According to Michael Porter, a competitive advantage, in a given industry could be pursued in two key ways: low cost (cost leadership), or differentiation. A third generic strategy is focus. According to Porter a failure to do so would end up stuck in the middle scenario, where the company will not retain a long-term competitive advantage.
Porter’s five forces
In his book, “Competitive Advantage,” in 1985, Porter was trying to conceptualize and breaking down what determined a compeititve advantage for companies, wihtin specific marketplaces.
As he explained in the book, “competition is at the core of the success or failure of firms.”
The whole point for Porter was, through competitive strategy, “to establish a profitable and sustainable position against the forces that determine industry competition.”
For Porter the whole matter of competition lied in understanding what industries carried long-term profitability and what factors determined it.
The company able, through competitive strategy, to grasp those two factors would be able to build a competitive advantage (sustained long-term high profits).
At the same time, in order for a firm to create this competitive advantage, it needed to pick its competitive position.
According to Porter, then, the world of business strategy could be addressed according to two core, dynamic elements:
- Industry attractiveness.
- Competitive position change.
In that, competitive strategy will asnwer two core questions:
- How does the business environment look like? And,
- How can this environment be shaped in the firm’s favor?
Determine the industry’s attractiveness
- Porter’s five forces helped analyze the industry attractiveness, at a broader level.
- Porter’s generic strategies helped determine its competitive position within that industry.
Competitive positioning and Porter’s generic strategies
For Michael Porter a competitive advantage would be created as a firm exceets its costs
There are two basic types of competitive advantage: cost leadership
and differentiation. A third one is focus.
Let’s break them down.
According to Porter there are three core strategies for competitive positioning: cost leadership, differentiation and focus.
Cost leadership is straightforward, as the player rolling this out will become the lost-cost producer in the industry.
As Porter highlighted, a cost leader has to have a broad scope (and scale). Indeed, the broad scope is a key element fo cost leadership, in the first place.
A cost leader simply will be able to offer among the lowest priced products in the industry, because it achieved cost leadership.
Therefore, the cost-leader isn’t such because it started a price war. Quite the opposite, the cost leader is such, because thanks to its broad industry reach, efficiency, and scale, can sell its products at a lower price and yet make margins.
In short, the low priced product is the effect of cost leadership.
The cost leader has to keep an eye on differentiation as well. Thus, there isn’t a pure cost leader, meant able to be such without differenciation.
A cost leader has to be at least comparable or perceived as such, to enable the cost leader to have enough margins for long-term sustained advantage.
Cost leadership can be achieved through things like:
- Economies of scale.
- Proprietary technology.
- Preferential access to raw materials.
In a differentiation strategy, companies work on being perceived as unique in their industries, for buyers. As the company is able to be perceived as unique it will be able to charge a premium price.
Porter hihglights that differentiaiton can be different on any industry, and it can be based on:
- Delivery system.
- Marketing approach.
- Or other factors combined.
Differentiation will be achieved as a firm will attract buyers based on its unique features, or perhaps by how the firm is perceived in the marketplace and industry.
Where the cost leadership and differentiation seek a competitive advantage “in a broad range of industry segments,” focus strategies aim at a narrow segment, either through a cost advantage (cost focus) or differentiation (differentiation focus).
The focus strategy can be broken down in two sub-categories:
- Cost focus.
- Differentiation focus.
The focuser ‘selects a segment or group of
segments in the industry and tailors its strategy to serving them to
the exclusion of others. By optimizing its strategy for the target seg·
ments, the foeuser seeks to achieve a competitive advantage in its
target segments even though it does not possess a competitive advantage overaLL
Stuck in the middle
Where a company fails in achieving one of the three generic strategies, it falls in a scenario that Porter calls “stuck in the middle.”
In this scenario, the company failed to achieve any competitive advantage, as such it will experience a below-average performance.
That’s because, according to Porter, the companies implementing one of the three generic strategies, will have a competitive advantage, and the company stuck in the middle, therefore, will experience a disadvantage.
- According to Porter, competitive advantage can be achieved by understanding the industry attractiveness, and based on that by applying a competitive positioning.
- The industry attractiveness can be evaluated, according to Porter, through five forces, which determine the structural anatomy of that industry.
- Once the industry attractiveness is evaluated, a company will need to apply one of the three generic strategies (cost leadership, differentiation, focus).
- In cost leadership, the cost leader will create, for instance, through economies of scale, a cost structure able to sustain lower prices within the same industry, and yet be profitable in the long-term.
- The differentiator, instead, will be able to grab premium prices, thanks to the fact that it is perceived as unique by industry buyers (through product features, marketing, distribution, or a mix of those factors).
- Contrary to cost leaders and differentiation, which aim at broad markets, the focuser will target a narrow segment of the industry, either by targeting cost or differentiation.
- In the scenario, a company fails to choose a generic strategy it will fall in a “stuck in the middle scenario,” where according to Porter, it will lose its long-term competitiveness, as it will run at disadvantage.