Porter's Generic Strategies

If the primary determinant of a firm's profitability is the attractiveness of the industry in which it operates, an important secondary determinant is its position within that industry. Even though an industry may have below-average profitability, a firm that is optimally positioned can generate superior returns.

A firm positions itself by leveraging its strengths. Michael Porter has argued that a firm's strengths ultimately fall into one of two headings: cost advantage and differentiation. By applying these strengths in either a broad or narrow scope, three generic strategies result: cost leadership, differentiation, and focus. These strategies are applied at the business unit level. They are called generic strategies because they are not firm or industry dependent. The following table illustrates Porter's generic strategies:

Porter's Generic Strategies

Target Scope

Advantage

Low Cost Product Uniqueness

Broad(Industry Wide)

Cost LeadershipStrategy

DifferentiationStrategy

Narrow(Market Segment)

FocusStrategy(low cost)

FocusStrategy(differentiation)

Cost Leadership Strategy

This generic strategy calls for being the low cost producer in an industry for a given level of quality. The firm sells its products either at average industry prices to earn a profit higher than that of rivals, or below the average industry prices to gain market share. In the event of a price war, the firm can maintain some

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profitability while the competition suffers losses. Even without a price war, as the industry matures and prices decline, the firms that can produce more cheaply will remain profitable for a longer period of time. The cost leadership strategy usually targets a broad market.

Some of the ways that firms acquire cost advantages are by improving process efficiencies, gaining unique access to a large source of lower cost materials, making optimal outsourcing and vertical integration decisions, or avoiding some costs altogether. If competing firms are unable to lower their costs by a similar amount, the firm may be able to sustain a competitive advantage based on cost leadership.

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.

Each generic strategy has its risks, including the low-cost strategy. 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.

Differentiation Strategy

A differentiation strategy calls for the development of a product or service that offers unique attributes that are valued by customers and that customers perceive to be better than or different from the products of the competition. The value added by the uniqueness of the product may allow the firm to charge a premium price for it. The firm hopes that the higher price will more than cover the extra costs incurred in offering the unique product. Because of the product's unique attributes, if suppliers increase their prices the firm may be able to pass along the costs to its customers who cannot find substitute products easily.

Firms that succeed in a differentiation strategy often have the following internal strengths:

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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.

The risks associated with a differentiation strategy 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.

Focus Strategy

The 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.

Some risks of focus strategies 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.

A Combination of Generic Strategies - 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

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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.

Generic Strategies and Industry Forces

These generic strategies each have attributes that can serve to defend against competitive forces. The following table compares some characteristics of the generic strategies in the context of the Porter's five forces.

Generic Strategies and Industry 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 because of 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

Can use low price to defend against substitutes.

Customer's become attached to differentiating attributes, reducing threat of substitutes.

Specialized products & core competency protect against substitutes.

Rivalry Better able to compete on price.

Brand loyalty to keep customers from rivals.

Rivals cannot meet differentiation-focused customer needs.

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Porter generic strategiesMichael Porter has described a category scheme consisting of three general types of strategies that are commonly used by businesses to achieve and maintain competitive advantage. These three generic strategies are defined along two dimensions: strategic scope and strategic strength. Strategic scope is a demand-side dimension (Porter was originally an engineer, then an economist before he specialized in strategy) and looks at the size and composition of the market you intend to target. Strategic strength is a supply-side dimension and looks at the strength or core competency of the firm. In particular he identified two competencies that he felt were most important: product differentiation and product cost (efficiency).He originally ranked each of the three dimensions (level of differentiation, relative product cost, and scope of target market) as either low, medium, or high, and juxtaposed them in a three dimensional matrix. That is, the category scheme was displayed as a 3 by 3 by 3 cube. But most of the 27 combinations were not viable.

Porter's Generic Strategies

In his 1980 classic Competitive Strategy: Techniques for Analysing Industries and Competitors, Porter simplifies the scheme by reducing it down to the three best strategies. They are cost leadership, differentiation, and market segmentation (or focus). Market segmentation is narrow in scope while both cost leadership and differentiation are relatively broad in market scope.

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Empirical research on the profit impact of marketing strategy indicated that firms with a high market share were often quite profitable, but so were many firms with low market share. The least profitable firms were those with moderate market share. This was sometimes referred to as the hole in the middle problem. Porter’s explanation of this is that firms with high market share were successful because they pursued a cost leadership strategy and firms with low market share were successful because they used market segmentation to focus on a small but profitable market niche. Firms in the middle were less profitable because they did not have a viable generic strategy.

Combining multiple strategies is successful in only one case. Combining a market segmentation strategy with a product differentiation strategy is an effective way of matching your firm’s product strategy (supply side) to the characteristics of your target market segments (demand side). But combinations like cost leadership with product differentiation are hard (but not impossible) to implement due to the potential for conflict between cost minimization and the additional cost of value-added differentiation.

Since that time, some commentators have made a distinction between cost leadership, that is, low cost strategies, and best cost strategies. They claim that a low cost strategy is rarely able to provide a sustainable competitive advantage. In most cases firms end up in price wars. Instead, they claim a best cost strategy is preferred. This involves providing the best value for a relatively low price.

Cost Leadership Strategy

This strategy emphasizes efficiency. By producing high volumes of standardized products, the firm hopes to take advantage of economies of scale and experience curve effects. The product is often a basic no-frills product that is produced at a relatively low cost and made available to a very large customer base. Maintaining this strategy requires a continuous search for cost reductions in all aspects of the business. The associated distribution strategy is to obtain the most extensive distribution possible. Promotional strategy often involves trying to make a virtue out of low cost product features.

To be successful, this strategy usually requires a considerable market share advantage or preferential access to raw materials, components, labour, or some other important input. Without one or more of these advantages, the strategy can easily be mimicked by competitors. Successful implementation also benefits from:

process engineering skills products designed for ease of manufacture sustained access to inexpensive capital

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close supervision of labour tight cost control incentives based on quantitative targets.

always ensure that the costs are kept at the minimum possible level.

Examples include retailers such as Wal-Mart and KwikSave as well as IT firms such as Dell and Lenovo.

When a firm designs, produces and markets a product more efficiently than competitors such firm has implemented a cost leadership strategy (Allen et al. 2006, p.25,). Cost reduction strategies across the activity cost chain will represent low cost leadership (Tehrani 2003, p.610, Beheshti 2004, p. 118). Attempts to reduce costs will spread through the whole business process from manufacturing to the final stage of selling the product. Any processes that do not contribute towards minimization of cost base should be outsourced to other organisations with the view of maintaining a low cost base (Akan et al. 2006, p.48). Low costs will permit a firm to sell relatively standardised products that offer features acceptable to many customers at the lowest competitive price and such low prices will gain competitive advantage and increase market share (Porter 1980 cited by Srivannboon 2006, p.88; Porter 1979;1987;1986, Bauer and Colgan 2001; Hyatt 2001; Anon 1988; Davidson 2001; Cross 1999 cited by Allen and Helms 2006, p.435). These writings explain that cost efficiency gained in the whole process will enable a firm to mark up a price lower than competition which ultimately results in high sales since competition could not match such a low cost base. If the low cost base could be maintained for longer periods of time it will ensure consistent increase in market share and stable profits hence consequent in superior performance. However all writings direct us to the understanding that sustainability of the competitive advantage reached through low cost strategy will depend on the ability of a competitor to match or develop a lower cost base than the existing cost leader in the market.

A firm attempts to maintain a low cost base by controlling production costs, increasing their capacity utilization, controlling material supply or product distribution and minimizing other costs including R&D and advertising (Prajogo 2007,p.70). Mass production, mass distribution, economies of scale, technology, product design, learning curve benefit, work force dedicated for low cost production, reduced sales force, less spending on marketing will further help a firm to main a low cost base (Freeman 2003, p.86; Trogovicky et al. 2005, p.18). Decision makers in a cost leadership firm will be compelled to closely scrutinise the cost efficiency of the processes of the firm. Maintaining the low cost base will become the primary determinant of the cost leadership strategy. For low cost leadership to be effective a firm should have a large market share (Robinson and Chiang 2000, p.857; Hyatt 2001 cited by Allen and Helms 2006, p.435). New entrants or firms with a smaller market share may not benefit from such strategy since mass production, mass distribution and economies of scale will not make

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an impact on such firms. Low cost leadership becomes a viable strategy only for larger firms. Market leaders may strengthen their positioning by advantages attained through scale and experience in a low cost leadership strategy. But is their any superiority in low cost strategy than other strategic typologies? Can a firm that adopts a low cost strategy out perform another firm with a different competitive strategy? If firms costs are low enough it may be profitable even in a highly competitive scenario hence it becomes a defensive mechanism against competitors (Kim et al. 2004, p.21). Further they mention that such low cost may act as entry barriers since new entrants require huge capital to produce goods or services at the same or lesser price than a cost leader. As discussed in the academic frame work of competitive advantage raising barriers for competition will consequent in sustainable competitive advantage and in consolidation with the above writings we may establish the fact that low cost competitive strategy may generate a sustainable competitive advantage. However, this is not true in all cases.

Further in consideration of factors mentioned above that facilitate a firm in maintaining a low cost base; some factors such as technology which may be developed through innovation (mentioned as creative accumulation in Schumpeterian innovation) and some may even be resources developed by a firm such as long term healthy relationships build with distributors to maintain cost effective distribution channels or supply chains (inimitable, unique, valuable non transferable resource mentioned in RBV). Similarly economies of scale may be an ultimate result of a commitment made by a firm such as capital investments for expansions (as discussed in the commitment approach). Also raising barriers for competition by virtue of the low cost base that enables the low prices will result in strong strategic positioning in the market (discussed in the IO structural approach). These significant strengths align with the four perspectives of sustainable competitive advantage mentioned in the early parts of this literature review. Low cost leadership could be considered as a competitive strategy that will create a sustainable competitive advantage.

