Thursday, July 30, 2009

Porter's Generic Strategies

Michael Porter has described a category scheme consisting of three general types of strategies that are commonly used by businesses to achieve and maintain competitive advantage. These three generic strategies are defined along two dimensions: strategic scope and strategic strength. Strategic scope is a demand-side dimension (Porter was originally an engineer, then an economist before he specialized in strategy) and looks at the size and composition of the market you intend to target. Strategic strength is a supply-side dimension and looks at the strength or core competency of the firm. In particular he identified two competencies that he felt were most important: product differentiation and product cost (efficiency).

He originally ranked each of the three dimensions (level of differentiation, relative product cost, and scope of target market) as either low, medium, or high, and juxtaposed them in a three dimensional matrix. That is, the category scheme was displayed as a 3 by 3 by 3 cube. But most of the 27 combinations were not viable.

In his 1980 classic Competitive Strategy: Techniques for Analysing Industries and Competitors, Porter simplifies the scheme by reducing it down to the three best strategies. They are cost leadership, differentiation, and market segmentation (or focus). Market segmentation is narrow in scope while both cost leadership and differentiation are relatively broad in market scope.

Empirical research on the profit impact of marketing strategy indicated that firms with a high market share were often quite profitable, but so were many firms with low market share. The least profitable firms were those with moderate market share. This was sometimes referred to as the hole in the middle problem. Porter’s explanation of this is that firms with high market share were successful because they pursued a cost leadership strategy and firms with low market share were successful because they used market segmentation to focus on a small but profitable market niche. Firms in the middle were less profitable because they did not have a viable generic strategy.

Combining multiple strategies is successful in only one case. Combining a market segmentation strategy with a product differentiation strategy is an effective way of matching your firm’s product strategy (supply side) to the characteristics of your target market segments (demand side). But combinations like cost leadership with product differentiation are hard (but not impossible) to implement due to the potential for conflict between cost minimization and the additional cost of value-added differentiation.

Since that time, some commentators have made a distinction between cost leadership, that is, low cost strategies, and best cost strategies. They claim that a low cost strategy is rarely able to provide a sustainable competitive advantage. In most cases firms end up in price wars. Instead, they claim a best cost strategy is preferred. This involves providing the best value for a relatively low price.

Cost Leadership Strategy
This strategy emphasizes efficiency. By producing high volumes of standardized products, the firm hopes to take advantage of economies of scale and experience curve effects. The product is often a basic no-frills product that is produced at a relatively low cost and made available to a very large customer base. Maintaining this strategy requires a continuous search for cost reductions in all aspects of the business. The associated distribution strategy is to obtain the most extensive distribution possible. Promotional strategy often involves trying to make a virtue out of low cost product features.

To be successful, this strategy usually requires a considerable market share advantage or preferential access to raw materials, components, labour, or some other important input. Without one or more of these advantages, the strategy can easily be mimicked by competitors.

Successful implementation also benefits from:

  • process engineering skills
  • products designed for ease of manufacture
  • sustained access to inexpensive capital
  • close supervision of labour
  • tight cost control
  • incentives based on quantitative targets.
always ensure that the costs are kept at the minimum possible level.

When a firm designs, produces and markets a product more efficiently than competitors such firm has implemented a cost leadership strategy. Cost reduction strategies across the activity cost chain will represent low cost leadership. Attempts to reduce costs will spread through the whole business process from manufacturing to the final stage of selling the product. Any processes that do not contribute towards minimization of cost base should be outsourced to other organisations with the view of maintaining a low cost base. Low costs will permit a firm to sell relatively standardised 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. These writings explain that cost efficiency gained in the whole process will enable a firm to mark up a price lower than competition which ultimately results in high sales since competition could not match such a low cost base. If the low cost base could be maintained for longer periods of time it will ensure consistent increase in market share and stable profits hence consequent in superior performance. However all writings direct us to the understanding that sustainability of the competitive advantage reached through low cost strategy will depend on the ability of a competitor to match or develop a lower cost base than the existing cost leader in the market.

A firm attempts to maintain a low cost base by controlling production costs, increasing their capacity utilization, controlling material supply or product distribution and minimizing other costs including R&D and advertising. Mass production, mass distribution, economies of scale, technology, product design, learning curve benefit, work force dedicated for low cost production, reduced sales force, less spending on marketing will further help a firm to main a low cost base. Decision makers in a cost leadership firm will be compelled to closely scrutinise the cost efficiency of the processes of the firm. Maintaining the low cost base will become the primary determinant of the cost leadership strategy. For low cost leadership to be effective a firm should have a large market share. New entrants or firms with a smaller market share may not benefit from such strategy since mass production, mass distribution and economies of scale will not make an impact on such firms. Low cost leadership becomes 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. But is their any superiority in low cost strategy than other strategic typologies? Can a firm that adopts a low cost strategy out perform another firm with a different competitive strategy? If firms costs are low enough it may be profitable even in a highly competitive scenario hence it becomes a defensive mechanism against competitors. Further they mention that such low cost may act as entry barriers since new entrants require huge capital to produce goods or services at the same or lesser price than a cost leader. As discussed in the academic frame work of competitive advantage raising barriers for competition will consequent in sustainable competitive advantage and in consolidation with the above writings we may establish the fact that low cost competitive strategy may generate a sustainable competitive advantage. However, this is not true in all cases.

