Unit 6: Porters Generic

Strategy & Value Chain

• Porter suggested four "generic" business strategies that could be adopted in
order to gain competitive advantage
• The strategies relate to the extent to which the scope of a business' activities
are narrow versus broad and the extent to which a business seeks to
differentiate its products
• The key strategic challenge for most businesses is to find a way of achieving
a sustainable competitive advantage over the other competing products and
firms in a market.
• A competitive advantage is an advantage over competitors gained by
offering consumers greater value, either by means of lower prices or by
providing greater benefits and service that justifies higher prices.
• The Generic Strategies can be used to determine the direction (strategy) of
your organization
• These approaches are examples of "generic strategies," because they can be
applied to products or services in all industries, and to organizations of all
sizes
• They were first set out by Michael Porter in 1985 in his book, "Competitive
Advantage: Creating and Sustaining Superior Performance."
• Michael Porter uses 4 strategies that an organization can choose from
• He believes that a company must choose a clear course in order to be able to
beat the competition
• A firm's relative position within its industry determines whether a
firm's profitability is above or below the industry average
• The fundamental basis of above average profitability in the long run is
sustainable competitive advantage
• There are two basic types of competitive advantage a firm can possess:
low cost or differentiation
• The two basic types of competitive advantage combined with the
scope of activities for which a firm seeks to achieve them, lead to three
generic strategies for achieving above average performance in an
industry:
• Cost leadership,
• Differentiation, and
• Focus
• The focus strategy has two variants,
• Cost focus and
• Differentiation focus
• Porter called the generic strategies
• Cost Leadership (no frills),
• Differentiation (creating uniquely desirable products and services) and
• Focus (offering a specialized service in a niche market)
• He then subdivided the Focus strategy into two parts:
• Cost Focus and
• Differentiation Focus
 The Cost Leadership Strategy
• With this strategy, the objective is to become the lowest-cost
producer in the industry.
• The sources of cost advantage are varied and depend on the structure
of the industry
• They may include the pursuit of economies of scale, proprietary
technology, preferential access to raw materials and other factors
• A low cost producer must find and exploit all sources of cost
advantage, if a firm can achieve and sustain overall cost leadership,
then it will be an above average performer in its industry, provided it
can command prices at or near the industry average.
• Porter's generic strategies are ways of gaining competitive advantage –
in other words, developing the "edge" that gets you the sale and takes
it away from your competitors
• There are two main ways of achieving this within a Cost Leadership
strategy:
• Increasing profits by reducing costs, while charging industry-average prices.
• Increasing market share by charging lower prices, while still making a
reasonable profit on each sale because you've reduced costs
• The Cost Leadership strategy is exactly that – it involves being the
leader in terms of cost in your industry or market
• Simply being amongst the lowest-cost producers is not good enough, as
you leave yourself wide open to attack by other low-cost producers who
may undercut your prices and therefore block your attempts to increase
market share
• Companies that are successful in achieving Cost Leadership usually
have:
• Access to the capital needed to invest in technology that will bring costs down.
• Very efficient logistics
• A low-cost base (labor, materials, facilities), and a way of sustainably
cutting costs below those of other competitors.
• The greatest risk in pursuing a Cost Leadership strategy is that these
sources of cost reduction are not unique to you, and that other
competitors copy your cost reduction strategies
• This is why it's important to continuously find ways of reducing every
cost
• The traditional method to achieve this objective is to produce on a
large scale which enables the business to exploit economies of scale.
• Why is cost leadership potentially so important? Many (perhaps all)
market segments in the industry are supplied with the emphasis placed
on minimizing costs. If the achieved selling price can at least equal (or
near) the average for the market, then the lowest-cost producer will (in
theory) enjoy the best profits.
• This strategy is usually associated with large-scale businesses offering
"standard" products with relatively little differentiation that are
readily acceptable to the majority of customers
• Occasionally, a low-cost leader will also discount its product to
maximize sales, particularly if it has a significant cost advantage over
the competition and, in doing so, it can further increase its market
share.
