry.

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The Contrasting Features of the Generic Competitive Strategies

Each generic strategy:

Positions the firm differently in its market

Establishes a central theme for how the firm intends to outcompete rivals

Creates boundaries or guidelines for strategic change as market circumstances unfold

Entails different ways and means of maintaining the basic strategy

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The choice of which generic strategy to employ spills over to affect many aspects of how the business will be operated and the manner in which value chain activities must be managed. 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.

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Table 5.1 Distinguishing Features of the Five Generic Competitive Strategies (1 of 2)

FEATURE Low-Cost Broad Differentiation Focused low-cost Focused differentiation Best-Cost
Strategic target A broad cross-section of the market A broad cross-section of the market A narrow market niche where buyer needs and preferences are distinctively different A narrow market niche where buyer needs and preferences are distinctively different Value-conscious buyers. Or, a middle-market range
Basis of competitive strategy Lower overall costs than competitors Ability to offer buyers something attractively different from competitors’ offerings Lower overall cost than rivals in serving niche members Attributes that appeal specifically to niche members Ability to offer better goods at attractive prices
Product line A good basic product with few frills (acceptable quality and limited selection) Many product variations, wide selection, emphasis on differentiating features Features and attributes tailored to the tastes and requirements of niche members Features and attributes tailored to the tastes and requirements of niche members Items with appealing attributes and assorted features; better quality, not best
Production emphasis A continuous search for cost reduction without sacrificing acceptable quality and essential features Build in whatever differentiating features buyers are willing to pay for; strive for product superiority A continuous search for cost reduction for products that meet basic needs of niche members Small-scale production or custom-made products that match the tastes and requirements of niche members Build in appealing features and better quality at lower cost than rivals
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Deciding which generic competitive strategy to employ is not a trivial matter. Each of the five generic competitive strategies positions the company differently in its market and competitive environment. Each establishes a central theme for how the company will endeavor to outcompete rivals. Each creates some boundaries or guidelines for maneuvering as market circumstances unfold and as ideas for improving the strategy are debated. Each entails differences in terms of product line, production emphasis, marketing emphasis, and means of maintaining the strategy, as shown in Table 5.1.