Further in consideration of factors mentioned above that facilitate a firm in maintaining a low cost base; some factors such as technology which may be developed through innovation (mentioned as creative accumulation in Schumpeterian innovation) and some may even be resources developed by a firm such as long term healthy relationships build with distributors to maintain cost effective distribution channels or supply chains (inimitable, unique, valuable non transferable resource mentioned in RBV). Similarly economies of scale may be an ultimate result of a commitment made by a firm such as capital investments for expansions (as discussed in the commitment approach). Also raising barriers for competition by virtue of the low cost base that enables the low prices will result in strong strategic positioning in the market (discussed in the IO structural approach). These significant strengths align with the four perspectives of sustainable competitive advantage mentioned in the early parts of this literature review. Low cost leadership could be considered as a competitive strategy that will create a sustainable competitive advantage.

However, low cost leadership is attached to a disadvantage which is less customer loyalty. Relatively low prices will result in creating a negative attitude towards the quality of the product in the mindset of the customers. Customer’s impression regarding such products will enhance the tendency to shift towards a product which might be higher in price but projects an image of quality. Considering analytical in depth view regarding the low cost strategy, it reflects capability to generate a competitive advantage but development and maintenance of a low cost base becomes a vital, decisive task.

Differentiation Strategy
Differentiation is aimed at the broad market that involves the creation of a product or services that is perceived throughout its industry as unique. The company or business unit may then charge a premium for its product. This specialty can be associated with design, brand image, technology, features, dealers, network, or customers service. Differentiation is a viable strategy for earning above average returns in a specific business because the resulting brand loyalty lowers customers' sensitivity to price. Increased costs can usually be passed on to the buyers. Buyers loyalty can also serve as an entry barrier-new firms must develop their own distinctive competence to differentiate their products in some way in order to compete successfully. Examples of the successful use of a differentiation strategy are Hero Honda, Asian Paints, HLL, Nike athletic shoes, Perstorp BioProducts, Apple Computer, and Mercedes-Benz automobiles. Research does suggest that a differentiation strategy is more likely to generate higher profits than is a low cost strategy because differentiation creates a better entry barrier. A low-cost strategy is more likely, however, to generate increases in market share. This may or may not be true.

Variants on the Differentiation Strategy
The shareholder value model holds that the timing of the use of specialized knowledge can create a differentiation advantage as long as the knowledge remains unique [1]. This model suggests that customers buy products or services from an organization to have access to its unique knowledge. The advantage is static, rather than dynamic, because the purchase is a one-time event.

The unlimited resources model utilizes a large base of resources that allows an organization to outlast competitors by practicing a differentiation strategy. An organization with greater resources can manage risk and sustain losses more easily than one with fewer resources. This deep-pocket strategy provides a short-term advantage only. If a firm lacks the capacity for continual innovation, it will not sustain its competitive position over time.

Focus Strategy
In this strategy the firm concentrates on a select few target markets. It is also called a segmentation strategy or niche strategy. It is hoped that by focusing your marketing efforts on one or two narrow market segments and tailoring your marketing mix to these specialized markets, you can better meet the needs of that target market. The firm typically looks to gain a competitive advantage through product innovation and/or brand marketing rather than efficiency. It is most suitable for relatively small firms but can be used by any company. A focus strategy should target market segments that are less vulnerable to substitutes or where a competition is weakest to earn above-average return on investment.

Examples of firm using a focus strategy include Southwest Airlines, with provides short-haul point-to-point flights in contrast to the hub-and-spoke model of mainstream carriers, and Family Dollar, which targets poor urban American families who can not drive to Wal-Marts in the suburbs because they do not own a car.

Recent developments
Michael Treacy and Fred Wiersema and tarun (1993) have modified Porter's three strategies to describe three basic "value disciplines" that can create customer value and provide a competitive advantage. They are operational excellence, product leadership, and customer intimacy.

