If you are not already operating in an industry and are looking to invest in a new business, chances are that you will do some serious thinking (and analysis) to figure out which industries are attractive in terms of future potential. For that, you may use a framework, possibly Porter’s Five Forces Analysis. The Five Forces Analysis is a framework to analyse the level of competition within an industry and, as is evident from the name, looks at five forces that determine the competitive intensity and, hence, attractiveness of an industry. As a next step, you would choose an industry to set up your business. For this, you may want to do a SWOT analysis (look at your strengths and weaknesses, your opportunities and threats). However, what after that? What next? If you are going about things systematically, you will have to figure out what strategy you would like to follow to build a sustainable and profitable business in the industry that you have chosen to operate in. For that, you would want to consider Porter’s Generic Strategies.
Before we come to the Generic Strategies, let’s look at the airlines industry. Would you like to travel in a no-frills airline like IndiGo or Ryanair or would you prefer an airline like Jet Airways or British Airways that offer full service and a choice of seats (First, Business, Economy)? Would you prefer to shop at Nordstrom (an upscale retailer) or would rather shop at Walmart that guarantees low prices? While your preferences would depend upon a number of factors, what you should note is that the strategies being followed by Ryanair and Walmart are radically different from the ones that Nordstrom and British Airways are following. Deciding the strategy that you would follow with your business would be crucial.
Porter’s Generic Strategies outlines the possible strategies that a business could follow. The strategies are called generic because they are relevant for any type or size of business. The strategies were put forward by Michael Porter, the Harvard business strategy guru, in his 1985 book ‘Competitive Advantage: Creating and Sustaining Superior Performance.’ The generic strategies describe how a company could pursue competitive advantage across its chosen market scope.
Let’s look at the Generic Strategies:
According to Porter, a company’s strength could fall under two headings – lower cost or differentiation. Depending upon whether a company was looking at a narrow target (a small, clearly defined market) or a broad target (industry-wide market), three clear strategies would emerge – cost leadership, differentiation and focus. Focus could be divided into two – Cost Focus and Differentiation Focus. Do note that these terms are confusing – Cost Focus does not mean a ‘focus on costs’; it means that a company goes for cost minimization in a focus market. Similarly, Differentiation Focus does not imply a ‘focus on differentiation’; it means that a company would pursue a differentiation strategy within a focussed market.
Let’s take a closer look at each of the segments:
Cost Leadership Strategy: In this strategy, a company should be able to produce its products at the lowest cost possible; it does not necessarily mean that the company would sell its products at the lowest prices. In fact, a company following the cost leadership strategy could price its products at the average market rate and earn good margins or it could sell at very low prices to gain market share.
A Cost Leadership strategy can be risky because a company following this strategy is open to attacks from companies that could beat it on lower costs. If a competitive company could do that, it would cut prices and gain market share at the expense of the previous company. So if you do decide to follow a Cost Leadership strategy, do keep the following in mind:
- You should have enough capital to invest in significant production assets. The amount of capital that you put in could act as a barrier to entry of other companies.
- You should have capabilities to have efficiencies in manufacturing and service. High asset utilization would be critical for you. These capabilities should be difficult for competition to emulate.
- Your direct and indirect costs have to be kept low.
- You must maintain low costs and efficiency over the entire value chain.
Cost Leadership is possible for large companies, companies that can put in enough resources to be able to enjoy economies of scale by selling large volumes.
Walmart is a good example of a company following the Cost Leadership strategy. The company has thousands of stores stocking a wide range of products that are available at the lowest possible prices. Walmart CEO, Doug McMillon said this recently, “At Walmart, we serve value-conscious customers that come from all walks of life and all income levels. Price matters to our customers and it always will. As a company, being a low cost operator is in our DNA. This will never change and we will be the price leader, across a broad assortment, everywhere we operate. Experience is about customer service. From our associates in stores to our engineers and data scientists, we’ll invent new ways to surprise and delight customers.”
Differentiation Strategy: A company following a Differentiation Strategy will come out with products that are unique or significantly different from those of competition. This allows the company to charge a price premium on its products.
