Michael Porter’s “Generic Strategies

Porter’s five-forces model describes strategy as taking actions that create defendable positions in an industry.

• In general, the strategy can be offensive or defensive with respect to competitive forces.

• Defensive strategies take the structure of the industry as given, and position the company to match its
strengths and weaknesses to it.

• In contrast, offensive strategies are designed to do more than simply cope with each of the competitive forces;
they are meant to alter the underlying cause of such forces, thereby altering the competitive environment
itself.

Generic strategies were used initially in the early 1980s, and seem to be even more popular today. They outline the
three main strategic options open to organization that wish to achieve a sustainable competitive advantage. Each of
the three options are considered within the context of two aspects of the competitive environment

Sources of competitive advantage - are the products differentiated in any way, or are they the lowest cost producer
in an industry?Competitive scope of the market - does the company target a wide market, or does it focus on a very
narrow, niche market?

There are, of course, many specific strategies of each type (offensive or defensive), and identifying which is best
depends on the circumstances. But Porter suggests 3 broad or generic strategies for creating a defendable position in
the long-run and outperforming competitors.

The generic strategies are: 1. Cost leadership, 2. Differentiation, and 3. Focus.

1. Cost Leadership.

The low cost leader in any market gains competitive advantage from being able to many to produce at the lowest
cost. Factories are built and maintained, labor is recruited and trained to deliver the lowest possible costs of
production. 'cost advantage' is the focus. Costs are shaved off every element of the value chain. Products tend to be
'no frills.' However, low cost does not always lead to low price. Producers could price at competitive parity,
exploiting the benefits of a bigger margin than competitors. Some organizations, such as Toyota, are very good not
only at producing high quality autos at a low price, but have the brand and marketing skills to use a premium pricing
policy. This strategy involves the organisation aiming to be the lowest cost producer within their industry. The
orgainisation aims to drive cost down through all the elements of the production of the product from sourcing, to
labour costs. The cost leader usually aims at a broad market, so sufficient sales can cover costs. Low cost producers
include Easyjet airline, Ryan air, Asda and Walmart. Some organisation may aim to drive costs down but will not
pass on these cost savings to their customers aiming for increased profits clearly because their brand can command a
premium rate.

• Cost leadership means having the lowest per-unit (i.e., average) cost in the industry – that is, lowest
cost relative to your rivals.

• This could mean having the lowest per-unit cost among rivals in highly competitive industries, in
which case returns or profits will be low but nonetheless higher than competitors

• Or, this could mean having lowest cost among a few rivals where each firm enjoys pricing power and
high profits.

• Notice that cost leadership is defined independently of market structure.

Cost leadership is a defendable strategy because:
 I. It defends the firm against powerful buyers. Buyers can drive price down only to the level
of the next most efficient producer.

II. It defends against powerful suppliers. Cost leadership provides flexibility to absorb an
increase in input costs, whereas competitors may not have this flexibility.

III. The factors that lead to cost leadership also provide entry barriers in many instances.
Economies of scale require potential rivals to enter the industry with substantial capacity
to produce, and this means the cost of entry may be prohibitive to many potential
competitors.

Achieving a low cost position usually requires the following resources and skills:

I. Large up-front capital investment in new technology, which hopefully leads to large market share in the long-run,
but may lead to losses in the short-run.

II. Continued capital investment to maintain cost advantage through economies of scale and market share.

III. Process innovation – developing cheaper ways to produce existing products.

IV. Intensive monitoring of labor, where workers frequently have an incentive-based pay structure (i.e., a contract
which includes some combination of a fixed-wage plus piece-rate pay).

V. Tight control of overhead.

2. Differentiation

Differentiated goods and services satisfy the needs of customers through a sustainable competitive advantage. This
allows companies to desensitize prices and focus on value that generates a comparatively higher price and a better
margin. The benefits of differentiation require producers to segment markets in order to target goods and services at
specific segments, generating a higher than average price. For example, British Airways differentiates its service.

The differentiating organization will incur additional costs in creating their competitive advantage. These costs must
be offset by the increase in revenue generated by sales. Costs must be recovered. There is also the chance that any
differentiation could be copied by competitors. Therefore there is always an incentive to innovated and continuously
improve. to be different, is what organisations strive for. Having a competitive advantage which allows the company
and its products ranges to stand out is crucial for their success. With a differentiation strategy the organisation aims
to focus its effort on particular segments and charge for the added differentiated value. If we look at Brompton
folding cycles their compact design differentiates them from other folding bike companies. New concepts which
allow for differentiation can be patented, however patents have a certain life span and organisation always face the
danger that their idea that gives the competitive advantage will be copied in one form or another.

• Differentiating the product offering of a firm means creating something that is perceived industry wide as
being unique.

• It is a means of creating your own market to some extent.