However, low cost leadership is attached to a disadvantage which is less customer loyalty (Vokurka and Davis 2004, p. 490, Cross 1999 cited by Allen and Helms 2006, p.436). Relatively low prices will result in creating a negative attitude towards the quality of the product in the mindset of the customers (Priem 2007, p.220). Customer’s impression regarding such products will enhance the tendency to shift towards a product which might be higher in price but projects an image of quality. Considering analytical in depth view regarding the low cost strategy, it reflects capability to generate a competitive advantage but development and maintenance of a low cost base becomes a vital, decisive task.

Differentiation Strategy

Differentiation is aimed at the broad market that involves the creation of a product or services that is perceived throughout its industry as unique. The

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company or business unit may then charge a premium for its product. This specialty can be associated with design, brand image, technology, features, dealers, network, or customers service. Differentiation is a viable strategy for earning above average returns in a specific business because the resulting brand loyalty lowers customers' sensitivity to price. Increased costs can usually be passed on to the buyers. Buyers loyalty can also serve as an entry barrier-new firms must develop their own distinctive competence to differentiate their products in some way in order to compete successfully. Examples of the successful use of a differentiation strategy are Hero Honda, Asian Paints, HLL, Nike athletic shoes, Perstorp BioProducts, Apple Computer, and Mercedes-Benz automobiles. Research does suggest that a differentiation strategy is more likely to generate higher profits than is a low cost strategy because differentiation creates a better entry barrier. A low-cost strategy is more likely, however, to generate increases in market share. This may or may not be true.

Variants on the Differentiation Strategy

The shareholder value model holds that the timing of the use of specialized knowledge can create a differentiation advantage as long as the knowledge remains unique. This model suggests that customers buy products or services from an organization to have access to its unique knowledge. The advantage is static, rather than dynamic, because the purchase is a one-time event.

The unlimited resources model utilizes a large base of resources that allows an organization to outlast competitors by practicing a differentiation strategy. An organization with greater resources can manage risk and sustain losses more easily than one with fewer resources. This deep-pocket strategy provides a short-term advantage only. If a firm lacks the capacity for continual innovation, it will not sustain its competitive position over time.

Focus Strategy

The firm focuses on a few target markets (also called a segmentation strategy or niche strategy). It is hoped that by focusing your marketing efforts on one or two narrow market segments and tailoring your marketing mix to these specialized markets, you can better meet the needs of that target market. The firm typically looks to gain a competitive advantage through product innovation and/or brand marketing rather than efficiency. It is most suitable for relatively small firms but can be used by any company. A focus strategy should target market segments that are less vulnerable to substitutes or where a competition is weakest to earn above-average return on investment.

Examples of firm using a focus strategy include Southwest Airlines, with provides short-haul point-to-point flights in contrast to the hub-and-spoke model of mainstream carriers, and Family Dollar, which targets poor urban American

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families who can not drive to Wal-Marts in the suburbs because they do not own a car.

Recent developments

Michael Treacy and Fred Wiersema (1993) have 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 leadership, and customer intimacy.

Criticisms of generic strategies

Several commentators have questioned the use of generic strategies claiming they lack specificity, lack flexibility, and are limiting.

In particular, Miller (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".

A popular post-Porter model was presented by W. Chan Kim and Renée Mauborgne in their 1999 Harvard Business Review article "Creating New Market Space". In this article they described a "value innovation" model in which companies must look outside their present paradigms to find new value propositions. Their approach fundamentally goes against Porter's concept that a firm must focus either on cost leadership or on differentiation. They later went on to publish their ideas in the book Blue Ocean Strategy.

An up-to-date critique of generic strategies and their limitations, including Porter, appears in Bowman, C. (2008) Generic strategies: a substitute for thinking? [1]

From the three generic business strategies Porter stress the idea that only one strategy should be adopted by a firm and failure to do so will result in “ stuck in the middle” scenario (Porter 1980 cited by Allen et al. 2006,Torgovicky et al. 2005). He discuss the idea that practising more than one strategy will lose the entire focus of the organisation hence clear direction of the future trajectory could not be established. The argument is based on the fundamental that differentiation will incur costs to the firm which clearly contradicts with the basis of low cost strategy and in the other hand relatively standardised products with features acceptable to many customers will not carry any differentiation (Panayides 2003, p.126) hence, cost leadership and differentiation strategy will be mutually exclusive ( Porter 1980 cited by

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Trogovicky et al. 2005, p.20). Two focal objectives of low cost leadership and differentiation clash with each other resulting in no proper direction for a firm.

However, contrarily to the rationalisation of Porter, contemporary research has shown evidence of firms practising such a “hybrid strategy”. Hambrick (1983 cited by Kim et al. 2004, p.25) identified successful organisations that adopt a mixture of low cost and differentiation strategy (Kim et al. 2004, p.25). Research writings of Davis (1984 cited by Prajogo 2007, p.74) state that firms employing the hybrid business strategy (Low cost and differentiation strategy) outperform the ones adopting one generic strategy. Sharing the same view point, Hill (1988 cited by Akan et al. 2006, p.49) challenged Porter’s concept regarding mutual exclusivity of low cost and differentiation strategy and further argued that successful combination of those two strategies will result in sustainable competitive advantage. As to Wright and other (1990 cited by Akan et al. 2006, p.50) multiple business strategies are required to respond effectively to any environment condition. In the mid to late 1980’s where the environments were relatively stable there was no requirement for flexibility in business strategies but survival in the rapidly changing, highly unpredictable present market contexts will require flexibility to face any contingency (Anderson 1997, Goldman et al. 1995, Pine 1993 cited by Radas 2005, p.197).After eleven years Porter revised his thinking and accepted the fact that hybrid business strategy could exist (Porter cited by Projogo 2007, p.70) and writes in the following manner

…Competitive advantage can be divided into two basic types: lower costs than rivals, or the ability to differentiate and command a premium price that exceeds the extra costs of doing so. Any superior performing firm has achieved one type of advantage, the other or both ( 1991,p.101).

Though Porter had a fundamental rationalisation in his concept about the invalidity of hybrid business strategy, the highly volatile and turbulent market conditions will not permit survival of rigid business strategies since long term establishment will depend on the agility and the quick responsiveness towards market and environmental conditions. Market and environmental turbulence will make drastic implications on the root establishment of a firm. If a firm’s business strategy could not cope with the environmental and market contingencies, long term survival becomes unrealistic. Diverging the strategy into different avenues with the view to exploit opportunities and avoid threats created by market conditions will be a pragmatic approach for a firm.

Critical analysis done separately for cost leadership strategy and differentiation strategy identifies elementary value in both strategies in creating and sustaining a competitive advantage. Consistent and superior performance than competition could be reached with stronger foundations in the event “hybrid strategy” is adopted. Depending on the market and competitive conditions hybrid strategy should be adjusted regarding the extent which each generic strategy (cost leadership or differentiation) should be given priority in practise.

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Porter's Generic StrategiesChoosing Your Route to Competitive Advantage

Which do you prefer when you fly: a cheap, no-frills airline, or a more expensive operator with fantastic service levels and maximum comfort? And would you ever consider going with a small company which focuses on just a few routes?

The choice is up to you, of course. But the point we're making here is that when you come to book a flight, there are some very different options available.

Why is this so? The answer is that each of these airlines has chosen a different way of achieving competitive advantage in a crowded marketplace.

The no-frills operators have opted to cut costs to a minimum and pass their savings on to customers in lower prices. This helps them grab market share and ensure their planes are as full as possible, further driving down cost. The luxury airlines, on the other hand, focus their efforts on making their service as wonderful as possible, and the higher prices they can command as a result more than make up for their higher costs.

Meanwhile, smaller airlines try to make the most of their detailed knowledge of just a few routes to provide better or cheaper services than their larger, international rivals.

These three 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. 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". These are shown in Figure 1 below.

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The terms "Cost Focus" and "Differentiation Focus" can be a little confusing, as they could be interpreted as meaning "A focus on cost" or "A focus on differentiation". Remember that Cost Focus means emphasizing cost-minimization within a focused market, and Differentiation Focus means pursuing strategic differentiation within a focused market.

The Cost Leadership Strategy

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 through charging lower prices, while still making a reasonable profit on each sale because you've reduced costs.

Remember that Cost Leadership is about minimizing the cost to the organization of delivering products and services. The cost or price paid by the customer is a separate issue!

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

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low cost producers who may undercut your prices and therefore block your attempts to increase market share.

You therefore need to be confident that you can achieve and maintain the number one position before choosing the Cost Leadership route. 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. One successful way of doing this is by adopting the Japanese Kaizen philosophy of "continuous improvement".

The Differentiation Strategy

Differentiation involves making your products or services different from and more attractive 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.

To make a success of a generic 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. Otherwise, they risk attack on several fronts by competitors pursuing Focus Differentiation strategies in different market segments.

The Focus Strategy

Companies that use Focus strategies well concentrate on particular niche markets and, by understanding the dynamics of that market and the unique needs of customers in it, develop uniquely low cost or well-specified products for the market. Because they serve customers in their market uniquely well, they

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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.

But 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 "something extra" that you add can contribute to reducing costs (perhaps through your knowledge of specialist suppliers) or to increasing differentiation (though your deep understanding of customers' needs).

Generic strategies apply to not-for-profit organizations too. A not-for-profit can use a Cost Leadership strategy to minimize the cost of getting donations and achieving more for their income, while one with pursing a Differentiation strategy will be committed to the very best outcomes, even if the volume of work they do as a result is lower. Local charities are great examples of organizations using Focus strategies to get donations and contribute to their communities.

Choosing the Right Generic Strategy

Your choice of which generic strategy to pursue underpins every other strategic decision you make, so it's worth spending time to get it right.

But you do need to make a decision: Porter specifically warns against trying to "hedge your bets" by following more than one strategy. One of the most important reasons why this is wise advice is that the things you need to do to make each type of strategy work appeal to different types of people. Cost Leadership requires a very detailed internal focus on processes. Differentiation, on the other hand, demands an outward-facing, highly creative approach.

So, when you come to choose which of the three generic strategies is for you, it's vital that you take your organization's competencies and strengths into account.

Use the following steps to help you choose.

