Porter's Generic Strategies

MBA 613 – International Management Strategies

Professor: Ester V. Tan, ED.D

Prepared by: Christian A. Diaz

Michael Eugene Porter

Harvard Business School University Professor

he is a leading authority on company strategy and the competitiveness of nations and regions

author of 18 books and numerous articles including Competitive Strategy, Competitive Advantage, Competitive Advantage of Nations, and On Competition

he is generally recognized as the father of the modern strategy field, and his ideas are taught in virtually every business school in the world

he has served as strategy advisor to numerous leading U.S. and international companies, including Caterpillar, Procter & Gamble, Scotts Miracle-Gro, Royal Dutch Shell, and Taiwan Semiconductor

six-time winner of the McKinsey Award for the best Harvard Business Review article of the year

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 strategy involves the firm attractive market share by appealing to cost-conscious or price-sensitive customers. This is achieved by having the lowest prices in the target market segment, or at least the lowest price to value ratio (price compared to what customers receive). To succeed at offering the lowest price while still achieving profitability and a high return on investment, the firm must be able to operate at a lower cost than its rivals.There are three main ways to achieve this.

1. achieving a high asset turnover2. achieving low direct and indirect operating costs3. control over the supply/procurement chain to ensure low

costs

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

• Access to the capital required making a significant investment in production assets; this investment represents a barrier to entry that many firms may not overcome.• Skill in designing products for efficient manufacturing, for example, having a small component count to shorten the assembly process.• High level of expertise in manufacturing process engineering.• Efficient distribution channels.

Risks Associated with Cost Leadership Strategy

• 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. • 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.

• This strategy is appropriate where the target customer segment is not price-sensitive, the market is competitive, customers have very specific needs which are possibly under-served, and the firm has unique resources and capabilities which enable it to satisfy these needs in ways that are difficult to copy.Firms that succeed in differentiation strategy often have the following internal strengths:

• Access to leading scientific research.• Highly skilled and creative product development team.• Strong sales team with the ability to successfully communicate the perceived strengths of the product.• Corporate reputation for quality and innovation.

Risks Associated with Differentiation Strategy

• imitation by competitors• changes in consumers tastes• various firms pursuing focus strategies may be able to achieve even greater differentiation in their market segments

Focus Strategy• In adopting a narrow focus, the company ideally focuses on a few target markets, a distinct groups with specialized needs. The choice of offering low prices or differentiated products/services should depend on the needs of the selected segment and the resources and capabilities of the firm. 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.• Target market segments that are less vulnerable to substitutes or where a competition is weakest to earn above-average return on investment.

Focus Strategy

Example:Southwest Airlines, providing short-haul point-to-point flights in contrast to the hub-and-spoke model of mainstream carriers, and Family Dollar.In adopting a broad focus scope, the principle is the same: the firm must ascertain the needs and wants of the mass market, and compete either on price (low cost) or differentiation (quality, brand and customization) depending on its resources and capabilities.

Examples:Wal Mart has a broad scope and adopts a cost leadership strategy in the mass market.Pixar also targets the mass market with its movies, but adopts a differentiation strategy, using its unique capabilities in story-telling and animation to produce signature animated movies that are hard to copy, and for which customers are willing to pay to see and own.Apple also targets the mass market with its iPhone and iPod products, but combines this broad scope with a differentiation strategy based on design, branding and user experience that enables it to charge a price premium due to the perceived unavailability of close substitutes.

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

• Firms using a focus strategy often enjoys a high degree of customer loyalty, and this deep-rooted loyalty discourages other firms from competing directly.• Firms pursuing a focus strategy have lower volumes and therefore less bargaining power with their suppliers. • 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 wide range of product development strengths to a relatively narrow market segment that they know very well. Risks Associated with Focus

Strategy• imitation and changes in the target segments• trouble-free for a broad-market cost leader to adapt its product in order to compete directly• other focusers may be able to create sub-segments that they can serve even better

Generic Strategies and Industry Forces 

IndustryForce

Generic Strategies

Cost Leadership Differentiation Focus

EntryBarriers

Ability to cut price in retaliation prevents 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.

RivalryBetter able to compete on price.

Brand loyalty to keep customers from rivals.

Rivals cannot meet differentiation-focused customer needs.

Diagram of Porter's 5 Forces

 

SUPPLIER POWER Supplier concentration

Importance of volume to supplier Differentiation of inputs

Impact of inputs on cost or differentiation Switching costs of firms in the industry

Presence of substitute inputs Threat of forward integration

Cost relative to total purchases in industry

 

BARRIERS TO ENTRY Absolute cost advantages Proprietary learning curve

Access to inputs Government policy Economies of scale Capital requirements

Brand identity Switching costs

Access to distribution Expected retaliation Proprietary products

THREAT OF SUBSTITUTES -Switching costs

-Buyer inclination to substitute

-Price-performance trade-off of substitutes

 

BUYER POWER Bargaining leverage

Buyer volume Buyer information

Brand identity Price sensitivity

Threat of backward integration Product differentiation

Buyer concentration vs. industry Substitutes available Buyers' incentives

DEGREE OF RIVALRY -Exit barriers -Industry concentration -Fixed costs/Value added -Industry growth -Intermittent overcapacity -Product differences -Switching costs -Brand identity -Diversity of rivals -Corporate stakes

Rivalry Economists measure rivalry by indicators of  industry concentration. Concentration Ratio (CR) is one which measures rivalry in a particular industry. CR indicates the percent of market share held by the four largest firms, in addition CR's for the largest 8, 25, and 50 firms in an industry also are available. The Bureau of Census periodically reports the CR for major Standard Industrial Classifications (SIC's)A high concentration ratio indicates that a high concentration of market share is held by the largest firms. With only a few firms holding a large market share, the competitive landscape is less competitive.