• A strategy of cost leadership requires close cooperation between all the functional areas
of a business
• It is natural that companies which adopt lower cost strategy need to handle the value
chain in the most efficient way, in order to produce products or services with the lowest
price without putting quality at risk
• To be the lowest-cost producer, a firm is likely to achieve or use several of the following:
• High levels of productivity
• High capacity utilization
• Use of bargaining power to negotiate the lowest prices for production inputs
• Lean production methods (e.g. JIT)
• Effective use of technology in the production process
• Access to the most effective distribution channels
 Example
• Wal-Mart Stores Inc. has been successfully using cost leadership strategy very well for
over years
• The store has been attracting buyers with low prices; the low prices are offered on each
product sold by the store to attract customers
• The products are offered at a cheaper rate than competitors consistently, not occasionally
• Wal-Mart is able to carry on the gigantic business due to its large scale and efficient
supply chain management
• They source products from low-priced domestic suppliers and from low-wage foreign
markets
• This allows the company to sell their items at low prices and they earn profits through
thin margins gained from high volumes of business
• The retail giant is has thus achieved price leadership.
 The Differentiation Strategy
• Differentiation involves making your products or services different from and
more attractive than those of your competitors
• How you do this depends on the exact nature of your industry and of the
products and services themselves, but will typically involve features,
functionality, durability, support, and also brand image that your customers
value
• In a differentiation strategy a firm seeks to be unique in its industry along
some dimensions that are widely valued by buyers
• It selects one or more attributes that many buyers in an industry perceive as
important, and uniquely positions itself to meet those needs
• It is rewarded for its uniqueness with a premium price
• To make a success of a Differentiation strategy, organizations need:
• Good research,
• Development and
• Innovation
• The ability to deliver high-quality products or services
• Effective sales and marketing, so that the market understands the benefits
offered by the differentiated offerings
• Large organizations pursuing a differentiation strategy need to stay agile with
their new product development processes
• They risk attack on several fronts by competitors pursuing focus differentiation
strategies in different market segments
 Example
• Nike’s product differentiation strategy is to establish the company as the
standard in athletic wear
• By focusing on their product line, they are able to produce high quality
products that meet customer expectations
• Nike’s product line is not wide: they offer athletic shoes, workout clothes
and a very limited number of additional products
• Their focus is clear: give the athlete the equipment they need to succeed
• This single-minded focus has allowed them to develop efficient networks
of suppliers and manufacturers who can provide high quality materials
 The Focus Strategy
• The generic strategy of focus rests on the choice of a narrow
competitive scope within an industry
• The focuser selects a segment or group of segments in the industry and
tailors its strategy to serving them to the exclusion of others
• Companies that use Focus strategies concentrate on particular niche
markets and, by understanding the dynamics of that market and the
unique needs of customers within it, develop uniquely low-cost or
well-specified products for the market
• Because they serve customers in their market uniquely well, they tend
to build strong brand loyalty amongst their customers
• This makes their particular market segment less attractive to
competitors
• As with broad market strategies, it is still essential to decide whether
you will pursue Cost Leadership or Differentiation once you have
selected a Focus strategy as your main approach:
• Focus is not normally enough on its own
• Whether you use cost focus or differentiation focus, the key to making
a success of a generic focus strategy is to ensure that you are adding
something extra as a result of serving only that market niche
• It's simply not enough to focus on only one market segment because
your organization is too small to serve a broader market (if you do,
you risk competing against better-resourced broad market companies'
offerings)
• The focus strategy has two variants
• In cost focus a firm seeks a cost advantage in its target segment, while in 
• Differentiation focus a firm seeks differentiation in its target segment
• Both variants of the focus strategy rest on differences between a focuser's
target segment and other segments in the industry
• The target segments must either have buyers with unusual needs or else the
production and delivery system that best serves the target segment must
differ from that of other industry segments
• Cost focus exploits differences in cost behaviour in some segments, while
differentiation focus exploits the special needs of buyers in certain segments
• In Cost focus a business seeks a lower-cost advantage in just one or a
small number of market segments.
