Michael Porter’s Generic Strategies free essay sample

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 â€Å"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 â€Å"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 RD, 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 significant bargaining power. The basic idea is to under price competitors and thereby gains market share and sales, driving some competitors out of the market entirely. Some companies which have successfully followed this strategy are: Wal-Mart, Southwest Airlines, Timex, Black Decker, Mc Donald’s etc. A successful cost leadership strategy usually provides the entire firm with high efficiency, low overhead, limited perks, intolerance of waste, intensive screening of budget requests, and wide span of control efforts. However, some risks of pursuing this strategy are that competitors might imitate the strategy, thus, driving overall industry profits down; that technology breakthroughs in the industry may make the strategy ineffective; or that buyer’s interest may swing to other differentiating features besides price. Firms that succeed in cost leadership often have the following internal strengths: †¢ Access to the capital required to make a significant investment in production assets; this investment represents a barrier to entry that many firms may not overcome. Skill in designing products for efficient manufacturing, for example, having a small component count to shorten the assembly process. †¢ High level of expertise in manufacturing process engineering. †¢ Efficient distribution channels. Its high market share means that it will have high bargaining power relative to its suppliers and its low price will also serve as a barrier to entry. Differentiation Strategies It is aimed at the broad mass market and involves the creation of a product or service that is perceived unique throughout the industry. The company or firm may then charge premium for its products. This specialty can be associated with design, branch image, technology, features, dealer network, customer service etc. It is a viable strategy for earning above average returns in a specific business because the resulting brand loyalty lowers customer’s sensitivity to price. Instead cost can be transferred to the buyers. Brand loyalty will also serve as entry barrier- new firms must develop their own distinctive competence to differentiate their products in some way to compete successfully. Researches do suggest that a differentiation strategy is more likely to fetch higher profit margins than a low cost strategy. Firms that succeed in a differentiation strategy often have the following internal strengths: †¢ Access to leading scientific research. †¢ Highly skilled and creative product development team. †¢ Strong sales team with the ability to successfully communicate the perceived strengths of the product. †¢ Corporate reputation for quality and innovation. However, differentiation doesn’t not guarantee competitive advantage especially if standard products sufficiently meets customer needs or rapid imitation by competitors is possible. Successful differentiation means greater product flexibility, greater comparability, improved service, greater convenience, or more features. A risk of pursuing this strategy is that the unique product may not be valued highly enough by customers to justify the higher price. When this happens a low cost strategy easily will beat a differentiation strategy. Another risk is that the competitors may develop ways to copy the differentiating features quickly. Key ingredients for a company to pursue this strategy include strong RD, strong marketing, creative human resource etc. Companies which have successfully adopted this strategy include, Maytag appliances, Nike athletic shoes, Mercedes Benz, BMW, Apple Computer etc. Focus Strategies This strategy depends on an industry segment that is of sufficient size, has good growth potential and is not crucial to the success of other competitors. Strategies such as market penetration and market development offer substantial focusing advantages. Focus strategies are most effective when consumers have distinctive preferences or requirements and when rival firms are not attempting to specialize in the same target segment. For instance, in the insurance industry, Safeco divested from its life insurance and investment management division to focus exclusively on property casualty insurance operations. Risks of pursuing this strategy include the possibility that numerous competitors will recognize the successful focus strategy and copy it, or that consumer preferences will drift towards the product attributes desired by the market as a whole. Cost Focus It is a low cost competitive strategy that focuses on a particular buyers group or geographic market and attempts to serve only this niche, to the exclusion of others. In using cost focus, the company or business unit seeks a cost advantage in its target segment. A good example of this strategy is Fadal Engineering. Fadal focuses its efforts on building and selling no frills machine and by focuses its marketing efforts strictly on its market niche. The cost focus strategy is valued by those who believe that a company or business unit that focuses its efforts is better able to serve its narrow strategic target more efficiently than can its competition. Differentiation Focus Like cost focus, this strategy also concentrates on a particular buyer group, product line segment, or geographic market. This is the strategy successfully followed by Morgan Motor Car Company which manufactures classic British Sports Cars. In using differentiation focus, the company or business units seek differentiating in a target market segment. This is valued by those who believe that a company or a unit that focuses its efforts is better able to serve the special needs of a narrow strategic target more than effectively than can its competitors. Which Strategy to Choose? These generic strategies are not necessarily compatible with one another. If a firm attempts to achieve an advantage on all fronts, in this attempt it may achieve no advantage at all. For example, if a firm differentiates itself by supplying very high quality products, it risks undermining that quality if it seeks to become a cost leader. Even if the quality did not suffer, the firm would risk projecting a confusing image. For this reason, Michael Porter argued that to be successful over the long-term, a firm must select only one of these three generic strategies. Otherwise, with more than one single generic strategy the firm will be stuck in the middle and will not achieve a competitive advantage. Porter argued that firms that are able to succeed at multiple strategies often do so by creating separate business units for each strategy. By separating the strategies into different units having different policies and even different cultures, a corporation is less likely to become stuck in the middle.