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Step 1: For each generic strategy, carry out a SWOT analysis of your strengths and weaknesses, and the opportunities and threats you would face, if you adopted that strategy.

Having done this, it may be clear that your organization is unlikely to be able to make a success of some of the generic strategies.

Step 2: Use Five Forces Analysis to understand the nature of the industry you are in.

Step 3: Compare the SWOT analyses of the viable strategic options with the results of your Five Forces analysis. For each strategic option, ask yourself how you could use that strategy to:

Reduce or manage supplier power. Reduce or manage buyer/customer power. Come out on top of the competitive rivalry. Reduce or eliminate the threat of substitution. Reduce or eliminate the threat of new entry.

Select the generic strategy that gives you the strongest set of options.

Porter's Generic Strategies offer a great starting point for strategic decision making. Once you've made your basic choice, though, there are still many strategic options available. Bowman's Strategy Clock helps you think at the next level of details, in that it splits Porter's options into eight sub-strategies.

Key Points:

According to Porter's Generic Strategies model, there are three basic strategic options available to organizations for gaining competitive advantage. These are: Cost Leadership, Differentiation and Focus.

Organizations that achieve Cost Leadership can benefit either by gaining market share through lowering prices (whilst maintaining profitability,) or by maintaining average prices and therefore increasing profits. All of this is achieved by reducing costs to a level below those of the organization's competitors.

Companies that pursue a Differentiation strategy win market share by offering unique features that are valued by their customers. Focus strategies involve achieving Cost Leadership or Differentiation within niche markets in ways that are not available to more broadly-focused players.

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Apply This to Your Life

Ask yourself what your organization's generic strategy is. How does this affect the choices your make in your job?

If you're in an organization omitted to achieving Cost Leadership, can you reduce costs by hiring less expensive staff and training them up, or reducing turnover? Can you reduce training costs by devising in-house schemes for sharing skills and knowledge amongst team members? Can you reduce expenses by using technology such as video conferencing over the Internet?

If your organization is pursuing to Differentiation, can you improve customer service? Customer Experience Mapping may help here. Can you help to foster a culture of continuous improvement and innovation in your team?

And if you're working for a company that has a chosen a Focus strategy, what knowledge or expertise can you use or develop to add value for your customers that isn't available to broad market competitors?

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Strategy and Marketing Primer

CONTENTS

1 GENERIC STRATEGY: TYPES OF COMPETITIVE ADVANTAGE.......................................1

2 CONCEPTUAL STRATEGY FRAMEWORKS: HOW COMPETITIVE ADVANTAGE IS CREATED...................................................................................................................................... 2

2.1 PORTER'S 5 FORCES & INDUSTRY STRUCTURE....................................................................22.2 CORE COMPETENCE AND CAPABILITIES...............................................................................52.3 RESOURCE-BASED VIEW OF THE FIRM (RBV)......................................................................62.4 ALTERNATIVE FRAMEWORKS: EVOLUTIONARY CHANGE AND HYPERCOMPETITION..................7

3 ADDITIONAL TOOLS FOR STRATEGIC THINKING AND ANALYSIS.................................9

3.1 GAME THEORY...................................................................................................................93.2 OPTIONS.......................................................................................................................... 103.3 STRATEGIC SCENARIOS....................................................................................................123.4 OTHER PARTICULARLY RELEVANT EES&OR CORE CONCEPTS..........................................13

4 MARKETING MODELS FOR PRODUCT STRATEGY.........................................................14

4.1 NEW PRODUCT DIFFUSION MODELS..................................................................................144.2 CONJOINT ANALYSIS.........................................................................................................15

5 CONCEPTUAL MARKETING FRAMEWORKS....................................................................18

5.1 THE FOUR P’S OF THE MARKETING MIX.............................................................................185.2 MARKET-ORIENTED STRATEGIC PLANNING........................................................................185.3 MARKET SEGMENTATION, TARGETING, AND POSITIONING...................................................205.4 ANALYZING INDUSTRIES AND COMPETITORS.......................................................................225.5 THE TECHNOLOGY ADOPTION LIFE CYCLE: DISCONTINUOUS INNOVATIONS..........................23

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Generic Strategy: Types of Competitive Advantage

Basically, strategy is about two things: deciding where you want your business to go, and deciding how to get there. A more complete definition is based on competitive advantage, the object of most corporate strategy:Competitive advantage grows out of value a firm is able to create for its buyers that exceeds the firm's cost of creating it. Value is what buyers are willing to pay, and superior value stems from offering lower prices than competitors for equivalent benefits or providing unique benefits that more than offset a higher price. There are two basic types of competitive advantage: cost leadership and differentiation.

-- Michael Porter, Competitive Advantage, 1985, p.3

The figure below defines the choices of "generic strategy" a firm can follow. A firm's relative position within an industry is given by its choice of competitive advantage (cost leadership vs. differentiation) and its choice of competitive scope. Competitive scope distinguishes between firms targeting broad industry segments and firms focusing on a narrow segment. Generic strategies are useful because they characterize strategic positions at the simplest and broadest level. Porter maintains that achieving competitive advantage requires a firm to make a choice about the type and scope of its competitive advantage. There are different risks inherent in each generic strategy, but being "all things to all people" is a sure recipe for mediocrity - getting "stuck in the middle".

Treacy and Wiersema (1995) offer another popular generic framework for gaining competitive advantage. In their framework, a firm typically will choose to emphasize one of three “value disciplines”: product leadership, operational excellence, and customer intimacy.

Porter's Generic Strategies (source: Porter, 1985, p.12)

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COMPETITIVE ADVANTAGE

COMPETITIVESCOPE

Lower Cost Differentiation

BroadTarget

NarrowTarget

1. Cost Leadership 2. Differentiation

3A. Cost Focus 3B. Differentiation Focus

References: Porter, Michael, Competitive Advantage, The Free Press, NY, 1985. Porter, Michael, "What is strategy?" Harvard Business Review v74, n6 (Nov-

Dec, 1996):61 (18 pages). Treacy, M., F. Wiersema, The Discipline of Market Leaders, Addison-Wesley,

1995.

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Conceptual Strategy Frameworks: How Competitive Advantage is Created

Frameworks vs. ModelsWe distinguish here between strategy frameworks and strategy models. Strategy models have been used in theory building in economics to understand industrial organization. However, the models are difficult to apply to specific company situations. Instead, qualitative frameworks have been developed with the specific goal of better informing business practice. In another sense, we may also talk about “frameworks” in this class as referring to the guiding analytical approach you take to your project (i.e. decision analysis, economics, finance, etc.).

Some Perspective on Strategy Frameworks: Internal and External Framing for Strategic DecisionsIt may be helpful to think of strategy frameworks as having two components: internal and external analysis. The external analysis builds on an economics perspective of industry structure, and how a firm can make the most of competing in that structure. It emphasizes where a company should compete, and what's important when it does compete there. Porter's 5 Forces and Value Chain concepts comprise the main externally-based framework. The external view helps inform strategic investments and decisions. Internal analysis, like core competence for example, is less based on industry structure and more in specific business operations and decisions. It emphasizes how a company should compete. The internal view is more appropriate for strategic organization and goal setting for the firm.

Porter's focus on industry structure is a powerful means of analyzing competitive advantage in itself, but it has been criticized for being too static in an increasingly fast changing world. The internal analysis emphasizes building competencies, resources, and decision-making into a firm such that it continues to thrive in a changing environment. Though some frameworks rely more on one type of analysis than another, both are important. However, neither framework in itself is sufficient to set the strategy of a firm. The internal and external views mostly frame and inform the problem. The actual firm strategy will have to take into account the particular challenges facing a company, and would address issues of financing, product and market, and people and organization. Some of these strategic decisions are event driven (particular projects or reorgs responding to the environment and opportunity), while others are the subject of periodic strategic reviews.

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Porter's 5 Forces & Industry Structure

What is the basis for competitive advantage?Industry structure and positioning within the industry are the basis for models of competitive strategy promoted by Michael Porter. The “Five Forces” diagram captures the main idea of Porter’s theory of competitive advantage. The Five Forces define the rules of competition in any industry. Competitive strategy must grow out of a sophisticated understanding of the rules of competition that determine an industry's attractiveness. Porter claims, "The ultimate aim of competitive strategy is to cope with and, ideally, to change those rules in the firm's behavior." (1985, p. 4) The five forces determine industry profitability, and some industries may be more attractive than others. The crucial question in determining profitability is how much value firms can create for their buyers, and how much of this value will be captured or competed away. Industry structure determines who will capture the value. But a firm is not a complete prisoner of industry structure - firms can influence the five forces through their own strategies. The five-forces framework highlights what is important, and directs manager's towards those aspects most important to long-term advantage. Be careful in using this tool: just composing a long list of forces in the competitive environment will not get you very far – it’s up to you to do the analysis and identify the few driving factors that really define the industry. Think of the Five Forces framework as sort of a checklist for getting started, and as a reminder of the many possible sources for what those few driving forces could be.

