1st March 2019
Outside Fortress Europe Excerpts
This third foundation Global Business Strategy Blog essay is based upon unabridged excerpts from Chapter Four, Theories of Strategy and Competition, in Outside Fortress Europe: Strategies for the Global Market.
Outside Fortress Europe Excerpt
In 1980 Professor Michael Porter of Harvard Business School published what has become one of the most widely disseminated books on competitive strategy, a staple for business schools worldwide and the source of faculty department squabbles as each claims the ideas for its own discipline, especially strategy (e.g. Johnsn et al., 2017), marketing (e.g. Jobber and Ellis-Chadwick, 2016) and operations management (e.g. Slack et al., 2016). Porter argued that in any particular industry there were three potentially successful “generic strategies” which could lead to superior business performance. These were: (i) overall cost leadership; (ii) differentiation; (iii) focus. Focus equates with ‘niche’ and a focus competitive strategy can be either cost leadership or differentiation but is typically the latter (e.g., luxury goods). He also described competitive platforms as either broad-scope (participate in many market segments) or narrow-scope (participate in few market segments).
Exploring Michael Porter’s generic strategies
Porter has been heavily criticised for presenting these generic strategies as mutually exclusive options, although the critique itself is often flawed. Porter’s principal concern in isolating the three approaches was to warn of the dangers of ‘strategic sloppiness’, whereby firms achieved neither differentiation nor cost leadership and so ended up being ‘stuck in the middle’, i.e. unprofitable. Nonetheless, Porter is pretty unambiguous on the exclusivity of his generic strategy classification:
Sometimes the firm can successfully pursue more than one approach as its primary target, though this is rarely possible.
A detailed analysis of the components, pros and cons of these alternative generic strategies is beyond the scope of this Chapter, but it would be remissible not to at least summarise their main elements, particularly given that it is difficult to imagine a strategy course curriculum without them. Whatever critiques are levelled at Porter, no one can suggest that his major works are not accessible. It is our contention here that his observations on competitive strategy are far more relevant in the context of contemporary globalization than when he first outlined them in a US context in 1980. Hence, in a break from the narrative we will summarise the key points associated with Porter’s generic strategies here in a series of lists which do, though, have a logical flow and are written to be self-explanatory with cross-references to relevant Chapters in the book where appropriate.
Cost leadership strategy
- Requires driving costs to the lowest level in the industry.
- The company can then have the lowest prices and/or the biggest margins.
- It is essential to keep value proposition benefits above qualifying levels, e.g. to comply with regulatory quality standards.
- The company must identify the key cost drivers relative to other companies in the industry which can prove extremely difficult, especially if the rivals have complex global supply chains (see Economist, 2018, April 28th, for a briefing on this topic: Global Logistics – Thinking outside the box).
Dangers of cost leadership strategy
- By definition, all rivals in the industry are losers except one.
- Rivals can easily surpass a cost leadership strategy, e.g. by moving manufacturing facilities to low-cost countries and/or by outsourcing.
- In service sectors where the cost leadership position is based upon a specific technology, rival companies could acquire it themselves. In financial services, for example, when IBM develops a major productivity technology (e.g., cloud computing, blockchain database solutions) it will supply it to all firms in the industry it targets, e.g. online banking service providers.
- For most customers (not all), cost/price is a secondary buying criterion (see Chapter Six, Strategic Marketing and Global Brand Management).
- A corporate obsession with efficiency could compromise effectiveness and erode customer value to such an extent that the minimum qualifying criteria are not met.
Broad-scope differentiation strategy
- Requires benefits-based sustainable differential advantage (see Chapter Six, Strategic Marketing and Global Brand Management).
- Usually generates:
- A loyal customer base;
- Bigger volumes and /or premium prices.
- Allows latitude on costs but price must be kept below market segment qualifying level.
- Superiority can be found anywhere in the value proposition and marketing mix components.
Differentiation and customer value (see Chapter Six, Strategic Marketing and Global Brand Management)
- Differentiation must be valued by customers otherwise it will be both inefficient and ineffective (see Chapter One and/or the End~Note Glossary for definitional clarity).
- Consumers derive value from cost reductions and/or satisfaction growth.
- Business customers derive value from cost reductions and/or performance growth.
- Customers’ value criteria must be constantly monitored and be adapted to if/when they change.
Routes to differentiation
- New substitutes;
- Unique features;
- Unique packaging;
- Zero defects;
- Customised design.
- Better methods;
- Superior message;
- Better timing;
- More intensity;
- Unique methods.
- Wider coverage;
- Focused coverage;
- Best dealers;
- Unique linkages;
- Unique methods.
- Price / terms:
- Premium prices;
- Lowest prices;
- More flexibility;
- Countertrade deals;
- Finance options.
- Superior before-sales;
- Superior post-sales;
- Help desk support;
- Superior employees;
- Unique services.
- Focus on building trust;
- Ongoing interaction;
- Problem sharing;
- Assets sharing;
- Help them in times of crises.
- Customer cost reduction (efficiency and productivity):
- JIT delivery;
- Value chain linkages;
- Trade-in prices;
- Joint promotions;
- People training.
Customer recognition of superior offerings: create customer value signals
- Effective marketing communications are essential to convey differentiation benefits to target customers (see Chapter 6, Strategic Marketing and Global Brand Management), to include:
- Brand names;
- Strong image;
- Market leadership;
- Time since established;
- Parent company prestige;
- Reference accounts;
- Product design;
- Premium price: price itself is a signal of value.
The economics of differentiation
- Price must not exceed the qualifying level: even a Rolex watch will have an upper-acceptable price level.
- Differentiating is likely to inflate ‘costs’ (think investments!).
