Porters generic strategies by iliyan stoyanov by Dr. Hartwig Maly

STRATEGIC MANAGEMENT

Porter’s Generic Strategies “Stuck In The Middle” ILIYAN STOYANOV 31/01/2013

Porter’s Generic Strategies

Index 1.

Introduction .................................................................................................................. 2

Michael Porter’s Biography ......................................................................................... 2

An Example To Understand The Generic Strategies ................................................. 2

Generic Strategies........................................................................................................ 2 4.1.

Cost Leadership Strategy ..................................................................................... 3

4.2.

Differentiation Strategy ......................................................................................... 3

4.3.

Focus Strategy ...................................................................................................... 6

4.3.1.

Focused Cost Leadership Strategy .............................................................. 6

4.3.2.

Focused Differentiation Strategy .................................................................. 6

Stuck In The Middle ...................................................................................................... 7

Criticism of Porter’s Generic Strategies ..................................................................... 8

Bibliography ................................................................................................................. 9

Porter’s Generic Strategies

1. Introduction The aim of the present paper is to explain the simple view that Michael Porter’s got to business and how companies can generate superior returns from their business. These are the three Porter’s Generic Strategies- Cost Leadership, Differentiation and Focus- on which firms should specialize. However, if they don’t choose right they, they could get “stuck in the middle” of more than one strategy and, thus, lose competitive advantage.

2. Michael Porter’s Biography Michael Eugene Porter (born May 23, 1947) is the Bishop William Lawrence University Professor at Harvard Business School. He is a leading authority on company strategy and the competitiveness of nations and regions. Michael Porter’s work is recognized in many governments, corporations and academic circles globally. He chairs Harvard Business School's program dedicated for newly appointed CEOs of very large corporations. Michael Porter is the author of 18 books and numerous articles including Competitive Strategy, Competitive Advantage, Competitive Advantage of Nations, and On Competition. A six-time winner of the McKinsey Award for the best Harvard Business Review article of the year, Professor Porter is the most cited author in business and economics. Michael Porter’s core field is competition and company strategy. He is generally recognized as the father of the modern strategy field, and his ideas are taught in virtually every business school in the world. His work has also re-defined thinking about competitiveness, economic development, economically distressed urban communities, environmental policy, and the role of corporations in society. Porter serves as an advisor to business, government, and the social sector. He has served as strategy advisor to numerous leading U.S. and international companies, including Caterpillar, Procter & Gamble, Scotts Miracle-Gro, Royal Dutch Shell, and Taiwan Semiconductor. Professor Porter serves on two public boards of directors, Thermo Fisher Scientific and Parametric Technology Corporation. Professor Porter also plays an active role in U.S. economic policy with the Executive Branch and Congress, and has led national economic strategy programs in numerous countries. He is currently working with the Presidents of Rwanda and South Korea. His main academic objectives focus on how a firm or a region can build a competitive advantage and develop competitive strategy1,2.

1 http://www.hbs.edu/faculty/Pages/profile.aspx?facId=6532 2

http://en.wikipedia.org/wiki/Michael_Porter

Porter’s Generic Strategies 3. An Example To Understand The Generic Strategies When taking a plane for travelling, passengers can choose between a cheap, no-frills airline, or a more expensive operator with fantastic service levels and maximum comfort. The reason there are so many different choices available is that each of these airlines has chosen a different way of achieving competitive advantage in a crowded marketplace. The no-frills operators have opted to cut costs to a minimum and pass their savings on to customers in lower prices. This helps them grab market share and ensure their planes are as full as possible. On the other hand, the luxury airlines focus their efforts on making their service as wonderful as possible, so that allows them to charge a higher price to their clients. Meanwhile, smaller airlines try to make the most of their detailed knowledge of just a few routes to provide better or cheaper services than their larger, international rivals. These three approaches are examples of "generic strategies", because they can be applied to products or services in all industries, and to organizations of all sizes. They were first set out by Michael Porter in 1980 in his book “Competitive Strategy”. He called them "Cost Leadership", "Differentiation” and "Focus". He then subdivided the Focus strategy into two parts: "Cost Focus" and "Differentiation. The no-frills fits into the cost leadership, meanwhile the luxury companies fit into differentiation, and the small airlines offering specialized services in niche markets fit into the focus strategy3.

