Business Strategy

LO 4
 Competitive advantage
• Is the ability of an organisation to add more value for
its customers than its rivals and therefore attain a
position of relative advantage
• Is what gives a firm an edge over its rivals
• Arises from the selection of the generic strategy that
best fits the organisation’s competitive environment
• The key drivers of competitive advantage are cost
leadership and differentiation of product
 Competitive strategy
• Competitive strategy is the means by which
organisations seek to achieve and sustain
competitive advantage
• Porter argues that competitive strategy means
“taking offensive or defensive actions to create a
defendable position in an industry, to cope with …
competitive forces and thereby yield a superior
return for the firm”
• Firms have discovered different approaches
competitive strategy -the best strategy for a firm
should reflect its particular circumstances
 The basis of the generic strategies

• Porter argues that a firm’s strengths ultimate fall into

one of two headings: cost advantage and
differentiation
• By applying these strengths in a broad or a narrow
focus, three generic strategies result: cost leadership,
differentiation and focus
• They are called generic strategies because they are
not specific to a firm or an industry
 Porter’s Generic strategies
• Porter identified the four strategies to achieve a
competitive advantage
• Cost leadership: superior profits through lower costs
• Differentiation: higher profits by adding value to the
product areas which are of real significance for
customers who in turn are willing to pay premium
prices
• Focus strategy: concentrating on a limited part of the
market Focus strategy is then subdivided into focus
cost leadership and focus differentiation
 Porter’s generic strategies
Advantage Advantage
Target scope Low cost Product uniqueness

Broad Cost leadership Differentiation strategy

(industry wide) strategy

Narrow Focus strategy Focus strategy

(market wide) (low cost) (differentiation)
 Generic strategies at a glance

Low cost Differentiation Focus

Low cost culture Adding value Niche markets
Economies of scale through Targeting
Eliminate -product features Limited territory
unnecessary costs -product quality Focus on a specific
Enjoy high profits -distinctive offering group of customers
through cost Offer something Either cost leader
advantage new or different or differentiation
High costs but with in the segment
charge premium
price
 Cost leadership
• This strategy concentrates on aiming to become
the lowest cost producer in the industry through
economies of scale
• In this way the firm can compete on price with
every other producers in the industry and earn
higher unit profits
• Cost reduction provides the focus of the
organisation’s strategy
• Competitive advantage is achieved by driving
down costs
 Cost leadership
• Cost leadership is based on
– Efficiency to drive down costs
– Effectiveness- knowing what is and what is not important
to customers and saving on the latter
• But there is room for only one cost leader
• A successful cost leadership strategy requires that
the firm is the cost leader and is unchallenged in this
position
• Cost leadership is especially beneficial in markets
where customers are price sensitive
 Sources of cost leadership
• Size - economies of scale
• Greater labour efficiency and effectiveness
• Control of overheads
• Superior management
• Greater operating efficiency and effectiveness
• Low cost production
• Low cost labour
• Design for low cost production
• Use the latest technology to reduce costs and or enhance
productivity
• Relocation to low cost site
• Favourable access to low cost sources of supply
• Reduction in waste
 Firms that succeed in cost leadership

• Firms that succeed in cost leadership have the

following strengths:
– Access to the capital required to make significant
investment in fixed assets
– Design skills for efficient manufacture
– A high level of expertise in manufacturing process
engineering
– Efficient distribution channels
• Examples of cost leadership : Ryanair, Toyota, Wal-
Mart (parent company of Asda), Tesco
 A misconception
• Cost leadership is often seen as a strategy that aims
to attract customers with low prices that are made
possible by low costs
• But cost leadership does not necessarily mean selling
at the lowest price
• It might mean selling at the industry average price
but enjoying above average profits through low cost
production
• The low costs result in high profit margins
 Benefits of cost leadership
• Enjoy higher than average profits
• Engage in price war
• Eliminate rivals
• Defend market share
• Increase market share
• Build barriers to the entry of newcomers to the
market
• Weaken the threat of substitutes
• Enter new markets
 Five forces analysis
• Porter developed the five forces model as a framework for
the analysis of profitability of the industry
• The five forces are:
– Suppliers power: powerful suppliers can push up the cost of inputs
– Buyers’ power: powerful buyers can negotiate low prices
– The threat of substitutes: where there is a strong threat firms need to
remain very competitive
– The ease or otherwise of entry to the market: low barriers raise the
prospect new firms pushing down prices
– The intensity of rivalry in the market: intense competition forces firms
to keep prices down
• The five forces model can be used to analyse each of the
generic strategies
 Five forces and cost leadership
The five forces The cost leader is

