Chapter 5 The Five Generic Competitive Strategy Options: Which One to Employ? 101 Strategy: Core Concepts and Analytical Approaches Arthur A. Thompson, The University of Alabama 6th Edition, 2020-2021 An e-book published by McGraw-Hill Education chapter 5 The Five Generic Competitive Strategy Options: Which One to Employ? Competitive strategy is about being different. It means deliberately choosing to perform activities differently or to perform different activities than rivals to deliver a unique mix of value. —Michael E. Porter Strategy is all about combining choices of what to do and what not to do into a system that creates the requisite fit between what the environment needs and what the company does. —Costas Markides The essence of strategy lies in creating tomorrow’s competitive advantages faster than competitors mimic the ones you possess today. —Gary Hamel and C. K. Prahalad Competing in the marketplace is like war. You have injuries and casualties, and the best strategy wins. —John Collins A company can employ any of several basic approaches to competing successfully and gaining a competitive advantage over rivals, but they all involve striving to deliver superior value to customers compared to the offerings of rival sellers. Superior customer value can mean a good product at a lower price, a superior product that is worth paying more for, or a best-value offering that represents an attractive combination of price, features, quality, service, and other appealing attributes. Delivering superior value—whatever form it takes— nearly always requires performing value chain activities differently from rivals and developing competitively potent resources and capabilities that rivals cannot readily match or trump. This chapter describes the five generic competitive strategy options. Each of the five strategy options represents a distinctly different approach to competing in the marketplace. Which of the five options to employ is a company’s first and foremost choice in crafting an overall strategy and beginning its quest for competitive advantage. 101 Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? The Five Generic Competitive Strategies A company’s competitive strategy deals exclusively with the specifics of management’s game plan for competing successfully—how it intends to please customers, offensive and defensive moves to counter the maneuvers of rivals, responses to shifting market conditions, and initiatives to strengthen the company’s market position and achieve a particular kind of competitive advantage. Chances are remote that any two companies—even companies in the same industry—will employ competitive strategies that are exactly alike in every detail. Why? Because the differing external and internal circumstances of different companies vary too widely for the managers of different companies to arrive at precisely the same conclusion about what strategy to employ, down to each and every detail. However, when one strips away the details to get at the real substance, the two biggest factors that distinguish one competitive strategy from another boil down to (1) whether a company’s market target is broad or narrow, and (2) whether the company is pursuing a competitive advantage linked to lower costs or differentiation. As shown in Figure 5.1, these two factors give rise to five competitive strategy options for staking out a market position, operating the business, and delivering superior value to buyers:1 1. A low-cost provider strategy—striving to achieve lower overall costs than rivals in offering a product/ service with attributes sufficient to attract a broad spectrum of buyers. Gaining a low-cost advantage over rivals offering comparable products/services enables a company to either boost sales and market share by underpricing rivals or else earn bigger profits by simply matching whatever prices its highercost rivals are charging. 2. A broad differentiation strategy—seeking to differentiate the company’s product offering from rivals’ offerings with attributes that will appeal to a broad spectrum of buyers. 3. A focused low-cost strategy—concentrating on a narrow buyer segment (or market niche) and striving to meet the specific needs and requirements of niche members at lower costs than rivals, thus being in a position to win buyer favor and outcompete rivals with a lower-priced product offering. 4. A focused differentiation strategy—concentrating on a narrow buyer segment (or market niche) and striving to outcompete rivals by offering niche members customized attributes that meet their tastes and requirements better than the product offerings of rivals. 5. A best-cost provider strategy—striving to incorporate upscale product attributes at a lower cost than rivals. Being the “best-cost” producer of an upscale, multi-featured product allows a company to give customers more value for their money by underpricing rivals whose products have similar upscale, multi-featured attributes. This competitive approach is a hybrid strategy that blends elements of the previous four options in a unique and often effective way. The remainder of this chapter explores the ins and outs of these five generic competitive strategy options. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 102 Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? Market Target Figure 5.1 103 The Five Generic Competitive Strategy Options A Broad Cross-Section of Buyers Overall Low-Cost Provider Strategy Broad Differentiation Strategy Best-Cost Provider Strategy A Narrow Buyer Segment (or Market Niche) Focused Low-Cost Strategy Focused Differentiation Strategy Lower Cost Differentiation Type of Competitive Advantage Being Pursued Source: This is an author-expanded version of a three-strategy classification discussed in Michael E. Porter, Competitive Strategy (New York: Free Press, 1980), pp. 35–40. Low-Cost Provider Strategies Striving to achieve lower overall costs than rivals is an especially potent competitive approach in markets with many price-sensitive buyers. A company achieves low-cost leadership when it becomes the industry’s lowest-cost provider rather than just being one of perhaps several competitors with comparatively low costs. A lowCORE CONCEPT cost provider’s foremost strategic objective is meaningfully A low-cost leader’s basis for competitive lower costs than rivals—but not necessarily the absolutely advantage is lower overall costs than rivals. lowest possible cost. In striving for a cost advantage over Successful low-cost leaders are exceptionally rivals, company managers must take care to incorporate good at finding ways to drive costs out of their features and attributes that buyers consider essential—a businesses. product offering that is too features-free can undermine its attractiveness to buyers even if it is cheaper priced. For maximum effectiveness, a low-cost provider also needs to pursue cost-saving approaches and/or have costreducing capabilities that are difficult for rivals to copy. When it is relatively easy or inexpensive for rivals to imitate the low-cost firm’s methods, any resulting cost advantage evaporates too quickly to gain a valuable edge in the marketplace. A company has two options for translating a low-cost advantage over rivals into attractive profit performance. Option 1 is to use its lower-cost edge to underprice competitors and attract price-sensitive buyers in great A low-cost advantage over rivals can translate into enough numbers to increase total profits. Option 2 is to better profitability than rivals. charge a price comparable to other low-priced rivals, be content with the resulting sales volume and market share, and rely upon the low-cost edge over rivals to earn a bigger profit margin per unit sold, thereby boosting the firm’s total profits and return on investment. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? While many companies are inclined to exploit a low-cost advantage by using Option 1 (attacking rivals with lower prices in hopes that the expected gains in sales and market share will lead to higher total profits), this strategy can backfire if rivals respond with retaliatory price cuts of their own (to defend against a loss of sales and protect their customer base). Such a rush to cut prices can often trigger a ferocious price war that lowers the profits of all price discounters. The bigger the risk that rivals will respond with matching price cuts, the more appealing it becomes to employ the second option for using a low-cost advantage to achieve higher profitability. The Two Major Avenues for Achieving a Cost Advantage To achieve a low-cost edge over rivals, a firm’s cumulative costs across its overall value chain must be lower than competitors’ cumulative costs—and the means of achieving the cost advantage must be durable. There are two ways to accomplish this.2 1. Perform value chain activities more cost effectively than rivals. 2. Revamp the firm’s overall value chain to eliminate or bypass some cost-producing activities. Cost-Efficient Management of Value Chain Activities For a company to do a more cost-efficient job of managing its value chain than rivals, managers must diligently search out cost-saving opportunities in every part of the value chain. No activity can escape cost-saving CORE CONCEPT scrutiny, and all company personnel must be expected to use their talents and ingenuity to come up with innovative A cost driver is a factor that has a strong and effective ways to keep costs down. Particular attention influence on a company’s costs. 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. Figure 5.2 shows the most important cost drivers. Cost-saving approaches that demonstrate effective use of the cost drivers include: n Capturing all available economies of scale. Economies of scale stem from an ability to lower unit costs by increasing the scale of operation—many occasions arise when a large plant can achieve lower costs per unit produced than a small or medium-sized plant, when a large distribution center is more cost-efficient than a small one, or when the unit selling and marketing costs for a wide product line are lower than for a small product line. Often, manufacturing economies can be achieved by using common parts and components in different models and/or by cutting back on the number of models offered (especially slow-selling ones)—which enable a company to escape the costs of inventorying a greater number of parts and components, avoid the costs associated with model changeover, and schedule longer production runs for fewer models. n Taking full advantage of experience and learning-curve effects. The cost of performing an activity can decline over time as the learning and experience of company personnel build. Learning/experience economies can stem from debugging and mastering newly introduced technologies, using the experiences and suggestions of workers to install more efficient plant layouts and assembly procedures, and the added speed and effectiveness that accrues from repeatedly picking sites for and building new plants, distribution centers, or retail outlets. n Operating facilities at full capacity. Whether a company is able to operate at or near full capacity has a big impact on unit costs when its value chain contains activities associated with substantial fixed costs. Higher rates of capacity utilization allow depreciation and other fixed costs to be spread over a larger unit volume, thereby lowering fixed costs per unit. The more capital-intensive the business, or the higher the percentage of fixed costs as a percentage of total costs, the greater the unit-cost penalty for operating at less than full capacity. Also, successful efforts to boost sales volumes and move closer to full capacity utilization spread R&D, advertising, sales promotion, and administrative support costs across more units, thus contributing to lower costs per unit sold. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 104 Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? Figure 5.2 Cost Drivers—The Keys to Driving Down Costs Outsourcing or vertical integration Economies of scale Online systems and software Product design and production technology Labor efficiency, pay scales, and incentives Learning and experience COST DRIVERS Capacity utilization Raw materials and components Supply chain efficiency Bargaining power vis-à-vis suppliers Source: Adapted by the author from Michael E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York: The Free Press, 1985), Chapter 3. n Substituting the use of low-cost for high-cost raw materials or component parts whenever there is little or no sacrifice in product quality or product performance. If the costs of certain raw materials and parts are “too high,” a company can switch to using lower-cost items or maybe even design the high-cost components out of the product altogether. n Using the company’s bargaining power vis-à-vis suppliers to gain concessions. A company may have sufficient bargaining clout with suppliers to win price discounts on large-volume purchases or realize other cost savings. n Improving supply chain efficiency. Partnering with suppliers to streamline the ordering and purchasing process, to reduce inventory carrying costs via just-in-time inventory practices, to economize on shipping and materials handling, and to ferret out other cost-saving opportunities in supply chain activities is a much-used approach to cost reduction. A company with a core competence (or better still, a distinctive competence) in cost-efficient supply chain management can sometimes achieve a sizable cost advantage over less adept rivals. n Pursuing actions to lower labor costs per unit produced. Such actions can include instituting incentive compensation systems that boost labor productivity and/or curtail production defects, installing robotassisted production methods or other types of labor-saving equipment, and training workers in using best practice production/assembly methods. Achieving lower labor costs may also entail shifting production from geographic areas where pay scales are high to geographic areas where pay scales are low and avoiding the use of union labor to escape costly work rules and/or union demands for excessive pay scales and fringe benefits. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 105 Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? n Improving product design and employing cost-saving production techniques. Many companies aggressively search for ways to redesign parts and components to permit speedier and more economical manufacture or assembly. Often production costs can be cut by (1) using design for manufacture (DFM) procedures and computer-assisted design (CAD) techniques that enable more integrated and efficient production methods, (2) investing in highly automated robotic production technology, and (3) shifting to a production process that enables manufacturing multiple versions of a product as cost efficiently as mass-producing a single version. Many companies use process management tools like total quality management systems and Six Sigma techniques to boost efficiency, eliminate errors and mistakes, and reduce the costs of activities across the value chain. n Using online systems and sophisticated software to achieve operating efficiencies. For example, sharing data and production schedules with suppliers, coupled with the use of enterprise resource planning (ERP) and manufacturing execution system (MES) software, can reduce parts inventories, trim production times, and lower labor requirements. n Using outsourcing and/or vertical integration to achieve cost savings. Outsourcing the performance of certain value chain activities can be more economical than performing them in-house if outside specialists, by virtue of their expertise and volume, can perform the activities at a lower cost. Furthermore, integrating into the activities of either suppliers or distribution channel allies can lower costs by increasing internal efficiency, lowering transactions costs, and bypassing suppliers or distributors with considerable bargaining power. In addition to the preceding ways of performing value chain activities at lower costs than rivals, managers can also achieve important cost savings by deliberately opting for a strategy with lower cost elements than the strategies employed by rivals. For instance, a company can often open up a durable cost advantage over rivals by: n Having lower specifications for purchased materials, parts, and components than rivals. For example, a maker of personal computers can use the cheapest hard drives, microprocessors, monitors, and other components to achieve lower production costs than rival PC makers. n Stripping frills and features from its product offering that are not highly valued by price-sensitive or bargain-hunting buyers. Deliberately restricting the company’s product offering to “the essentials” can help a company cut costs associated with snazzy attributes and a full lineup of options and extras. Activities and costs can also be eliminated by offering buyers fewer services. n Offering a limited product line as opposed to a full product line. Pruning slow-selling items from the product lineup and being content to meet the needs of most rather than all buyers can eliminate activities and costs associated with numerous product versions and a wide selection. n Distributing the company’s product only through low-cost distribution channels and avoiding high-cost distribution channels. n Choosing to use the most economical method for delivering customer orders (even if it results in longer delivery times). The point here is that a low-cost provider strategy entails not only performing value chain activities cost effectively but also judiciously choosing cost-saving strategic approaches. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 106 Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? Revamping the Value Chain Dramatic cost advantages can often emerge from reengineering the company’s value chain in ways that eliminate costly work steps and entirely bypass certain cost-producing value chain activities. Such value chain revamping can include: n Selling direct to consumers and cutting out the activities and costs of distributors and dealers. To circumvent the need for distributors–dealers, a company can (1) create its own direct sales force (which adds the costs of maintaining and supporting a sales force but which may well be cheaper than using independent distributors and dealers), and/or (2) conduct sales operations at the company’s website (costs for website operations and shipping may be a substantially cheaper way to make sales to customers than going through distributor–dealer channels). Costs in the wholesale/retail portions of the value chain frequently represent 35–50 percent of the price final consumers pay, so establishing a direct sales force or selling online may offer big cost savings. n Shifting to the use of technologies and/or information systems that bypass the need to perform certain high-cost value chain activities. Some manufacturers have adopted innovative production or processing technologies that eliminate the need for costly facilities or equipment and require fewer employees. Still others have instituted procedures whereby suppliers combine particular parts and components into preassembled modules, thus permitting a manufacturer to assemble its own product in fewer work steps and with a smaller workforce. Numerous companies have online systems and software that automate and communicate order acceptances and shipping notices to customers via e-mail and turn formerly time-consuming and labor-intensive tasks like purchasing, inventory management, invoicing, and bill payment into speedily performed mouse clicks. n Streamlining operations by eliminating low value-added or unnecessary work steps and activities. At Walmart, some items supplied by manufacturers are delivered directly to retail stores rather than being routed through Walmart’s distribution centers and delivered by Walmart trucks. In other instances, Walmart unloads incoming shipments from manufacturers’ trucks arriving at its distribution centers directly onto outgoing Walmart trucks headed to particular stores without ever moving the goods into the distribution center. Many supermarket chains have greatly reduced in-store meat butchering and cutting activities by shifting to meats that are cut and packaged at the meat-packing plant and then delivered to their stores in ready-to-sell form. Online systems allow warranty claims and product performance problems involving supplier components to be instantly relayed to the relevant suppliers so corrections can be expedited. New software has greatly reduced the time it takes to do product design and graphic design. n Reducing materials handling and shipping costs by having suppliers locate their plants or warehouses close to a company’s own facilities. Having suppliers locate their plants or warehouses close to a company’s own plant facilitates just-in-time deliveries of parts and components to the exact work station where they will be used in assembling the company’s product. This not only lowers incoming shipping costs but also curbs or eliminates the company’s need to build and operate storerooms for incoming parts and components, and have plant personnel move the inventories to work stations as needed for assembly. Examples of Companies That Revamped Their Value Chains to Reduce Costs Nucor Corporation, the most profitable steel producer in the United States and one of the largest steel producers worldwide, drastically revamped the value chain process for manufacturing steel products by using relatively inexpensive electric arc furnaces where scrap steel and direct-reduced iron are melted and then sent to a continuous caster and rolling mill to be shaped into steel bars, steel beams, steel plates, and sheet steel. Using electric arc furnaces to make new steel products by recycling scrap steel eliminated many of the steps used by traditional steel mills that made their steel products from iron ore, coke, limestone, and other ingredients using costly coke ovens, basic oxygen blast furnaces, ingot casters, and multiple types of finishing facilities—plus Nucor’s value chain system required far fewer employees. As a consequence, Nucor produces steel with a lower capital investment, a smaller workforce, Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 107 Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? 