Strategy and Competitive Advantage
Chapter 5
OB/ Aug 09
Chapter Outline
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5 Generic Competitive Strategies
Low Cost Provider Strategies
Differentiation Strategies
Best-Cost Provider Strategies
Focused or Market Niche Strategies
Competitive Strategy
• Competitive Strategy consists of all the moves
and approaches a firm has taken and is taking to
attract buyers, withstand competitive pressures
and improve its market position
5 Generic Competitive Strategies
• A low cost provider strategy – appeal to a broad
spectrum of customers by being the overall low cost
provider of good/ service
• A broad differentiation strategy – seek to differentiate
company’s product/ service from rivals in ways that
will appeal to a broad spectrum of buyers
5 Generic Competitive Strategies
(cont)
• A best cost strategy – give customers more value for money (
good to excellent attributes at lower costs than rivals)
• A focused or niche market strategy based on lower costs –
concentrate on a narrow buyer segment and serve niche buyers
at lower costs than rivals
• A focused or niche market strategy based on differentiation –
concentrate on a narrow buyer segment and outcompete rivals
by offering niche buyers attributes that meet their tastes and
requirements better
Low Cost Strategy
• Powerful competitive approach where buyers are price sensitive
• Develop a sustainable cost advantage over competitors
• Use lower costs as basis for underpricing competitors and gain
market share or
• Earn higher profits selling at the going price
• But must be careful not to pursue low cost so much that product
is too stripped down and lose buyer appeal
Figure 5.1: The Five Generic
Competitive Strategies
Type of Advantage Sought
Market Target
Lower Cost
Broad
Range of
Buyers
Narrow
Buyer
Segment
or Niche
Differentiation
Overall Low-Cost
Broad
Provider
Differentiation
Strategy
Strategy
Best-Cost
Provider
Strategy
Focused
Focused
Low-Cost
Differentiation
Strategy
Strategy
How to achieve Low Cost
Advantage?
• Firm’s cumulative costs across its activity cost chain
must be lower than competitors’.
• 2 ways to accomplish this:
– Improve efficiency and control costs along existing activity
cost chain
– Revamp firm’s activity cost chain to bypass some cost
producing activities
– Both approaches can be used simultaneously
Controlling Costs Drivers
• Economies or diseconomies of scale
• Learning curve effects
• Costs of key inputs
– Union v/s nonunion labour
– Bargaining power vis a vis suppliers and supply chain
– Location
• Industry value chain
• Sharing with other business units within the enterprise
Controlling Costs Drivers (cont)
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Vertical integration v/s Outsourcing
First mover advantages and disadvantages
Capacity utilisation
Strategic choices and operating decisions
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Adding/ removing services provided
Increasing/ decreasing distribution channels used
Lengthening/ shortening delivery times to customers
Raising / Lowering specifications of purchased materials
Putting more / less emphasis than rivals on incentive
compensation,wage increases, fringe benefits to motivate
employees and boost productivity
Revamping the Value Chain
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Make greater use of internet technology applications
Using direct to end user sales and marketing approaches
Simplify the product design
Stripping away the extras
Shift to simpler/ less capital intensive/ more flexible
technological process
Revamping the Value Chain (cont)
• Bypass high cost raw materials or component parts
• Relocate facilities
• Dropping the something for everyone approach
Keys to success in achieving Low
Cost Leadership
• Scrutinise each cost creating activity and determine what drives
costs
• Manage costs downward
• Restructure value chain
• Create cost conscious corporate culture- employee participation
in cost improvement efforts and limited perks for executives
• Small corporate staff to keep admin costs low
• Benchmark costs against best in class performers
• Invest in resources and capacities to reduce costs
Advantages of being Low Cost
Producer
• Provides defenses against the five competitive forces:
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Rivals > compete offensively on basis of price,defend
against price war, win sales and market share, earn above
average profits based on bigger profit margins or sales
volume
– Buyers > partial profit margin protection from powerful
customers
– Suppliers > protected from powerful producers if internal
efficiency is source of cost advantage
Advantages of being Low Cost
Producer
• Potential entrants > can use price cutting to make it harder for
new rival to win customers, acts as a barrier to entry
• Substitutes > can use low price as a defense against substitutes
When to go for Low Cost
Leadership
• Low cost price leadership should be used when:
– Price competition is a dominant competitive force
– Product is standardised,commodity type available from a
variety of sellers
– There are few ways to achieve product differentiation
– Most buyers use the product in the same ways – price and
not features becomes the dominant competitive force
– Low switching costs from one seller to another
– Buyers have significant power to bargain prices
The Drawbacks of Low Cost
Producer Strategy
• Technological breakthroughs can open up cost reductions for
rivals that nullify low previous low cost advantages
• Rival firms may find it easy or inexpensive to imitate leader’s
low cost methods
• Too focused on driving down costs that fails to pick up on
significant market changes- changing buyer preference, for
added quality or service,shifts in how buyers use the product,
declining buyer sensitivity to price.