A low concentration ratio indicates that the industry is characterized by many rivals, none of which has a significant market share. These fragmented markets are said to be competitive.

RivalryIn pursuing an advantage over its rivals, a firm can choose from several competitive moves:

Changing prices - raising or lowering prices to gain a temporary advantage.

Improving product differentiation - improving features, implementing innovations in the manufacturing process and in the product itself.

Creatively using channels of distribution - using a distribution channel that is new to the industry. for example, with high-end jewelry stores reluctant to carry its watches, Timex moved into drugstores and other non-traditional outlets and cornered the low to mid-price watch market.

Exploiting relationships with suppliers for example, from the 1950's to the 1970's Sears, Roebuck and Co. dominated the retail household appliance market. Sears set high quality standards and required suppliers to meet its demands for product specifications and price.

RivalryThe intensity of rivalry is influenced by the following industry characteristics:

1. A larger number of firms increase rivalry because more firms must compete for the same customers and resources.

2. Slow market growth causes firms to fight for market share. 3. High fixed costs result in an economy of scale effect that

increases rivalry. 4. High storage costs or highly perishable products cause a

producer to sell goods as soon as possible. If other producers are attempting to unload at the same time, competition for customers intensifies.

5. Low switching costs increases rivalry. When a customer can freely switch from one product to another there is a greater struggle to capture customers.

6. A low level of product differentiation is associated with higher levels of rivalry.

7. Strategic stakes are high when a firm is losing market position or has potential for great gains. This intensifies rivalry.

8. High exit barriers place a high cost on abandoning the product. The firm must compete. High exit barriers cause a firm to remain in an industry, even when the venture is not profitable.

Rivalry9. A diversity of rivals with different cultures, histories, and philosophies make an industry unstable. There is greater possibility for misjudging rival's moves. Rivalry is volatile and can be intense. 10. Industry Shakeout elimination of some competing businesses, products, etc., as a result of intense competition in a market of declining sales or rising standards of quality. An event that eliminates the weak or unproductive elements from a system.

Threat of Substitutes A threat from substitutes exists if there are alternative products with lower prices of better performance parameters for the same purpose. They could potentially attract a significant proportion of market volume and hence reduce the potential sales volume for existing players.

example 1, The price of aluminum beverage cans is constrained by the price of glass bottles, steel cans, and plastic containers. These containers are substitutes, yet they are not rivals in the aluminum can industry.

example 2, To the manufacturer of automobile tires, tire retreads are a substitute. Today, new tires are not so expensive that car owners give much consideration to retreading old tires. But in the trucking industry new tires are expensive and tires must be replaced often. In the truck tire market, retreading remains a viable substitute industry.

Threat of Substitutes Similarly to the threat of new entrants, the threat of substitutes is determined by factors like:

Brand loyalty of customers Close customer relationships Switching costs for customers The relative price for performance of substitutes Current trends

Buyer Power

This is how much pressure customers can place on a business. If one customer has a large enough impact to affect a company's margins and volumes, then the customer hold substantial power.

Here are a few reasons that customers might have power:

Small number of buyers Purchases large volumes Switching to another (competitive) product is simple The product is not extremely important to buyers; they can do without the product for a period of time Customers are price sensitive

Supplier Power

This is how much pressure suppliers can place on a business. If one supplier has a large enough impact to affect a company's margins and volumes, then it holds substantial power.

Here are a few reasons that suppliers might have power: There are very few suppliers of a particular product There are no substitutes Switching to another (competitive) product is very costly The product is extremely important to buyers - can't do without it The supplying industry has a higher profitability than the buying industry

Barriers to Entry / Threat of EntryBarriers to entry can exist as a result of government intervention (industry regulation, legislative limitations on new firms, special tax benefits to existing firms, etc.), or they can occur naturally within the business world. Some naturally occurring barriers to entry could be technological patents or patents on business processes, a strong brand identity, strong customer loyalty or high customer switching costs.The threat of new entries will depend on the extent to which there are barriers to entry. These are typically:

Economies of scale (minimum size requirements for profitable operations) High initial investments and fixed costs Cost advantages of existing players due to experience curve effects of operation with fully depreciated assets Brand loyalty of customers Protected intellectual property like patents, licenses etc. Scarcity of important resources, e.g. qualified expert staff Access to raw materials is controlled by existing players Distribution channels are controlled by existing players

Barriers to Entry / Threat of Entry

Existing players have close customer relations, e.g. from long-term service contracts High switching costs for customers Legislation and government action

Industry's entry and exit barriers can be summarized as follows:

Easy to Enter if there is: Common technology

Little brand franchise

Access to distribution channels

Low scale threshold

Difficult to Enter if there is: Patented or proprietary know-

how

Difficulty in brand switching

Restricted distribution channels

High scale threshold

Easy to Exit if there are: Salable assets

Low exit costs

Independent businesses

Difficult to Exit if there are: Specialized assets

High exit costs

Interrelated businesses

The End