PORTER’S STRATEGIES

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Competitive Advantage

• When a firm sustain profits that exceed the

average for its industry, the firm is said to

possess a competitive advantage over its rivals.

• Michael Porter identified two basic type of

competitive advantage.

1. Cost advantage

2. Differentiation advantage

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Competitive Advantage (cont’d)

• Competitive advantage exist when:-

1. The firm is able to deliver the same benefits as

competitors but at lower cost (cost advantage) or

2. The firm is able to deliver benefits that exceed those

of competing products (differentiation strategy)

• Competitive advantage enable the firm to create

superior value for its customers and superior

profits for itself.

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A MODEL OF

COMPETITIVE ADVANTAGE

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RESOURCES

CAPABILITIES

DISTINCT

COMPETENCIES

COST ADVANTAGE

/ DIFFERENTIATION

ADVANTAGE

VALUE

CREATION

Patents and trademarks Propriety know-how Installed customer base Reputation of the firm Brand Equity

Ability to utilize its resources effectively.E.g. Bringing a product to market faster than competitors

Enables innovation, efficiency, quality, and greater customer responsiveness

What are Porter’s Five Forces?

Developed by HBS professor, Michael Porter:

Competitive Advantage: Creating and Sustaining superior Performance

Extensive framework utilized to assess an industry’s competitive environment

Incredibly useful in determining a company’s positioning and evaluating its strategy

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The Five-Forces Model of CompetitionShapes Industry Competition Intensity

Potential development of substitute products

Rivalry among competing firms

Bargaining power of suppliers

Potential entry of new competitors

Bargaining power of consumers

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The Five-Forces Model of Competition

Potential Threat of

New Entrants

Barriers to Entry• Absolute cost advantage

• Propriety learning curve*

• Access to inputs

• Government policy*

• Economies of scale

• Capital requirements*

• Brand Identity*

• Switching costs*

• Access to distribution

• Expected retaliation

• Proprietary Products

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The Five-Forces Model of Competition

Bargaining Power of

SuppliersSuppliers exert power in the industry by:-

• Threatening to raise prices or to reduce quality

– Powerful suppliers can squeeze industry profitability if firms are unable to recover cost increases

Supplier Power• Supplier concentration

• Importance of volume to supplier

• Differentiation of inputs

• Impact of inputs on cost or

differentiation

• Switching costs of firms in the

industry

• Presence of substitute inputs

• Threat of forward integration

• Cost relative to total purchase in

industry

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The Five-Forces Model of Competition

Bargaining Power of

Buyers

Buyers compete with the supplying industry by:

• Bargaining down prices

• Forcing higher quality

• Playing firms off each other

Buyer Power• Bargaining leverage

• Buyer volume

• Buyer information

• Brand identity

• Price sensitivity

• Threat of backward integration

• Product differentiation

• Buyer concentration vs. industry

• Substitutes available

• Buyers’ incentives

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!!#$@

The Five-Forces Model of Competition

Threats of Substitutes

Products

Products with similar function limit the

prices firms can charge

Products with improving price/

performance tradeoffs relative to

present industry products

Keys to evaluate

substitute products:

• Switching cost

• Buyer inclination to substitute

• Price-performance trade-off of

substitutes

Example:

• Electronic security systems in place of security guards

• Fax machines in place of overnight mail delivery

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The Five-Forces Model of Competition

Rivalry

Buyers compete with the supplying industry by:

• Bargaining down prices

• Forcing higher quality

• Playing firms off each other

Degree of Rivalry• Exit barriers

• Industry concentration

• Fixed costs/ value added

• Industry growth

• Intermittent overcapacity

• Product differences

• Product differences

• Switching costs

• Brand identify

• Diversity of rivals

• Corporate stakes

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Rivalry Among Existing Competitors

Intense rivalry often plays out in the following ways:Jockeying for strategic position

Using price competition

Staging advertising battles

Making new product introductions

Increasing consumer warranties or service

Occurs when a firm is pressured or sees an opportunity

Price competition often leaves the entire industry worse off

Advertising battles may increase total industry demand, but may be costly to smaller competitors

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Example

Lets try out a simple exercise

How about Proton’s in Malaysia?

