Michael E. Porter, Professor at Harvard Business School, as a leading authority in strategy has motivated us to get deeper into his ideas and to look for their validity in the turbulent and dynamic current business environment by contrasting this one with the context under which Porter issued his strategic proposition. In order to do that, it is being focused on its proposition for business strategy, specifically the Three Generic Strategies.
Michael Porter's hypothesis to develop the generic strategies was the industrial organization affirming that companies have some influence on its microeconomic area. Porter's conception of strategy is that it is a matter of competitive position, that a company creates by differentiating themselves in the eyes of its valuable customers, including a process of adding value along a structure of different activities interrelated in a way imperceptible for competitors, and so that this complex mix differ from those created or used by competitors, proposing The Generic Strategies as three different ways of competing: leadership in costs, differentiation and focus to improve positioning on the eyes of consumers and so to increase profits sustainably. Additionally, he affirmed that the essence of a business strategy is the selection of a manner that will always lead the company to acquire competitive advantages.
Porter's opinion, the essence of a business strategy is the selection of a manner that will always lead the company to acquire competitive advantages. The way he designed the model has been retold by different authors including a framework of Porter's backgrounds on strategy but also on economics.
Porter proposed two dimensions: the strategic goal and the strategic advantage, the first one refers to the scope in which a company wants to develop its activities being one segment or the broad market. The second one, refers to the manner the company will perform the best results in the market either by highly differentiated products or by low costs.
To other authors, he explained that these common strategies used by companies within an industry, were based on the market economic analysis matching supply and demand to capture from the demand side the size of the market a company seeks for, defining weather it is an industry-wide strategic target or a particular segment to target. From the supply side, it captures the strategic advantages, stating two general most important advantages according to him, which are product differentiation and product low costs (cost efficiency).
Accordingly, by matching these two dimensions (supply and demand), companies have 3 alternatives as strategy as shown in figure1 and that will be explained in detail below.
According to Porter and in order to decide which of the three generic strategies to chose, a company must consider if it has the capability, the competencies, the resources required, and the organizational requirements also .
A competitive advantage is possible just for a specific given market context, so to model a competitive advantage is necessary to analyze the forces and issues that influence the business environment.
In his new vision on strategy, showed in the book The Competitive Advantage of Nations (1990) Porter recognizes that because of new circumstances and challenges that the process of globalization brought to markets, the companies development got influenced, and that this three generic strategies are unstable, and that is needed to create new more dynamic models to describe the competitive advantage.
The context in which the generic strategies were developed implies reasoning in which: Those are to be used independently (but also combined in the case of differentiation and focus strategy by broadening the market scope, and anyway this can hardly be possible), to build in a long term the desired position, that was aimed to bring the company better results than its competitors and so a sustainable competitive advantage.
Miller, criticized Porter's generic strategies in the fact that they cannot used mixed strategies, as porter said that companies that mix strategies would end either getting heavy in costs or structure to behave and compete with cost leadership focused companies, or confusing its targeted customers. He (Miller) affirmed that by mixing two of the generic strategies, entering with a niche strategy and then increasing its market as their internal strengths allowed it they go for a differentiation one, expanding their market going to a broader scope. Entered a market as a niche player and gradually expanded.
Porter's Generic Strategies are:
- Cost Leadership
- Differentiation
- Focus
The cost leadership corresponds to a strategy used by companies when they have abilities to produce at lower costs than the competitors, and so to get more profit when selling the products in high quantities.
This strategy calls for cost efficiencies, close control of costs, advantage or preferential access to raw materials, to components, to labor, and some other important inputs; because as long as it gets lower costs to produce, it can provide lower prices to its customers getting the valuable profit from a high level of sales, supported with a production process reinforced by economies of scale and experience curve effects; though it might be directed to a broad market scope.
Companies that implement this strategy expect to take advantage of economies of scale and the experience curve, by producing large amount of a product, to allow the company to compete with other companies in the same sector and that has decided to go for the same way of cost leadership. Examples of this include retailers such as Wal Mart but also IT firms such as IBM, Dell, and Lenovo.