Differentiation Strategy
• When buyer’s needs and preferences are too diverse to
be satisfied by a standardised product
• Must study buyers’ needs and behavior carefully to
learn what they consider important and valuable
• Competitive advantage results when buyers become
strongly attached to the attributes of differentiator’s
offering
Advantages of a Differentiating
Strategy
• Successful differentiation allows a firm to:
– Command a premium price for its product
– Sell more units
– Gain greater buyer loyalty to its brand
• Provides a buffer against rival strategies as buyers
become loyal to the brand and are willing to pay more
for it
• Erects barriers to entry in the form of customer loyalty
Advantages of a Differentiating
Strategy
• Provides defenses against the five competitive forces
• Mitigates bargaining power of large buyers
• Helps to fend off threats from substitutes
• The most appealing differentiation strategies are those
who are least subject to quick or inexpensive imitation
Achieving Differentiation
• Anything a firm can do to create buyer value represents a
potential basis for differentiation
• Differentiation can occur anywhere in the activity cost chain
• Approaches to a differentiating strategy:
– Taste
– Special Features
– Superior Service
– After sales service
– Prestige and Distinctiveness
– Reliability
– Technological leadership
Real Value,Perceived Value and
Signals of Value
• Buyers will not pay for value they do not perceive even
if extras are real
• Price premium must reflect value actually delivered as
well as the value perceived by the buyer
• Actual and perceived value may differ when buyers
have trouble assessing what their experience with the
product will be
• Incomplete knowledge on the part of buyers causes
them to judge value on signals such as price,
packaging, ad campaigns, firm’s market share, length
of time firm has been in business, professionalism of
employees, seller’s list of customers
Signals of Value (cont)
• Such signals of value may be as important as
actual value when:
– The nature of the differentiation is subjective or
hard to quantify
– Buyers are making a first time purchase
– When repurchase is infrequent
– Buyers are unsophisticated
Achieving a Differentiation based
Competitive Advantage
• Incorporate product attributes and user features that
lower the buyer’s overall costs of using the company’s
product
• Incorporate features that raise product performance
• Incorporate features that enhance buyer satisfaction in
non-economic or intangible ways
• To deliver value to customers via competitive
capabilities that rivals don’t have or can’t afford to
match
Achieving a Differentiation based
Competitive Advantage (cont)
• Extra price of product must outweigh the costs of achieving
differentiation
• Buyers must value the additional features highly enough to
buy the product in profitable quantities
• Incorporate differentiating features that are not costly but
that add to customer satisfaction
• Sustainable differentiation usually has to be linked to core
competencies, unique competitive capabilities and superior
management of value chain activities that competitors
cannot readily match or imitate
When a Differentiation Strategy
Works Best
• Differentiation strategies work best where:
– There are many ways to differentiate the product or
service and many buyers perceive these differences
as having value
– Buyer needs and uses are diverse
– Few rival firms are following a similar
differentiation approach
– Technological change is fast paced and competition
revolves around rapidly evolving product features
The Risks of a Differentiating
Strategy
• Pitfalls in pursuing differentiating strategy include:
– Trying to differentiate on the basis of something that does
not enhance buyers’ well-being as perceived by the buyer
– Over-differentiate so that the product quality or service
exceeds buyers’ needs
– Try to charge too high a price premium
– Tiny differences between rivals’ products offerings may
not be visible or important enough to buyers
– A low cost strategy can defeat a differentiation strategy
when buyers are satisfied with a basic product and don’t
think extras are worth a higher price
Best Cost Provider Strategies
• Best cost provider strategies aim at giving customers more
value for the money
• Deliver superior value to buyers by satisfying their
expectations on key quality/service/features/performance
attributes and beating their expectations on price
• Best cost strategies are hybrid strategies mid-ground
between a low cost advantage and a differentiation
advantage and the broad market and a narrow market niche
• The target market is value conscious buyers, a sizable part
of the overall market
Achieving Best Cost Provider
Strategies
• Best cost provider strategy is powerful where buyer
diversity makes product differentiation the norm and
where many buyers are also sensitive to price and
value
• Can position near the middle of the market with a
medium quality products at a below average price or
• A high quality product at an average price
Risks of a Best Cost Provider
Strategy
• Unless a company has resources, know-how and capabilities
to incorporate upscale attributes at a lower cost than rivals,
this strategy is ill advised
• Company may be squeezed between the strategies of firms