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Threat of Substitutes

Low/High

Bargaining Power of Suppliers

Low/High

Bargaining Power of Buyers

Low/High

Threat of New Entrants

Low/High

Intensity of Competition

Low/High

Porter’s 5 Forces for

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Factor Description Impact

Threat of Substitute Products

? ?

Threat of New Entrants ? ?

Bargaining Power of Buyers

? ?

Bargaining Power of Suppliers

? ?

Competitive Rivalry ? ?

PORTER’S GENERIC STRATEGIES

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Generic Strategy Diagram Choosing Your Route to Competitive Advantage

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BROADAll or most

industry segments

NARROWSmall number

of industry segments

High cost of production

Low cost of production

SCOPE

ADVANTAGE

Generic Strategy PictureChoosing Your Route to Competitive Advantage

Porter's Generic Strategies

Target ScopeAdvantage

Low Cost Product Uniqueness

Broad(Industry Wide)

Cost LeadershipStrategy

DifferentiationStrategy

Narrow(Market Segment)

FocusStrategy

(low cost)

FocusStrategy

(differentiation)

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Cost Leadership Strategy

• Firms that succeed in cost leadership often have the following internal strengths:

– Access to the capital required to make a significant investment in production assets; this investment represents a barrier to entry that many firms may not overcome.

– Skill in designing products for efficient manufacturing, for example, having a small component count to shorten the assembly process.

– High level of expertise in manufacturing process engineering.– Efficient distribution channels.

• Risks– For example, other firms may be able to lower their costs as well. As

technology improves, the competition may be able to leapfrog the production capabilities, thus eliminating the competitive advantage. Additionally, several firms following a focus strategy and targeting various narrow markets may be able to achieve an even lower cost within their segments and as a group gain significant market share.

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McDonald & Wal-Mart

• McDonald’s and Wal-Mart use the same strategy which is the Cost Leadership.

• They are the lowest cost suppliers of a certain product in the market that they are competing in.

• Because they use strategy, they are the market leaders and they are very profitable.

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Differentiation Strategy

• Firms that succeed in a differentiation strategy often have the following internal strengths:– Access to leading scientific research.– Highly skilled and creative product development team.– Strong sales team with the ability to successfully

communicate the perceived strengths of the product.– Corporate reputation for quality and innovation.

• Risks– include imitation by competitors and changes in customer

tastes. Additionally, various firms pursuing focus strategies may be able to achieve even greater differentiation in their market segments.

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NIKE & COCA-COLA

• Altough these companies’ products

does not have a lower cost

compared to other companies, they

use another strategy from the

Porter’s Diagram, which is

Differentiation.

• Branding is what makes people to

recognize the products of these

companies.

• The hand writing of Coca Cola and

the swoosh of Nike are two of the

brilliantly chosen logos.

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Focus Strategy• Concentrates on a narrow segment and within that segment attempts to achieve

either a cost advantage or differentiation. – The premise is that the needs of the group can be better serviced by focusing entirely

on it. – A firm using a focus strategy often enjoys a high degree of customer loyalty, and this

entrenched loyalty discourages other firms from competing directly.

• Because of their narrow market focus, firms pursuing a focus strategy have lower volumes and therefore less bargaining power with their suppliers. However, firms pursuing a differentiation-focused strategy may be able to pass higher costs on to customers since close substitute products do not exist.

• Firms that succeed in a focus strategy are able to tailor a broad range of product development strengths to a relatively narrow market segment that they know very well.

• Risks– include imitation and changes in the target segments. Furthermore, it may be fairly

easy for a broad-market cost leader to adapt its product in order to compete directly. Finally, other focusers may be able to carve out sub-segments that they can serve even better.

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IKEA

• IKEA uses the Cost

Focus in Porter’s

Diagram.

• They combine good

quality and good

function with low

prices.

