Business Strategy: The Three Generic Strategies
A strategy of a business can be reduced to one of three generic strategies. These strategies are cost leadership, differentiation, and focus.1,2,3 The three types were discovered by the Harvard professor Michael Porter and many works that discuss strategy refer back to his two books. This article examines each of the three generic strategies.
Cost Leadership Strategy
Cost Leadership is a strategy where "a firm sets out to become the low-cost producer in its industry."2 A firm with this strategy sets as a goal to produce or provide a service for a lower operating cost than the competitors. This enables the firm to sell goods or services at the same selling price as the competitors and make a larger profit. Also, the firm could lower the selling price to underbid the competitors and still make a profit. The emphasis is on lower costs, not on low selling prices. "Cost leadership requires aggressive construction of efficient-scale facilities, vigorous pursuit of cost reductions from experience, tight cost and overhead control, avoidance of marginal customer accounts, and cost minimization in areas like R&D..."1
Porter further states that this strategy "requires that a firm the the cost leader, not one of several firms vying for this position."2 The only way this strategy works is if the firm is the best. This is because the firm that is number one at cost reduction, can at any time reduce its selling price down below the other firms' operating cost. The number one firm can still make a profit (although slight) while forcing the other firms to match selling price and take a loss or keep the selling price higher. This is a huge advantage to the lowest operating cost firm.
The second generic business strategy is differentiation: being different than every other firm. Grant states this is an "emphasis on branding advertising, design, service, quality, and new product development."3 The firm adopting this strategy seeks to be unique in the industry. This uniqueness must be a feature for which customers will pay a premium price. This differentiation does not have to be anything outlandish. It can be as simple as the best customer service in the industry. Differentiation can also be speed in filling orders. The point of differentiation only has to be something that customers will be willing to pay a larger selling price than that of the cost leader.
Differentiation can lead to profitability. However, it does not lead to market share. As Porter states, differentiation creates a perception of exclusivity which is incompatible with a high market share.1 Thus, a firm with a differentiation strategy can focus on customer loyalty instead of attempting to create a large market share.
The focus strategy ignores most of a product or service market and focuses upon a particular niche. The niche could be "a particular buyer group, segment of the product line, or geographic market."1 For example in the automobile industry there are companies that specialize in selling vehicles for disabled people. These firms do not compete with the dealerships because these firms have a special vehicle the dealerships do not carry in inventory. The focus is to serve a very special group of customers.
As with the differentiation strategy, this also implies market share will be limited. Porter states, "Focus necessarily involves a trade-off between profitability and sales volume."1 However, if a firm adopts the focus strategy, the firm must ensure the market segment that is being served is absolutely different than the main market. If the segment is not different, then the focus strategy will not succeed.2
Summary and Caution
This article has discussed the three generic strategies that firms can have for a product or service. A firm picking one of these has a good chance of being profitable. However, many firms are what Porter describes as "stuck in the middle."1 A firm stuck in the middle is "almost guaranteed low profitability"1, "possesses no competitive advantage"2, and are susceptible to having market share destroyed by those firms with a competitive advantage.2 Thus, it is extremely important for a firm to wisely choose a business strategy and implement that strategy well.
1Porter, Michael (1998). Competitive Strategy. The Free Press: New York.
2Porter, Michael (1998). Competitive Advantage The Free Press: New York.
3Grant, Robert (2008). Contemporary Strategy Analysis. Blackwell Publishing: Malden, MA.