• The product will be basic - perhaps a similar product to the higher-
priced and featured market leader, but acceptable to sufficient
consumers
• Such products are often called "me-too s"
• In the differentiation focus strategy, a business aims to differentiate
within just one or a small number of target market segments
• The special customer needs of the segment mean that there are
opportunities to provide products that are clearly different from
competitors who may be targeting a broader group of customers
• The important issue for any business adopting this strategy is to ensure
that customers really do have different needs and wants - in other
words that there is a valid basis for differentiation - and that existing
competitor products are not meeting those needs and wants
• Differentiation focus is the classic niche marketing strategy
• Many small businesses are able to establish themselves in a niche
market segment using this strategy, achieving higher prices than un-
differentiated products through specialist expertise or other ways to
add value for customers
 Example
• IKEA is one of the most successful and largest furniture retailers in the world, which sells
self-assemble furniture, home decoration and daily necessities
• It was founded in Sweden in 1943 and has been triumphant for 73 years
• Based on Porter’s Generic Strategies, IKEA mainly follows the “Cost Leadership Strategy”
• IKEA looks out for suppliers who can manufacture well-designed subassemblies at the
lowest costs and customers need to assemble the products themselves
• This process saves delivery costs for both producers and customers
• It allows manufacturers reducing a lot of costs as soon as customers could pay for the
products on a much lower price with high quality and therefore, to receive different
segments of customers
• This is also IKEA’s “Focus Strategy” on low costs. With the competitive price, the company
could receive a vast market and easily won the business
 Stuck in the Middle: Neither Inexpensive
nor Differentiated
• A firm is said to be stuck in the middle if it does not offer features that
are unique enough to convince customers to buy its offerings and its
prices are too high to effectively compete on based on price
• Firms that are stuck in the middle generally perform poorly because
they lack a clear market or competitive pricing
• Some firms fail to effectively pursue one of the generic strategies
• A firm is said to be stuck in the middle if it does not offer features
that are unique enough to convince customers to buy its offerings, and
its prices are too high to compete effectively based on price
• Michael Porter proposed a new term that is “Stuck in the Middle” for
those organizations that are unable to make a choice between a cost
leader and differentiation or focus, or uses all of these strategies
simultaneously
• Porter argued that there is fourth state of affairs in business-level
competitive strategy; he labelled it "stuck in the middle" It is not a
deliberate strategy per se
• Rather, it is the result of not being able to successfully pursue any of
the three generic strategies
• The result of not having the lowest costs, not being really
differentiated in the minds of the consumer, or not successfully
targeting a market segment results in a weak profitability and market
picture
• The firm stuck in the middle is almost always associated with lower
profitability and mediocre market share
• The firm stuck in the meddle must make a fundamental strategic
decision
• Porter argues that a firm which is stuck in the middle is likely to fail because
it will not be able to sustain a competitive advantage for a longer period of
time, and its consequence might be a poor financial performance
• Because a company which is stuck in the middle have no strategy at all, and
if a company is in this position it can be successful for a shorter period of
time, but in the long run it’ll fail
• A firm must, therefore, make a choice between cost-leadership and
differentiation strategies or it will land into ‘stuck-in-the middle’
• Each firm needs consistency and logic in implementing strategies. In other
words when firms fail to effectively pursue one of the generic strategies, it is
said to be stuck in the middle
 Example
• IBM’s personal computer business offers an example
• IBM tried to position its personal computers via a differentiation
strategy
• In particular, IBM’s personal computers were offered at high prices,
and the firm promised to offer excellent service to customers in return
• Unfortunately for IBM, rivals such as Dell were able to provide equal
levels of service while selling computers at lower prices
• Nothing made IBM’s computers stand out from the crowd, and the
firm eventually exited the business
 Example
• In the airlines business customers opt for a choice of carrier that is able to offer high standard quality
service, on-time arrival and low fares
• The difference between a low-cost and a full-service carrier is simple; low-cost airlines sell only the
core product i.e. a seat to travel from one point to another to the passenger for the airfare, and
passengers need to pay separately for the additional frills
• Full-service airlines offer passengers a host of value added services, including in-flight meals, free
beverages, and lounge for frequent fliers, among others but generally at a higher fare as these
elements are packaged together
• In India, airlines such as IndiGo, SpiceJet and GoAir operate as low-cost airlines. These airlines
operate on low-cost model in domestic markets for two-three hours flight nicely
• But, in the international segment, airlines such as Air Canada, Hainan Airlines, Korean Air,
Lufthansa, Qantas and Singapore Airlines have subsidiaries with long-haul low-cost operations
• The model is not yet mature enough to have reached in all parts of the world, at the moment it is stuck
in the middle.
Value Chain
• Value chain refers to all the activities undertaken by a company from initially
purchasing raw materials and then manufacturing a product, to placing it on the market
ready to be bought by consumers
• All the value-adding activities in the value chain are interlinked, and are designed to
make the best possible product or service, thus giving the commercial enterprise a
competitive advantage in the marketplace
• Activities involved in a company’s value chain include those in the design, production,
marketing and distribution of a product or service, as well as after sales service
• The term refers to everything a business goes through to bring a good or service from
conception to delivery, and maintaining customer loyalty
• If a company produces goods, its value chain starts with the raw materials it uses to
make its products, plus everything that is added to it before consumers purchase it
 What Is a Value Chain?
