Tag: Porter’s generic strategies

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.

 

 

The advantages of market segmentation

I have often discussed Porter’s generic marketing strategies in this blog. As you will be aware, Michael Porter of Harvard Business School stated businesses could follow three strategic routes, differentiation, cost focus and niche.

Differentiation means developing an offer attractive to each segment of a market.  Cost Focus means targeting your spending on those areas which target customers value and offering the ‘best value’ offer in the market. Niche means choosing a narrow, target segment and developing a product offer which meets the needs of that target group.

Porter goes on to say that a firm trying to carry out more than one of these strategies simultaneously risks death in a marketing ‘no man’s land as they waste scarce resources and develop muddled strategies.

All three of these strategies rely on the management of firms understanding the importance of market segmentation.  The process of finding out what segments exist in your market and which are suitable targets for your business is critical to successful marketing.

The methods of segmenting markets sit on a spectrum from ‘descriptors’ to ‘motivators’ i.e. those factors which simply describe your potential customers to those things which actually define why consumers buy.

Using descriptors is a rather old fashioned way of segmenting markets. This is segmentation by race, occupation, geography, gender, age, etc.  When you here of businesses targeting ‘millennials’ this is segmentation by descriptor.  It is a poor method of segmentation as, in many countries, ‘millennial’ will describe about a quarter of the population.  It is not a sensible segmentation category as there will be a huge difference in the needs, wants and tastes of such a large grouping. Another descriptor categorisation is the A, B, C1, C2, D, E, system developed for the UK census.  This is segmentation by social class.  Alan Sugar may describe himself as working class, but he is a millionaire businessman and member of the House of Lords. I doubt very much that he still desires the needs and wants of someone who collects his bins.

Using descriptors to segment markets can be seen as easy, efficient and cheap.  It appears to offer quick wins and requires little change within organisations. But such an approach is tactical not strategic.

The science of market segmentation has moved on from descriptors as the primary method of segmentation.  Marketing strategists now rely on motivators i.e. what actually motivates customers to buy particular products.

This approach targets personality, the higher motivators on the Maslow hierarchy such as self actualisation needs, emotions, community and relationships, the desire for experience and perceptions of brand.

The use of motivators is real segmentation BUT:

  • It is a more difficult approach than using descriptors.
  • It requires more research
  • It costs more
  • It may lead to process inefficiencies
  • It may result in lower economies of scale
  • It is a method that thrives on changes to organisational structures and cultures.

However, using motivators to segment markets offers tactical and strategic gains to a business:

Tactical Gains

  • Better targeting of marketing activities on market segments which actually want your products or services
  • More efficient promotion of products and your brand.
  • Less marketing wastage as your mix is directed at the correct customer groups
  • Improved customer retention
  • ‘Improved’ service levels as you are targeting those who truly appreciate what you do.  You do the ‘right’ things that the segment values
  • More efficient production as you are making products which will be sought and bought.
  • You are able to achieve price premiums and through higher prices, increase profit margins
  • You will achieve more focused new product development.

Strategic Gains

  • You can create unique customer propositions by gaining insights into customer needs, and you are able to act on those insights.
  • You have clear market positioning from the customers’ perspective.
  • You are able to create a market position which separates you from the offer of your competitors in the minds of target customers.
  • You create brand value and personality.
  • You develop retention and loyalty through creating relationships with your customers
  • You can develop sustainable competitive advantage
  • You can influence your market, take the influence Apple has had on the design and functionality of smartphones
  • You can develop market leadership, not just in terms of market share but also leadership of thought and share of voice.
  • You can develop premium prices and margins
  • You can increase profitability.

Modern motivator-based market segmentation is critical to business success in the 21st century. If you are an SME and expect your business to be attractive to all, you may not be making the most of your budgets and resources.

Identifying Competitive Advantage

Marketing strategy is about creating a consumer-focused business which has sustainable and relevant competitive advantage.

Davidson (1997) said:

“Competitive advantage is achieved when you do something better than your competitors.  If that something is important to customers, or if a number of advantages can be combined, then you have an exploitable competitive advantage.”

So how do you go about identifying the competitive advantages in your business and how do you apply them to your marketing strategy to ensure you create exploitable differences in your business compared to that of your competitors? How do you turn your areas of expertise and excellence into customer-focused advantages?

The answer is a two-part process, understanding the strategic options available and understanding what attributes of your products and services customers believe to be important.  it is perfectly possible to have a strong advantage over your competitors; but if that advantage is not seen as important by your target customers, it may not be sustainable or effective.

Michael Porter of Harvard Business School identified three generic marketing strategies:

  • Cost Leadership
  • Differentiation; and
  • Focused Differentiation (or niche marketing)

Cost leadership was later split into two sub categories, overall cost leadership and focused cost leadership.

These generic strategies underpin all marketing activity.  They are crucial to developing sustainable competitive advantage.

To develop a competitive advantage strategy you need to make two decisions:

  1.  Decide on your generic strategy;
  2. Determine the strategic scope of your business.

Let’s examine each of Porter’s generic strategies and select potential areas for competitive advantage within them.

Cost leadership is about seeking overall cost leadership in your chosen market, or focused segments within that market.  Do not consider this as simply being the cheapest offer in the market.  There are plenty of products priced at their industry average level which use a cost leadership strategy.  Cost leadership is about bearing down on costs to maximise margins.  However, it can be a ‘best value’ strategy not a cheapest price strategy.