Entry barriers Able to cut prices to discourage potential

entrants to the market
Buyer power Able to offer a competitive price to buyers
with power
Supplier power Protected from a powerful buyer by low
costs
Threat of Able to make use of low price as defence
substitution against substitutes
Rivalry Is better able to compete on price
 Risks of cost leadership
• Vulnerability to even lower cost operators
• As technology improves, a competitor may be able to
leapfrog the production capabilities, thus eliminating
the competitive advantage
• It could lead to a damaging price wars
• There might by difficulty in sustaining cost leadership
in the long run
• A firm following a focus strategy might be able to
achieve even lower cost within their segment
 Differentiation
• A differentiation strategy calls for the
development of a product or service that
offers attributes that are both unique and are
valued by customers
• Customers perceive the product to be
different and better than that of rivals
• As a result the value added by the uniqueness
of the product may allow the firm to charge a
premium price for it
 Differentiation
• Success in a differentiation strategy means
– Gaining a competitive advantage by making their product
different from competitors
– Competing on the basis of value added to customers
– Persuading customers that the firm’s product is superior to
that offered by rivals
– Customers being willing to pay a premium price to cover
higher costs
• Differentiation can be based on product image or
durability,after-sales,quality,additional features,after
sales
• And it requires talent, research capability and strong
marketing
 Extra costs and premium prices
• Differentiation adds costs in order to add value
• The extra costs can only be recouped if the market is
willing to pay a premium price
• Problems occur if the extra costs incurred outweigh
the additional revenue generated by higher prices
• For a successful differentiation strategy it is
insufficient merely to add value - customers must
recognise and appreciate the difference
• Extra costs should be added only in areas that
customers perceive to be important
 Sources of differentiation
• Creation of strong brand
• Superior performance
• High quality
• Additional features offered
• Innovation in packaging
• Speed of distribution
• Higher service levels
• Greater flexibility
• Delivery
• Quality of the materials
 Firms that succeed in a differentiation strategy

• Firms that succeed in a differentiation strategy have:

– Have access to leading scientific research
– A strong creative product development team
– Strong sales team with the ability to successfully
communicate the strengths of the product
– Reputation for quality and innovation
• Examples:
– BMW
– Miele - high quality domestic appliances
– James Purdey – rifles
– Bang and Olufsen- high quality hi-fi
– Mercedes
 Differentiation: benefits
• Differentiation offers the prospect of charging a
premium price
• Demand for a differentiated product will be less
elastic than that for competitors products
• Differentiation can result in above average profits
• Differentiation can create additional barriers to entry
to the market for newcomers
 The five forces and differentiation

Five forces A firm pursuing a differentiation strategy…

Entry barriers Benefits from customer loyalty which discourages
potential entrants

Buyer power Enjoys some protection since large buyers have

less power to negotiate because of the absence of
close alternatives
Supplier power Is better able to pass on supplier price increases
to customers

Threat of Is protected from the threat of substitutes by

substitution customer loyalty

Rivalry Benefits from brand loyalty to keep customers

from rivals
 Risks of differentiation strategy
• There are difficulties of sustaining differentiation
• Differentiation involves higher costs
• There is a risk of creating differences that customers do not
value
• Customers might become price sensitive and choose on price
rather than uniqueness
• It might involve differentiation on dimensions that become
less important to customers over time
• Customers may no longer need the differentiation factor
• Imitators may narrow the differentiation
• Rivals pursuing a focus strategy may be able to achieve even
greater differentiation in their market segments
 Focus strategy
• In a focus strategy the firm concentrates on one (or at most a
limited number of) segments of the market
• The premise behind this strategy is that the needs of the
group can be bettered served by focussing entirely on it
• The firm might feel more secure in the niche with greater
insulation from competition
• A focus strategy means that the firm’s efforts are not spread
too thinly
• Focus strategies are
– Cost focus: cost leader in a particular segment
– Focus differentiation: differentiation in the chosen segment
 Requirements of a focus strategy
• A focus strategy requires…
• The identification of a suitable target customer group
• Identification of the specific needs of that group
• Confirmation that the market is sufficiently large to
sustain the business
• Estimation of the extent of competition within the
segment
• Production of products to meet the specific needs of
that group
• A decision on whether to opt for cost leadership or
differentiation within the segment
 Benefits of a focus strategy
• It involves lower investment in resources
• The firm benefits from specialisation
• It provides scope for greater knowledge of a
segment of the market
• It makes entry to new markets easier and less
costly
• Firms using a focus strategy often enjoy a high
degree of customer loyalty
 Focussed cost leadership
• A strategy that aims…
• To attract one type of customer with a low
cost product
• To be the lowest cost operator in one
particular niche segment of the market
• Example :Hyundai
 Focussed differentiation
• A strategy that aims to attract one type of
customer with a differentiated product
• It involves distinctiveness in one segment
• Aims to exploit unique position in a niche
segment of the market
• Not the cheapest but the best or most
distinctive in that segment
• Example: BMW, Mercedes
 The five forces and a focus strategy

