The Five Generic Competitive Strategies

The five distinctive competitive strategies are:

1. Low-cost provider strategy
2. Broad Differentiation strategy
3. Best-cost provider strategy
4. A focused (or market niche) strategy based on lower
cost
5. A focused (or market niche) strategy based on
differentiation
Low-cost provider strategies
• A company achieves low-cost leadership when it becomes
the industry's lowest-cost provider. e.g. Nano
• It is lower-cost than rivals but not necessarily absolute
lowest cost. E.g. Maruti 800 is low cost car but not lower
than Nano
• The product should include features and services that
buyers consider essential.
• A product offerings that is too frill-free sabotages that
attractiveness of the company's product and can turn
buyers off even if it is cheaper than competing products.
• The low-cost has to be achieved in a way that would be
difficult for the competitors to copy for the low-cost
advantage to yield valuable edge in the marketplace.
There are two options for translating a low-cost
advantage into attractive profit performance:
1. Use the lower-cost edge to under price
competitors and attract price-sensitive buyers in
great numbers to increase total profits.
– Here the company has to keep the size of the price cut
smaller than the size of the firm's cost advantage
(bigger profit margin per unit) or generate enough
added volumes to increase total profits despite thinner
margins.
1. Maintain the present price, be content with the
present market share, and use low-cost edge to
earn a higher profit margin on each unit sold.
Avenues for achieving cost advantage
• To achieve a cost advantage, a company must
make sure that its cumulative costs across its
overall value chain are lower than competitors'
cumulative costs.
• The two ways to accomplish this are:
1. Out manage rivals in the efficiency with which value
chain activities are performed and in controlling the
factors that drive the costs of value chain activities.
2. Revamp the firm's overall value chain to eliminate
some cost-producing activities.
Controlling the cost drivers
1. Economics or diseconomies of scale
– Economics of scale arise when activities can be performed more
cheaply at larger volumes than smaller volumes and from ability to
spread out certain costs like R&D and advertising over a greater
sale volume. e.g. in manufacturing it is achieved by simplifying the
product line, scheduling longer production runs for fewer models
and using common parts and components in different models.
1. Learning curve effects
– It is the effect when the cost of performing an activity declines over
time as the experience of the company personnel builds. E.g. Tata’s
building Nano versus Bajaj building their low cost car
– It can stem from debugging and mastering newly introduce
technologies, finding ways to improve plant layout and work flows,
making product design modifications that streamline the assembly
process.
– It is important to keep the learning proprietary to whatever possible
extent.
3. The cost of key resource inputs
– How well a company manages the costs of acquiring key
resource inputs is often a big driver of costs.
The input costs are affected by four factors
1. Union versus nonunion labor
• Union labor increases cost of production as more facilities are
demanded and there are lot of resistance to increasing productivity.
e.g. low productivity rate in public sectors
1. Bargaining power vis-a-vis suppliers
• Purchasing in large numbers helps in bring down the cost. e.g. Wal-
Mart
1. Location variables
• Location costs like tax, transport, shipping, wage tax, energy costs
play a major role in input costs. e.g. manufacturing in tax beneficial
states like Himachal Pradesh
1. Supply chain management expertise
• Partnerships with suppliers, e-procurement lower the cost of supply
logistics.
4. Links with other activities in the company or
industry value chain
– When the cost of one activity is affected by how other
activities are performed, costs can be reduced by
ensuring that the linked activities are performed in a
cooperative and coordinated fashion. e.g. inventory
cost can be brought down by coordination with
suppliers for design of parts, quality of manufacturing
and just-in-time supply.
5. Sharing opportunities with other organizational
or business units within the enterprise
– e.g. sharing common resources like sales force,
warehouse, billing system, distribution facilities, etc.
can create significant cost savings.
6. The benefits of vertical integration versus outsourcing
– Vertical integration ( expanding backwards into source of supply,
forward towards the user, or both) helps when buyers or
suppliers have bargaining powers.
– In majority of the cases outsourcing is always helpful as it brings
expertise and economics of scale.
– e.g. Reliance used backward integration effectively
7. First-mover advantages and disadvantages
– The first mover has the advantage of establishing a brand name at
very low cost. e.g. Google, eBay, Bislere
– Competitors have to spend considerable money to compete against
these first mover brands.
– When technology is fast developing the later entrants have the
advantage of using better technology at a lower price. e.g. Cost and
technology of using internet connection in the early days of software
revolution was very high
– Companies that follow product development often study the existing
products and avoid mistakes made by the first mover products
8. The percentage of capacity utilization
– Capacity utilization for activities with substantial fixed cost. e.g.
manufacturing set-up
– It helps in lowering the fixed costs per unit.
– It is important for capital intensive businesses.
– Operating close to full capacity for most of the time is an
important source of cost advantage.