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Porter's 5 Forces - Elements of Industry Structure (source: Porter, 1985, p.6)

New Entrants

BuyersSuppliers

Substitutes

IndustryCompetitors

Intensityof Rivalry

Threat ofSubstitutes

Threat ofNew Entrants

Bargaining Powerof Suppliers

Bargaining Powerof Buyers

Determinants of Buyer Power

Bargaining Leverage• Buyer concentration vs. firm concentration• Buyer volume• Buyer switching costs relative to firm switching costs• Buyer information• Ability to backward integrate• Substitute products• Pull-through

Price Sensitivity• Price/total purchases• Product differences• Brand identity• Impact on quality/ performance• Buyer profits• Decision maker’s incentives

Determinants of Substitution Threat• Relative price performance of substitutes• Switching costs• Buyer propensity to substitute

Rivalry Determinants• Industry growth• Fixed (or storage) costs / value added• Intermittent overcapacity• Product differences• Brand identity• Switching costs• Concentration and balance• Informational complexity• Diversity of competitors• Corporate stakes• Exit barriers

Entry Barriers• Economies of scale• Proprietary product differences• Brand identity• Switching costs• Capital requirements• Access to distribution• Absolute cost advantages Proprietary learning curve Access to necessary inputs Proprietary low-cost product design• Government policy• Expected retaliation

Determinants of Supplier Power• Differentiation of inputs• Switching costs of suppliers and firms in the industry• Presence of substitute inputs• Supplier concentration• Importance of volume to supplier• Cost relative to total purchases in the industry• Impact of inputs on cost or differentiation• Threat of forward integration relative to threat of backward integration by firms in the industry

How is competitive advantage created?At the most fundamental level, firms create competitive advantage by perceiving or discovering new and better ways to compete in an industry and bringing them to market, which is ultimately an act of innovation. Innovations shift competitive advantage when rivals either fail to perceive the new way of competing or are unwilling or unable to respond. There can be significant advantages to early movers responding to innovations, particularly in industries with significant economies of scale or when customers are more concerned about switching suppliers. The most typical causes of innovations that shift competitive advantage are the following: new technologies new or shifting buyer needs the emergence of a new industry segment shifting input costs or availability changes in government regulations

How is competitive advantage implemented?But besides watching industry trends, what can the firm do? At the level of strategy implementation, competitive advantage grows out of the way firms perform discrete activities - conceiving new ways to conduct activities, employing

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new procedures, new technologies, or different inputs. The "fit" of different strategic activities is also vital to lock out imitators. Porters "Value Chain" and "Activity Mapping" concepts help us think about how activities build competitive advantage.

The value chain is a systematic way of examining all the activities a firm performs and how they interact. It scrutinizes each of the activities of the firm (e.g. development, marketing, sales, operations, etc.) as a potential source of advantage. The value chain maps a firm into its strategically relevant activities in order to understand the behavior of costs and the existing and potential sources of differentiation. Differentiation results, fundamentally, from the way a firm's product, associated services, and other activities affect its buyer's activities. All the activities in the value chain contribute to buyer value, and the cumulative costs in the chain will determine the difference between the buyer value and producer cost.

A firm gains competitive advantage by performing these strategically important activities more cheaply or better than its competitors. One of the reasons the value chain framework is helpful is because it emphasizes that competitive advantage can come not just from great products or services, but from anywhere along the value chain. It's also important to understand how a firm fits into the overall value system, which includes the value chains of its suppliers, channels, and buyers.

With the idea of activity mapping, Porter (1996) builds on his ideas of generic strategy and the value chain to describe strategy implementation in more detail. Competitive advantage requires that the firm's value chain be managed as a system rather than a collection of separate parts. Positioning choices determine not only which activities a company will perform and how it will configure individual activities, but also how they relate to one another. This is crucial, since the essence of implementing strategy is in the activities - choosing to perform activities differently or to perform different activities than rivals. A firm is more than the sum of its activities. A firm's value chain is an interdependent system or network of activities, connected by linkages. Linkages occur when the way in which one activity is performed affects the cost or effectiveness of other activities. Linkages create tradeoffs requiring optimization and coordination.

Porter describes three choices of strategic position that influence the configuration of a firm's activities: variety-based positioning - based on producing a subset of an industry's

products or services; involves choice of product or service varieties rather than customer segments. Makes economic sense when a company can produce particular products or services using distinctive sets of activities. (i.e. Jiffy Lube for auto lubricants only)

needs-based positioning - similar to traditional targeting of customer segments. Arises when there are groups of customers with differing needs,

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and when a tailored set of activities can serve those needs best. (i.e. Ikea to meet all the home furnishing needs of a certain segment of customers)

access-based positioning - segmenting by customers who have the same needs, but the best configuration of activities to reach them is different. (i.e. Carmike Cinemas for theaters in small towns)

Porter's major contribution with "activity mapping" is to help explain how different strategies, or positions, can be implemented in practice. The key to successful implementation of strategy, he says, is in combining activities into a consistent fit with each other. A company's strategic position, then, is contained within a set of tailored activities designed to deliver it. The activities are tightly linked to each other, as shown by a relevance diagram of sorts. Fit locks out competitors by creating a "chain that is as strong as its strongest link." If competitive advantage grows out of the entire system of activities, then competitors must match each activity to get the benefit of the whole system.

Porter defines three types of fit: simple consistency - first order fit between each activity and the overall

strategy reinforcing - second order fit in which distinct activities reinforce each other optimization of effort - coordination and information exchange across activities

to eliminate redundancy and wasted effort.

How is competitive advantage sustained?Porter (1990) outlines three conditions for the sustainability of competitive advantage: Hierarchy of source (durability and imitability) - lower-order advantages such

as low labor cost may be easily imitated, while higher order advantages like proprietary technology, brand reputation, or customer relationships require sustained and cumulative investment and are more difficult to imitate.

Number of distinct sources - many are harder to imitate than few. Constant improvement and upgrading - a firm must be "running scared,"

creating new advantages at least as fast as competitors replicate old ones.

References: Porter, Michael, Competitive Advantage, The Free Press, NY, 1985. Porter, Michael, The Competitive Advantage of Nations, The Free Press, NY,

1990. Porter, Michael, "What is strategy?" Harvard Business Review v74, n6 (Nov-

Dec, 1996):61 (18 pages).

Core Competence and Capabilities

Proponents of this framework emphasize the importance of a dynamic strategy in today's more dynamic business environment. They argue that a strategy based

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on a "war of position" in industry structure works only when markets, regions, products, and customer needs are well defined and durable. As markets fragment and proliferate, and product life cycles accelerate, "owning" any particular market segment becomes more difficult and less valuable. In such an environment, the essence of strategy is not the structure of a company's products and markets but the dynamics of its behavior. A successful company will move quickly in and out of products, markets, and sometimes even business segments. Underlying it all, though, is a set of core competencies or capabilities that are hard to imitate and distinguish the company from competition. These core competencies, and a continuous strategic investment in them, govern the long term dynamics and potential of the company.

What are core competencies and capabilities? Prahalad and Hamel (1990) speak of core competencies as the collective

learning in the organization, especially how to coordinate diverse production skills and integrate multiple streams of technology. These skills underlie a company's various product lines, and explain the ease with which successful competitors are able to enter new and seemingly unrelated businesses. Three tests can be applied to identify core competencies: (1) provides potential access to wide variety of markets, (2) makes significant contribution to end user value, and (3) difficult for competitors to imitate.

Examples of core competence: Sony in miniaturization, allowing it to make everything from Walkmans to video cameras to notebook computers. Canon's core competence in optics, imaging, and microprocessor controls have enabled it to enter markets as seemingly diverse as copiers, laser printers, cameras, and image scanners.

Stalk, Evans, and Schulman (1992) speak of capabilities similarly, but defined more broadly to encompass the entire value chain rather than just specific technical and production expertise.

Examples of capabilities: Wal-mart in inventory management, Honda in dealer management and product realization.

Implications for strategy? Portfolio of competencies. An essential lesson of this framework is that

competencies are the roots of competitive advantage, and therefore businesses should be organized as a portfolio of competencies (or capabilities) rather than a portfolio of businesses. Organization of a company into autonomous strategic business units, based on markets or products, can cripple the ability to exploit and develop competencies - it unnecessarily restricts the returns to scale across the organization. Core competence is communication, involvement, and a deep commitment to working across organizational boundaries.

Products based on competencies. Product portfolios (at least in technology-based companies) should be based on core competencies, with core products being the physical embodiment of one or more core competencies. Thus, core competence allows both focus (on a few competencies) and

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diversification (to whichever markets firm's capabilities can add value). To sustain leadership in their chosen core competence areas, companies should seek to maximize their world manufacturing share in core products. This partly determines the pace at which competencies can be enhanced and extended (through a learning-by-doing sort of improvement).

Continuous investment in core competencies or capabilities. The costs of losing a core competence can be only partly calculated in advance - since the embedded skills are built through a process of continuous improvement, it is not something that can be simply bought back or "rented in" by outsourcing. Wal-mart, for example, has invested heavily in its logistics infrastructure, even if the individual investments could not be justified by ROR analysis. They were strategic investments that enabled the company's relentless focus on customer needs. While Wal-mart was building up its competencies, K-mart was outsourcing whenever it was cheapest.

Caution: core competencies as core rigidities. Bowen et al. talk about the limitations to restricting product development to areas in which core competencies already exist, or core rigidities. Good companies may try to incrementally improve their competencies by bringing in one or two new core competencies with each new major development project they pursue.

References: Bowen, Clark, Holloway, Wheelright, Perpetual Enterprise Machine, Oxford

Press, 1994. Prahalad, C.K. and Gary Hamel, "The Core Competence of the Corporation,"

Harvard Business Review, v68, n3 (May-June, 1990):79 (13 pages). Stalk, G., Evans, P., and L. Schulman, "Competing on Capabilities: the New

Rules of Corporate Strategy," v70, n2 (March-April, 1992):57 (13 pages).

Resource-Based View of the Firm (RBV)

What is RBV?The RBV framework combines the internal (core competence) and external (industry structure) perspectives on strategy. Like the frameworks of core competence and capabilities, firms have very different collections of physical and intangible assets and capabilities, which RBV calls resources. Competitive advantage is ultimately attributed to the ownership of a valuable resource. Resources are more broadly defined to be physical (e.g. property rights, capital), intangible (e.g. brand names, technological know how), or organizational (e.g. routines or processes like lean manufacturing). No two companies have the same resources because no two companies have had the same set of experience, acquired the same assets and skills, or built the same organizational culture. And unlike the core competence and capabilities frameworks, though, the value of the broadly-defined resources is determined in the interplay with

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market forces. Enter Porter's 5 Forces. For a resource to be the basis of an effective strategy, it must pass a number of external market tests of its value.

Collins and Montgomery (1995) offer a series of five tests for a valuable resource:1. Inimitability - how hard is it for competitors to copy the resource? A company

can stall imitation if the resource is (1) physically unique, (2) a consequence of path dependent development activities, (3) causally ambiguous (competitors don't know what to imitate), or (4) a costly asset investment for a limited market, resulting in economic deterrence.