The five forces A firm pursuing a focus strategy…

Entry barriers Develops core competencies that can act as an entry
barrier

Buyer power Enjoys some insulation since large buyers have less
power to negotiate because few alternatives are
available

Supplier power Is better able to pass on supplier price rises thereby

reducing the impact of supplier power

Threat of substitution Enjoys some protection against substitutes by

specialised products and core competencies

Rivalry Enjoys some protection because rivals cannot meet

differentiation focused customer needs
 Problems associated with focus strategy

• Limited opportunities for growth

• Sacrifice of economies of scale that would be
available from a larger market
• The firm could outgrow the market
• Danger of decline in the chose segment or niche
• A reputation for specialisation inhibits move into new
sectors
• Risk of imitation
• Risk of changes in the target segment
 Stuck in the middle
• Porter argued that a firm must make a conscious
choice about the competitive advantage it seeks to
develop
• If it fails to choose one of these strategies,it risks
being “stuck in the middle”,trying to be all things to
all people,and ends up with no competitive strategy
at all
• Being stuck in the middle leads to low profitability
• Competitors with a clear strategy outperform those
whose strategy is unclear or attempt a combination
of strategies
 What is wrong with being “stuck in the
middle”?
• It is difficult to simultaneously become differentiated
and low cost
• The firm loses out to others able to undercut it and
to those able to offer a superior product
• If a firm differentiates itself by supplying very high
quality products it risks undermining that quality if it
seeks to be come a cost leader
• Such a firm also suffers from a blurred corporate
culture and the projection of a confusing image
 Multiple strategies
• Firms that are able to succeed at multiple
strategies create separate business units for
each strategy
• By separating the strategies into
– Different units
– Each with its own culture
– Each with its own brands
 Generic strategies: summary
• Cost leadership
– Being the lowest cost producer in the industry as a whole
• Differentiation
– The exploitation of a product or service which is believed
to be unique
• Focus
– Restricting activities to only part of the market through:
– Providing goods or services at lower cost to that segment
(cost focus)
– Providing a differentiated product or service to that
segment (differentiation focus)
Bowman’s Strategic Cost
 Low Price and Low Value Added
(Position 1)
• Commodity-like products or services
• Price-sensitive customers
• High buyer power and/ or low switching costs
• Small number of providers with similar market
shares
• Avoiding the major competitors
• This is not a very competitive position for a
business. The product is not differentiated and
the customer perceives very little value,
despite a low price.
 Low Price (Position 2)
• A strategy of cost minimisation is required for
this to be successful, often associated with
economies of scale. Profit margins on each
product are low, but the high volume of
output can still generate high overall profits.
• Lower price than competitors
• Maintain similar product/service benefits
• Public sector – year on year efficiency gains
• Pitfalls of low price strategy
– Margin reduction (competitor reaction)
– Inability to reinvest leading to loss of perceived
benefit of product
• Need a low cost base
– Low cost itself not a basis for advantage
– Low cost achieved in ways that competitors
cannot match to give sustainable advantage
 Hybrid (Position 3)
• As the name implies, a hybrid position involves some
element of low price (relative to the competition),
but also some product differentiation. The aim is to
persuade consumers that there is good added value
through the combination of a reasonable price and
acceptable product differentiation.
• Simultaneously achieving differentiation and
• a price lower than competitors
•
• Achieve greater volumes
• Clarity about activities on which
differentiation can be built (core
competences)
• Reduce costs on other activities
• Entry strategy in market with established
competitors
 Differentiation (Position 4)
• The aim of a differentiation strategy is to offer
customers the highest level of perceived
added value. Branding plays a key role in this
strategy, as does product quality.
• A high quality product with strong brand
awareness and loyalty is perhaps best-placed
to achieve the relatively prices and added-
value that a differentiation strategy requires
 Differentiation Strategies
Offering benefits different from competitors
Widely valued by buyers
Better products/services at same or higher price
Public sector - centre of excellence