9. Strategic choices and operating decisions
– The following managerial decisions impact the cost
1. Adding/cutting the services provided to buyers e.g. ATM
2. Incorporating more/fewer performance and quality features into the
product. E.g., Lexus
3. Increasing/decreasing the number of different channels utilized in
distributing the firm's product
4. Lengthening/shortening delivery times to customers e.g. Domino's
5. Putting more/less emphasis than rivals on the use of incentive
compensation, wage increases and fringe benefits to motivate
employees and boost worker productivity.
6. Raising/lowering the specifications for purchased materials
Revamping the value chain
• The primary way companies achieve a cost advantage is by
reconfiguring their value chain include:
1. Making greater use of internet technology applications
– Internet is a powerful and pervasive tool for reengineering company and industry
value chains.
– e.g. in supply chain management, collaboration in new product development,
purchasing, just -in-time deliveries, cost-effective customer manufacturing, "back
office" data management processes can be handled fast, accurately and with less
paperwork and few personnel
– Using the direct-to-end-user sales and marketing approaches e.g. Dell
– Costs of the wholesale/retail portions of the value chain frequently represent 35-
50 percent of the price end consumers pay.
– e.g. direct downloading of software eliminates the cost of burning CDs, packaging
and shipping thus increasing the profit margin of manufacturers and reducing the
final price paid by the consumers; increased online sales of tickets have helped
airline to eliminate the commission paid to the agents
2. Simplifying the product design
– Using computer assisted design techniques, reducing
the number of parts, standardizing parts and
components across models and styles and shifting to an
easy-to-manufacture product design can all simplify the
value chain
3. Stripping away the extras
– Offering only basic products or services can help a
company cut costs associated with multiple features
and options. e.g. low cost airlines like Go
4. Shifting to simpler, less capital-intensive or more
streamlined or flexible technological process
– These help in efficiency and product customization
5. Bypassing the use of high-cost raw materials or
component parts
– With better design
6. Relocating facilities
– Moving plants closer to suppliers, customers, or both
can help curtail inbound and outbound logistics costs
7. Dropping the "something for everyone" approach
– Pruning slow-selling items and concentrating on needs
of most buyers rather than all buyers helps in
elimination of costs associated with numerous product
versions.
The keys to success in achieving low-cost leadership
1. The managers must scrutinize each cost-creating
activity and determine what drives its cost.
2. They need to exhaustively pursue cost savings
throughout the value chain.
3. Non-essential work steps and low-cost activities must
be eliminated.
4. Cost-conscious corporate cultures involving employees
in cost improvement efforts must be built.
5. Administrative costs must to kept to minimum.
6. Benchmarking against the best-in-the-class companies.
7. Investment in resources and capabilities that drive
down costs. e.g. Wal-Mart
When a low-cost provider strategy works best
1. Price competition among rival sellers is especially
vigorous. e.g. FMCG companies
2. The products of rival sellers are essentially identical
and supplies are readily available from any of
several eager sellers.
3. There are few ways to achieve product
differentiation that have value to buyers.
4. Most buyers use the product in the same ways
5. Buyers incur low costs in switching their purchases
from one seller to another. E.g. FMCG products
6. Buyers are large and have significant power to
bargain down prices
7. Industry newcomers use introductory low prices to
attract buyers and build a customer base
Pitfalls of a low-cost provider strategy
1. Getting carried away with overly aggressive cost
cutting and ending up with lower, rather than
higher profitability.
2. Not emphasizing avenues of cost advantage that
can be kept proprietary. or that relegate rivals to
playing catch-up.
3. Becoming too fixated on cost reduction.
Differentiation strategies
• Differentiation strategies are attractive when buyers' needs
and preferences are too diverse to be fully satisfied by a
standardized product or by sellers with identical capabilities.
• A company attempting to succeed through differentiation
must study buyers' needs and behavior to learn what buyers
consider important, what they think has value and what they
are willing to pay for.
• Competitive advantage results once a sufficient number of
buyers become strongly attached to the differentiated
attribute.
• Differentiation enhances profitability whenever the extra
price the product commands outweighs the added costs for
achieving the differentiation .
• Differentiation strategy fails when buyers don't value the
brand's uniqueness and/or when the differentiation is easily
copied by its rivals.
Advantages of successful differentiation for a firm
1. It can command a premium price for its product
2. Increase in unit sales due to additional buyers
won over by differentiation.
3. Gain buyer loyalty to its brand when buyers are
strongly attracted to the differentiating feature.
