Tag: Cost focus

Some detail about Porter’s Generic Strategies

In the 1980s Michael Porter of Harvard Business School created his generic strategy model.  In it he suggests that there are three potential strategies for a business to follow when creating a marketing plan: Cost Focus, Differentiation, and Focus (Niche).  He suggests that businesses who try to adopt two or more of these strategies simultaneously enter a marketing wilderness; a wasteful middle of the road position.  Other academics have gone further to describe this middle ground position as a marketing death zone.

There has been some controversy over Porter’s three generic strategy model. Academics point to some businesses which are clearly not following the model. However, many of these businesses either prove Porter’s point or are clear exceptions to his rule which use tactics to mitigate the effects of a middle of the road position.

The point of Porter’s model is that a focus on one of the three generic strategies allows marketers to create clear and meaningful selling propositions.  Porter’s position is that businesses should choose a generic strategy and stick to it.  They need consistency when pursuing a strategy and they should choose a strategy which matches their organisational strengths.

Porter originally defined cost leadership as a strategy aimed at achieving the lowest cost of production so prices were lower than competitors.  This is the strategy pursued by businesses such Lidl and RyanAir.  The strategic focus is to drive down costs to reduce prices and to use that lower price position to increase market share.  The aim is to become the market leader.

This position has seen some criticism.  It was the strategy of Carrillion, the construction and public service contract firm which went spectacularly bust a few years ago.  Carillion aimed to always be the low bidder for contracts. When costs increased due to issues such as construction delays, or if they failed to achieve a contract, Carillion were bidding at such a low margin, their earnings were wiped out and they had to increase borrowing to an unsustainable level.  The company was even using subcontractors as a line of credit; often refusing to pay the agreed subcontractor price.

A second form of cost focus is the concept of Best Value i.e. not being the cheapest offer in the market but offering the best value to customers e.g. by offering better post purchase service and other product halo functionality i.e. functionality which does not cost a lot to supply but which target customers value.

A cost focus strategy can be created through:

  • Building the size of the organisation and creating economies of scale
  • Using tools like value chain analysis to identify the value factors important to customers
  • Relocating manufacture to areas of the world with cheaper labour costs.
  • Increasing operational efficiency and effectiveness e.g. Just in Time supply chains
  • Increasing productivity
  • Building strategic alliances and vertical integration
  • Finding cheaper sources of supply.
  • A focus on organisational learning
  • Creating cost linkages
  • Good timing i.e. time to market
  • Superior management and leadership skills
  • Investments in new and advanced technology
  • Smart buying.

The benefits of cost leadership come from out performing your competitors (something Carillion failed to do).  You must be able to resist the five forces of your businesses micro-environment – Supplier and Customer bargaining power, new market entrants, current competitors and substitute products and services.

There can be serious problems with a cost focus approach.  You are highly vulnerable if cheaper alternatives come on the market and you can enter a downward spiral in margins if a price war begins.  You also need to be able to maintain cost advantages over the long-term.

A cost-focus strategy is best used in price driven markets in order to gain market leadership from complacent competitors with higher cost bases.

Cost leadership requires the construction of efficient scale facilities and a vicious pursuit of cost reduction through exploitation of the experience curve, tight cost controls and avoiding marginal customer accounts (Carillion made all their customer accounts marginal).  it also requires cost minimisation in areas such as after sales service, sales force, advertising, etc.

In a differentiation strategy, you focus on a particular element of your marketing mix that customers see as important.  This could be being seen as a quality leader, a technology leader, speed to market and speed of supply, reliability, design, after sales service levels, unique product features and brand image.  It means developing stronger and more meaningful relationships with the stakeholders and customers of your business.

So BMW are renowned for engineering excellence and consistency.  Apple are leaders in the visual and tactile design of their products, etc.

Bear in mind the focus mix factor is consistent across the product range when other factors vary, this allows large firms to address the mass market and adapt products for particular market segments.  However, on occasions the focus factor is inconsistent with a target market. This is why Toyota created Lexus so as to enter the executive and luxury car market.  Other firms create ‘fighter brands, a defensive strategy against their primary brand being undercut and to make market entry more difficult.

Again, scale of operations is required to ensure the target mix factor can be properly maintained across a product range.  Often a a differentiation strategy is best employed where products are very similar across the market e.g. cigarettes, beer.