• There are several approaches to differentiation:

� Different design
 � Brand image

� Number of features

� New technology
A differentiation strategy may mean differentiating along 2 or more of these dimensions.
Differentiation is a defendable strategy for earning above average returns because:

I. It insulates a firm from competitive rivalry by creating brand loyalty; it lowers the price
elasticity of demand by making customers less sensitive to price changes in your
products.

II. Uniqueness, almost by definition, creates barriers and reduces substitutes. This leads to
higher margins, which reduces the need for a low-cost advantage.

III. Higher margins give the firm room to deal with powerful suppliers.

IV. Differentiation also mitigates buyer power since buyers now have fewer alternatives.

Achieving a successful strategy of differentiation usually requires the following:

I. Exclusivity, which unfortunately also precludes market share and low cost advantage.

II. Strong marketing skills.

III. Product innovation as opposed to process innovation.

IV. Applied R&D.

V. Customer support.

VI. Less emphasis on incentive based pay structure.

Focus or Niche strategy

The focus strategy is also known as a 'niche' strategy. Where an organization can afford neither a wide scope cost
leadership nor a wide scope differentiation strategy, a niche strategy could be more suitable. Here an organization
focuses effort and resources on a narrow, defined segment of a market. Competitive advantage is generated
specifically for the niche. A niche strategy is often used by smaller firms. A company could use either a cost focus
or a differentiation focus.

With a cost focus a firm aims at being the lowest cost producer in that niche or segment. With a differentiation focus
a firm creates competitive advantage through differentiation within the niche or segment. There are potentially
problems with the niche approach. Small, specialist niches could disappear in the long term. Cost focus is
unachievable with an industry depending upon economies of scale e.g. telecommunications.
Here we focus on a particular buyer group, product segment, or geographical market.

• Whereas low cost and differentiation are aimed at achieving their objectives industry wide, the focus or
niche strategy is built on serving a particular target (customer, product, or location) very well.
 • Note, however, that a focus strategy means achieving either a low cost advantage or differentiation in a
narrow part of the market. For reasons discussed above, this creates a defendable position within that
part of the market.

Here the organisation focuses its effort on one particular segment and becomes well known for providing
products/services within the segment. They form a competitive advantage for this niche market and either succeed
by being a low cost producer or differentiator within that particular segment. Examples include Roll Royce and
Bentley.

With both of these strategies the organisation can also focus by offering particular segments a differentiated
product/service or a low cost product/service. The key is that the product or service is focused on a particular
segment. (see diagram below)

Stuck in the Middle:

• Failure to develop a strategy in one of these 3 directions is a firm that is “stuck in the middle.”

• This means you lack the market share, capital, and overhead control to be a cost leader, and lack the industry
wide differentiation necessary to create margins which obviate the need for a low-cost position.

• Being “stuck” implies low profits as a rule: profits are bid away to compete with low cost producers; or, the
firm loses high margin business to firms who achieve better differentiation.

• Classic examples of this problem are large, international airline companies, many of which are now bankrupt.

• Depending on a firm’s capabilities and resources, a “stuck” firm must gravitate toward either low cost (usually
by buying market share) or focus or differentiation (which may mean decreasing market share).
Risks of each Strategy:
Each generic strategy is based on erecting different kinds of defences against the competitive forces, and hence they
involve different risks.

1) Cost Leadership:

Maintaining cost leadership can be risky because:

i. Innovations nullify past inventions and learning, and hence cost leadership requires continual capital
investment to maintain cost advantage.

ii. Exclusive attention to cost can blind firms to changes in product requirements.

iii. Cost increases narrow price differentials and reduce ability to compete with competitors’ brand
loyalty.

2) Differentiation:

Risks are:

i. Cost differentiation between low cost firms and differentiating firms becomes too large to hold
customer loyalty. Buyers trade-off features, service, or image for price.

ii. Buyers need for differentiation falls.

iii. Imitation decreases perceived differentiation.

Porter emphasized the mutual exclusivity of cost leadership and differentiation based on his observation that
companies risk getting 'stuck in the middle' where competitors surpass them both on cost and superior product
offerings. The distinction between the two options applies as well to his 3. focus strategy.

The industry's character determines the range of effective strategies. In a commodity market, only costs matter. In
economic terms, this means "perfect competition". The haute couture business, on the other hand, is driven solely by
differentiation. Price is not a factor in a customer's purchase decision. Most industries tend to be mixed where one
cost leader flourishes and opportunity exists for multiple differentiators.

Porter proposed a three stage analysis to determine and execute a competitive strategy:

1. analyse and choose the industry in which to compete (five forces);

2. analyse and choose the organisation's competitive strategy (generic strategies);
3. implement the strategy by managing the firm's activities (value chain analysis).

A firm's position must be modified when the relationship between the five forces in the industry change.