According to Porter, "Low costs will enable a firm to sell relatively standardized products that offer features acceptable to many customers at the lowest competitive price and such low prices will gain competitive advantage and increase market share".
Additionally he stated that if the low cost support can be sustained for a company during long periods of time, this will guarantee that they will increase market recognition and so market share, increasing sales and profits and thus superior performance will be reached by this company in its specific industry or market.
Limitation:
Yet, as soon as the model starts to be developed, the critics start to match Porter's ideas to say in this part that the sustainability of a cost based company's competitive advantage last until a competitor develop a model allowing it to provide lower costs to the customer, and so critics argues that it is not in hands of a company but that its strategy will always be dependent to the competitors and that it doesn't allow a company to react freely and follow its own path, because if this situation continues, this company will end by copying and minimize the competitor's strategy in a cyclic process that finally will stop when all competitors in an industry have the same strategy, eroding the market profits in hands of the consumers.
Some disadvantages on the cost leadership strategy pointed out by authors like Vokurka are that it would represent for the company a decreasing customer loyalty , that the author sees as the killer of the same strategy in the long run, because as the company educates the customer to get the value from the lower price, any other competitor that would be able to reach the same or an improved cost based performance and so would offer lower prices to the customer, this last one will have no doubt on getting the "best-value" (from their position) from whatever company offering the lowest price for a generic product. This is happening in the present context of telecom sector in India.
One of the most contradictory publications towards Michael Porter's proposal, Kim and Al with the Blue Ocean Strategy book, explained that this strategy can be possible only for one company per industry, and so that it is quite optimistic. According to Kim et Al, only "if firms costs are low enough it may be profitable even in a highly competitive scenario hence it becomes a defensive mechanism against competitors" .
Low cost leadership becomes thus a viable strategy only for larger firms. Market leaders may strengthen their positioning by advantages attained through scale and experience in a low cost leadership strategy. In fact, maintaining this strategy requires a continuous search for cost reductions in all aspects of the business.
Emphasized on efficiency, this strategic option is not an acceptable approach of difference or advantage right now, because technology nowadays are getting accessible for lower costs and improved constantly so it turns a production process cheaper and allow companies to low prices, so the possibility for all the industries to have access to it, makes it an easy to copy approach. The solution that Porter gave to this easy imitable issue was that it is not necessary to produce at less cost but also when doing that, companies must create tradeoffs that lead competitors to desist to get into these new technologies.
For the cost leadership strategy to be accurately implemented, and to have more chances for it to be successful there are some situational issues that can help and that have been pointed out by Buble. These are:
- Prices are the dominant mean of competition
- Products are highly standardized, but not customized. (Like Rice, Wheat, Telecommunication, Steel etc.)
- Customers are not especially bounded to a specific product brand.
- Products have ordinary usage characteristics
- Customers can change product preferences easily due to lower prices, or customers possess extensive bargaining power
This approach is criticized for been considering operational efficiency, which according to Porter in a latter work is necessary but not sufficient.
The cost leadership brings a big problem for companies and is that once the company has reduced costs from several processes, if a competitor achieve to improve its performance with lower costs, the chances are that the company can't react to this situation, loosing not only the competitive advantage and the market leadership but also inducing losts and devasted revenues and profitability.
2. Differentiation Strategy
The differentiation strategy, also directed at a broad market involves the creation of a product or service that is perceived throughout its industry as unique and that is valued for a customer meaning that he/she is able to pay more for this uniqueness. This uniqueness usually is reflected in design, brand image, technology, features, network, or customers' service. In this strategy, the sustained competitive advantage is given by customers loyalty reflected on low price sensitivity what allows companies to cover extra costs to provide customers high value by charging them in a differentiated product, this happens without affecting the demand.
Some examples of companies with this strategy are Nike in the clothing sector, Apple in the IT sector, but also in the automobile sector with Mercedes-Benz and BMW or big designers on clothing worldwide like Dolce & Gabanna. This vision of differentiation is easy diluted in globalization as customers get the same differentiated product from a huge number of companies.