Types of differentiation themes
1. Unique taste. e.g. MTR
2. Multiple features. e.g. Microsoft office
3. Wide selection and one-stop shopping e.g. Big Bazaar
4. Superior service e.g. FedEx
5. Spare part availability e.g. Caterpillar
6. Engineering design and performances e.g. Mercedes
7. Prestige and distinctiveness e.g. Rolex
8. Product reliability e.g. J&J in baby products
9. Quality manufacture e.g. Toyota
10.Technology leadership e.g. 3M in bonding and coating
products
11.A full range of services e.g. ICICI bank
12.A complete line of products e.g. Samsung
13.Top-of-the-line image and reputation e.g. Oberoi hotels
Where along the value chain to create the differentiating
attributes
1. Supply chain activities that affect the performance or
quality of the company's end product. e.g. Starbucks
has very strict specifications on the coffee beans it
purchases.
2. Product R&D activities that aim at
– improved product designs and performance features
– wider variety
– added user safety
– enhanced environmental protection.
1. Production R&D and technology-related activities that
– permit custom-order manufacture at an efficient cost
– make production safer for the environment
– improve product quality, reliability and appearance.
– e.g. Toyota manufacturing different models of cars from the same
assembly line.
4. Manufacturing activities that
– reduce product defects
– prevent premature product failure
– extend product life
– allow better warranty coverage
– improve economy of use
– result in more end-user convenience or enhanced product
appearance.
– e.g. Japanese manufacturing technology
4. Outbound logistics and distribution activities that
– allow for faster delivery
– more accurate order filling
– lower shipping costs
– fewer warehouse and on-the-shelf stoke outs.
6. Marketing, sales and customer service activities
that result in
– superior technical assistance to buyers
– faster maintenance and repair services
– more and better product information provided to customers
– more and better training materials for end users
– better credit terms
– quicker order processing
– greater customer convenience.
Achieving a differentiation based competitive advantage
• One approach is to incorporate product attributes and
user features that lower the buyer's overall costs of
using the company's product.
– reduce buyer's raw material waste (providing to-size
components)
– reduce a buyer's inventory requirements (providing just-in-time
deliveries)
– increasing maintenance intervals and product reliability thus
reducing repair and maintenance cost
– use online system to reduce buyer's procurement and order
processing costs
– providing free technical support
• Second approach is to incorporate features that raise
product performance
– by providing greater reliability, durability, convenience or ease
of use
• Third option is to incorporate features that
enhance buyer satisfaction in noneconomic or
intangible ways.
– LIC provides a sense of safety
– BMW, Rolex provide status, image, prestige, upscale
fashion, superior craftsmanship and finer things in life.
– giving lifelong guarantees to products
• A fourth approach is to differentiate on the basis
of capabilities - to deliver value to customers via
competitive capabilities that rivals don't have or
can't afford to match.
– Japanese automakers can bring new models to market
faster than others
– Indian software companies can provide best quality
software at most competitive prices
The importance of perceived value
• The price premium commanded by a differentiating strategy
reflects the value actually delivered and the value perceived.
• Actual and perceived value can differ whenever buyers have
trouble assessing what their experience with the product will
be
• Incomplete knowledge on the part of the customers often
cause them to judge value based on things like
– price (where price connotes quality)
– attractive packaging
– expensive ad campaigns
– ad content and image
– quality of brochures and sales representatives
– seller's facilities
– seller's list of customers
– firm's market share
– length of time the firm has been in business and professionalism
– personality of seller's employees
Perceived value may be important as much as
actual value when
1. The nature of differentiation is subjective or hard
to quantify
2. Buyers are making a first-time purchase
3. Repurchase is infrequent
4. Buyers are unsophisticated
Keeping the cost of differentiation in line
• Profitable differentiation is possible when
– the cost of achieving the differentiation is below the
price premium the differentiating attributes can
command in the market (thus increasing the profit
margin)
– offset thinner profit margins with enough added volume
to increase total profits.
– e.g. FedEx provide tracking system for all orders, free
home delivery, providing free parking space at a
apartment
When a differentiating strategy works best
1. There are many ways to differentiate the product or service and
many buyers perceive these differences as having value
– e.g. Five star hotels, mobile phone handsets
1. Buyer needs and users are drivers
– The more diverse buyer preferences are, the more room firms have to
pursue different approaches to differentiate.eg. mobile phone handsets
1. Few rival firms are following similar differentiation approach.
– Each of the companies are pursuing their own differentiation path with less
overlapping. e.g. Intel and AMD
1. Technological change is fast-paced and competition revolves
around rapidly evolving product features
– Frequent introductions of next-version products help maintain buyer
interest and provide space for companies to pursue separate differentiating
paths. e.g. mobile phone handsets
The pitfalls of a differentiation strategy
1. No guarantee that differentiation will produce a meaningful
competitive advantage.
2. Buyers may see little value in the unique attributes or
capabilities of a product.
3. Competitors can copy the differentiating features.
4. It is very time consuming to come up with genuine
differentiators which would be difficult to copy.