4. Generic Strategies Since firms position themselves into a market by leveraging their strengths, Michael Porter has suggested that these ultimately fall into one of two dimensions that he defines: cost advantage and differentiation. By applying these strengths in either broad or narrow scope, three generic strategies are defined: cost leadership, differentiation and focus (or market segmentation)4,5. Being the last one narrow in scope, while both cost leadership and differentiation are relatively applied to wider markets6.

(Source: http://www.quickmba.com/strategy/generic.shtml) 7

http://www.quickmba.com/strategy/generic.shtml http://www.slideshare.net/RyanBraganza/porters-generic-strategies* (S.5 and 9) 9 http://en.wikipedia.org/wiki/Reliance_Industries 10 http://www.slideshare.net/chetnasetia/porters-generic-competitive-strategies (S.7) 12,14 http://www.mindtools.com/pages/article/newSTR_82.htm 8,11,13

Porter’s Generic Strategies 4.1.

Cost Leadership Strategy

This generic strategy calls for being the low cost producer in an industry for a given level of quality. The firms sell their products either at average industry prices to earn a profit higher than that of competitors, or below the average industry prices to gain market share. Whether price wars occur, the firms can keep having some profits while rivals suffer losses. However, producing more cheaply, even without price wars, will help companies be profitable for a longer period of time. This type of strategy always targets broad markets7. “Firms that succeed in this kind of strategy 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 for many firms. Skill in designing products for efficient manufacturing. High level of expertise in manufacturing process engineering. Efficient distribution channels.”8

The greatest risk in pursuing a Cost Leadership strategy is that these sources of cost reduction are not unique to one firm, and that other competitors copy the cost reduction strategies. This is why it's important to continuously find ways of reducing every cost. An example of a company using a cost leadership strategy is the Indian company called “Reliance Industries” which operates in three segments: petrochemicals, refining and oil & gas9. It has become a global leader due to innovation in production methods, economies of scale and low-cost access to raw materials10.

4.2.

Differentiation Strategy

A differentiation strategy involves making products different and more attractive than those offered by competitors. That means offering unique attributes such as features, functionality, durability and brand image, which customers will value and, therefore the firm will be better perceived than rivals11,12. “The value added by the uniqueness of the product may allow the firm to charge a premium price for it. The firm hopes that the higher price will more than cover the extra cost incurred in offering the unique product”13. The firms that succeed in differentiation strategy often have the following strengths: -

Access to leading scientific research and ability to innovate Highly skilled and creative product development team. Strong sales team able to successfully communicate the strengths and benefits of the product14

Porterâ&#x20AC;&#x2122;s Generic Strategies Some of the risks associated with this strategy are imitation by rival firms and changes in customerâ&#x20AC;&#x2122;s needs, besides the fact that companies going after focus strategies may be able to achieve even greater differentiation in their market segment15. An example of a firm following the differentiation strategy is Apple, which prides itself on its innovation. It pioneered the PDA market by introducing the Newton in 1993 and then introduced the iMac in 1998, followed by its updates in later years. Nevertheless, the main critical points in its history were the introduction of the iBook in 1999 and iTunes in 200116.

15 16

http://www.quickmba.com/strategy/generic.shtml http://www.miniworkshopseries.com/highlights/?p=1498

Porterâ&#x20AC;&#x2122;s Generic Strategies 4.3.

Focus Strategy

The focus strategy concentrates on a narrow segment of the market (niche) and intends to achieve either a cost advantage or differentiation within it. It is based on the idea that the needs of the group may be better served by entirely on it. Firms using this kind of strategy often enjoy a high level of customer loyalty, and this loyalty discourages other firms from competing directly. Some of the strengths of firms succeeding in this strategy are: -

The good knowledge of the market segment, so they can serve customers better than industry-wide companies. The company has a unique ability to identify the needs or preferences of narrow segments that its core competencies will enable it to meet better than its competitors17.

4.3.1. Focused Cost Leadership Strategy With this strategy companies compete by following cost leadership strategies to serve narrow market niches, thus, generally target the smallest buyers in an industry (those who purchase in such small quantities that industry-wide competitors cannot serve them at the same low cost). An example for this strategy is the global furniture retailer Ikea. The company offers home furnishings that combine good design, function, and quality with low prices. It displays its products in room-like settings so that customer can view different combinations of furniture, eliminating the need for assistance from sales associates or decorators to visualise the setting. This allows the company to reduce employee costs18.