To achieve a differentiation strategy you need:

  • A strong brand identity
  • the ability to identify and utilise what customers see as important
  • High performance over a spectrum of attributes
  • The ability to create strategic break points
  • Cost parity with your competition in areas which affect differentiation
  • Packaging innovation and the ability to build in additional features
  • Speed of distribution
  • Distribution breadth or depth
  • High service levels
  • Better after-sales service
  • Flexibility
  • Focused relationship building

You derive benefit from a differentiation through creating distance from your competitors and through creating market competitive advantage.

It can be difficult to sustain the bases of differentiation e.g. fashion brands quickly find that high street retailers quickly adopt design features.  Firms such as H & M will have similar styles in store within days of London fashion week.  Differentiation needs to be meaningful to target consumers; they must value the difference.

Too often a differentiation strategy focuses on the core product and not the halo surrounding it. Differentiation factors can become less important over time.  Car stereos used to be a novelty, now you would complain if your car doesn’t have an MP3 port.

Differentiation can mean a loss of cost competitivity and you can lose barriers to market entry.

A differentiation strategy is best used in mature markets where points of difference are small but important.  Differentiation points must be such that it is difficult for competitors to copy them e.g. protected via intellectual property.

A focus or niche marketing strategy is often the best bet for SMEs.  Here you concentrate on a single identified market segment (or a small number of closely related segments).  you need to create a strong specialist reputation.

The benefits of niche marketing means you have a detailed understanding of your market through which you can create barriers to entry.  You also have the ability  to concentrate your resources and efforts on a clearly defined market.

A niche strategy can make it difficult to grow your market or to spread your business to new sectors.  For example, Xerox were so well known as a photocopier brand, their attempt to enter the desk top computer market failed spectacularly.

A niche strategy is best used by firms with small market share or who are new to the market.

 

 

Designing and Delivering Customer Value

I have recently had the time to read the London School of Economics paper which gives a critique of the work of Professor Patrick Minford and the group Economists for Brexit.

Professor Minford’s work is regularly referred to by politicians who advocate a ‘hard’ Brexit where the UK cuts all ties to the European Union and looks to trade on World Trade organisation terms such as the General Agreement on Tariffs and Trade (GATT).

The LSE critique is damning.  It accuses Professor Minford of using out of date methodology and that he has ignored modern evidence based practices.  The LES also accuse Professor Minford of making massive assumptions as to the UK’s trading arrangements post-Brexit.  In particular they point to:

  1. Minford’s assumption that the UK can develop an economy based almost entirely on services with little or no manufacturing.
  2. That Professor Minford incorrectly assumes extensive levels of deregulation which would leave consumers and businesses with little protection other than the concept of caveat emptor.  Minford assumes that all regulation does is create cost for business and he ignores the concept that sensible regulation provides a framework for effective competition.
  3. That Minford assumes the UK can drop all external tariffs unilaterally.  In doing so he ignores the destructive impact such a move would have e.g. the mass importation of cheap New Zealand lamb on UK hill farming or the effect dumping of cheap Chinese steel would have on what is left of the UK steel industry.
  4. That Minford’s Liverpool model of the UK economy ignores the concept of economic gravity.  This is the evidence based concept that, regardless of tariffs and other trade barriers, countries generally do the majority of their export trade to which they are geographically close.  For the UK, this means Europe.

The LSE accuse Professor Minford of placing political bias ahead of data.  That he has decided what outcome he would like to see and structured his models to obtain that outcome.  A position which is contrary to scientific method.

From a marketer’s point of view there is one startling assumption in Professor Minford’s work.  It is that he assumes perfect competition.

Perfect competition assumes that all competing firms in a market sector make identical goods, they have the same cost base, they operate in identical environments and that the only determinant consumers use when deciding what goods to purchase is the price.

Given that price is a crucial element of the marketing mix, and that the concepts of psychological and brand pricing are well understood, to base economic forecasts on perfect competition is a ludicrous position. It is preposterous.

In Minford’s modelling, BMW make identical products to those of Kia and Fiat.  Anyone who drives will tell you such a position is nonsense.  As would anyone who favours Nike trainers or Levi’s jeans.

Minford is clearly ignoring the high elements of Maslow’s hierarchy of needs such as esteem and self actualisation.

Marketers know that consumers buy for a variety of reasons and that, given the correct marketing mix, price premiums can be achieved.

It is extremely worrying that UK government policy is in part being driven by the work of Professor Minford which the vast majority of economists (at least 90%) see as pure bunkum.

