According to Porter, strategies allow organizations to gain competitive advantage from three different bases: cost leadership, differentiation and focus. Porter calls these bases as generic strategies.
Cost leadership emphasizes producing standardized products at a very low per unit cost for consumers who are price sensitive. Differentiation is a strategy aimed at producing products and services considered unique industry wide and directed at customers who are relatively price insensitive. Focus means producing products and services that fulfill the needs of small groups of customers (niche market).
When we consider competitiveness, the following questions are raised:
1.Should we compete on the basis of low cost (and thus price), or should we differentiate our products or services on some basis other than cost, such as quality and service?
2.Should we compete head to head with our major competitors for the biggest but most sought after share of the market, or should we focus on niche in which we can satisfy a less sought after but also profitable segment of the market?
Michael Porter proposes 2 “generic” competitive strategies for outperforming other firms in a particular industry: lower cost and differentiation. His strategies imply different organizational arrangements, control procedures, and incentive systems. Larger firms with greater access to resources typically compete on a cost leadership and /or differentiation basis, whereas smaller firms often compete on a focus approach. Hence, he calls these strategies as “generic” as these can be pursued by any business firms irrespective of their size and type.
Porter further proposes that a firm’s competitive advantage in an industry is determined by its competitive scope, that is, the breadth of the company’s or business unit’s target market. Before using these strategies, the firm or business must choose the range of product varieties it will produce, the distribution channel it will employ, they types of buyers it will serve the geographic areas in which it will sell, and the array of related industries in which it will also compete.
A company can choose between a broad target/scope which is aimed at the middle of the mass market; or a narrow target/scope which is aimed at a market niche. Combining these two markets with two different competitive strategies results in four different strategies as depicted below.
When the lower cost and differentiation strategy have broad market target, they are simply called cost leadership and differentiation strategy. When they are focused on narrow market (niche), they are called cost focus and differentiation focus.
Although researches do show that established firms pursuing broad scope strategies outperform firms following narrow scope strategies in terms of ROA, new entrepreneurial firms have a better chance of surviving if they follow a narrow scope over a broad scope strategy.
Cost Leadership Strategies
It is a low cost competitive strategy that aims at the broad market and requires aggressive construction of effective scale facilities, vigorous pursuit of cost reduction from experience, tight cost, overhead control and cost minimization in areas like R&D, service, sales force, advertising and so on. Because of its low cost, the cost leader is able to charge a lower price for its products other than its competitors and still make a satisfactory profit margin.
A primary reason for pursuing forward, backward or horizontal integration is to gain cost leadership benefits.
Striving to be the low cost producer in an industry can be especially effective:
1.When the market is composed of many price sensitive buyers, 2.When there are few ways to achieve product differentiation, 3.When the buyers do not care much about differences from brand to brand, or 4.When there are large numbers of buyers with...