4.3.2. Focused Differentiation Strategy Companies using this kind of strategy produce customised products for small market segments and exploit the special needs of buyers in a certain segment. Some examples can be manufacturers such as Ferrari, Aston Martin, and Lamborghini, which compete in the tiny super car category with prices starting at $150,000 and running as high as $600,00019. These are the strategies that Porter defined and he stated that a firm should specialize in only one of them in order to get competitive advantage in the market, since he argued they were exclusive.

17,18

http://www.openlearningworld.com/books/Business%20Strategies/Business%20Strategy/Focus%2 0Strategies.html 19 http://www.slideshare.net/chetnasetia/porters-generic-competitive-strategies (slide 12) 6

Porter’s Generic Strategies 5. Stuck In The Middle Porter defined “being stuck in the middle” as the situation in which a firm fails to make a choice between cost leadership and differentiation. It happens because the business managers don’t know what they have to choose or think that they can be both. Therefore, since there is no clear strategy, customers get confused about what the firm stands for and what to expect from it. Confusion is also caused among employees, since they don’t understand the properties of their work performance. This situation leads to the lack of competitive advantage and poor financial results20. A stuck in the middle position occurs when a business designed to be low cost start adding little extra features which don’t add a corresponding amount to the customer value of a product. The business suffers the cost, but the customer doesn’t appreciate the improvement. Or when a differentiated business comes under pressure on prices and starts cutting costs in areas which damage the differentiation advantage. Porter explains in his Competitive Strategy book as follows: “The firm stuck in the middle is almost guaranteed low profitability. It either loses the high-volume customers who demand low prices or must bid away its profits to get this business away from low-cost firms. Yet it also loses high-margin businesses — the cream — to the firms who are focused on highmargin targets or have achieved differentiation overall. The firm stuck in the middle also probably suffers from a blurred corporate culture and a conflicting set of organizational arrangements and motivation system.” (Competitive Strategy, p. 41-42) The following table gives some examples of various industries. The firms in “the middle” have felt or are feeling a severe contraction. Differentiators

The Middle

Nordstrom, Banana Republic, J.

K-Mart, Sears,

Crew

Woolworth

Beer

Microbrewers

Pabst, Blatz

SAB Miller, INBEV

Airlines

Singapore, Cathay Pacific

American

SouthWest, Peoples Express

Cellphones Apple, Google

Nokia

Commodity Manufacturers

Autos

Chrysler, GM

Retailing

Cost Leaders

Target

Japanese Auto BMW, Mercedes

Manufacturers

Soft Drinks Coke, PepsiCo

Dr. Pepper

http://blogs.darden.virginia.edu/deansblog/2012/01/stuck-in-the-middle/

Private labels

Porter’s Generic Strategies Orange Juice

Tropicana, Minute Maid 100 small brands

White Goods

Sub-Zero, Viking

Maytag, Whirlpool Korean Manufacturers

Motor Scooters

Aprilia

Piaggio

Private labels

Honda, Yamaha

(Source: http://blogs.darden.virginia.edu/deansblog/2012/01/stuck-in-the-middle/)

American Airlines recently filed for bankruptcy. Chrysler and GM required a government bailout in 2009. Piaggio acquired its way into the differentiated end of the market by buying Aprilia. Dr. Pepper was acquired by Cadbury Schweppes. These examples seem to suggest, the middle is not a place to become stuck, as Porter suggested21. However, there are some companies which adopted more than one generic strategy and succeeded by mixing differentiation strategy and cost leadership simultaneously (hybrid strategy). Some firms that can be used as example are Toyota, Nissan and Benetton22.

6. Criticism of Porter’s Generic Strategies “A popular post-Porter model was presented by W. Chan Kim and Renée Mauborgne in their 1999 Harvard Business Review article "Creating New Market Space". In this article they described a "value innovation" model in which companies must look outside their present paradigms to find new value propositions. Their approach fundamentally goes against Porter's concept that a firm must focus either on cost leadership or on differentiation. They later went on to publish their ideas in the book Blue Ocean Strategy.”23 “Research writings of Davis (1984 cited by Prajogo 2007, p. 74) state that firms employing the hybrid business strategy outperform the ones adopting one generic strategy.”24 “Hill (1988 cited by Akan et al. 2006, p. 49) challenged Porter’s concept regarding mutual exclusivity of low cost and differentiation strategy and further argued that successful combination of those two strategies will result in sustainable competitive advantage.”25 Bob Bruner, Dean of the Darden School of Business says in an article at Forbes magazine that: “being stuck in an unattractive business without a viable exit is one of the worst situations for a firm”. He also mentions some problems such as high exit costs, aging assets and obsolete technology, wrong locations and so forth26. “The challenge for business leadership is not to avoid the middle, but rather, to develop flexibility—such as a sensible “Plan B”—if the dice turn against you. The middle is bad if you are stuck in some important way. The inability to respond flexibly and appropriately to new competitive conditions is the grave threat”, he says. “The problem is not the middle; it is allowing your firm to get stuck at all.”