using low cost and differentiation strategies
• High end differentiators can steal customers with appeal of
better products attributes – must achieve significantly lower
costs in providing upscale features
• Low cost leaders may steal away customers with appeal of a
lower price – must provide significantly better product
attributes to justify price above low price leaders
Focused or Market Niche Strategies
• Concentrated attention on a narrow piece of the total market
• Target segment or niche can be defined by:
– Geographic uniqueness
– Specialised requirements in using the product
– Special product attributes that appeal to only relatively small
numbers of buyers
• Examples:
– eBay : online auctions
– Porsche : sports cars
– Google: internet search engine
Focused Low-Cost Strategy
• Based on low cost securing a competitive advantage by
serving buyers in niche target market at lower cost and
lower price than rivals
• Strategy attractive a firm which can lower costs
significantly by limited customer base to well defined buyer
segment
• Avenues to achieving cost advantage over rivals in niche
market are same as for low cost leadership
– Outmanage rivals in controlling factors that drive costs
– Reconfigure the firm’s value chain in ways that yield cost edge
over rivals
Focused Low-Cost Strategy (cont)
• Examples:
– Generic items imitative of name brand merchandise
e.g medicines, ink cartridge manufacturers
– Selling directly to retail chains wanting a basic
house brand to sell to price-sensitive shoppers
A Focused Differentiation Strategy
• Based on differentiation aims at securing a competitive
advantage by offering niche members a product they
perceive as suited to their tastes and preferences
• Successful use of a focused differentiation strategy depends
on:
– Existence of buyer segment that is looking for special product
attributes or seller capabilities
– Firm’s ability to stand apart from rivals competing in the same
target market niche
Achieving a Focused Differentiation
Strategy
• Examples: Chanel, Gucci, Rolex, Rolls Royce
• Most markets contain a buyer segment willing to pay a price
premium for the finest items available opening a window to
pursue differentiation based focused strategy aimed at the
very top of the pyramid
When is a Focused Low-Cost or Focused
Differentiation Strategy is Attractive
• A focused strategy based either on low cost or
differentiation becomes attractive when the following
conditions are met:
– The target market niche is big enough to be profitable and offers
good growth potential
– Industry leaders do not see that being present in the niche is crucial
to their success
– It is costly or difficult to meet the specialised needs of the niche
and mainstream customers at the same time
– The industry has many different niches and segments – less
competition
When is a Focused Low-Cost or Focused
Differentiation Strategy is Attractive (cont)
– Few if any other rivals are attempting to specialise in the
same target segment – reducing the risk of segment
overcrowding
– The focuser can compete effectively based on its capabilities
and resources and goodwill to serve the targeted niche
– A focuser’s unique capabilities in serving a market niche can
also act as an entry barrier as well as a hurdle for makers of
substitute products
– Even if niche buyers may have substantial bargaining power,
their power is reduced by having to shift to rival firms less
capable of meeting their needs
The Risks of a Focused Low-Cost or
Focused Differentiation Strategy
• Focusing also carries risks:
– Competitors may come up with ways to serve the niche
market better than the focuser with more appealing offerings
or by developing capabilities that offset the focuser’s
strength
– There is potential for the preferences and needs of the niche
members to shift over time toward the product attributes
desired by the majority of buyers
The Risks of a Focused Low-Cost or
Focused Differentiation Strategy (cont)
– Erosion of differences over buyer segments lowers the
barriers to entry into the focuser’s niche and rivals in
adjacent segments can start to compete for the focuser’s
customers
– The segment can be so attractive that it is flooded with
competitors, intensifying rivalry and diminishing segment
profits
5 Generic Strategies: A Summary
• Each of the 5 generic competitive strategies positions
the company differently in its market and competitive
environment
• Each creates a central theme of how company will try
to outcompete rivals
• Each provides boundaries and guidelines for
maneuvering
• Each entails differences in product line,production,
marketing and sustaining the strategy, affects how the
business operated and manner in which value chain
activities are managed
5 Generic Strategies: A Summary
(cont)
• Deciding which generic strategy to employ is perhaps the
most important strategic commitment a company makes- it
tends to drive the rest of the strategic actions of the company
• Compromise or middle ground strategies rarely produce
sustainable competitive advantage or a distinctive
competitive position except for a well executed best cost
producer strategy
• Companies with compromise strategies end up with a middle
of the pack industry ranking - having a competitive edge
over rivals is the most dependable contributor to above
average profitability and industry leadership