Michael Porter of Harvard Business School described three generic marketing strategies, Differentiation, Niche and Cost Focus ( often referred to as price leadership).  Porter says that a firm attempting the compete on more than one of these strategies simultaneously enters a ‘piggy in the middle’ death zone; a position where they cannot effectively compete.

For most small firms, the initial option is that of niche marketing.  They lack the economies of scale to compete directly against larger firms on price and they lack the resources to offer a significant number of diversifications to meet all market segments.  Often SME’s have to choose specific target market segments to serve.

As firms grow, they may expand beyond their initial niche through the use of market expansion strategies or through the riskier strategy of diversification.  Such expansions often involve transferring strategy to one of either differentiation or price leadership.

Many firms operate on the basis of price leadership for example the airline Ryanair or the supermarket chain Lidl.

Some markets are driven by price.  These are often referred to as commodity markets.  These usually contain undifferentiated products on a business to business basis.  for example, the wholesale market for milk or the market for natural gas.  But in consumer markets there are clear examples of firms being able to build price premiums.  For example Starbuck’s can achieve a 20% mark up on its coffee and Evian obtains a 10% price premium on their bottled water.

Under Professor Minford’s model, such price premiums should not be possible as consumers will always go for a cheaper alternative, the base priced product in the market.  IN the mind of Professor Minford, Starbuck’s should not exist or succeed, yet they are the market-leading coffee shop chain.

But professional marketers don’t just sell products, they also sell the product surround.  They are selling value propositions and part of their job is to put the value of a products intangible benefits into the minds of consumers.  Through this process, they augment base products.  The selling of value goes further than the physical and now requires the development of value propositions beyond price alone.

Philip Kotler argues that there are three ways to offer value:

  1.  To charge a lower price than your competitors and to be the discount competitor in the market.  (this fits Minford’s view although he expects all firms to do this)
  2. To help the consumer to lower other costs
  3. To offer the consumer additional tangible and intangible benefits.  This could include a More for More strategy where you are not the lowest priced product in the market but the additional attributes of a product offer additional value.

Aggressive pricing policies can be dangerous as they often mean operating on very low margins.  Carillion, the construction and public service outsourcing firm is an example of a company which operated on a cost focus/low margin basis, collapsed spectacularly when costs rose due to project delays.  The company’s margins disappeared and it developed ever-increasing losses.

H & M, the high street fashion chain, which operates on a high volume, low-cost model, recently suffered significant losses as shop rents rose and the cold spring meant sales were lower than expected.

Toys R Us was a firm described as a category killer.  Its business model was reliant having the largest range of toys but on keeping costs down.  Again this was a low margin, high volume business.  Again, it was unable to compete with internet retailers and the changing focus onto downloadable electronic games.  As the rents of its stores rose and sales volumes of traditional toys fell, Toys R Us went into liquidation.

To be a price leader can also lead to disruptive price wars.  If you price in an overly aggressively, so might your competitors and your market will enter a downward pricing spiral that damages all competitors.

A better cost focus strategy is to help lower your customers other costs.  For example, low energy light bulbs are not as cheap as the traditional filament bulbs but they are sold on the basis that their long lifespan and ability to lower electricity bills gives them a lower lifetime cost.

Caterpillar market their excavators and construction machinery not by being the cheapest on the market but on the basis that customers will enjoy efficiency of operation which lowers the overall costs of construction projects.  These include:

  • Fewer mechanical breakdowns
  • Faster repair cycles
  • Longer equipment lifespans, and
  • Higher second-hand resale prices.

Other B2B suppliers help to lower processing and ordering costs by promising to improve process efficiency, e.g.

  • Helping improve yields
  • Reducing waste and rework costs
  • reducing labour costs
  • reducing accident rates
  • reducing energy costs

Porter’s third price leadership option is to offer increased value by offering more benefits to target customers.  This can be achieved through:

  1. Product customisation (or in digital markets, personalisation)
  2. Increased product convenience
  3. Faster service times
  4. More and better service
  5. Coaching, training or consultancy services in addition to core product
  6. Guarantees
  7. Hardware and software tools
  8. Membership benefit programmes.

Often these form parts of More for More pricing strategies.  With such strategies goods may be more expensive than those of competitors but in the minds of consumers additional value can be seen.  The key to a more for more strategy is to offer additional attributes which are highly valued by your consumers but which can be provided at relatively low-cost to the producer.

As Porter’s generic strategies show, Professor Minford is wrong.  Market competition is not perfect.  Consumers see value beyond price and he most successful and profitable firms develop market offers where consumers see worth in both the product and its surround.