This strategy is not accurate by the current business environment as customers are each time more aware of the suppliers and are more exigent (needing urgent attention) when doing a purchase, wanting to cover all their most little desires on any product. As there are wide forms of differentiation and customer with very specific needs, companies and competitors "differentiated" for a wide scope, maybe do not satisfied the very specific needs of its customers, and so this is how the competitive advantage on this strategy as customer loyalty are lost, giving entrance to new comers that can supply widely a customer specific needs. In this approach we must consider increasingly higher competition reinforced by lowered boundaries on design, production, and distribution that brings differentiated portfolios constantly to the market in the same worldwide market.
For a company to be able to develop a differentiation strategy it is necessary that it has remarkable strengths and advantages in research and development, design, marketing, and quality control, but also an innovative orientation, a technological level superior to the average of industry, beside others.
This internal requirements cause also increased costs especially under the means of product development and marketing campaigns to inform about the products specifications and to promote product tasting. What can sustain this strategy is the continuing development of differentiated products that match customer's needs and preferences along trends, and in order to reach that, a company must monitor constantly its customers trying to identify their preferences and understand their behavior, until the point of predicting how they can react to certain product changes.
As well, this strategy implies some requirements that must be seen on the industry, such as the existence of numerous market segments, as well as specific customer's needs and wants, which are not satisfied by products in the current market.
3. Focus Strategy
The focus strategy is aimed to attend specific small niches that require special features or prices to be provided and so for the company to get the market. Porter proposed this way of competing as to get involved into specific market segments either by focus on differentiation on products or by focus on costs.
An example of this strategy in firms is Southwest Airlines, which provides short-haul point-to-point flights in contrast to the hub-and-spoke model of mainstream.
To run a focus strategy a company must have a selective offering provided to selective markets, every process must be focus oriented, in both meeting the market segment needs and doing it with lower costs than the average of its competitors. After what a company will direct its efforts headed for a specific group whose specific needs were not satisfied for companies with the broader scope of differentiation.
According to Porter, for a successful implementation of a focus strategy the market must be a big one and expect to growth dramatically. And have for a company too much different segments in which it can focuses on or represent the impossibility to go to the broader perspective, because this are facts creating tradeoffs, and so barriers to imitation.
These specific needs usually generates specific demands, that includes specific inputs to be provided and so higher prices to cover this costs and that are reasonable for the customers demanding such products.
In the long run, the company will not only maintain these customers but also will integrate more customers by continuing improvements on technologies and research and development processes.
The risks implied in this approach are the volatility in the customer's preferences and trends on its consumption patterns that would implies a change on supplier of the product and so to give a try to competitor's products. Another risk is the fact that new comers would easily saturate the market that would bring about all the already known consequences.
Stuck in the middle
Michael Porter explains that companies that don't fit in any position are about to be "stuck in the middle" meaning that its customers will find more value on competitors with strong defined position as those are offering them more value either in characteristics or in price, by using its resources more accurately to what their market is asking for.
Porter was also criticized for its co-existence of two strategy types, related to this concept of "stuck in the middle", Luis Eduardo Ayala Ruiz described that there is an incoherent reasoning between the cost leadership and the differentiation strategy relationship; because in some industries, there were companies able to have a cost leadership and would choose to compete at prices comparables to the industry. This situation, according to Porter would be classified as stuck in the middle, meaning that this company will not have superior performance compared to its industry, but actually the financial situation of those companies were superior to the average, showing that even if a company can lower the prices there is no reason to do it when a customer will buy at a price of the industry, not entering a price war, and keeping profits in the hands of the company whose revenues will be higher, rather than in the hands of customers that were able to pay more for the same.
References:
- Michel E. Porter, The five competitive forces that shape strategy, Harvard Business Review, Jan. 2008.
- Pankaj G. & Jose Luis, Case-Zara: Fast Fashion, Harvard Business Review, Dec 21, 2006.
- Porter, Michael E. (1980): Competitive Strategy: Techniques for analyzing industries and competitors, New York. Free press.
- Kim et Al. Blue Ocean Strategy, 2004, p.21
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