5. Adding features that do not reduce the buyer's cost or
enhance a buyer's well-being, as perceived by the buyer.
6. Over differentiating so that the product quality or service
level exceeds buyer's needs.
7. Trying to charge too high a premium. It may give an
opportunity for buyers to switch to a lower cost product.
8. Not striving to fill the real gaps in quality or performance or
service of the rival firms. Tiny difference between product
offerings may not be important for the buyers.
Best cost provider strategies
• It aims at giving customers more value for the
money.
• The objective is to deliver superior value to
buyers by satisfying their expectations on key
quality/feature/performance attributes and
beating their expectations on price.
• It derives from the ability to incorporate attractive
attributes at a low cost than rivals.
• To become a best-cost provider a company must
have resources and capabilities to achieve good-
to-excellent quality, appealing features, match
product performance and provide good-to-
excellent services - all a lower cost than rivals.
• The best-cost provider strikes out a middle path between
persuing lower cost advantage and a differentiating
advantage and between appealing to the broad market or the
niche market.
• Best-cost strategy is a hybrid, which does a balancing of
strategic emphasis on low cost against a strategic emphasis
on differentiation.
• The target market is the value conscious buyer.
• The competitive advantage of a best-cost provider is lower
costs than rivals in incorporating good-to-excellent attributes.
• It is very effective in markets where buyer diversity makes
differentiation the norm and where many buyers are also
sensitive to price and value.
• The pricing strategy can be a medium-quality product at a
lower price or a high quality product at an average price.
Illustration on page 131 about strategy followed by
Toyota for Lexus
Risk of a best-cost provider strategy
• The company using this will get squeezed
between companies following low-cost strategy
and differentiating strategies.
• Low cost companies get customers with low cost
and differentiating companies will offer more
additional features to attract the customers.
• A best-cost provider product must have
"significantly" better attributes in order to justify
the cost above what the low-cost leaders are
charging and should be "significantly" lower-cost
with upscale features so that it can outcompete
higher end differentiators on the basis of an
attractive lower price.
Focused (or market niche) strategies
• This strategy focuses on a small size of the total
market.
• The target market, or niche, can be defined by
geographic uniqueness, specialized requirements
in using the product, or special product attributes
that appeal only to relatively small number of
buyers.
• e.g. eBay (online auctions), L&T Constructions
(infrastructure projects), Ayush from HUL
(ayurveda), Himalaya (herbal products)
Focused low-cost strategy
• A focused strategy based on low-cost aims at securing
a competitive advantage by serving buyers in the
target niche market at a lower cost and price than the
rivals.
• It is attractive when the company can find the niche
market and lower its cost significantly to serve that
market.
• The strategy to provide lower cost than rivals in the
niche market is controlling factors that drive the cost.
– e.g. Producers of private label generic items with less product
development cost, marketing, distribution and advertisement
can offers these products at lower price than branded
products.
– Manufacturers of clone products like ink cartridges for HP
printers without violating patents.
Focused differentiation strategy
• It focuses on offering feature differentiations
which would be perceived by the niche customers
as well suited to their own unique tastes and
preferences.
• This strategy depends on the existence of an
buyer segment that is looking for special product
attributes and the ability of the company to
provide those features.
– e.g. Rolex (watches), Rolls Royce - focus of upscale
customers looking for best products.
– Himalaya (herbal products), Cafe Coffee Day (business
ambience)
When does a focused strategy become attractive
1. The target niche is big enough to be profitable and
offers good growth potential.
2. Industry leaders do not see having a presence in
the niche to be crucial to their own success. This
prevents having competition from the big players.
3. It is costly or difficult for multisegment players to
put capabilities in place to meet the specialized
needs of the niche and at the same time satisfy
the expectations of their main customers.
4. The industry has many niches and segments,
allowing the company to choose a niche matching
the capabilities of the company. With multiple
niches players can choose their niche without
competing with other players.
5. A very few other rivals being interested in the
same segment. This prevents overcrowding.
6. The company focused on a niche has the
capability to serve the niche the best due to its
capabilities and the goodwill it would have
generated with the customers. This can act as a
barrier for rivals planning to enter this segment.
This also makes manufacturers of substitute
products think if they should focus on a niche
already dominated by another company.
The risks of a focused low-cost and of a focused
differentiation strategy
1. Competitors will find effective ways of matching the
capabilities of the company serving the niche market.
E.g. Microsoft offering photo editing feature to
compete with Photoshop
2. Shifting of the preferences and needs of the
customers over time to those preferred by majority of
the buyers.
3. An erosion of the differences between segments thus
reducing the entry barriers for companies in other
segments to target customers from the company's
niche market.
4. The segment may become very attractive thus
inviting many competitors and intensifying rivalry and
reducing segment profits.