Module 2 - Strategies for Competitive Advantage
2.2
Generic Strategies
Porter identified three generic approaches to competitive strategy:
1. Cost leadership strategy
2. Differentiation strategy
3. Focus strategy
a. Cost focus
b. Differentiated focus
Sources of competitive advantage may be easier to identify than achieve. In practice, there may be a
number of difficulties facing the firm trying to pursue competitive advantage as follows:
1. Trade-off between cost and differentiation
2. Stuck in the middle
3. One cost leader
4. Sustainability
2.3
The Value Chain
The value chain breaks the firm down into component activities to identify actual and potential sources
of competitive advantage. A value chain analysis:
 is applied at SBU level
 identifies physically and technological separable activities
 separate out activities which may have an impact on cost or differentiation advantage
The value chain can be used to look at linkages within the chain itself to check how the chain is
configured and how it is contributing to competitive advantage. It can also be used to look at linkages
between value chains to see whether and where shared activities may contribute to added value.
A representative value chain and some elements:
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sale
trucks
Distribution
Marketing
Production
R&D
marketing development
market research
advertisement
plant
equipment
labour force
research
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R&D
Representative value chains and interrelationships:
rce
s fo
sale
trucks
Distribution
marketing development
market research
advertisement
Marketing
plant
equipment
labour force
Production
research
develo
pmen
t
R&D
Divisional structure for unrelated value chains:
H.Q.
Division1
Division 2
Division 3
Functional structure for related value chains:
H.Q.
Marketing
Production
Mixed structure for partially related value chains:
2.4
Cost leadership
The main cost-drivers identified by Porter are as follows:
 Economies of scale
 Learning and experience curve gains
 Capacity utilisation
R&D
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R&D
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Vertical links within the value chain, and links with suppliers’ and buyers’ value chains.
Horizontal links with other value chains – economies of scope
Timing
Location
Institutional factors such as government regulation, taxation and subsidies
Discretionary policies
External economies
Cost leadership is most likely to be successful where there are some factors that cannot be easily
replicated.
To get and sustain cost leader advantage:
1. In the early stages of product lifecycle if the firm can steal an advantage over competitors:
i. First mover – faster learning curve, gain economy of scale and so on
ii. Second-in advantage by learning from competitors mistake
2. In later stages if the product is a standardised commodity type product with high priceelasticity of demand and buyers do not face significant switching costs from one seller to
another
A cost leader's best strategy is to keep price low whatever the other firm does. A dominant strategy
for the cost leader represents the best choice for the firm no matter what the competing firm does.
Porter
chain:
1.
2.
3.
summarises the major steps to be taken in undertaken a strategic cost analysis of the value
Identify the value chain and separate out and assign costs and asset attributable to it
Identify the relevant cost drivers and how they interact with each other
Identify competitor value chains, costs, and sources of cost advantages (Is cost leadership a
viable strategy?)
4. Develop a strategy to reduce costs through cost drivers or by reconfiguring value chain
5. Guard against eroding differentiation
6. Test for sustainability (Can competitors replicate what you have done?)
2.5
Differentiation
Differentiation is a strategy that may be feasible if a firm can be unique at something valued by buyers.
2.5.1
The Sources of Differentiation
The main differentiation drivers identified by Porter:
 Policy choices – firms intend to differentiate
 Linkages – connection within value-chain and vertical links with other (buyer or seller) value
chain can help generate differentiated advantage
 Timing – invaluable differentiation
 Location
 Interrelationships with other value chains
 Learning - particularly important in complex products
 Vertical integration and control
 Scale
Porter distinguishes two kinds of purchase criteria that buyers can use to make their decision.
1. Use criteria which reflect the actual impact of the product or service on buyer performance or
cost.
2. Signalling criteria which reflects signals of value that may encourage the buyer to infer or
judge the quality or service – for instance advertising
2.5.2
Signalling Quality: The Market for Lemons
Asymmetric information can cause problems in transactions for both buyers and sellers. It means
that the seller knows more about the real quality than the buyer.
How lemons and asymmetric information can destroy the market:
Reduced market price
Reduces perceived
average quality
Pushes out higher
quality products
Increases proportion of
lemaons in the market
There are a number of devices that can be used to at least partially offset the lemon problem:
 Reputation and word of mouth recommendations
 Warranties and guarantees
 Industrial professional associations
 Brand name recognition
 Chains and franchising
 Consumer guides and reviews
 Intermediaries
2.5.3
Steps in Differentiation
Porter suggests that there are several steps that should be taken if a firm wishes to pursue a
differentiated strategy:
1. Identify the relevant buyer
2. Identify the firm’s impact on the buyer’s value chain
3. Identify the buyers’ criteria for purchasing
4. Identify actual and potential sources of uniqueness
5. Identify the cost of actual and potential sources of differentiation
6. Assess benefit versus cost of differentiation alternatives
7. Test for sustainability
8. Reduce costs that do not affect differentiation
2.6
Focus
Focus strategies depend on differences between segments of the same market and can reflect
search for cost advantage in a particular segment or limited set of segments (cost focus) or search for
differentiation advantage gains in a segment or limited set of segments (differentiation focus).
A focus strategy can be firm-wide or just part of the firm.
The advantage of a firm-wide focus strategy is that it allows the whole of the firm’s value chain to
be dedicated to satisfying the purchase criteria for the buyers in the selected market segment.
The possible disadvantages of a firm-wide focused strategy can include:
 Limited opportunities for economies of scope
 Limited growth opportunities
 Vulnerability to external threats
It could be obvious that a focused strategy for part of the firm might not add much value through
linkages with the rest of the firm.
But could such a strategy actually destroy or reduce value?
1. Fallacy of free focus (opportunity cost)
2. Linkages cost
a. Cost of co-ordination
b. Cost of compromise
c. Cost of inflexibility
Porter argues that it is not possible for a firm to pursue both cost advantage and differentiation
strategy in the same segment because the two generic strategies make incompatible demands on the
firm. Differentiation typically involves costly expenditures
Being stuck in the middle is a consequence of a lack of clarity and consistency in formulating and
maintaining a competitive strategy designed to deliver competitive advantage to the firm.
There may be circumstances in which a firm can pursue both cost leadership and differentiation in a
market. Ex cost leadership in food and differentiation in seafood.
2.7
The Dangers of Hybrid Strategies
Porter identifies possibe cases where it may be possible for the firm to pursue a ‘stuck in the middle’
strategy, that is, it pursues differentiation and cost leadership strategy using the same business unit
and based on the one value chain. The case is as follows:
 Competitors are also stuck in the middle
 Cost is strongly related to scale
 Being the first to innovate