108 and lower operating costs than traditional steel mills. Nucor’s strategy to replace the traditional steel-making value chain with its simpler, quicker value chain approach has made it one of the world’s lowest-cost producers of steel, enabling it to take substantial sales and market share away from traditional steel companies and earn consistently good profits (Nucor reported a profit in 203 out of 208 quarters during 1966–2018—a remarkable feat in a mature and cyclical industry notorious for roller coaster bottom-line performance). Southwest Airlines has achieved considerable cost-savings by reconfiguring the traditional value chain of commercial airlines, thereby permitting it to offer travelers lower fares. Its mastery of fast turnarounds at the gates (about 25 minutes versus 45 minutes for rivals) allows its planes to fly more hours per day. This translates into being able to schedule more flights per day with fewer aircraft, allowing Southwest to generate more revenue per plane on average than rivals. Southwest does not offer assigned seating, baggage transfer to connecting airlines, or first-class seating and service, thereby eliminating all the cost-producing activities associated with these features. The company’s fast and user-friendly online reservation system facilitates e-ticketing and reduces staffing requirements at telephone reservation centers and airport counters. Its use of automated check-in equipment reduces staffing requirements for terminal check-in. The company’s carefully designed point-to-point route system minimizes connections, delays, and total trip time for passengers, allowing about 75 percent of Southwest passengers to fly nonstop to their destinations while at the same time reducing Southwest’s costs for flight operations. The Keys to Being a Successful Low-Cost Provider To succeed with a low-cost provider strategy, company managers must scrutinize each cost-creating activity and determine what factors result in higher/lower costs. Then, they have to use this knowledge about the cost drivers to streamline or reengineer how activities are performed, Success in achieving a low-cost edge over rivals exhaustively pursuing cost efficiencies throughout the comes from out-managing rivals in finding ways value chain. Normally, low-cost producers try to engage all to perform value chain activities faster, more company personnel in continuous cost-improvement efforts, accurately, and more cost efficiently. and they strive to keep administrative costs to a minimum. Many successful low-cost leaders also use benchmarking to keep close tabs on how their costs compare with rivals and firms performing comparable activities in other industries, and they are quick to implement best practices. But while low-cost providers are champions of frugality, they seldom hesitate to spend aggressively on technologies and resource capabilities that promise to drive down costs. Indeed, investing in state-of-the art cost-saving competitive assets is one of the best pathways to achieving sustainable competitive advantage as a low-cost provider. Walmart, one of the world’s foremost low-cost providers, has been an early adopter of state-of-the-art technology throughout its operations—its distribution facilities are an automated showcase, it has developed sophisticated online systems to order goods from suppliers and manage inventories, it equips its stores with cutting-edge sales-tracking and check-out systems, and it sends daily point-of-sale data to 4,000 vendors, but Walmart carefully estimates the cost savings of new technologies before it rushes to invest in them. By continuously, yet prudently, investing in cost-saving technologies and operating improvements, Walmart has sustained its low-cost advantage over rivals for more than 30 years. Uber and Lyft™, employing a formidable low-cost provider strategy and an innovative business model, have stormed their way into hundreds of locations across the world, totally disrupting and seemingly forever changing competition in the taxi markets where they have a presence. And, most significantly, the ultra-low fares charged by Uber and Lyft™ have resulted in dramatic increases in the demand for taxi services, particularly those provided by these two low-cost providers. Other companies noted for their successful use of low-cost provider strategies include Vizio in big-screen TVs, Briggs & Stratton in small gasoline engines, Bic in ballpoint pens, Stride Rite in footwear, Poulan in chain saws, and General Electric and Whirlpool in major home appliances. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? 109 When a Low-Cost Provider Strategy Works Best A low-cost provider strategy becomes increasingly appealing and competitively powerful when: n Price competition among rival sellers is vigorous. Low-cost providers are in the best position to compete offensively on the basis of price, to use the appeal of lower price to grab sales (and market share) from rivals, to win the business of price-sensitive buyers, to remain profitable despite strong price competition, and to survive price wars. n The products of rival sellers are essentially identical and readily available from many eager sellers. Look-alike products and/or overabundant supplies set the stage for lively price competition. In such markets, it is the less efficient, higher-cost companies whose profits get squeezed the most. n It is difficult to achieve product differentiation in ways that have value to buyers. When the differences between brands do not matter much to buyers, buyers are nearly always sensitive to price differences and the industry-leading companies tend to be those with the lowest-price brands. n Most buyers use the product in the same ways. With common user requirements, a standardized product can satisfy the needs of most buyers, in which case low selling price, not features or quality, becomes the dominant factor in causing buyers to choose one seller’s product over another’s. n Buyers incur low costs in switching their purchases from one seller to another. Low switching costs give buyers the flexibility to shift purchases to lower-priced sellers having equally good products, or to attractively priced substitute products. A low-cost leader is well positioned to use low price both to attract new customers and to induce its customers not to switch to rival brands or substitutes. n Large-volume buyers with significant power to bargain down prices account for a big fraction of the industry’s sales. Low-cost providers have partial profit-margin protection in bargaining with highvolume buyers, since powerful buyers are rarely able to bargain prices down past the survival level of the next most cost-efficient seller. n Industry newcomers use introductory low prices to attract buyers and build a customer base. A low-cost provider can use price cuts of its own to make it harder for a new rival to win customers. Moreover, the pricing power of a low-cost provider acts as a barrier for new entrants. Pitfalls to Avoid in Pursuing a Low-Cost Provider Strategy Perhaps the biggest mistake a low-cost provider can make to spoil the profitability of its low-cost advantage is getting carried away with overly aggressive price cutting to win sales and market share away from rivals. Higher unit sales and market shares do not automatically translate into higher total profits. Reducing price results in earning a lower profit margin on each unit sold. For a lower price to result in larger total profits, the gains in unit sales A lower price improves profitability only if the must be large enough to produce revenue increases sufficient lower price results in gains in unit sales (and thus to overcome the effects of a lower profit margin. Otherwise, revenues) that are big enough to overcomethe a lower price results in lower, not higher profitability. A combined effects of a smaller profit margin and simple numerical example tells the story: suppose a firm the added costs of the extra units sold. selling 1,000 units at a price of $10, a cost of $9, and a profit margin of $1 opts to cut the price five percent to $9.50— which reduces the firm’s profit margin to $0.50 per unit sold (unless higher sales volumes cause unit costs to fall below $9); assuming unit costs remain at $9, then it takes a 100 percent sales increase to 2,000 units just to offset the narrower profit margin and get back to total profits of $1,000—and a more than 100 percent sales increase for the price cut to boost total profits above what was being earned at the $10 price. Hence, whether a price cut will result in higher or lower profitability depends on how big the resulting sales gains will be and how much, if any, unit costs will fall as sales volumes increase. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? 110 A second pitfall of a low-cost provider strategy is relying on cost reduction approaches that can be easily copied by rivals. The value of a cost advantage depends on its sustainability. Sustainability, in turn, hinges on whether the company achieves its cost advantage in ways that can be kept proprietary or that are very costly and/or timeconsuming for rivals to copy. A third pitfall is becoming too fixated on cost reduction. Low cost cannot be pursued so zealously that a firm’s offering ends up being too features poor to generate buyer appeal. Furthermore, a company driving hard to push its costs down must guard against misreading or ignoring A low-cost provider’s product offering must increased buyer interest in added features or service, always contain enough attributes to be attractive declining buyer sensitivity to price, or new developments to prospective buyers—low price, by itself, is not that start to alter how buyers use the product. A low-cost always appealing to buyers. zealot risks losing market ground if buyers start opting for more upscale or features-rich products. Even if these mistakes are avoided, a low-cost provider strategy still entails risk. An innovative rival may discover an even lower-cost value chain approach. Important cost-saving technological breakthroughs may suddenly emerge. And if a low-cost provider has heavy investments in its present means of operating, it can prove costly to quickly shift to the new value chain approach or a new technology. Broad Differentiation Strategies Differentiation strategies are attractive whenever buyers’ needs and preferences are too diverse to be fully satisfied by a standardized product offering. Successful product differentiation requires careful study to determine what features and attributes buyers will view as appealing, CORE CONCEPT valuable, and worth paying for.3 Then the company must incorporate a combination of these features and attributes The essence of a broad differentiation strategy into its product offering that will not only be attractive to is to offer unique product attributes that a wide a broad range of buyers but also be unique and different range of buyers find appealing and worth paying enough to stand apart from rivals’ product offerings—in for (because of the added value they deliver). this latter regard, a strongly differentiated product offering is always preferable to a weakly differentiated one. A broad differentiation strategy can yield a competitive advantage when an attractively large number of buyers become strongly attached to a company’s differentiated attributes. Successful differentiation allows a firm to do one or more of the following: n Command a premium price for its product. n Increase unit sales (because additional buyers are won over by the differentiating features). n Gain buyer loyalty to its brand (because many customers really like the differentiating features and bond with the company and its products). Differentiation enhances profitability whenever a company’s product can command a sufficiently higher price or generate sufficiently bigger unit sales to more than cover the added costs of achieving the differentiation. Company differentiation strategies fail when buyers don’t place much value on the brand’s uniqueness and/or when a company’s differentiating features are easily copied by rivals. Companies can pursue differentiation from many angles: a unique taste (Dr Pepper, Listerine); multiple features (Microsoft Office, Apple Watch); wide selection and one-stop shopping (The Home Depot, Amazon.com); superior service (Nordstrom, Ritz-Carlton); engineering design and performance (Mercedes, BMW); prestige and distinctiveness (Rolex); quality manufacture (Michelin in tires); technological leadership (3M Corporation Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? in bonding and coating products); spare parts availability (Caterpillar in heavy construction equipment and John Deere in farm and lawn equipment); a full range of services (Charles Schwab); many varieties (Campbell’s soups); and high-fashion design (Gucci, Prada, and Chanel). Managing Value Chain