2. Durability - how quickly does the resource depreciate?3. Appropriability - who captures the value that the resource creates: company,

customers, distributors, suppliers, or employees?4. Substitutability - can a unique resource be trumped by a different resource?5. Competitive Superiority - is the resource really better relative to competitors?

Similarly, but from a more external, economics perspective, Peteraf (1993) proposes four theoretical conditions for competitive advantage to exist in an industry:1. Heterogeneity of resources => rents exist

A basic assumption is that resource bundles and capabilities are heterogeneous across firms. This difference is manifested in two ways. First, firms with superior resources can earn Ricardian rents (profits) in competitive markets because they produce more efficiently than others. What is key is that the superior resource remains in limited supply. Second, firms with market power can earn monopoly profits from their resources by deliberately restricting output. Heterogeneity in monopoly models may result from differentiated products, intra-industry mobility barriers, or first-mover advantages, for example.

2. Ex-post limits to competition => rents sustainedSubsequent to a firm gaining a superior position and earning rents, there must be forces that limit competition for those rents (imitability and substitutability).

3. Imperfect mobility => rents sustained within the firmResources are imperfectly mobile if they cannot be traded, so they cannot be bid away from their employer; competitive advantage is sustained.

4. Ex-ante limits to competition => rents not offset by costsPrior to the firm establishing its superior position, there must be limited competition for that position. Otherwise, the cost of getting there would offset the benefit of the resource or asset.

Implications for strategy? Managers should build their strategies on resources that pass the above

tests. In determining what are valuable resources, firms should look both at external industry conditions and at their internal capabilities. Resources can

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come from anywhere in the value chain and can be physical assets, intangibles, or routines.

Continuous improvement and upgrading of the resources is essential to prospering in a constantly changing environment. Firms should consider industry structure and dynamics when deciding which resources to invest in.

In corporations with a divisional structure, it's easy to make the mistake of optimizing divisional profits and letting investment in resources take a back seat.

Good strategy requires continual rethinking of the company's scope, to make sure it's making the most of its resources and not getting into markets where it does not have a resource advantage. RBV can inform about the risks and benefits of diversification strategies.

References: Collis, David J.; Montgomery, Cynthia A. "Competing on resources: strategy

in the 1990s", Harvard Business Review, v73, n4 (July-August, 1995):118 (11 pages).

M.A. Peteraf, "The Cornerstones of Competitive Advantage: A Resource-Based View," in Strategic Management Journal 1993, Vol. 14, pp. 179-191.

Alternative Frameworks: Evolutionary Change and Hypercompetition

Recently, strategy literature has focused on managing change as the central strategic challenge. Change, the story goes, is the striking feature of contemporary business, and successful firms will be the ones that deal most effectively with change, not simply those that are good at planning ahead. When the direction of change is too uncertain, managers simply cannot plan effectively. When industries are rapidly and unpredictably changing, strategy based on industry analysis, core capabilities, and planning may be inadequate by themselves, and would be well complemented by an orientation towards dealing with change effectively and continuously.

Evolutionary ChangeTheories that draw analogies between biological evolution and economics or business can very satisfying: they explain the way things work in the real world, where analysis and planning is often a rarity. Moreover, they suggest that strategies based on flexibility, experimentation and continuous change and learning can be even more important than rigorous analysis and planning. Indeed, overplanning is a danger to be avoided.

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In Competing on the Edge, Eisenhardt (1998) advocates a strategy based on what she calls "competing on the edge," combining elements of complexity theory with evolutionary theory. In such a framework, firms develop a "semi-coherent strategic direction" of where they want to go. They do this by having the right balance between order and chaos - firms can then successfully evolve and adapt to their unpredictable environment. By competing at the "edge of chaos," a firm creates an organization that can change and produce a continuous flow of competitive advantages that form the "semi-coherent" direction. Firms are not hindered by too much planning or centralized control, but they have enough structure so that change can be organized to happen. They successfully evolve, because they pursue a variety of moves, and in doing so make some mistakes but also relentlessly reinvent the business by discovering new growth opportunities. This strategy is characterized by being unpredictable, uncontrolled, and inefficient, but it works. It's important to note that firms should not just react well to change, but must also do a good job of anticipating and leading change. In successful businesses, change is time-paced, or triggered by the passage of time rather than events.

In Built to Last, Collins and Porras (1994) outline habits of long-successful, visionary companies. Underlying the habits is an orientation towards evolutionary change: try a lot of stuff and keep what works. Evolutionary processes can be a powerful way to stimulate progress. Importantly, though, Collins and Porras also find that successful companies each have a core ideology that must be preserved throughout the progress. There is no one formula for the "right" set of core values, but it is important to have them. In strategy-speak, it is this core ideology that most fundamentally differentiates the firm from competitors, regardless of which market segments they get into. They are deeply held values that go beyond "vision statements" - they are mechanisms and systems that are built into the system over time. Attention to the core beliefs may sometimes defy short-term profit incentives or conventional business wisdom, but it is important to maintain them. Examples of core ideologies are: HP's commitment to making an "original technical contribution" in every market they enter, Wal-mart's "exceed customer expectations," Boeing's "being on the leading edge of aviation," and 3M's "respect for individual initiative." Notice the "maximize shareholder wealth" is not an adequate core ideology - it does not inspire people at all levels and provides little guidance.

In the context of strategy and planning, this book offers a couple of important lessons: Unplanned, evolutionary change can be an important component to success.

Strategy and planning should foster and complement such change, not suffocate it.

Certain core beliefs are fundamental to organizations, and should be preserved at all costs. Not everything about an organization is a candidate for change in considering alternative strategies.

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HypercompetitionTraditional approaches to strategy stress the creation of advantage, but the concept of hypercompetition teaches that strategy is also the creative destruction of an opponent advantage. This is because in today's environment, traditional sources of competitive advantage erode rapidly, and sustaining advantages can be a distraction from developing new ones. Competition has intensified to make each of the traditional sources of advantage more vulnerable; the traditional sources are: price & quality, timing and know-how, creation of strongholds (entry barriers have fallen), and deep pockets. The primary goal of this new approach to strategy is disruption of the status quo, to seize the initiative through creating a series of temporary advantages. It is the speed and intensity of movement that characterizes hypercompetition. There is no equilibrium as in perfect competition, and only temporary profits are possible in such markets.

Successful strategy in hypercompetitive markets is based on three elements: Vision for how to disrupt a market (setting goals, building core competencies

necessary to create specific disruptions) Key capabilities enabling speed and surprise in a wide range of actions Disruptive tactics illuminated by game theory (shifting the rules of the game,

signaling, simultaneous and strategic thrusts)

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Additional Tools for Strategic Thinking and Analysis

Game TheoryGame Theory in StrategyGame theory helps analyze dynamic and sequential decisions at the tactical level. The main value of game theory in strategy is to emphasize the importance of thinking ahead, thinking of the alternatives, and anticipating the reactions of other players in your "game." Key concepts relevant to strategy are the payoff matrix, extensive form games, and the core of a game. Application areas in strategy are: new product introduction licensing versus production pricing R&D advertising regulation

The Importance of Understanding "The Game"Successful strategy cannot depend just on one firm's position in industry, capabilities, activities, or what have you. It depends on how others react to your moves, and how others think you will react to theirs. By fully understanding the dynamic with others, you can recognize win-win strategies that make you better off in the long term, and signaling tactics that avoid lose-lose outcomes. Moreover, if you understand the game, you can take actions to change the rules or players of the game in your favor. Brandenburger and Nalebuff (1995) give some good examples of this. One way a company can change the game and capture more value is by changing the value other players can bring to it, as the Nintendo example illustrated. In summary, companies can change their game of business in their favor by changing: players ("Value Net") - customers, suppliers, substitutors, and complementors

(not just the competitors) added values - the value that each player brings to the collective game rules - laws, customs, contracts, etc. that give a game its structure tactics - moves used to shape the way players perceive the game and hence

how they play scope - boundaries of the game.

Game theory has been a burgeoning branch of economics in recent years. It is a complex subject that spans games of static (one-time) and dynamic (repeated) nature under perfect or imperfect information. The references below will be helpful for those wishing to explore the theory and modeling of game theory in more detail. For strategy, though, it can often be a major step just to recognize

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certain situations as games, and thinking about how a player can set out to change the game.

References:Introduction to game theory in corporate strategy Oster, S.M., Modern Competitive Analysis, Chapter, 13, Oxford Press, 1994,

pp.237-250. Brandenburger, Adam M.; Nalebuff, Barry J. "The right game: use game

theory to shape strategy" Harvard Business Review v73, n4 (July-August, 1995):57.

Basic introduction to game theory concepts A.K. Dixit and B. J. Nalebuff, Thinking Strategically: The Competitive Edge in

Business, Politics, and Everyday Life, W.W. Norton & Company, pp. 347-367 Gibbons, R., Game Theory for Applied Economists, Princeton: Princeton

University Press, 1992. Binmore, K., Fun and Games: A Text on Game Theory, Lexington: D.C.

Heath & Co., 1992.

More advanced economics texts on game theory Fudenberg, D. and J. Tirole, Game Theory, Cambridge: MIT Press, 1991. Myerson, R., Game Theory: An Analysis of Conflict, Cambridge: Harvard

University Press, 1991.

OptionsOptions theory has influenced corporate strategy unlike any other paradigm coming from Wall Street. The “real option” is analogous to the financial option in that a company with an investment opportunity holds the right but not the obligation to purchase an asset at some time in the future. Business schools have taught managers to analyze/evaluate investment decisions using net present value (NPV), which assumes one of two things: 1) the investment is reversible or 2) if not, it is a now-or-never proposition. In fact, most investment decisions are irrevocable allocations of resources and capable of being delayed. Dixit and Pindyck (1995) discuss how the options approach to capital investment provides a richer framework that allows managers to address the issues of irreversibility, uncertainty, and timing more directly.