http://www.slideshare.net/chetnasetia/porters-generic-competitive-strategies (slide 13) http://en.wikipedia.org/wiki/Porter_generic_strategies 25,26 http://www.forbes.com/sites/mattsymonds/2012/02/24/stuck-in-the-middle-take-the-flexibleapproach/ 22,23,24

Porterâ&#x20AC;&#x2122;s Generic Strategies 7. Bibliography 1. http://www.hbs.edu/faculty/Pages/profile.aspx?facId=6532 (29th January 2013, 16:34) 2. http://en.wikipedia.org/wiki/Michael_Porter (29th January 2013, 16:55) 3. http://www.mindtools.com/pages/article/newSTR_82.htm (29th January 2013, 19:21) 4. http://www.slideshare.net/RyanBraganza/porters-generic-strategies* (slide 2, 29th January 2013, 19:21) 5. http://www.slideshare.net/chetnasetia/porters-generic-competitive-strategies (slide 4, 29th January 2013, 20:12) 6. http://www.slideshare.net/chetnasetia/porters-generic-competitive-strategies (slide 4, 29th January 2013, 20:12) 7. http://www.quickmba.com/strategy/generic.shtml (30th January 2013, 19:45) 8. http://www.slideshare.net/RyanBraganza/porters-generic-strategies* (slide 5, 29th January 2013, 21:45) 9. http://en.wikipedia.org/wiki/Reliance_Industries (29th January 2013, 21:14) 10. http://www.slideshare.net/chetnasetia/porters-generic-competitive-strategies (slide 7, 29th January 2013, 22:13) 11. http://www.slideshare.net/RyanBraganza/porters-generic-strategies* (slide 9, 31th January 2013, 20:30) 12. http://www.mindtools.com/pages/article/newSTR_82.htm (29th January 2013, 19:21) 13. http://www.slideshare.net/RyanBraganza/porters-generic-strategies* (slide 9, 31th January 2013, 20:30) 14. http://www.mindtools.com/pages/article/newSTR_82.htm (30th January 2013, 14:45) 15. http://www.quickmba.com/strategy/generic.shtml (30th January 2013, 14:53) 16. http://www.miniworkshopseries.com/highlights/?p=1498 (30th January 2013, 15:11) 17.http://www.openlearningworld.com/books/Business%20Strategies/Business%20Strategy/ Focus%20Strategies.html (30th January 2013, 15:33) 18.http://www.openlearningworld.com/books/Business%20Strategies/Business%20Strategy/ Focus%20Strategies.html (30th January 2013, 17:33) 19. http://www.slideshare.net/chetnasetia/porters-generic-competitive-strategies (slide 12) (30th January 2013, 17:44) 18. http://www.differentiateyourbusiness.co.uk/is-your-business-stuck-in-the-middle (30th January 2013, 18:11)

Porterâ&#x20AC;&#x2122;s Generic Strategies 20. http://blogs.darden.virginia.edu/deansblog/2012/01/stuck-in-the-middle/ (30th January 2013, 22:33) 21. http://www.slideshare.net/chetnasetia/porters-generic-competitive-strategies (slide 13) (30th January 2013, 22:44) 22. http://en.wikipedia.org/wiki/Porter_generic_strategies (30th January 2013, 22:54) 23. http://en.wikipedia.org/wiki/Porter_generic_strategies (30th January 2013, 22:54) 24. http://en.wikipedia.org/wiki/Porter_generic_strategies (30th January 2013, 22:54) 25. http://www.forbes.com/sites/mattsymonds/2012/02/24/stuck-in-the-middle-take-theflexible-approach/ (30th January 2013, 23:14) 26. http://www.forbes.com/sites/mattsymonds/2012/02/24/stuck-in-the-middle-take-theflexible-approach/ (30th January 2013, 23:14)