Activities to Create Differentiating Attributes that Add Customer Value 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. Success in employing a differentiation strategy comes from deliberate efforts to perform value chain activities in ways that create value-adding differentiating attributes and also better differentiate the company’s product/ service offering from rivals’ offerings. Perhaps, the most systematic approach managers can take to achieve successful differentiation involves focusing on the value drivers, a set of factors—analogous to cost drivers— that are particularly effective in creating differentiation and adding value for customers—see Figure 5.3. Figure 5.3 Value Drivers—Keys to Value-Adding Differentiation Product features and performance Distribution activities Marketing, advertising, and brandbuilding Inputs and activities that improve product quality and reliability VALUE DRIVERS New product R&D and product innovation Production R&D and breakthrough production techniques Employee skills, training, experience Customer service Wide product selection Source: Adapted by the author from Michael E. Porter, Competitive Advantage (New York: The Free Press, 1985), pp. 124–126. Ways that managers can use the value drivers to enhance differentiation include the following: n Create value-adding product features and performance attributes that appeal to a wide range of buyers. A product’s physical and functional features have a big influence on differentiation. Styling and looks are big differentiating factors in the apparel and motor vehicle industries. Size and weight matter in binoculars and mobile devices. Most companies employing broad differentiation strategies make a point of incorporating innovative and novel features in their product/service offering, especially those that improve performance and functionality, and they regularly introduce next-generation versions with both upgraded existing features and additional features. Offering a growing set of features is generally a strong plus. Having unique features and performance capabilities not found in rival products is a must. Often new or improved attributes that will have wide buyer appeal are developed in close collaboration with suppliers. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 111 Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? n Pursuing continuous quality improvements via the use of better parts, components, or ingredients and the use of quality control processes throughout the value chain. Customer-perceived differences in quality are an important differentiating and value-adding attribute. Improvements in product quality can lead to greater reliability, fewer repairs and less frequent maintenance, longer product life, and the convenience of trouble-free use—all of which make it economical to offer longer warranty coverage and contribute to an enhanced reputation for quality among customers. Quality improvement opportunities exist in such value chain activities as product design, the caliber of items purchased from suppliers, manufacturing and assembly, and customer service. For example, Starbucks gets high ratings on its coffees partly because it works closely with coffee growers to produce coffee beans that will meet its strict quality specifications. Quality differentiation can also be achieved by using assorted quality control techniques throughout the value chain rather than in just manufacturing or assembly. For instance, using quality control techniques in customer service can lead to more accurate handling of service requests and consistently solving customer problems on the first attempt or contact. n Emphasizing new product R&D and product innovation. The potential differentiating outcomes here include greater ongoing ability to introduce new and improved innovative products (which can lead to more first-on-the-market victories and a reputation for product innovation), new or improved features and styling, better functional performance, more aesthetic product designs and appearance, expanded end uses and applications, added user safety, or environmentally safe use of the product. Innovation that is hard for rivals to replicate is a source of competitive advantage. n Improving production selection. Amazon.com and big-box retailers like The Home Depot and Target have demonstrated that an expansive lineup of products, together with multiple models/styles/varieties of each type of product, is attractive to a broad spectrum of shoppers. Not only does wide selection offer the time-saving benefit of a one-stop shopping experience, but it also enables shoppers to compare the assorted models/styles/varieties within a product category and pick what suits their tastes, requirements, and pocketbook. An added differentiating feature of shopping at Amazon.com and other online retailers is one-click access to reviews of each item offered for sale—information gleaned from reviews often facilitates making wiser buying decisions. n Investing in production-related R&D, striving for technological advances, and implementing better production techniques. Better or different performance of production-related value chain activities can spur breakthrough production techniques for making an innovative product, enable custom-order manufacture at an efficient cost, make production methods safer for the environment, curtail productionrelated defects, reduce premature product failure, or improve economy of use. n Improving customer service and/or providing more service options. In some businesses, offering better customer service and/or a bigger range of service options contribute as much to differentiation enhancement as attributes relating to product quality, features, or performance. Examples of differentiation-enhancing customer services include no-hassle return policies, multiple payment plans, better credit terms, faster or better-quality maintenance and repairs, expert technical assistance, personal concierge services, more and better product information, training for end users, and round-the-clock availability of knowledgeable customer-service representatives (as opposed to having to call only during regular business hours). n Emphasizing human resource management activities that improve the skills, expertise, and knowledge of company personnel. A company with high-caliber intellectual capital often has the capacity to generate the kinds of ideas that drive product innovation, technological advances, better product design and product performance, improved production techniques, and higher product quality. Skilled customer service representatives can make a huge difference in how customers perceive the caliber of a company’s customer services. Well-designed incentive compensation systems can often unleash the efforts of talented personnel to develop and implement new and effective differentiating attributes. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 112 Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? 113 n Pursuing sales, marketing, and advertising activities that lead to greater brand name power. The manner in which a company conducts its marketing and brand management activities has a significant influence on customer perceptions of the value of a company’s product offering and the price they will pay for it. A highly skilled and competent sales force, effectively communicated product information, eye-catching ads, in-store displays, and special promotional campaigns can all cast a favorable light on the differentiating attributes of a company’s product/service offering and contribute to greater brandname awareness and brand-name power. A highly positive brand image keyed to various differentiating attributes builds customer loyalty to the brand and raises customers’ perceived cost of switching to a rival brand. Activities that contribute to greater brand name power are thus an important avenue for achieving stronger differentiation. n Improving distribution capabilities and collaborating with distribution allies to enhance customer perceptions of value. Distribution activities hold potential for a variety of differentiating attributes. Differentiation can be enhanced via a bigger distributor/dealer network than rivals and/or wider geographic distribution capabilities than rivals. Close collaboration with distribution partners—independent distributors, dealers, and retailers—can produce an assortment of differentiating attributes. It is common for motor vehicle manufacturers to set facilities standards for their dealerships (nice showrooms, wellappointed waiting areas) and to insist that all mechanics and service managers be factory trained and maintain ongoing factory certification. Many manufacturers work directly with retailers on in-store displays and signage, joint advertising campaigns, and providing sales clerks with product knowledge and tips on sales techniques—all to enhance customer-buying experiences. Companies can work with distributors and shippers to ensure fewer “out-of-stock” annoyances, quicker delivery to customers, more accurate order filling, lower shipping costs, and provide a variety of shipping choices to customers. Signaling Value to Buyers A company can often assist its efforts to achieve differentiation by signaling the value of its product offering to buyers.4 Typical signals of value include a high price (in instances where high price implies high quality and performance), more appealing or fancier packaging than competing products, ongoing or extensive ad campaigns (which impact a product’s image and make it more widely known), ad content that emphasizes a product’s standout attributes, the quality of brochures and sales presentations, the Signaling value to buyers can assist a company’s luxuriousness and ambience of a seller’s facilities (important differentiation efforts. for high-end retailers and for offices or other facilities that customers frequent), making buyers aware that a company has prestigious customers, and the professionalism, appearance, and personalities of the seller’s employees. Signaling value is particularly important when (1) the nature of differentiation is subjective or hard to quantify, (2) buyers are making a first-time purchase and are unsure what their experience with the product will be, (3) buyers are not fully aware of a product’s many attributes, and (4) repurchase is infrequent and buyers need to be reminded of a product’s value. Achieving Sustainable Competitive Advantage The most appealing approaches to differentiation are those that are hard or expensive for rivals to duplicate. Resourceful competitors can, in time, clone almost any product feature or attribute. If General Motors offers Easy-to-copy differentiating attributes cannot self-driving features in many of its models, so can Ford and produce sustainable competitive advantage. Toyota. If Samsung offers QLED TVs with super ultra-high definition, so can Sony and LG. Consequently, for a company to build a sustainable competitive advantage via differentiation, it needs to base its differentiation strategy on attributes that are difficult or expensive for rivals to copy or to overcome or that creates high switching costs for users. The best routes to achieving a sustainable competitive advantage via differentiation include: n Focusing on continuous product innovation, with a goal of developing the resources and capabilities to out-innovate rivals on an ongoing basis as concerns appealing product features, better product performance, and/or higher product quality. Patent-protected innovations have enormous differentiating value because rivals must wait until the patent expires to introduce the innovation into its own product offering. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? n Incorporating features that raise product performance and deliver added value to the buyer/end-user. This can be accomplished by including attributes that add functionality, expand the range of uses, save time for the user, are more reliable, or make the product cleaner, safer, quieter, simpler to use, portable, more convenient, or longer lasting than rival brands. n Incorporating product attributes and user features that lower the buyer’s overall costs of using the company’s product. Fewer product defects, greater product reliability, and longer maintenance intervals reduce user costs for repairs and maintenance. Energy-saving light bulbs and appliances cut buyers’ utility bills. Fuel-efficient vehicles reduce buyer outlays for gasoline. n Incorporating features or attributes that enhance buyer satisfaction in intangible ways. Toyota’s Prius appeals to environmentally conscious motorists who wish to help reduce global carbon dioxide emissions. Rolls Royce, Tiffany, Rolex, and Prada enjoy differentiation-based competitive advantages linked to the desires of luxury goods buyers for status, prestige, upscale fashion, craftsmanship, and the finer things in life. While rivals can often duplicate tangible product features quickly, such intangible attributes as a highly-regarded brand name and long-standing relationships with customers take a long time to imitate. n Delivering value to customers on the basis of competitively valuable resources and capabilities that rivals don’t have or can’t afford to match.5 Competencies and capabilities that are sufficiently unique in delivering value to buyers provide a route to differentiation that is not tied exclusively to the attributes of a product or service. A company with superior technological capabilities vis-à-vis rivals can incorporate attributes into its product offering directly linked to its technological capabilities and thereby gain substantial protection from the rivals’ attempts to match its product offering. Health care facilities like M.D. Anderson, Mayo Clinic, and Cleveland Clinic have specialized expertise and equipment for treating certain diseases that most hospitals and health care providers cannot afford to emulate. When a Broad Differentiation Strategy Works Best Broad differentiation strategies tend to work best in market circumstances where: n Buyer needs and uses of the product are diverse. Diverse buyer preferences present competitors with a bigger window of opportunity to do things differently and set themselves apart with product attributes that appeal to particular buyers. For instance, the diversity of consumer preferences for menu selection, ambience, pricing, and customer service gives restaurants exceptionally wide latitude in creating a differentiated product offering. Other companies having many ways to strongly differentiate themselves from rivals include magazine publishers, motor vehicle manufacturers, and the makers of cabinetry and countertops. n There are many ways to differentiate the product or service that have value to buyers. There’s plenty of room for retail apparel competitors to stock different styles and quality of apparel merchandise. Likewise, there is ample differentiation opportunity among the makers of furniture and breakfast cereals. Hotels and restaurants have easy pathways to setting themselves apart. But there are almost no ways for the makers of paper clips, copier paper, gasoline, and sugar to set their products apart in ways that deliver added value to consumers. n Few rival firms are following a similar differentiation approach. The best differentiation approaches involve trying to appeal to buyers on the basis of attributes that rivals are not emphasizing. A differentiator encounters less head-to-head rivalry when it goes its own separate way in creating uniqueness. When several (or even worse, many) rivals base their differentiation efforts on the same attributes, the most likely result is a market space that is overcrowded with me-too competitors trying to appeal to much the same buyers with weakly differentiated product offerings that deliver much the same value. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 114 Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? n Technological change is fast paced, and competition revolves around rapidly evolving product features and attributes. Rapid product innovation and frequent introductions of next-version products heighten buyer interest and provide space for companies to pursue separate differentiating paths. In wearable Internet devices, golf equipment, battery-powered and self-driving cars, unmanned drones for hobbyists and commercial use, rivals are locked into an ongoing battle to set themselves apart by introducing the best next-generation products. Companies that fail to come up with ongoing product improvements and unique features quickly lose ground in the marketplace. Pitfalls to Avoid in Pursuing a Differentiation Strategy Differentiation strategies can fail for any of several reasons. A differentiation strategy keyed to product or service attributes that are easily and quickly copied is always doomed. Rapid imitation means that no rival achieves CORE CONCEPT differentiation, since whenever one firm introduces some Any differentiating feature that works well is a aspect of uniqueness that strikes the fancy of buyers, fastmagnet for imitators. following copycats quickly reestablish similarity. This is why a firm must search out sources of uniqueness that are time-consuming or burdensome for rivals to match if it hopes to use differentiation to win a sustainable competitive edge. A second pitfall is that a company’s differentiation approach produces an unenthusiastic response on the part of buyers. Thus, even if a company succeeds in setting its product apart from those of rivals, its strategy can result in disappointing sales and profits in the event that buyers do not perceive the differentiating features as valuable or worth paying for. Any time many potential buyers look at a company’s differentiated product offering and conclude “so what,” the company’s differentiation strategy is in deep trouble. The third big pitfall of a differentiation strategy is overspending on efforts to differentiate the company’s product offering, thus eroding profitability. Company efforts to achieve differentiation nearly always raise costs. The key to profitable differentiation is either to keep the costs of achieving differentiation below the price premium the differentiating attributes can command in the marketplace (thus increasing the profit margin per unit sold) or to offset thinner profit margins per unit by selling enough additional units to increase total profits. If a company goes overboard in pursuing costly differentiation efforts and then unexpectedly discovers that buyers are unwilling to pay a sufficient price premium to cover the added costs of differentiation, it ends up saddled with unacceptably thin profit margins or even losses. The need to contain differentiation costs is why many companies add little touches of differentiation that add to buyer satisfaction but are inexpensive to institute. Upscale restaurants often provide valet parking. Laundry detergent and soap manufacturers add pleasing scents to their products. Ski resorts provide skiers with complimentary coffee or hot apple cider at the base of the lifts in the morning and late afternoon. Other common mistakes in crafting a differentiation strategy include:6 n Being timid and not striving to open up meaningful gaps in quality or service or performance features vis-à-vis the products of rivals. Tiny or trivial differences between rivals’ product offerings may not be visible or important to buyers. If a company wants to generate the fiercely loyal customer following needed to earn superior profits and open up a Overdifferentiating and overcharging are fatal differentiation-based competitive advantage over differentiation strategy mistakes. rivals, then its strategy must result in strong rather than weak product differentiation. In markets where differentiators do no better than achieve weak product differentiation (because buyers view the attributes of rival brands as very similar), customer loyalty to any one brand is weak, the costs of buyers to switch to rival brands are fairly low, and no one company has enough of a differentiation edge to command much of a price premium. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 115 Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? n Adding so many frills and extra features that the product exceeds the needs and use patterns of most buyers. A dazzling array of features and options not only drives up a product’s price but also runs the risk that many buyers will conclude that a less deluxe and lower-priced brand is a better value since they have little occasion or reason to use some of the deluxe attributes. n Charging too high a price premium. While buyers may be intrigued by a product’s deluxe features, they may nonetheless see it as being overpriced relative to the value delivered by the differentiating attributes. A company must guard against turning off would-be buyers with what is perceived as “price gouging.” Normally, the bigger the price premium for the differentiating extras, the harder it is to keep buyers from switching to the lower-priced offerings of competitors. A low-cost provider strategy can defeat a broad differentiation strategy when most buyers are satisfied with a basic product and don’t think “extra” attributes deliver enough added value to justify paying a higher price. Focused (or Market Niche) Strategies What sets focused strategies apart from low-cost provider and broad differentiation strategies is concentrated attention on a narrow piece of the total market. The target segment, or niche, can be defined by geographic uniqueness, by specialized requirements in using the product, or by special product attributes that appeal only to buyers comprising the market niche. Examples of firms that concentrate on a well-defined market niche keyed to a particular product or buyer segment include Animal Planet and the History Channel (in cable TV); Tiffany and Cartier (in high-end jewelry); Airbnb in by-owner lodging rental; Bandag (a specialist in truck tire recapping that promotes its recaps aggressively at more than 1,000 truck stops), CGA, Inc. (a specialist in providing insurance to cover the cost of lucrative hole-in-one prizes at golf tournaments); and Ferrari (in sports cars). Micro-breweries, bed-and-breakfast inns, local bakeries, and local owner-managed retail boutiques have also scaled their operations to serve niche markets. A Focused Low-Cost Strategy A focused low-cost strategy seeks to achieve a competitive advantage by serving buyers in the target market niche at a lower cost and lower price than rival competitors. This strategy has considerable attraction when a firm can lower costs significantly by limiting its customer base to a well-defined buyer segment. The avenues to achieving a cost advantage over rivals also serving the target market niche are the same as for low-cost leadership—out-manage rivals in using the cost drivers to perform value chain activities very cost-efficiently and search for innovative ways to bypass non-essential value chain activities. The only real difference between a low-cost provider strategy and a focused low-cost strategy is the size of the buyer group that a company is trying to appeal to—the former involves a product offering that appeals broadly to most all buyer groups and market segments, whereas the latter aims to satisfy the needs of a narrowly defined buyer group. Focused low-cost strategies are fairly common. Producers of private-label goods are able to achieve low costs in product development, marketing, distribution, and advertising by concentrating on making generic items imitative of name-brand merchandise and selling directly to retail chains wanting a basic house brand to sell to price-sensitive shoppers. Budget motel chains—like Motel 6, Sleep Inn, Super 8, and Days Inn—cater to priceconscious travelers who just want to pay for a clean, no-frills place to spend the night. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 116 Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? A Focused Differentiation Strategy A focused strategy keyed to differentiation aims at securing a competitive advantage with a product offering tailored to the unique preferences and needs of a narrow well-defined group of buyers (as opposed to a broad differentiation strategy aimed at many buyer groups and market segments). Successful use of a focused differentiation strategy depends on (1) the existence of a buyer segment that is looking for special product attributes or seller capabilities and (2) a firm’s ability to create an appealing product offering that stands apart from those of rivals competing in the same target market niche. Whole Foods Market, acquired by Amazon in 2017, has become the largest organic and natural foods supermarket chain in the United States by catering to healthy-eating and nutrition-conscious consumers who prefer organic, natural, minimally processed, locally grown, and healthier-style prepared foods, Celebrity-chef restaurants employ focused differentiation strategies aimed at fine dining enthusiasts. Companies like Godiva Chocolates, Louis Vuitton, Haägen-Dazs, Boll and Branch (high-end bed linens), and W. L. Gore (the maker of GORE-TEX) have been successful with differentiation-based focused strategies targeting upscale buyers wanting products and services with world-class attributes. Indeed, most markets contain a buyer segment willing to pay a big price premium for the finest items available, thus opening the strategic window for some competitors to pursue differentiation-based focused strategies aimed at the high-end of the market. When a Focused Low-Cost or Focused Differentiation Strategy Is Attractive A focused strategy aimed at securing a competitive edge based either on low cost or differentiation becomes increasingly attractive as more of the following conditions are met: n The target market niche is big enough to be profitable and offers good growth potential. n Industry leaders have chosen not to compete in the niche—in which case focusers can avoid battling head-to-head against some of the industry’s biggest and strongest competitors. n It is costly or difficult for companies with a broad market target to put capabilities in place to meet the specialized needs of buyers comprising the target market niche and at the same time satisfy the expectations of their mainstream customers. n The industry has many different niches and segments, thereby allowing a focuser to pick a competitively attractive niche suited to its resources and capabilities. Also, with more niches there is room for focusers to concentrate on different market segments and avoid competing in the same niche for the same customers. n Few, if any, other rivals are attempting to specialize in the same target segment—a condition that reduces the risk of segment overcrowding. n The focuser has a reservoir of customer goodwill and loyalty (accumulated from having catered to niche members’ specialized needs and preferences over many years) that it can draw upon to help stave off any ambitious challengers looking to horn in on its business. The advantages of focusing a company’s entire competitive effort on a single market niche are considerable, especially for smaller and medium-sized companies that may lack the breadth and depth of resources to tackle going after a broad customer base with a “something for everyone” lineup of models, styles, and product selection. YouTube has become a household name by concentrating on short video clips posted online. Papa John’s and Domino’s Pizza have created impressive businesses by focusing on the home delivery segment. Porsche and Ferrari have done well catering to wealthy sports car enthusiasts. Canada Goose has become the world’s leader provider of upscale cold weather parkas made of goose down sourced from rural Canada, achieving sales exceeding $300 million in 50 countries. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 117 Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? 118 The Risks of a Focused Low-Cost or Focused Differentiation Strategy Focusing carries several risks. One is the chance that competitors outside the niche will find effective ways to match the focused firm’s capabilities in serving the target niche—perhaps by coming up with products or brands specifically designed to appeal to buyers in the target niche or by developing resources and capabilities that offset the focuser’s strengths. In the lodging business, large chains like Marriott have launched multibrand strategies that allow them to compete effectively in several lodging segments simultaneously. Marriott has flagship JW Marriott and Ritz-Carlton hotels with deluxe accommodations for business travelers and resort vacationers. Its Courtyard by Marriott and SpringHill Suites brands cater to business travelers looking for moderately priced lodging, whereas Marriott Residence Inns and TownePlace Suites are designed as a “home away from home” for travelers staying five or more nights, and the Fairfield Inn & Suites brand is intended to appeal to travelers looking for quality lodging at an “affordable” price. Multibrand strategies are attractive to large companies like Marriott, Procter & Gamble, and Nestlé precisely because they enable entry into smaller market segments and siphon away business from companies employing a focused strategy. A second risk of employing a focus strategy is the potential for the preferences and needs of niche members to shift over time toward the product attributes desired by buyers in the mainstream portion of the market. An erosion of the differences across buyer segments lowers entry barriers into a focuser’s market niche and provides an open invitation for rivals in adjacent segments to begin competing for the focuser’s customers. A third risk is that the segment may become so attractive it is soon inundated with competitors, intensifying rivalry and splintering segment profits. And there is always the risk for segment growth to slow to such a small rate that a focusers’ prospects for future sales and profit gains become unacceptably dim. Best-Cost Provider Strategies As Figure 5.1 indicates, best-cost provider strategies stake out a middle ground between pursuing a low-cost advantage and a differentiation advantage, and between appealing to the broad market as a whole and a narrow market niche. Such a middle ground allows a company to aim squarely at the sizable mass of middle-market buyers looking for a good-to-very-good product or service at an economical price. Such buyers frequently shy away from both cheap low-end products and expensive high-end products, but they are quite willing to pay a “fair” price for extra features and functionality they find appealing and useful. The essence of a best-cost provider strategy is giving customers the best value for the money by satisfying buyer desires for appealing features/performance/quality/service and charging a lower price for these attributes compared to rivals with similar-caliber product offerings.7 From a competitive positioning standpoint, best-cost provider strategies are thus a hybrid, balancing a strategic emphasis on low cost against a strategic emphasis on differentiation (desirable extras at an attractive price). To profitably employ a best-cost provider strategy, a company must have the capability to incorporate attractive upscale attributes at a lower cost than those rivals with CORE CONCEPT comparable upscale product offerings. When a company can incorporate appealing features, good-to-excellent The competitive advantage of a best-cost provider product performance or quality, or more satisfying customer is lower costs than rivals in incorporating upscale service into its product offering at a lower cost than rivals, attributes (appealing features or functionality or then it enjoys “best cost” status—it is the low-cost provider quality, or satisfying customer service), putting the of a product or service with upscale attributes. A best-cost company in a position to underprice rivals whose provider can use its low-cost advantage to underprice rivals products have similar upscale attributes. whose products or services have similar upscale attributes and still earn attractive profits. It is usually not difficult for a company to entice buyers away from rivals when it offers buyers an equally good product at a more economical price. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? Being a best-cost provider is different from being a low-cost provider because the additional upscale attributes entail additional costs (that a low-cost provider can avoid by offering buyers a basic product with fewer features). Moreover, the two strategies aim at a distinguishably different target market. The target market for a best-cost provider is buyers looking for appealing extras and functionality at an appealingly low price. The target market for a low-cost provider is price-conscious buyers who are looking for or are satisfied with a basic low-priced product. One of the attractive reasons for adopting a best-cost provider strategy is that buyers hunting for upscale products at a “good” price often constitute a large segment of the overall market for a product or service. Toyota has employed a classic best-cost provider strategy for its Lexus line of motor vehicles. It has designed an array of high-performance characteristics and upscale features into its Lexus models to make them comparable in performance and luxury to Mercedes, BMW, Audi, Jaguar, Cadillac, and Lincoln models. To further draw buyer attention, Toyota established a network of Lexus dealers, separate from Toyota dealers, dedicated to providing exceptional and attentive customer service. Most important, though, Toyota has drawn upon its considerable skills and know-how in making high-quality Toyota models at low cost to produce its high-tech upscale-quality Lexus models at substantially lower costs than Mercedes, BMW, and other luxury vehicle makers have been able to achieve in producing their models. To capitalize on its lower manufacturing costs, Toyota prices its Lexus models below those of comparable Mercedes, BMW, Audi, and Jaguar models to induce value-conscious luxury car buyers to purchase a Lexus instead. The price differential has typically been quite significant. For example, in 2019 a well-equipped Lexus RX 350, a mid-sized SUV, had a sticker price of $57,640, whereas the sticker price of a comparably equipped Mercedes GLE-class SUV was $65,685 and the sticker price of a comparably equipped BMW X5 SUV was $72,220. When a Best-Cost Provider Strategy Works Best A best-cost provider strategy works best in markets where product differentiation is the norm and attractively large numbers of buyers shopping for “best value for the money” products can be induced to purchase midrange or near-luxury products rather than the cheap basic products of low-cost producers or the expensive products of top-of-the-line differentiators. A best-cost provider usually needs to position itself near or just above the middle of the market with either a medium-quality product at a below-average price or a good-to-high quality product at a price significantly lower than premium-priced, premium quality products. Best-cost provider strategies also work well in hard economic times when even more buyers are attracted to economically-priced products and services with especially appealing attributes. But unless a company has the resources and capabilities to incorporate upscale product or service attributes at a lower cost than rivals, adopting a best-cost strategy is illadvised because the company lacks ability to execute it. The Big Risk of a Best-Cost Provider Strategy A company’s biggest vulnerability in employing a best-cost provider strategy is getting squeezed between the strategies of firms using low-cost and high-end differentiation strategies. Low-cost providers may be able to siphon customers away with the appeal of a lower price (despite their less appealing product attributes). Highend differentiators may be able to steal customers away with the appeal of better product attributes (even though their products carry a higher price tag). To escape being squeezed from both below and above, a best-cost provider needs to offer buyers significantly better product attributes to justify a price above what low-cost leaders are charging while also having significantly lower costs in providing upscale features so it can out-compete highend differentiators on the basis of a significantly lower price. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 119 Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? Successful Competitive Strategies Are Always Underpinned by Resources and Capabilities That Allow the Strategy to Be Well-Executed For a company’s competitive strategy to deliver good profitability and the intended competitive edge over rivals, it must be underpinned by resources and capabilities that enable the company to execute its strategy with a high degree of proficiency. To succeed in employing a low-cost provider strategy, a company must have the resource and capabilities to keep its costs below those of competitors. This means having the expertise to leverage the cost drivers and manage value chain activities more cost-efficiently than rivals and/or the innovative CORE CONCEPT capability to bypass certain value chain activities being A company’s competitive strategy is unlikely performed by rivals. To succeed in strongly differentiating to result in good performance or sustainable its product in ways that are appealing to buyers, a company competitive advantage unless the company has must have the capabilities to leverage the value drivers and a competitively potent collection of resources incorporate unique attributes into its product offering that a and capabilities that enable the company to broad range of buyers will find appealing and worth paying execute its strategy with great proficiency. for. This is easier said than done because, given sufficient time, competitors can clone most any product feature that buyers find appealing. Hence, long-term differentiation success is usually dependent on having a hard-to-imitate portfolio of resources and capabilities (like key patents, top-notch technological know-how, proven skills in product innovation, expertise in customer service) to achieve and sustain a competitive edge. Successful focus strategies require the resources and capabilities to do an outstanding job of satisfying the needs and expectations of niche buyers. Success in employing a best-cost strategy requires the resources and capabilities to incorporate upscale product or service attributes at a lower cost than rivals. For all types of competitive strategies, success in sustaining the intended competitive edge depends on having at least some unique and valuable resources/ capabilities that are hard for rivals either to duplicate or to develop offsetting close substitute resources/ capabilities. Key Points Deciding which of the five generic competitive strategies to employ—overall low-cost, broad differentiation, focused low-cost, focused differentiation, or best-cost—is perhaps the most important strategic commitment a company makes. It tends to drive the remaining strategic actions a company undertakes and sets the whole tone for pursuing a competitive advantage over rivals. In employing a low-cost provider strategy and trying to achieve a low-cost advantage over rivals, a company must do a better job than rivals of cost effectively managing value chain activities and/or it must find innovative ways to bypass or eliminate cost-producing value chain activities. Low-cost provider strategies work particularly well when the products of rival sellers are virtually identical or very weakly differentiated, when supplies are readily available from eager sellers, when there are not many ways to achieve value-adding differentiation, when many buyers are price sensitive and shop the market for the lowest price, and when buyer switching costs are low. Broad differentiation strategies seek to produce a competitive edge by incorporating attributes and features that set a company’s product/service offering apart from rivals in ways that buyers consider valuable and worth paying for. Successful differentiation allows a firm to (1) command a premium price for its product, (2) increase unit sales (because additional buyers are won over by the differentiating features), and/or (3) gain buyer loyalty to its brand (because some buyers are strongly attracted to the differentiating features and bond with the company and its products). Differentiation strategies work best when diverse buyer preferences open up windows of opportunity to strongly differentiate a company’s product offering from those of rival brands, in situations Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 120 Chapter 5 • The Five Generic Competitive Strategy Options: Which One to Employ? where few other rivals are pursuing a similar differentiation approach, and in circumstances where companies are racing to bring out the most appealing next-generation product. A differentiation strategy is doomed when competitors are able to quickly copy most or all of the appealing product attributes a company comes up with, when a company’s differentiation efforts fail to interest many buyers, and when a company overspends on efforts to differentiate its product offering or tries to overcharge for its differentiating extras. A focus strategy delivers competitive advantage either by achieving lower costs than rivals in serving buyers comprising the target market niche, or by developing a specialized ability to offer niche buyers an appealingly differentiated offering that meets their needs better than rival brands. A focused strategy based on either low cost or differentiation becomes increasingly attractive when the target market niche is big enough to be profitable and offers good growth potential, when it is costly or difficult for multi-segment competitors to put capabilities in place to meet the specialized needs of the target market niche and at the same time satisfy the expectations of their mainstream customers, when there are one or more niches that present a good match with a focuser’s resources and capabilities, and when the target segment is not overcrowded with rivals. Best-cost provider strategies create competitive advantage by giving buyers the best value for the money—an approach that entails (1) matching close rivals on key quality/service/features/performance attributes, (2) beating them on the costs of incorporating such attributes into the product or service, and (3) charging a more economical price. A best-cost provider strategy works best when there is a big buyer segment desirous of purchasing upscale products/services for less money than comparable upscale products. In all cases, achieving sustained competitive advantage depends on having first-rate resources and capabilities that enable the company to execute its chosen competitive strategy with great proficiency. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 121 Chapter 6 Supplementing the Chosen Competitive Strategy— Other Important Strategy Choices 122 Strategy: Core Concepts and Analytical Approaches Arthur A. Thompson, The University of Alabama 6th Edition, 2020-2021 An e-book published by McGraw-Hill Education chapter 6 Supplementing the Chosen Competitive Strategy— Other Important Strategy Choices Winners in business play rough and don’t apologize for it. The nicest part of playing hardball is watching your competitors squirm. —George Stalk, Jr. and Rob Lachenauer Whenever you look at any potential merger or acquisi­tion, you look at the potential to create value for your shareholders. —Dilip Shanghvi, Founder and managing director of Sun Pharmaceuticals Don’t form an alliance to correct a weakness and don’t ally with a partner that is trying to correct a weakness of its own. The only result from a marriage of weaknesses is the creation of even more weaknesses. —Michel Robert Think of your priorities not in terms of what activities you do, but when you do them. Timing is everything. —Dan Millman O nce a company has settled on which of the five generic competitive strategies to employ, attention turns to what other strategic actions it can take to complement its competitive approach and maximize the power of its overall strategy. Several decisions must be made: n Whether to go on the offensive and initiate aggressive strategic moves to improve the company’s market position. n Whether to employ defensive strategies to protect the company’s market position. n What role the company’s website should play in its overall strategy to be a successful performer. n Whether to outsource certain value chain activities or perform them in-house. n Whether to integrate backward or forward into more stages of the industry value chain. n Whether to enter into strategic alliances or partnership arrangements with other enterprises. n Whether to bolster the company’s market position via mergers or acquisitions. 122 Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission Chapter 6 • Supplementing the Chosen Competitive Strategy—Other Important Strategy Choices n When to undertake strategic moves—whether advantage or disadvantage lies in being a first mover, a fast follower, or a late mover. This chapter presents the pros and cons of each of these strategy-enhancing measures. Figure 6.1 shows the menu of strategic options a company has in crafting a comprehensive set of strategic actions and the order in which the choices should generally be made. The portion of Figure 6.1 below the five generic competitive strategy options illustrates the structure of this chapter and the topics that will be covered. Figure 6.1 A Company’s Menu of Strategy Options Generic Competitive Strategy Options (A company’s first strategic choice) Broad Differentiation? Low-Cost Provider? Focused Differentiation? Focused Low Cost? Best-Cost Provider? Complementary Strategy Options (A company’s second set of strategic choices) Initiate offensive strategic moves? Employ defensive strategic moves? What type of website strategy to employ? Whether to outsource selected value chain activities? Employ backward or forward vertical integration strategies? Enter into strategic alliances and partnerships? Use merger and acquisition strategies to strengthen competitiveness? Functional Area Strategies to Support the Above Strategic Choices R&D Engineering Production Marketing & Sales Human Resources Finance (A company’s third set of strategic choices) Timing a Company’s Strategic Moves in the Marketplace First Mover? Fast-Follower? Late-Mover? (When to initiate actions to pursue or make adjustments in any of the above strategic choices—timing matters!) Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 123 Chapter 6 • Supplementing the Chosen Competitive Strategy—Other Important Strategy Choices 124 Going on the Offensive—Strategic Options to Improve a Company’s Market Position No matter which of the five generic competitive strategies a company employs, there are times when it makes sense for a company to go on the offensive to improve its market position and business performance. Strategic offensives are called for when a company sees opportunities to gain profitable market share at rivals’ expense, when a CORE CONCEPT company should strive to whittle away at a strong rival’s Sometimes a company’s best strategic option competitive advantage, and when a company opts to is to seize the initiative, go on the attack, and pursue newly emerging market opportunities. Companies launch a strategic offensive to improve its like Google, Amazon, Apple, and Facebook play hardball, market position. It takes successful offensive aggressively pursuing competitive advantage and trying strategies to build competitive advantage, widen to reap the benefits a competitive edge offers—a leading an existing advantage, or narrow the advantage market share, excellent profit margins, rapid growth (as held by a strong competitor. compared to rivals), and the reputational rewards of being 1 known as a company on the move. The best offensives tend to incorporate several behaviors and principles: (1) focusing relentlessly on building competitive advantage and then striving to convert competitive advantage into decisive advantage, (2) employing the element of surprise as opposed to doing what rivals expect and are prepared for, (3) applying resources where rivals are least able to defend themselves, and (4) being impatient with the status quo and displaying a strong bias for swift and decisive actions to overwhelm rivals.2 Choosing the Basis for Competitive Attack As a rule, challenging rivals on competitive grounds where they are strong is an uphill struggle.3 Offensive initiatives that exploit competitor weaknesses stand a better chance of succeeding than do those that challenge competitor strengths, especially if the weaknesses represent important vulnerabilities and weak rivals can be caught by surprise with no ready defense.4 A company’s strategic offensives should be powered by competitively powerful resources and capabilities—such as a better-known brand name, lower production and/or distribution costs, better technological capability, or a core or distinctive competence in designing and producing superior performing products. Designing a strategic CORE CONCEPT offensive spearheaded by relatively weak company The best offensives use a company’s most resources and capabilities is like marching into battle with a potent resources and capabilities to attack popgun—the prospects for success are dim. For instance, it rivals where they are competitively weakest. is foolish for a company with relatively high costs to employ a price-cutting offensive. Price-cutting offensives are best left to financially strong companies whose costs are relatively low in comparison to those of the companies being attacked. Likewise, it is ill-advised to pursue a product innovation offensive without proven expertise in R&D, new product development, and speeding new or improved products to market. The principal offensive strategy options include the following: n Offering an equally good or better product at a lower price. Lower prices can produce market share gains if competitors don’t respond with price cuts of their own and if the challenger convinces buyers that its product is just as good or better. However, such a strategy increases total profits only if the gains in additional unit sales are enough to offset the impact of thinner margins per unit sold. Pricecutting offensives generally work best when a company first achieves a cost advantage and then hits competitors with a lower price.5 Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission Chapter 6 • Supplementing the Chosen Competitive Strategy—Other Important Strategy Choices n Leapfrogging competitors by being the first adopter of next-generation technologies or being first to market with next-generation products. In technology-based industries, the opportune time to launch an offensive against rivals is by leading the way in introducing a next-generation technology or product. Amazon got its Alexa-enabled Amazon Echo into the smart-home controls market about two years ahead of Google’s Google Home device. But in 2019 both rivals were racing to introduce next-generation versions with wider-ranging features and capabilities. Two other brands, the Sonos One from Sonos, and Anker’s Eufy Genie, were also trying to gain buyer favor. The pace at which next-version products with ever more appealing capabilities and useful functions would be introduced was expected to produce a formidable leapfrogging battle. n Pursuing continuous product innovation to draw sales and market share away from rivals with comparatively weak product innovation capabilities. Ongoing introductions of new/improved products can put rivals with deficient product innovation capabilities under tremendous competitive pressure. But such offensives can be sustained only if a company can keep its product development pipeline full of new and improved products that spark buyer enthusiasm.6 n Pursuing disruptive product innovation to create new markets. While this strategy can be riskier and more costly than continuous product innovation, “big bang” disruptive product innovation can be a game changer if successful.7 Disruptive innovation involves perfecting a new product with a few trial users, then quickly rolling it out to the whole market in an attempt to get many buyers to embrace an altogether new and better value proposition quickly. Examples include online degree programs, selfdriving capabilities for motor vehicles, Apple Music, and Amazon’s Kindle (which undercut the sales of hardcopy fiction and non-fiction books). n Adopting and improving on the good ideas of other companies (rivals or otherwise).8 The idea of warehouse home improvement centers did not originate with The Home Depot cofounders Arthur Blank and Bernie Marcus. They got the “big box” concept from their former employer Handy Dan Home Improvement. But they were quick to improve on Handy Dan’s business model and strategy and take The Home Depot to the next plateau in terms of product line breadth and customer service. Offenseminded companies are often quick to adopt any good idea (not nailed down by a patent or other legal protection) in an effort to create competitive advantage for themselves.9 n Deliberately attacking those market segments where a key rival makes big profits.10 Long a dominant force in small automobiles, Toyota launched a hardball attack on General Motors, Ford, and Chrysler in the U.S. market for light trucks and SUVs, the very market segments where the Detroit automakers historically earned big profits (roughly $10,000 to $15,000 per vehicle). Toyota now offers equivalent vehicles, earns handsome profits of its own in these two market segments, and has stolen sales and market share from its U.S.-based rivals. Dell opted to introduce its own brand of printers and printing supplies in the 1990s because its principal rival in desktop and laptop computers was Hewlett-Packard, which made its biggest profits in printing and printing supplies; by attacking H-P in the market for printers, Dell sought to force H-P to devote management attention and resources to defending its printing business and distract its attention away from trying to wrest market leadership away from Dell in the PC market. n Attacking the competitive weaknesses of rivals. Such offensives present many options. One is to go after the customers of those rivals whose products lag on quality, features, or product performance. If a company has especially good customer service capabilities, it can make special sales pitches to the customers of those rivals who provide subpar customer service. Aggressors with a recognized brand name and strong marketing skills can launch efforts to win customers away from rivals with weak brand recognition. There is considerable appeal in emphasizing sales to buyers in geographic regions where several rivals have low market shares or are less well-equipped to serve. If the attacker’s most potent resources and capabilities should prove powerful enough to outcompete the targeted rivals and result in competitive advantage, so much the better. Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission 125 Chapter 6 • Supplementing the Chosen Competitive Strategy—Other Important Strategy Choices n Maneuvering around competitors and concentrating on capturing unoccupied or less contested market territory. Examples include launching initiatives to build strong positions in geographic areas or market segments where close rivals have little or no market presence. Southwest Airlines became a major carrier not by invading the turf where big airlines had their “hubs”—like Chicago O’Hare, Dallas-Fort Worth, Los Angeles, and New York LaGuardia, but by scheduling point-to-point flights to lesser-sized airports (Las Vegas, Baltimore-Washington, Chicago Midway, and Fort Lauderdale) where relatively weak competition enabled it to gain the leading market share in a fairly short time. Going into 2016, Southwest commanded the biggest share of passenger traffic in over 60 of the 84 airports it served in the United States. n Using hit-and-run or guerrilla warfare tactics to grab sales and market share from complacent or distracted rivals. Options for “guerrilla offensives” include occasional low-balling on price (to win a big order or steal a key account from a rival); surprising key rivals with sporadic but intense bursts of promotional activity (offering a 20 percent discount for one week to draw customers away from rival brands); or undertaking special campaigns to attract buyers away from rivals plagued with a strike or problems in meeting buyer demand.11 Guerrilla offensives are particularly well suited to small challengers who have neither the resources nor the market visibility to mount a full-fledged attack on industry leaders. n Launching a preemptive strike to secure an advantageous position that rivals are prevented or discouraged from duplicating.12 What makes a move preemptive is its one-of-a-kind nature— whoever strikes first stands to acquire competitive assets that rivals can’t readily match. Examples of preemptive moves include (1) securing the best distributors in a particular geographic region or country; (2) obtaining the most favorable site along a heavily traveled thoroughfare, at a new interchange or intersection, in a new shopping mall, in a natural beauty spot, close to cheap transportation or raw material supplies or market outlets, and so on; (3) tying up the most reliable, high-quality suppliers via exclusive partnerships, long-term contracts, or even acquisition; and (4) moving swiftly to acquire the assets of distressed rivals at bargain prices. To be successful, a preemptive move doesn’t have to totally block rivals from following or copying; it merely needs to give a firm a prime position that is not easily circumvented. How long it takes for an offensive to yield good results varies with the competitive circumstances.13 It can be short if buyers respond immediately (as can occur with a dramatic price cut, an imaginative ad campaign, or an especially appealing new product). Securing a competitive edge can take much longer if winning consumer acceptance of the company’s product will take some time or if the firm may need several years to debug a new technology or put new production capacity in place. But how long it takes for an offensive move to improve a company’s market standing—and whether the move will prove successful—depends in part on whether and how quickly rivals recognize the threat and begin a counter-response. And any responses on the part of rivals hinge on whether (1) they have effective countermoves in their arsenal of strategic options and (2) they believe that a c...
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