The options framework places value on flexibility (keeping the investment option alive) and modularity (creating options):

Flexibility examples: 1) Investments in R&D can create options that allow the company to undertake other investments in the future should market conditions be favorable. 2) A mining facility operating at a loss given current prices may be

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deliberately kept open because closure would incur the opportunity cost of giving up the option to wait for higher future prices.

Modularity examples: 1) A land purchase could lead to development of mineral reserves. 2) An electric utility could invest in small additions to capacity as needed to meet uncertain demand instead of building expensive, large-scale plants.

The option is structured such that the company can exercise it when profitable and let it expire when it is not, depending on how uncertainty is resolved. As long as there are some contingencies under which the company would choose not to invest, the option has value. Thus, options theory captures the fact that the greater the uncertainty, the greater the value of the opportunity and the greater the incentive to wait and keep the option alive rather than exercise it.

Implications for strategy? The options approach is particularly appropriate for companies in very volatile

and unpredictable industries, such as electronics, telecommunications, biotech, and pharmaceutical industries.

When raising capital, greater value should be placed on investments that create options, compared to those that exercise options.

Options are especially appropriate for analyzing a series of phased investments.

Options theory helps us understand how traditional discounted cash flow analysis systematically underestimates the benefits of waiting.

Real options also provide a means for evaluating disinvestment, an often overlooked opportunity to avoid future losses (e.g., closing a facility in response to a market downturn).

Consider whether the client would be in a better position after some uncertainty is resolved. In framing alternatives, consider strategies that include downstream decisions. Options might be the ideal way to model such decision opportunities.

Introductory Books on Real Options

Amram, M. and N. Kulatilaka, Real Options : Managing Strategic Investment in an Uncertain World, Harvard Business School Press, 1998.- takes the finance approach to real options, much like the Luenberger text.

Focus is on problems in which risks are priced by exchange traded securities (market risks).

Real Options in Capital Investment, Trigeorgis, L, editor, 1995.- A collection of articles intended for both academic and professional audience.

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Trigeorgis, L., Real Options : Managerial Flexibility and Strategy in Resource Allocation, MIT Press, 1996.- Perhaps the best overall general introduction to real options, without taking a strictly finance or strictly decision analytic approach. Features a good comparison of various approaches to valuing risky investments. A practical approach that is not as academic as Dixit and Pindyck.

Academic References

Dixit, Avinash K. and Robert S. Pindyck, Investment Under Uncertainty, Princeton, 1994.The book to read if you are interested in mathematical formulations of real options problems (i.e. dynamic programming and stochastic differential equations)

Luenberger, D., Investment Science, Oxford Univ. Press, 1997Luenberger’s binomial lattice approach is a useful simplification of dynamic programming approaches to real options. The book also includes some powerful finance tools for pricing market risk.

Smith, James E., “Options in the real world: Lessons learned in evaluating oil and gas investments,” Operations Research, Jan/Feb 1999.

Smith, James E. and Robert Nau, “Valuing Risky Projects: Option Pricing Theory and Decision Analysis,” Management Science, Vol. 41, No. 5, May 1995.

Smith, James E., “Valuing Oil Properties: Integrating Option Pricing and Decision Analysis Approaches,” Operations Research, Mar/Apr 1998.

- Jim Smith’s work has been instrumental in integrating the decision analysis and finance approaches to risky investments. Focuses mainly on problems that are at least partly influenced by market-spanning risks (i.e. risks that are priced by exchange traded derivatives, such as oil and gas futures)

Popular Business ReferencesA number of recent articles have promoted real options to the general management audience:

Amram, M., N. Kulatilaka, “Disciplined decisions: Aligning strategy with the financial markets,” Harvard Business Review, Jan/Feb 1999.- a concise summary of the concepts in their book (see above).

Dixit, Avinash K. and Robert S. Pindyck, “The Options Approach to Capital Investment,” Harvard Business Review, May 1995.- a good overview of why flexibility in decision making is important. Written by the authors who are also experts in the academic real options literaure. A good starting point for those who are already familiar with decision analysis.

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Leslie, K. and Michaels, M. “The Real Power of Real Options,” McKinsey Quarterly, 1997 No 3.- promotes the intuition from analysis of real options as a framework for strategic thinking.

Copeland, T. and P. Keenan, “How much is flexibility worth,” McKinsey Quarterly, 1998 No 2- general introduction to real options as a means to price market risk, focusing more on the finance tradition of real options (no arbitrage pricing) than the decision analysis tradition. Useful if you are dealing with uncertainties that are tracked well by the market (i.e. oil and gas prices, etc.)

Luehrman, T., “Investment Opportunities as Real Options: Getting Started on the Numbers,” Harvard Business Review, July 1998.

Luehrman, T., “Strategy as a Portfolio of Real Options,” Harvard Business Review, September 1998.

- try to generalize the Black-Scholes basis for real options thinking to a general audience. A bit hoky and simplistic.

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Strategic ScenariosScenarios are powerful vehicles for challenging our mental models of the world. The value is not in predicting the future, but in making better decisions today. The decision makers could be individuals, businesses, or policy makers. Scenarios are a nice complement to the principles of decision analysis: the DA cycle ends in decisions and insights, while the scenario process ends in a scenario.

Why Develop Scenarios? - Uncovering the DecisionBesides predicting the future, scenarios aid in strategic decision making: Make the decision conscious. The first step in the scenario process is making

the decision conscious. People's decision agenda is often unconscious, and people should not avoid a decision just because they feel powerless.

Articulate current mindsets. Scenarios are like stories we can tell ourselves - they are a powerful way of suspending disbelief and avoiding the dangers of denial. Often, people may refuse to think about possibilities that are unappealing to them. The process of scenario building, considering both optimistic and pessimistic and just plain different futures, overly exposes "mental models" and assumptions that may be inbred in the organization.

Develop insights and solid instincts. Insights come from asking the right questions - from having to consider more than one scenario. Also, scenario building helps develop a gut feeling for a situation, and assures us that we've been comprehensive in covering the bases relevant to our decision.

How to Develop Scenarios?Developing scenarios is similar to developing and pruning influence diagrams in DA, but the scope of consideration is a little broader with scenarios. Still, scenario builders should consider both narrow (situation specific) and broad questions. Typically, the scenario building exercise will result in no more than four scenarios - any more is too complex to draw insights. The set of scenarios should span a range of outcomes; typically something like "same but better," "worse," and "different but better."

Steps to developing scenarios are as follows:1. Identify the focal issue or decision. (DA analogue: frame the decision)2. Identify the basic driving forces influencing the outcome: social, technological,

economic, political, environmental. (DA analogue?)3. Identify the key forces in the local environment: determining the

predetermined elements and critical uncertainties. (DA analogue: identify the uncertainties)

4. Rank the uncertainties in order of importance. (DA analogue: tornado diagram)

5. Selecting scenario plots (logics). Scenario plots typically run according to certain logics, like:winners & losers, challenge & response, evolution, revolution, cycles, etc.

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6. Flesh out scenarios. Each plot will lead to a different decision today. From the different plots, narrow and combine them to form two or three coherent scenarios.

7. Assess implications of scenarios on decision.8. Identify leading indicators and signposts. Learn to notice symptoms, cues,

and warning signals of certain plots unraveling before you.

References: Schwarz, Peter, The Art of the Long View: Planning for the Future in an

Uncertain World, Doubleday, New York, 1991. Schwartz, Peter, "Composing a Plot for Your Scenario," Plannning Review

20, no. 3 (1992):41-46. Mason, David H. "Scenario-based Planning: Decison Model for the Learning

Organization," Planning Review 22, no. 2 (1994):6-11. (This also introduces the idea of organizational learning).

Simpson, Daniel G., "Key Lessons for Adopting Scenario Planning in Diversified Companies," Planning Review 20, no. 3 (1992): 10-17, 47-48.

Other Particularly Relevant EES&OR Core Concepts

Students in EES&OR have a host of analytical tools available to add insight to strategic thinking and analysis. Some of the more directly relevant topics include:

Decision Analysis- decision hierarchy and framing- strategy tables- tornado diagrams- analysis of decisions under uncertainty- value of information- options in decisions

Finance- investment analysis- real options

Economics- demand-oriented pricing (dynamic, monopolistic pricing)- game theory

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Marketing Models for Product Strategy

EES&OR 483 teaches two product planning methodologies that may be used independently or as complements to each other. They add rigor to strategy at the level of product planning and implementation. An excellent reference for these and other marketing models is Lilien and Rangasaway (1998).

New Product Diffusion ModelsThe diffusion process is the spread of an idea or the penetration of a market by a new product from its source of creation to its ultimate users or adopters. Note that adoption refers to the decision to use an innovation regularly, whereas diffusion is only concerned with initial trial of the product. (Source: Lilien, Kotler and Moorthy, 1992, p. 461)

There are two types of diffusion effects: Innovation: trial of product caused by advertising and promotions Imitation: trial of product caused by word-of-mouth recommendations and

reputation

Prior to Bass (1969), diffusion models were either pure innovative (assume diffusion only caused by external forces) or pure imitative (assume diffusion only caused by imitation / word of mouth). The Bass model combines innovative and imitative behavior into one model:

where:

= Magnitude of trial demand (= the number of adopters at time t = derivative of N with respect to t)

= Cumulative number of adopters= Potential number of ultimate adopters= Influence parameter for innovation= Influence parameter for imitation

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This expression can be rewritten for additional intuitive understanding using the equivalent representation:

Terms can be interpreted as representing one group of innovators and one group of imitators, or as representing both the internal and external influences on all adopters.

Important Guidelines for Market Forecasting The model forecasts total market potential for a product, not sales for a particular company.

Company sales would depend on market share of the total, which depends on particular product variables like quality, cost, and promotion, and distribution. Diffusion models only help with the big picture; use conjoint analysis or other methods to forecast market share.

In practice the actual coefficients are usually estimated by analogy to past products. Coefficients for past products are generally available in tables, or may be estimated by regression.

Remember that diffusion models only represent demand associated with the trial of a product. Additional terms need to be added to account for repeat purchase. A model that takes into consideration both trial and repeat purchase demand would be a complete sales forecast.