Criticisms of generic strategies
Several commentators have questioned the use of generic strategies claiming they lack specificity, lack flexibility, and are limiting.
In particular, Miller (1992) questions the notion of being "caught in the middle". He claims that there is a viable middle ground between strategies. Many companies, for example, have entered a market as a niche player and gradually expanded. According to Baden-Fuller and Stopford (1992) the most successful companies are the ones that can resolve what they call "the dilemma of opposites".< A popular post-Porter model was presented by W. Chan Kim and Renée Mauborgne in their 1999 Harvard Business Review article "Creating New Market Space". In this article they described a "value innovation" model in which companies must look outside their present paradigms to find new value propositions. Their approach fundamentally goes against Porter's concept that a firm must focus either on cost leadership or on differentiation. They later went on to publish their ideas in the book Blue Ocean Strategy.

An up-to-date critique of generic strategies and their limitations, including Porter, appears in Bowman, C. (2008) Generic strategies: a substitute for thinking? [1]

If the primary determinant of a firm's profitability is the attractiveness of the industry in which it operates, an important secondary determinant is its position within that industry. Even though an industry may have below-average profitability, a firm that is optimally positioned can generate superior returns.

A firm positions itself by leveraging its strengths. Michael Porter has argued that a firm's strengths ultimately fall into one of two headings: cost advantage and differentiation. By applying these strengths in either a broad or narrow scope, three generic strategies result: cost leadership, differentiation, and focus. These strategies are applied at the business unit level. They are called generic strategies because they are not firm or industry dependent.

The following table illustrates Porter's generic strategies:

Porter's Generic Strategies
Target ScopeAdvantage
Low CostProduct Uniqueness

Broad (Industry Wide)
Cost Leadership

(Market Segment)

(low cost)


Cost Leadership Strategy

This generic strategy calls for being the low cost producer in an industry for a given level of quality. The firm sells its products either at average industry prices to earn a profit higher than that of rivals, or below the average industry prices to gain market share. In the event of a price war, the firm can maintain some profitability while the competition suffers losses. Even without a price war, as the industry matures and prices decline, the firms that can produce more cheaply will remain profitable for a longer period of time. The cost leadership strategy usually targets a broad market.

Some of the ways that firms acquire cost advantages are by improving process efficiencies, gaining unique access to a large source of lower cost materials, making optimal outsourcing and vertical integration decisions, or avoiding some costs altogether. If competing firms are unable to lower their costs by a similar amount, the firm may be able to sustain a competitive advantage based on cost leadership.

Firms that succeed in cost leadership often have the following internal strengths:

  • Access to the capital required to make a significant investment in production assets; this investment represents a barrier to entry that many firms may not overcome.

  • Skill in designing products for efficient manufacturing, for example, having a small component count to shorten the assembly process.

  • High level of expertise in manufacturing process engineering.

  • Efficient distribution channels.

Each generic strategy has its risks, including the low-cost strategy. For example, other firms may be able to lower their costs as well. As technology improves, the competition may be able to leapfrog the production capabilities, thus eliminating the competitive advantage. Additionally, several firms following a focus strategy and targeting various narrow markets may be able to achieve an even lower cost within their segments and as a group gain significant market share.

Differentiation Strategy

A differentiation strategy calls for the development of a product or service that offers unique attributes that are valued by customers and that customers perceive to be better than or different from the products of the competition. The value added by the uniqueness of the product may allow the firm to charge a premium price for it. The firm hopes that the higher price will more than cover the extra costs incurred in offering the unique product. Because of the product's unique attributes, if suppliers increase their prices the firm may be able to pass along the costs to its customers who cannot find substitute products easily.

Firms that succeed in a differentiation strategy often have the following internal strengths:

  • Access to leading scientific research.

  • Highly skilled and creative product development team.

  • Strong sales team with the ability to successfully communicate the perceived strengths of the product.

  • Corporate reputation for quality and innovation.

The risks associated with a differentiation strategy include imitation by competitors and changes in customer tastes. Additionally, various firms pursuing focus strategies may be able to achieve even greater differentiation in their market segments.

Focus Strategy
The focus strategy concentrates on a narrow segment and within that segment attempts to achieve either a cost advantage or differentiation. The premise is that the needs of the group can be better serviced by focusing entirely on it. A firm using a focus strategy often enjoys a high degree of customer loyalty, and this entrenched loyalty discourages other firms from competing directly.

Because of their narrow market focus, firms pursuing a focus strategy have lower volumes and therefore less bargaining power with their suppliers. However, firms pursuing a differentiation-focused strategy may be able to pass higher costs on to customers since close substitute products do not exist.

Firms that succeed in a focus strategy are able to tailor a broad range of product development strengths to a relatively narrow market segment that they know very well.

Some risks of focus strategies include imitation and changes in the target segments. Furthermore, it may be fairly easy for a broad-market cost leader to adapt its product in order to compete directly. Finally, other focusers may be able to carve out sub-segments that they can serve even better.

A Combination of Generic Strategies

- Stuck in the Middle?