• Value chain management is the process of organizing all those activities
• Its goal is to make sure that within each stage, those in charge are liaising with each
other, so that their product is being delivered to customers as rapidly and
seamlessly as possible.
• For companies that produce goods, a value chain comprises the steps that involve
bringing a product from conception to distribution, and everything in between—
such as procuring raw materials, manufacturing functions, and marketing activities
• A company conducts a value-chain analysis by evaluating the detailed procedures
involved in each step of its business
• The purpose of a value-chain analysis is to increase production efficiency so that a
company can deliver maximum value for the least possible cost
• Because of ever-increasing competition for unbeatable prices,
exceptional products, and customer loyalty, companies must
continually examine the value they create in order to retain
their competitive advantage
• A value chain can help a company to discern areas of its business that
are inefficient, then implement strategies that will optimize its
procedures for maximum efficiency and profitability
• Michael E. Porter, of Harvard Business School, introduced the concept
of a value chain in his book, Competitive Advantage: Creating and
Sustaining Superior Performance
• He wrote: "Competitive advantage cannot be understood by looking at
a firm as a whole. It stems from the many discrete activities a firm
performs in designing, producing, marketing, delivering, and
supporting its product"
 Components of a Value Chain
• In his concept of a value chain, Porter splits a business's activities into
two categories, "primary" and "support," whose sample activities we
list below
• Specific activities in each category will vary according to the industry
• Primary Activities
• Support Activities
• The idea is to divide the activities into
• Primary activities (those activities that relate to core operations, sales,
marketing, and customer service), and
• Support activities, which are activities related to human
resource management, firm infrastructure management, information
technology & technology development, and procurement& then to
identify which activities add value and which don’t
• Presumably each activity adds some value.
 Primary Activities
• Primary activities consist of five components, and all are essential for
adding value and creating competitive advantage:
• Inbound logistics include functions like receiving, warehousing, and
managing inventory
• Operations include procedures for converting raw materials into a
finished product
 Primary Activities
• Outbound logistics include activities to distribute a final product to a
consumer
• Marketing and sales include strategies to enhance visibility and
target appropriate customers—such as advertising, promotion, and
pricing
• Service includes programs to maintain products and enhance the
consumer experience—like customer service, maintenance, repair,
refund, and exchange
 Support Activities
• The role of support activities is to help make the primary activities
more efficient
• When you increase the efficiency of any of the four support activities,
it benefits at least one of the five primary activities
• These support activities are generally denoted as overhead costs on a
company's income statement:
• Procurement concerns how a company obtains raw materials.
 Support Activities
• Technological development is used at a firm's research and
development (R&D) stage—like designing and developing
manufacturing techniques and automating processes
• Human resources (HR) management involves hiring and retaining
employees who will fulfill the firm's business strategy and help
design, market, and sell the product
• Infrastructure includes company systems and the composition of its
management team—such as planning, accounting, finance, and quality
control
 Value Chain and Competitive Advantage
• When analyzing a value chain in terms of competitive advantage, the
idea is to compare the aspects of the business’s chain to the aspects of
the value chains of competitors
• The value-creating activities in a company’s value chain contribute to
competitive advantage when they meet one of two criteria
• The activity is not performed by competitors
• The activity is performed superiorly than similar activities performed by
competitors
 Value Chain and Supply Chain
• According to Michael Porter, a value system is the interconnected system of value
chains along a supply chain. Participating in a strong value system can increase the
competitive advantage of a business
• The concept of the value system is similar to the value chain but on a broader scale
• The idea is to maximize value created by the value system while minimizing costs
• Therefore, analyze the entire system with the objective of creating and
capturing value throughout the entire system
• Optimizing a value system for increased efficiency and lower cost makes the
overall system more valuable than the sum of its contributing value chains and
adds value to the end consumer of the products
 Value chain analysis
• The aim of value chain analysis is to gain an edge over one’s competitors. In
the world of business, it is both an essential and extremely valuable tool
• It is a process where companies identify their primary support activities that
add value to their finished products, and then analyze each activity carefully to
minimize costs and increase differentiation
• It represents a firm’s internal activities associated with transforming inputs
into outputs – transferring what comes in (raw materials) to what goes out
(finished products)
• Value chain analysis relies on the fundamental economic principle of
advantage – commercial enterprises are best served by operating in sectors and
areas where they have a relative production advantage over their competitors