The Bass model is a predictive model that is most appropriate for forecasting sales of a discontinuous new technology or durable product that has no competitors. In such situations, the success of the product may be particularly uncertain, and the Bass model forecast may only depict one possible outcome.

Where you are in the product life cycle dictates the marketing and customer segmentation strategy. With discontinuous innovations different marketing strategies are called for at different stages of the technology life cycle to ensure that the product reaches a mass market (see Section 5.5).

More recent research has focused on relaxing the assumptions of the Bass model: Allowing market potential to vary over time Not restricting that diffusion of an innovation be independent of all other innovations Allowing geographical boundaries of the system in which diffusion takes place to vary over

time Incorporating the effect of marketing actions such as pricing, advertising, etc. on the diffusion

process Considering supply restrictions Consideration of uncertainty Consider variations in diffusion rates in different countries Allow word of mouth effects to vary over time

The area of marketing planning modeling includes the incorporation of feedback effects into diffusion models to turn advertising and pricing decisions over time into optimal control problems.

References

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Lilien, Gary L., Philip Kotler, and K. Sridhar Moorthy, Marketing Models (1992):457 (44 pages)

Lilien, Gary, and A. Rangasaway, Marketing Engineering, Addison-Wesley, 1998, pp.195-204.

Mahajan,Vijay, Eitan Muller, and Frank M. Bass, “New-Product Diffusion Models,” Handbooks in OR & MS, v. 5 (1993): 349 (23 pages).

Conjoint AnalysisConjoint analysis is market research methodology for modeling the market. A quantitative, grass-roots approach, conjoint analysis is used to predict consumer preferences for multiattribute alternatives. It is based on economic and psychological research on consumer behavior, especially at the individual level, which is considered key to making accurate predictions of the total market. The subject of a conjoint study can be either a physical product or a service, and the market can include both new and existing products/services.

What is conjoint analysis?Think of the decision process that consumers go through when choosing between complex alternatives. Products vary in terms of their features, performance, and quality and thus are offered at various prices. Conjoint analysis considers a product in terms of a bundle of attributes, or characteristics. Through an interview, data are collected from respondents to capture the tradeoffs they make between attributes. These data are processed to estimate a utility function that expresses each respondent’s value for product attributes. These utility values are then used in a market model or simulator to make predictions about how consumers would choose among new, modified, and existing products. Conjoint analysis allows us to analyze future market scenarios based on primary market research. Other techniques, such as historical analysis, would be insufficient to forecast the market for new products, whereas conjoint analysis can model consumers’ reaction to hypothetical products that may not yet exist.

Conjoint analysis is a decompositional model in that values are derived from consumers’ responses to interview questions, as compared to asking consumers to directly estimate model parameters. In direct assessment, respondents are asked how likely they are to buy a certain product or how much they would be willing to pay for a product with an attribute improvement. This technique is limited in that products are not shown in a competitive context and these questions do not generally represent realistic purchase decisions. Alternatively, conjoint analysis uses inference, which provides a more accurate picture of consumers’ buying behavior. In the analysis of responses to questions about hypothetical product concepts, we can infer the value to each respondent of having each attribute level. Rather than expecting respondents to provide direct assessments, they are asked to make a number of decisions that are more

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realistic and natural. In a typical pairwise comparison, two product concepts are considered jointly. For instance:

Which drug treatment would you prefer?

Major side effects

High efficacy

Minor side effects

Moderate efficacy

A B

Implications for strategy?The scope of product planning issues addressed with conjoint analysis ranges from the tactical level to the strategic level. The following is a list of some of the product planning decisions for which conjoint analysis is currently used worldwide:

Pricing New product design Product positioning Competitive strategy Marketing strategies Market segmentation Investment decisions Sales forecasting Capacity planning Distribution planning

Conjoint analysis is a widespread, time-proven strategic tool. To ensure success, practitioners must carefully set client expectations regarding what conjoint can and cannot do. Conjoint simulators are directional indicators that can provide significant insight into the relative importance of product features and preferences for product configurations. These market simulators predict preference share, that is market share potential. Many internal and external influences such as awareness, marketing, sales force effectiveness, and distribution drive market share in the real world. Unless these effects are explicitly modeled in, care should be taken to regard the model results as preference shares that assume perfect market penetration.

Conjoint analysis is implemented using commercially available software and custom-programmed applications. Descriptions of packages available from one of the leading developers, Sawtooth Software, are listed in the references below.

References (organized by needs/interest and ordered by usefulness):

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A host of references and guides to choosing software are available at http://www.sawtoothsoftware.com/ Getting Started with Conjoint on Your Project Curry, Joseph, “Conjoint Analysis: After the Basics” Orme, Bryan, “Which Conjoint Method Should I Use” (1997)

Client Interaction Curry, Joseph, “Understanding Conjoint Analysis in 15 Minutes” Orme, Bryan, “Helping Managers Understand the Value of Conjoint” Sawtooth Software, “Using Choice-Based Conjoint to Assess Brand Strength

and Price Sensitivity” (1996)

Choosing the Appropriate Software Sawtooth Software, “ACA System – Adaptive Conjoint Analysis, Version 4.0”

(1991-1996) Sawtooth Software, “CVA – A Full-Profile Conjoint System from Sawtooth

Software, Version 2.0” Sawtooth Software, “The CBC System for Choice-Based Conjoint Analysis”

(Jan 1995) Struhl, Steven, “Discrete Choice Modeling: Understanding a “Better Conjoint

than Conjoint”

Conjoint Methodology Design and Research Green, Paul E. and Abba M. Krieger, “Conjoint Analysis with Product-

Positioning Applications,” Handbooks in OR & MS, v. 5 (1993):467 (35 pages) Lilien, Gary, and A. Rangasaway, Marketing Engineering, Addison-Wesley,

1998, pp184-194. Huber, Joel, “What We Have Learned from 20 Years of Conjoint Research:

When to Use Self-Explicated, Graded Pairs, Full Profiles or Choice Experiments”

McFadden, Daniel F., “Conditional Logit Analysis of Qualitative Choice Behavior,” Frontiers of Econometrics (1973)

Green, Paul and Abba Krieger, “Individualized Hybrid Models for Conjoint Analysis”, Management Science/Vol.42, No.6 (June 1996)

Huber, Joel, Dan Ariely, and Gregory Fischer, “The Ability of People to Express Values with Choices, Matching and Ratings” (1998)

Orme, Bryan, Mark Alpert, and Ethan Christensen, “Assessing the Validity of Conjoint Analysis-Continued”

Huber, Joel, Dick Wittink, and Richard Johnson, “Learning Effects in Preference Tasks: Choice-Based Versus Standard Conjoint” (1992)

Wittink, Dick, and Joel Huber, John Fiedler, and Richard Miller, “The Magnitude of and an Explanation/Solution for the Number of Levels Effect in Conjoint Analysis” (1991)

Case Studies

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Page, Albert and Harold Rosenbaum, “Redesigning Product Lines with Conjoint Analysis: How Sunbeam Does It” (1987)

Wind, Jerry, Paul Green, Douglas Shifflet, and Marsha Scarbrough, “Courtyard by Marriott: Designing a Hotel Facility with Consumer-Based Marketing Models” (1989)

Conjoint History Green, Paul and V. Srinivasan , “Conjoint Analysis in Marketing: New

Developments with Implications for Research and Practice” (post-1978) Green, Paul and V. Srinivasan , “Conjoint Analysis in Consumer Research:

Issues and Outlook,” Journal of Consumer Research, Vol. 5 (1978) Lilien, Gary, Philip Kotler, and K. Sridhar Moorthy, “Decision Models for Product Design,”

Marketing Models (1992):238

Conceptual Marketing FrameworksMuch of the MBA level marketing material is not concerned with just sales and services, but rather with issues of strategic importance. While this material is not taught in EES&OR483, it may be helpful to be aware of some key themes in marketing. The following lists and descriptions provide an overview of important marketing concepts. You'll notice that some of the concepts overlap with strategy frameworks.

An excellent reference textbook for marketing frameworks: Kotler, Philip. Marketing Management : Analysis, Planning, Implementation, and Control , 9th ed. Upper Saddle River, NJ : Prentice Hall, 1997.

The Four P’s of the Marketing MixThe phrase “the four p’s” is an easy way to remember and characterize the four most important marketing decision variables. The four P’s are price, product, promotion, and place:

“Price” variables: Allowances and deals Distribution and retailer markups Discount structure

“Product”variables: Quality Models and sizes Packaging Brands Service

“Promotion” variables: Advertising Sales promotion Personal selling

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Publicity“Place” variables:

Channels of distribution Outlet location Sales territories Warehousing system

Source: Kotler, 1997

Market-Oriented Strategic Planning“Market-oriented strategic planning is the managerial process of developing and maintaining a viable fit between the organization’s objectives, skills, and resources and its changing market opportunities. The aim of strategic planning is to shape and reshape the company’s businesses and products so that they yield target profits and growth.” - Kotler, 1997

Three key ideas: Manage the company’s business as an investment portfolio. Assess the future profit potential of each business by consider the market

growth rate and the company’s fit. Develop a strategic game plan that makes sense in light of the company’s

industry position, objectives, skills, and resources.

The business strategic planning process:

Businessmission

Externalenvironmental

analysis

Internalenvironmental

analysis

Goalformulation

Strategyformulation

Programformulation Implementation

Feedbackand control

Boston Consulting Group Growth-Share Matrix: “Invest in the stars, get rid of the dogs!” The framework promotes the importance of market growth rate and market share in determining the strategic importance of a product.

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StarsQuestion

Marks

Cash Cows Dogs

Mar

ket

Gro

wth

Rat

e0%

10%

20%

10x 1x .1xRelative Market Share

Alternative Views Of The Value Creation Process:One traditional business approach ignores the impact of marketing research on product design. Under this framework, the first step is to make the product, and then the second step is to figure out how and to whom it will be sold. This is still a common problem in many companies today. A more sophisticated paradigm recognizes that the consumer demand should drive product design. Marketing research, segmentation, positioning, and conjoint analysis are all examples of this more sophisticated approach. The diagrams below illustrate the two paradigms.