Cost leadership strategies are about creating low-cost structures and investing resources in the areas where consumers derive value.  You need to control overheads and develop economies of scale.  You need to minimise costs in subsidiary processes (including marketing!) whilst concentrating assets on primary processes.  It often requires global supply chains and sourcing of materials and labour. Manufacturing is often outsourced to regions with lower labour costs.  Cost leadership means leveraging experience effects and applying new technologies such as artificial intelligence and manufacturing automation.

Companies choosing a cost leadership strategy need to be wary of bigger, better resourced competitors entering their chosen market segments.  Creating and sustaining economies of scale are crucial to this strategy.  Such economies can be hard to achieve without significant market share and difficult to maintain if market share is falling.

It is also difficult to alter fixed costs over the short or medium term.

Cost leadership is a high volume strategy which suits commodity products.

As already stated the basic drivers of a cost leadership strategy are economies of scale, driving efficiencies, leveraging purchasing power and using experience effects in manufacture.  Another crucial aspect of cost leadership is leveraging industry relationships through joint research and development, using common manufacturing platforms and having close ties to suppliers and distributors.  it is a strategy that drives vertical integration and just in time supply chains.  You need efficient infrastructure to drive this strategy so it often requires close links to government and regulators.

Identifying those areas where a cost focus is applied is also crucial.  Take Dyson, by no means the cheapest offer in the vacuum cleaner market, they choose to design in the UK; where customers perceive difference; but manufacture in the Far East, driving down manufacturing and labour costs.

A differentiation strategy requires the development of different product offers for different market segments and customer profiles. For example, most flag carrier airlines, such as British Airways, have differentiated product offers where first class, business and economy passengers receive different levels of service on the same flight.

It is crucial to identify sources of differentiation that are perceived as important by different customer groups.  The source of differentiation is what creates customer-value.  The George Clooney film, Up in the Air, has a scene where the main character discusses the various benefits he receives from the many frequent flier offers he gets.  The level of benefits received is important to his character, it helps express his identity.

A differentiation strategy can be a means to being able to demand a price premium.

To be able to use a differentiation strategy effectively, you need to be able to create reasons for purchase.  You have to be innovative and flexible. Often perception of product or service performance is more important than the actual performance when creating difference.

In creating a differentiation strategy, costs often outweigh the benefits.  Innovations are often rapidly replicated by competitors.  Customer needs may shift over time, making chosen points of differentiation obsolete.

Take the car market.  For many years, performance was prioritised.  Then consumers became concerned about fuel efficiency.  Today, with the rise of hybrid and electric vehicles, customer seek differentiation in terms of environmental standards.  Since the recent emissions test scandal, the sale of diesel vehicles has fallen dramatically.

So what are points for product differentiation:

  • Product Performance:  Quality, durability and capability when compared to competitors’ offers.  You have to give consumers a reason to pick your product over those of competitors.
  • Product Perception:  This is often more important than actual product performance and can develop brand loyalty
  • Customer Experience: An increasingly important element in creating a successful offer and points of difference.
  • Product Augmentation:  Add to consumer value.  Use the product halo to offer better customer service, better after-sales maintenance and more efficient packaging, etc.

Focus or niche marketing means concentrating on a narrow range of activities in selected market segments.  This is the strategy of being a market specialist and often requires detailed customer knowledge.

A narrow focus increases a businesses exposure to downturns and market factors.  It is easy for consumers to shift away from a niche as fashions and interests change.

A niche can be a focus on a particular geographic region tailoring products to local needs.  It can mean serving customer groups seen as being too small for larger competitors.  However, such segments must be viable and offer adequate turnover and margins.  Niche marketing requires an end-user focus and short distribution chains.  For example Hasselblad focus on high-end large and medium format cameras used by professional fashion and art photographers and sell their products predominantly through specialist business-only suppliers.  Niche strategies require specific price points and quality standards.  often the focus is on a single product line

Porter argued that a business should select one of these strategies and that they should not attempt to combine them. He argued that to do so would mean being ‘stuck in the middle’; a marketing death zone.

Take the major airlines when the short-haul discount brands entered the market.  At first they tried to match Easyjet and Ryanair with price offers whilst also maintaining differentiated provisions in business and first class.  This strategy backfired spectacularly.  In recent times, these flag carriers have revamped aircraft and airport lounges, offering more premium priced provision to business and first class customers whilst reducing economy provision, particularly on long-haul flights.

Sources of competitive advantage must be relevant to your current and future market and they must be achievable with your existing resource base.  You must be able to defend them, putting in place barriers to replication e.g. using intellectual property rights.  Often competitive advantage is skills-based.

A useful tool in assessing competitive advantage is the Boston Consulting Group Strategic Advantage Matrix.  This compares the size of a competitive advantage with the number of ways to achieve a competitive advantage.  The result is four market positions:

  1.  Stalemate Industries: Where there are few ways to create competitive advantage and the level of such advantage is small.  This is often the position in commodity markets, and therefore infers a cost focus strategy.
  2. Volume Industries:  Where there are few ways to create competitive advantage but the level of advantage is large.  Such markets are dominated by firms able to leverage economies of scale.
  3. Fragmented Markets:  Where the size of the advantages are small but there are many ways to create competitive advantage.  This type of market suits niche businesses.
  4. Specialist Markets:  Where there are many ways to create competitive advantage and the size of such advantage is large.  These are markets dominated by specialist professionals using innovative technology.

In summary, to develop competitive advantage, you need to;

  1.  Understand your chosen market and the appropriate generic strategy for that market.
  2. Properly apply that generic strategy making the most of your organisation’s resources and expertise.