Look at Apple Computers. All its products are beautifully designed and are extremely simple to use. Apple is the only company that uses its own operating system (OS and iOS); others are mostly using Windows and Android. Most importantly, Apple has created an ecosystem that has helped its differentiation strategy. This has made it possible for Apple to price its products very high, something that the buyers of its products don’t seem to mind.
A company following a Differentiation Strategy must have the following strengths:
- Strong R&D capabilities; an ability to innovate.
- Strong design capabilities to come out with products that are different both in form and function.
- Quality consciousness.
- A strong, creative Marketing and Sales team to effectively communicate the uniqueness of the products or services the company is offering.
Since a Differentiation Strategy is applied across a broad market, this strategy is also ideal for companies with deep pockets. Smaller companies would find it difficult to invest optimally in the areas outlined above.
Focus Strategy: A Focus Strategy implies that a company looks at one or a few targetted markets and follows a focussed or niche strategy. This is the ideal strategy for small players but that doesn’t mean that large companies cannot follow a niche strategy, possibly in conjunction with one or both of the other two strategies (Cost Leadership Strategy and Differentiation Strategy).
In the Focus Strategy, the choice of offering low prices or differentiated products or services should depend on the needs of the selected segment and the resources and capabilities of a company. By focusing your marketing efforts on one or two narrow market segments and tailoring your marketing mix to these specialised markets, you can better meet the needs of that target market.
The German small and medium sized companies – the Mittelstand – follow the Differentiation Focus Strategy. According to Wikipedia, ‘Mittelstand companies are “highly focused, achieving unprecedented efficiencies by designing a business model with a razor-thin focus and learning to do the one thing really well”; then to “compensate for their razor-thin focus . . . they diversify internationally and enjoy great economies of scale.” Many Mittelstand companies are export-oriented. They focus on innovative and high-value manufactured products, and occupy worldwide niche market leadership positions in numerous B2B segments. They are typically privately owned and often based in small, rural communities. Many of the successful Mittelstand companies combine a cautious and long-term-oriented approach to business with the adoption of modern management practices, such as employing outside professional management, and the implementation of lean manufacturing practices and total quality management. The Mittelstand emphasis on long-term profitability stands in contrast to the public corporations of many countries (including German public corporations) which face quarterly or annual pressure to meet expectations.’
Miele is another company following the Differentiation Focus Strategy. It is into domestic and commercial appliances that are so good (and so high-priced!) that it offers a 10-year warranty on many of its products, unthinkable for most other competitors. Steve Jobs owned a Miele washing machine and publicly praised its design philosophy!
Bang & Olufsen, the Danish consumer electronics company, is another example, producing high-end audio products, televisions and telephones that are quite delightful.
Local companies tend to follow the Cost Focus Strategy; they identify a niche market and serve it with products that have low costs and, often, low prices. Ginger, the low-priced hotel chain from the Taj Group follows the Cost Focus Strategy – it has selective hotels near railway stations and other less expensive locations to cater to business travellers looking for a neat, clean, basic and affordable accommodation.
Porter believed that a company should follow only one strategy amongst the three that he had propounded. He felt that if a company followed more than one strategy it could get ‘stuck in the middle.’
According to Wikipedia, Porter believed that ‘practising more than one strategy will lose the entire focus of the organization; hence clear direction of the future trajectory could not be established. The argument is based on the fundamental that differentiation will incur costs to the firm which clearly contradicts with the basis of low cost strategy and on the other hand relatively standardized products with features acceptable to many customers will not carry any differentiation; hence, cost leadership and differentiation strategy will be mutually exclusive. Two focal objectives of low cost leadership and differentiation clash with each other resulting in no proper direction for a firm.’ This contention has been challenged by many experts who have argued that a company could successfully follow a ‘hybrid’ strategy.
Porter’s Generic Strategies are a good starting point to develop a winning strategy for your company. If you are looking at starting something new, have some clarity on the strategy that you are going to following in the years to come.
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