Once the firm and its competitors have been analysed and positioned on the matrix, one has a better view of the strengths and weaknesses of all the parties concerned and a resultant strategy can be put into place. Porter advocates that there are certain processes that a firm can follow to sustain a competitive advantage. The significance of any strength or weakness is a function of its impact on relative cost or differentiation, which stem from the industry structure.
The two basic types of competitive advantage combined with the scope of activities for which the firm seeks to achieve these advantages results in three different types of strategy - cost leadership, differentiation and focus.
Generic Strategies
Cost leadership and differentiation strategies focus on competitive advantage in a broad range of industry segments while focus strategies aim at cost advantage or differentiation in a narrow segment.
The aim of this strategy is for a firm to become the low-cost producer in its industries that it serves. It has a broad scope and may serve in numerous industries and this is often important to its cost advantage. Sources of cost advantage are industry dependent and varied but must be identified. A firm has a cost advantage if its cumulative cost of performing all value activities is lower than competitor costs.
A firm’s relative cost position is a function of the composition of its value chain versus competitors and its relative position regarding the cost drivers of each activity.
Porter suggested an analysis of ones own and the competitors value chain. This is a view of the internal functioning of a firm.
The value chain is a business system concept, which was originally developed by McKinsey and Company and further developed and clarified by Porter. This concept captures the idea that a firm is a series of functions (e.g. R&D, manufacturing, marketing, distribution etc.) and that each of these can be analysed to determine ones own and the competitors’ strengths and weaknesses.
Value Chain
The value chain is made up of five categories of primary activities, which are sub-divisible into activities, dependent on the industry and the firm’s strategy.
The five areas are:
1. Inbound Logistics – activities associated with receiving, storing and disseminating inputs to the product (materials handling, warehousing, inventory control, vehicle scheduling, and returns to suppliers)
2. Operations – activities associated with transferring inputs into the final product form (machining, packaging, assembly, equipment maintenance, testing, printing, and facility operations)
3. Outbound Logistics – activities associated with collecting, storing and delivering the finished product to the customer/buyer (finished goods warehousing, material handling, delivery vehicle operation, order processing, scheduling)
4. Marketing and Sales – activities associated with providing a means by which buyers can purchase the product and inducing them to do so. (advertising, promotion, sales force, quoting, channel selection, channel relations, pricing)
5. Service – activities associated with providing service to enhance and maintain the value of the product (installation, repair, training, parts supply, product adjustment)
Each of these areas varies depending on the industry but all the areas will be present to some degree and may be vital to competitive advantage. Dramatic shifts in relative cost position often arise from a firm adopting a value chain that is significantly different from its competitors.
A low cost producer must find and exploit all sources of cost advantage and they typically sell a standard or ‘no-frills’ product placing great emphasis on getting cost advantage from all sources. A cost leader’s low cost position at equivalent or lower prices than the competitors, translates into higher returns.
If a firm can achieve and sustain overall cost leadership, it will be an above average performer in its industry provided that it can get prices at or near the industry average.
Steps in this Strategy:
1. Identify the value chain and assign costs and assets to it
2. Analyse the cost drivers of each value activity and how they interact
3. Identify competitor value chains then determine the relative cost of competitors and sources of cost differences
4. Develop a strategy to lower relative cost position through controlling cost drivers or reconstruct the value chain and/or downstream value
5. Make sure that cost reduction efforts do not erode differentiation or make a conscious effort to do so.
6. Test the cost reduction strategy for sustainability
In a differentiation strategy a firm looks for ways to be unique along some dimensions that are widely valued by buyers. It selects one or more attributes that buyers perceive as important and uniquely positions itself to meet those needs and it is rewarded for its uniqueness with a premium price.
Approaches to differentiation are peculiar to each industry and can take many forms – e.g. design or brand image, technology, customer service, dealer network. Differentiation can be enhanced in two ways – the firm can become more unique in performing its existing value chain activities or it may reconfigure its value chain in some way that enhances its uniqueness
A firm that can achieve and sustain differentiation will be an above-average performer in the industry if the price premium exceeds the extra costs involved in being unique. A differentiator aims at cost parity or proximity relative to the competitors by reducing costs in all areas that do not affect differentiation. The firm must choose attributes that are different from the rivals in order to differentiate it.
Steps in this Strategy
1. Determine who the real buyer is
2. Identify the buyers value chain and the firm’s impact on it
3. Determine the buyers purchase criteria (ranked by importance)
4. Assess the existing and potential sources of uniqueness of the firm’s value chain
5. Identify the cost of existing and potential sources of differentiation
6. Choose the composition of value activities that creates the most valuable differentiation for the buyer relative to the cost of differentiating
7. Test the chosen differentiation strategy for sustainability
8. Reduce the cost in activities that do not affect the chosen form of differentiation
A focused strategy chooses a segment or group of segments in the industry and tailors its strategy to serving them at the exclusion of others. This segment can be a particular buyer group, segment of the product line or geographic market. A focus strategy implies some limitations on the overall market share achievable
There are Two Variations to this Strategy – a cost focus where a firm seeks a cost advantage in its target segment and a differentiation focus where a firm seeks differentiation in its target segment. The target segments must either have buyers with unusual needs (differentiation focus) or the production and delivery system that best serves the target segment must differ from that of others industry segments. A cost focus exploits differences in cost behaviour in some segments.