• Success depends on
– Identification of strategic customers and knowing
what they value
– Knowing the competitors
• Narrow competitor base – focused differentiation
• Wide competitor base – address bases of differentiation
valued by customers
Focused Differentiation (Position 5)
• This strategy aims to position a product at the
highest price levels, where customers buy the
product because of the high perceived value.
This the positioning strategy adopted by
luxury brands, who aim to achieve premium
prices by highly targeted segmentation,
promotion and distribution.
 High perceived product/service benefits to
selected market segment (niche)
Premium products, heavily branded

• Choice to be made between focused differentiation and

broad differentiation if growth required
• Difficult when the focus strategy is only part of an
organisation’s overall strategy
• Possible conflict with stakeholder expectations
• New ventures start off focused, but need to grow
• Market situation may change, reducing differences
between segments
 Risky High Margins (Position 6)
• This is a high risk positioning strategy that you
might argue is doomed to failure – eventually.
With this strategy, the business sets high
prices without offering anything extra in terms
of perceived value. If customers continue to
buy at these high prices, the profits can be
high. But, eventually customers will find a
better-positioned product that offers more
perceived value for the same or lower price.
 Monopoly Pricing (Position 7)
• Where there is a monopoly in a market, there is
only one business offering the product. The
monopolist doesn’t need to be too concerned
about what value the customer perceives in the
product – the only choice they have is to buy or not.
There are no alternatives. In theory the monopolist
can set whatever price they wish. Fortunately, in
most countries, monopolies are tightly regulated to
prevent them from setting prices as they wish.
 Loss of Market Share (Position 8)
• This position is a recipe for disaster in any
competitive market. Setting a middle-range or
standard price for a product with low
perceived value is unlikely to win over many
consumers who will have much better options
(e.g. higher value for the same price from
other competitors).
 Horizontal Integration
• Horizontal Integration is the addition of other business
activities at the same level of the value chain.
• Two companies of the same industry and in the same
stage of production work together.
• These companies belong to the same supply chain stage
and normally produce or trade the same product.
• Firm add their strength to gain benefits.
• Affects the processes and structure design of
distribution networks
• Examples:
• The Standard Oil Company buying 40
refineries
• An automobile manufacturer buying a sport
utility vehicle manufacturer
• A radio station that also owns a newspaper
and magazine
 Two Option
• Acquisition
• Merger
• HI can occur in a form of mergers or
acquisitions. Merger is the joining of two
similar sizes, independent companies to make
one joint entity. Acquisition is the purchase
of another company.
 Advantages of Horizontal Integration

• Economics of scale: Selling more of the

same product in different parts of the world
• Economics of Scope: Sharing resources
common to different products. “Synergies” *
• Increased Market Power
• Reduction in cost
 Disadvantages
• Costs
• Increased work load
• Increased Responsibilities
• Anti-trust issues
• HI can lead to a monopoly
 Drawbacks and Limits of Horizontal
Integration
•Majority of mergers and acquisitions do not
create value
•Implementing a horizontal integration
strategy is not easy
•Mergers and acquisitions often fail to
produce the anticipated gains
•Can bring the company into conflict with
antitrust law
 Vertical Integration
• Vertical integration is the process in which
several steps in the production and / or
distribution of a product or service are
controlled by a single company or entity , in
order to increase that company’ s power in
the market place
 Backward (upstream) vertical integration: *
This is when a company owns some of the subsidiaries
that produce some of the inputs used in the production of
its products.
• Example: When an automobile company owns a tire company

 Forward vertical integration: *

This is when a company owns the subsidiaries that
market the product.
• Example: A mobile company opening its own mobile retail
chain

Balanced Vertical Integration: is a company that
sets up subsidiaries that supply them with inputs as
well as market their product.
 Reduce transportation cost Improve
 supply chain coordination
 More oppertunities to differeniate by means of
increased control of inputs
 Capture upstream and downstream profits
 Increase entry barriers to potiental competitors
 Disadvantages
•Capacity balancing: Making sure that inputs
will match outputs at all levels
•Potentially higher cost due to the lack of
supplier competition
•Decreased Flexibility
•Developing new competencies may
compromise existing competencies
•Increase bureaucratic costs
•Monopolization of markets
 This strategy may not always be the best choice for an
organization due to a lack of sufficient resources that are
needed to venture into a new industry. Sometimes the
alternatives to VI offer more benefits. The available
choices differ in the amount of investments required and
the integration level. For example, short-term contracts
require little integration and much less investments than
joint ventures.