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 a 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 tried to conceptualize and break down what determined a competitive advantage for companies within 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 lay 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, the competitive strategy will answer two core questions:
- What 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 exceeds its costs
There are two basic types of competitive advantage: cost leadership
and differentiation. A third one is a 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 of cost leadership in the first place.
A cost leader will simply be able to offer among the lowest-priced products in the industry because it achieves 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 differentiation.
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 highlights that differentiation can be different in any industry, and it can be based on the following:
- 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 into 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’s 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.
- Porter’s Competitive Advantage Framework: According to Michael Porter, competitive advantage within an industry can be achieved through two main strategies: low cost (cost leadership) and differentiation. A third strategy involves focusing on a specific segment of the market.
- Industry Attractiveness and Competitive Position: Porter emphasized that competition is central to a firm’s success or failure. Establishing a profitable and sustainable position against industry competition is the essence of competitive strategy. Companies need to assess industry attractiveness and choose a competitive position to gain a long-term competitive advantage.
- Porter’s Five Forces Model: Porter’s Five Forces model helps analyze industry attractiveness by considering five key factors: competitive rivalry, supplier power, buyer power, threat of substitutes, and threat of new entrants. These forces shape the competitive landscape of an industry.
- Generic Strategies: Porter identified three generic strategies for competitive positioning: cost leadership, differentiation, and focus. Cost leadership involves becoming the low-cost producer in the industry, achieving efficiency and scale. Differentiation strategy focuses on being perceived as unique, allowing the company to charge premium prices. Focus strategies target specific market segments either through cost advantage or differentiation.
- Stuck in the Middle Scenario: Companies that fail to adopt one of the three generic strategies end up in a “stuck in the middle” scenario. This means they lack a competitive advantage and experience below-average performance. Companies successfully implementing one of the generic strategies have a competitive advantage over those stuck in the middle.
- Key Takeaways:
- Competitive advantage is achieved by understanding industry attractiveness and applying a suitable competitive positioning strategy.
- Industry attractiveness can be assessed through Porter’s Five Forces, which analyze the competitive forces shaping an industry.
- The three generic strategies are cost leadership, differentiation, and focus.
- Cost leaders achieve low prices through efficiency and scale.
- Differentiators charge premium prices by being perceived as unique.
- Focus strategies target specific market segments through cost or differentiation.
- Companies failing to choose a generic strategy end up with a competitive disadvantage, referred to as “stuck in the middle.”
Other frameworks from Michael Porter
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