Traditional physical process sequence:

Make the Product Sell the product

Designproduct Procure Make Price Sell

Advertise/Promote Distribute Service

The value creation and delivery sequence (McKinsey):

Choose the value Communicate the value

Sourcing

Making

Distributing

Servicing

Provide the value

Customersegmentation

Marketselection/

focus

ValuePositioning

Productdevel

Servicedevel Pricing Salesforce

Salespromotion

Advertising

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Market Segmentation, Targeting, and Positioning

“STP Marketing” is one way to characterize the modern strategic marketing approach. STP stands for Segmenting, Targeting, and Positioning. The idea is to use a more direct “rifle” approach instead of an undirected “shotgun” approach:

1. Identify segmentationvariables and segment themarket.

2. Develop profiles of

resulting segments.

Market Targeting Market PositioningMarket Segmentation

1. Evaluate theattractiveness of

each segment. 2. Select the target

segment(s).

1. Identify possible positioning concepts for each target segment. 2. Select, develop, and communicate

the chosen positioning concept.

Additional Notes On Segmentation, Targeting And Positioning:The following set of notes provides a brief outline some of the key ideas in this area.

Alternative approaches to marketing strategy: Mass marketing: one product for all customers Product-variety marketing: a variety of products for customers to choose from Target marketing: targeted products for specific customer groups

Patterns of market segmentation: Homogeneous preferences Diffused preferences Clustered preferences

Market segmentation procedure (one common approach) (Kotler, 1997):1) Survey Stage: Exploratory interviews and focus groups, followed by

questionnaires to assess: Attributes and their importance ratings Brand awareness Product-usage patterns Attitudes toward the product category Demographics, etc.

2) Analysis Stage: Factor analysis applied to remove highly correlated variables. Cluster analysis applied to “create a specific number of maximally

different segments”.3) Profiling Stage: Each cluster is profiled in terms of its distinguishing

attitudes, behavior, … Each cluster is a market segment.

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Market targeting: 3 criteria for evaluating market segments: Segment size and growth Segment structural attractiveness (Porter’s 5 forces) Company objectives and resources

Five patterns of target market selection (Abell) (p. 284):M1 M2 M3 M1 M2 M3 M1 M2 M3 M1 M2 M3 M1 M2 M3

P1 P1 P1 P1 P1

P2 P2 P2 P2 P2

P3 P3 P3 P3 P3

Single-segment concentration

Single-segment concentration

Market specialization

Product specialization

Full coverage

P = Product M = Market

Developing a positioning strategy: “Positioning is the act of designing the company’s offer and image so that it

occupies a distinct and valued place in the target customers’ minds.” (Kotler) USP: Unique Selling Position. Promotion of a single benefit to the

marketplace. Effective strategy (as opposed to touting multiple benefits).

Positioning strategies: Attribute positioning Benefit positioning Use/application positioning User positioning Competitor positioning Product category positioning Quality/price positioning

Three steps:1. Identify differences2. Choose most important differences3. Effectively signal differences to the target market

Economics: Differentiation premium pricing

Treacy and Wiersema: 3 strategies that lead to successful differentiation and market leadership: Operational excellence Customer intimacy Product leadership

Differentiation: Product differentiation:

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Service differentiation: Personnel differentiation: Image differentiation:

Analyzing Industries and Competitors

Industries and competition play a central role in strategic analysis. The following notes reiterate these ideas from a marketing perspective.

Industry concept of competition - factors affecting industry structure and competition: Number of sellers and degree of differentiation Entry and mobility barriers Exit and shrinkage barriers Cost structures Vertical integration Global reach

Industry structure types: Pure monopoly Pure oligopoly Differentiated oligopoly Monopolistic competition Pure competition

Market concept of competition: It may be important to consider competitors which make different products but which meet similar needs. This is different from an industry perspective when the view of competition is limited to those firms offering the same or very similar products.

Product segmentationMarket segmentation

Competitive intelligence: gathering data about competitors. Benchmarking.

True market orientation balances consumer and competitor considerations. Changing consumer needs and latent competitors are key factors and can be more devastating than existing competitor actions.

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The Technology Adoption Life Cycle: Discontinuous Innovations

Some basic marketing concepts should be considered when thinking about market forecasts and new product strategies. For instance, thinking of the new product diffusion cycle (Bass model) as an inevitable cycle of sales can be very misleading. First of all, the diffusion model forecasts total market potential, and says nothing about the market share at a particular company. Second, the decisions of the firm can influence the sales. This is fairly obvious when it comes to the influence of product quality and cost, but marketing strategy is also critically important when introducing new products that are discontinuous innovations. In these cases, the market is not yet aware of the need for the new product, and an understanding of how a product moves through the technology life cycle will help a product reach its full potential faster and with higher likelihood of success.

Geoff Moore, in his books Crossing the Chasm (1991) and Inside the Tornado (1995), draws on marketing theory and high-tech experience to describe the elements of the product life cycle for technology innovations. His work examines how communities respond to discontinuous innovations - or any new products or services that require the end user in the marketplace to dramatically change their past behavior. He describes how companies must position their products differently through the cycle to reach their full sales potential and become an industry standard instead of a novelty. Many new hi-tech products start along a classic new product diffusion curve, but fail soon thereafter. Anyone developing strategy for discontinuous innovations should be familiar with the ideas Moore writes about. Through the various phases of the technology adoption life cycle, very different strategies for product and service offering and positioning are called for.

The basis of the technology adoption life cycle is similar to the basis for diffusion models: different groups of potential customers react differently to innovations, and adoption proceeds from most enthusiastic to most conservative. Communities respond to discontinuous innovation - when confronted with the opportunity to switch to a new infrastructure paradigm, customers self-segregate along an axis of risk-aversion. Moore separates customers into five categories, along which the cycle of new technology adoption proceeds:1. Innovators - technology enthusiasts who are fundamentally committed to new

technology on the grounds that sooner or later it will improve their lives.2. Early Adopters - visionaries and entrepreneurs in business and government

who want to use the innovation to make a break with the past and start an entirely new future

3. Early Majority - pragmatists who make up the bulk of all technology infrastructure purchases; their purchasing behavior is based on evolution

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rather than revolution, and they buy only when there is a proven track record of useful productivity improvement.

4. Later Majority - conservatives who are very price sensitive and pessimistic about the added value of the product; they buy only when technology has been simplified and commoditized.

5. Laggards - skeptics who are not really potential customers; goal is not to sell to them, but sell around their constant criticism.

The customer segments correspond to zones in the "landscape" figure below. In addition, there is a sixth zone that Moore calls the "chasm," separating adoption by the early market customers (1,2) from adoption by the early majority (3). Moore describes the chasm as follows:

Whenever truly innovative high-tech products are first brought to market, they will initially enjoy a warm welcome in an early market made up of technology enthusiasts and visionaries but then will fall into a chasm, during which sales will falter and often plummet. If the products can successfully cross this chasm, they will gain acceptance within a mainstream market dominated by pragmatists and conservatives. Since for product-oriented enterprises virtually all high-tech wealth comes from this third phase of market development, crossing the chasm becomes an organizational imperative. (1995, p.19)

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The Landscape of the Technology Adoption Lifecycle (source: Moore, 1995, p.25)

Early Market TheChasm

TheTornado

Main Street

End of Life

The strategy for "crossing the chasm," as well as the strategy for each of the other "zones", are very particular to where the product is in the life cycle.

The figure below emphasizes the different value disciplines required at different stages. Note that the source of competitive advantage changes through the cycle - in Porter terms, it draws on various combinations of competing on cost (operational excellence), differentiation (product leadership), and focus (customer intimacy).

Value Disciplines and the Life Cycle (source: Moore, 1995, p.176)

ProductLeadership

only

Product Leadership&

Operational Excellence

Product Leadership&

Customer Intimacy

Operational Excellence&

Customer Intimacy

Moore (1995, p.25) characterizes the zones as follows: The Early Market

A time of great excitement when customers are technology enthusiasts and visionaries looking to be first to get on board with the new paradigm.

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Visionaries are willing to work through bugs and put in effort themselves to make the solution work. The product sells itself.

The ChasmA time of great despair, when the early market's interest wanes but the mainstream market is still not comfortable with the immaturity of the solutions available. The only safe way to cross the chasm is to put all your eggs in one basket - target a single beachhead of pragmatist customers in a mainstream market segment and accelerate the formation of 100 percent of their whole product.

The Bowling AlleyA period of niche-based adoption in advance of the general marketplace, driven by compelling customer needs and the willingness of vendors to craft niche-specific whole products. A whole product is the minimum set of products and services necessary to ensure that the target customer will achieve his or her compelling reason to buy. Pragmatists want a whole product, with the necessary user infrastructure and customer support. At this stage, companies should resist the temptation to try to provide a general purpose whole product and simplify the whole product challenge. To get customers on board, service content is high, ROI to end user must be high, and partnerships with other companies may be called for. Success in the niche can then be leveraged elsewhere. The two keys to targeting the right niche customers here are (1) the segment has a compelling reason to buy, and (2) the segment is not currently well served by any competitor.

The TornadoAn ugly and frenzied period of mass-market adoption, when the general marketplace (early majority customers) switches over to the new infrastructure paradigm. It's a herd mentality. Keys to success in this period are to ignore customer needs and product modifications and just ship, riding the wave. Market share is critical at this stage to lock out competitors, and partners should be eliminated. Companies entering the tornado should expand distribution channels, attack the competition, and price to maximize market share.

Main StreetA period of aftermarket development, when the base infrastructure has been deployed and the goal is now to flesh out the potential. Another reversal of strategy is needed back to niche-based marketing. Before the product becomes obsolete, there is an opportunity to settle into a profitable period of differentiating the commoditized whole product with extensions focusing on the end user.

End of LifeWhich comes too soon in high-tech. Companies should find caretakers that can take over a fully commoditized product with low profit margin.

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