These generic strategies are not necessarily compatible with one another.
If a firm attempts to achieve an advantage on all fronts, in this attempt it may achieve no advantage at all.
For example, if a firm differentiates itself by supplying very high quality products, it risks undermining that quality if it seeks to become a cost leader.
Even if the quality did not suffer, the firm would risk projecting a confusing image.
For this reason, Michael Porter argued that to be successful over the long-term,
a firm must select only one of these three generic strategies.
Otherwise, with more than one single generic strategy the firm will be "stuck in the middle" and will not achieve a competitive advantage.

Porter argued that firms that are able to succeed at multiple strategies often do so by creating separate business units for each strategy. By separating the strategies into different units having different policies and even different cultures, a corporation is less likely to become "stuck in the middle."

However, there exists a viewpoint that a single generic strategy is not always best because within the same product customers often seek multi-dimensional satisfactions such as a combination of quality, style, convenience, and price.
There have been cases in which high quality producers faithfully followed a single strategy and then suffered greatly when another firm entered the market with a lower-quality product that better met the overall needs of the customers.

Generic Strategies and Industry Forces

These generic strategies each have attributes that can serve to defend against competitive forces.
The following table compares some characteristics of the generic strategies in the context of the Porter's five forces.

Generic Strategies and Industry Forces

Generic Strategies
Cost LeadershipDifferentiationFocus
Ability to cut price in retaliation deters potential entrants.Customer loyalty can discourage potential entrants.Focusing develops core competencies that can act as an entry barrier.
Ability to offer lower price to powerful buyers.Large buyers have less power to negotiate because of few close alternatives.Large buyers have less power to negotiate because of few alternatives.
Better insulated from powerful suppliers.Better able to pass on supplier price increases to customers.Suppliers have power because of low volumes, but a differentiation-focused firm is better able to pass on supplier price increases.
Threat of
Can use low price to defend against substitutes.Customer's become attached to differentiating attributes, reducing threat of substitutes.Specialized products & core competency protect against substitutes.
RivalryBetter able to compete on price.Brand loyalty to keep customers from rivals.Rivals cannot meet differentiation-focused customer needs.

Recommended Reading

From the three generic business strategies Porter stress the idea that only one strategy should be adopted by a firm and failure to do so will result in “ stuck in the middle” scenario. He discuss the idea that practising more than one strategy will lose the entire focus of the organisation hence clear direction of the future trajectory could not be established. The argument is based on the fundamental that differentiation will incur costs to the firm which clearly contradicts with the basis of low cost strategy and in the other hand relatively standardised products with features acceptable to many customers will not carry any differentiation hence, cost leadership and differentiation strategy will be mutually exclusive. Two focal objectives of low cost leadership and differentiation clash with each other resulting in no proper direction for a firm.

However, contrarily to the rationalisation of Porter, contemporary research has shown evidence of firms practising such a “hybrid strategy”. Hambrick identified successful organisations that adopt a mixture of low cost and differentiation strategy. Research writings of Davis state that firms employing the hybrid business strategy (Low cost and differentiation strategy) outperform the ones adopting one generic strategy. Sharing the same view point, Hill challenged Porter’s concept regarding mutual exclusivity of low cost and differentiation strategy and further argued that successful combination of those two strategies will result in sustainable competitive advantage. As to Wright and other multiple business strategies are required to respond effectively to any environment condition. In the mid to late 1980’s where the environments were relatively stable there was no requirement for flexibility in business strategies but survival in the rapidly changing, highly unpredictable present market contexts will require flexibility to face any contingency. After eleven years Porter revised his thinking and accepted the fact that hybrid business strategy could exist and writes in the following manner.

Competitive advantage can be divided into two basic types: lower costs than rivals, or the ability to differentiate and command a premium price that exceeds the extra costs of doing so. Any superior performing firm has achieved one type of advantage, the other or both.

Though Porter had a fundamental rationalisation in his concept about the invalidity of hybrid business strategy, the highly volatile and turbulent market conditions will not permit survival of rigid business strategies since long term establishment will depend on the agility and the quick responsiveness towards market and environmental conditions. Market and environmental turbulence will make drastic implications on the root establishment of a firm. If a firm’s business strategy could not cope with the environmental and market contingencies, long term survival becomes unrealistic. Diverging the strategy into different avenues with the view to exploit opportunities and avoid threats created by market conditions will be a pragmatic approach for a firm.

Critical analysis done separately for cost leadership strategy and differentiation strategy identifies elementary value in both strategies in creating and sustaining a competitive advantage. Consistent and superior performance than competition could be reached with stronger foundations in the event “hybrid strategy” is adopted. Depending on the market and competitive conditions hybrid strategy should be adjusted regarding the extent which each generic strategy (cost leadership or differentiation) should be given priority in practise.

  1. William E. Fruhan, Jr., "The NPV Model of Strategy—The Shareholder Value Model," 1979.
  2. Porter, Michael E., Competitive Strategy:Techniques for Analyzing Industries and Competitors


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