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FERRARI / ROLLS-ROYCE

• These companies use the

Differentiation Focus

strategy.

• They offer quality

products for premium

cost, but they have a

narrower target of

customers compared to

other car firms.

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Stuck in the Middle? • These generic strategies are not necessarily compatible with one another. If a firm attempts

to achieve an advantage on all fronts, in this attempt it may achieve no advantage at all. – For example, if a firm differentiates itself by supplying very high quality products, it risks

undermining that quality if it seeks to become a cost leader. Even if the quality did not suffer, the firm would risk projecting a confusing image.

• For this reason, Michael Porter argued that to be successful over the long-term, a firm must select only one of these three generic strategies. Otherwise, with more than one single generic strategy the firm will be "stuck in the middle" and will not achieve a competitive advantage.

• Porter argued that firms that are able to succeed at multiple strategies often do so by creating separate business units for each strategy. By separating the strategies into different units having different policies and even different cultures, a corporation is less likely to become "stuck in the middle."

• However, there exists a viewpoint that a single generic strategy is not always best because within the same product customers often seek multi-dimensional satisfactions such as a combination of quality, style, convenience, and price.

– There have been cases in which high quality producers faithfully followed a single strategy and then suffered greatly when another firm entered the market with a lower-quality product that better met the overall needs of the customers.

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Generic Strategies/Industry ForcesThese generic strategies each have attributes that can serve to defend against competitive forces.

IndustryForce

Generic Strategies

Cost Leadership Differentiation Focus

EntryBarriers

Ability to cut price in retaliation deters potential entrants.

Customer loyalty can discourage potential entrants.

Focusing develops core competencies that can act as an entry barrier.

BuyerPower

Ability to offer lower price to powerful buyers.

Large buyers have less power to negotiate -- few close alternatives.

Large buyers have less power to negotiate because of few alternatives.

SupplierPower

Better insulated from powerful suppliers.

Better able to pass on supplier price increases to customers.

Suppliers have power because of low volumes, but a differentiation-focused firm is better able to pass on supplier price increases.

Threat ofSubstitutes

Use low price to defend against substitutes.

Customers become attached to differentiating attributes, reducing threat of substitutes.

Specialized products & core competency protect against substitutes.

RivalryBetter able to compete on price.

Brand loyalty to keep customers from rivals.

Rivals cannot meet differentiation-focused customer needs. 28

Criticisms of generic strategies

• Michael Treacy and Fred Wiersema (1993) modified Porter's three strategies to describe three basic "value disciplines" that can create customer value and provide a competitive advantage. They are operational excellence, product innovation, and customer intimacy.

• Several commentators questioned the use of generic strategies claiming they lack specificity, lack flexibility, and are limiting. Trying to apply generic strategies is like trying to fit a round peg into one of three square holes: You might get the peg into one of the holes, but it will not be a good fit.

• In particular, Millar (1992) questions the notion of being "caught in the middle". He claims that there is a viable middle ground between strategies. Many companies, for example, have entered a market as a niche player and gradually expanded.

• According to Baden-Fuller and Stopford (1992) the most successful companies are the ones that can resolve what they call "the dilemma of opposites“.

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References

• Michael E Porter, Competitive Strategy, Free Press, 1980

• Philip Kotler, Marketing Management, Analysis, Planning, and Control, Prentice Hall, 1975(3rd edition) - This was a textbook that went through 6 editions and was used in MBA courses for 20 years. It talks about all three of these strategies.

• Treacy, M. and Wiesema, F. (1993) "Customer intimacy and other Value Disciplines", Harvard Business Review Jan/Feb 1993.

• Wendell R Smith, Product Differentiation and Market Segmentation as Alternative Marketing Strategies. Journal of Marketing, July 1966 - This is probably the first in depth description of these two strategies.

• Millar, D. (1992) "The Generic Strategy Trap", Journal of Business Strategy vol 13, no 1, Jan-Feb, 1992.

• Baden-Fullen, C. and Stopford, J. (1992) Rejuvenating the Mature Business, Harvard Business School Press, Boston, 1992.

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