- Therefore, look for exceptions:
- Some types involve no additional costs, e.g. recruit hippy-funny-outgoing-extrovert personality-type restaurant servers (think TGI Friday’s!);
- Others deflate costs, e.g. Customer Relationship Management (CRM) tools (think Salesforce.com).
- The golden rules are:
- Forbid unneeded differentiation which adds cost but not value (real or perceived);
- Only invest in differentiation when marginal revenue exceeds marginal costs.
Broad-scope differentiation strategy dangers
- Market needs and preferences differ – must use market segmentation process (see Chapter Six, Strategic Marketing and Global Brand management).
- Rivals copy or surpass value differentiators.
- Narrow-scopers (niche-players) triumph on a segment-by-segment basis (described by some authors, including yours truly, as ‘cherry-pickers’).
- Price ceases to qualify (typical with ‘Veblen Goods’ when, for example, the price of a Rolex or BMW is just too much, and demand will collapse; or is too low and exclusivity, the prime motivation underpinning brand choice, is lost. These two examples are real-world case scenarios of the ‘Veblen effect’, often described as ‘conspicuous consumption’).
Sustaining effective differentiation
- Requires ongoing research of customer buying criteria.
- Requires constant adaptation to match changing buyer needs and preferences.
- Must hold price below the qualifying level.
- Consistently apply new forms of superiority.
- Continuously apply multiple forms of superiority.
- Erect barriers to copying.
- Competing via specialisation:
- Narrow scope concentration;
- One or very few segments;
- Requires deep and extensive insights into market Key Success Factors (KSFs);
- Must understand market needs and conditions;
- Offerings customised for the targeted segment(s).
Key focus strategy questions
- Which target segments?
- Which competitive base (cost leadership or differentiation)?
- How many segments?
How many segments?
- A tailored value chain for one segment is optimal.
- That is how most companies begin, but they often compromise later (e.g., Blackberry and its futile attempt to enter the consumer segment).
- Marketing to multiple segments requires many value chains to be effective.
- But firms often resist offering variety for efficiency reasons.
- Centralisation can be a solution.
- But the best focusers enter few segments.
Dangers of focus strategy
- Similar problems as broad-scope differentiation strategy.
- Market size too small.
- Buyer needs are too similar to other segments.
- Company inflexibility to adapt to market conditions.
Sustaining an effective focus strategy
- Ensure ongoing research of buying criteria and other KSFs.
- Adapting to match market changes.
- Staying within qualifying limits.
- Finding new forms of superiority.
- Creating multiple superiorities.
- Creating barriers to copying.
Given our previous discussion and the lists above we can readily see the problem with Porter’s contention that there can only be three generic strategies. Over time, the combination of technological breakthroughs, the widespread adoption of robotics by manufacturing companies, the exploitation of ‘big data’ in service sectors and general management learning has allowed firms to achieve the ‘holy grail’ of being able to offer higher customer value at lower cost, an irresistible combination for the well-informed buyer. Porter’s analysis drew heavily on American case studies and examined market share and its cost relationships primarily in the US market context.
If we now consider world market share as the key cost driver in the era of global competition (where Chinese companies are moving through the value chain to its higher levels, e.g. branded goods and services suppliers such as Alibaba, Tencent, Huawei and Lenovo) a very different picture emerges. In the next section, we examine the developing structure of global industries in the contemporary competitive era and we profile the emerging ‘super-league’ of innovative global companies.
Competitive positioning in the era of global competition
The wholesale restructuring of international business constructs and business practices has generated a general hypothesis that most industrial sectors will ultimately be dominated by relatively few global companies. In Figure 1 we examine current and projected global competitive positions and, in the process, qualify but support and expand the validity of Porter’s generic strategies for the contemporary international business environment.
For illustration purposes, imagine that Figure 1 depicts one global industry with nine firms competing for industry profits. Firm 1 is the Market Ruler. It is enjoying the greatest profitability through a combination of higher revenues and lowest delivered costs and, most likely, higher prices (see Chapter Five, Analysing Global Markets and the Intelligent Company). Firm 2, a Thriver, enjoys similar high regard among customers but operates from a higher cost base than Firm 1. Its strategic intent is driven by process innovation and it constantly strives to dislodge Firm 1 from its coveted position by driving costs lower without compromising customer value.
Firm 3 is also a Thriver. While it does not deliver the highest perceived value, it does operate from a relatively low-cost base, thus enjoying high margins. This company’s strategic intent will be marketing mix innovation, i.e. enhancement of product, distribution, communication and customer service offerings to dislodge Firm 1 from its market-ruling position. This constant jockeying for position through process and product innovation leads to the emergence of a ‘Super-League’, a group of companies who develop apparently impenetrable competitive positions and enjoy strong profits to defend them. An output of their constant innovations is that they raise entry barriers, for example, through raising the capital intensity of production, securing the best distribution channels, attracting the best human resource, building large sales forces, raising customer service levels and committing to heavy advertising expenditures.
The Super League firms will likely benefit from the network effect, a market condition whereby a critical mass of inter-dependent customers use a common ‘platform’ to consume a product or service. For example, people join Facebook, LinkedIn, Twitter and other social networks and either explicitly or implicitly encourage friends and family to join them also. People will join a specific service not necessarily because it’s the best, but because it’s the most prevalent. The network inter-dependency may be real, e.g., file exchange of Microsoft Windows-designed software applications; or perceived, for example, the assumption that the market leader must be the best/safest choice because all those other customers who have chosen it can’t be wrong (e.g., ‘8 out of 10 cats prefer Whiskas’).
Reverting to Figure 1, Firms 4, 5 and 6 are in the ‘Second Division’. Firm 4 is a Chancer. Its competitive position is clearly Porter’s original cost leader, i.e., the lowest cost producer in the industry or, more likely, it is a company amongst a group of low-cost suppliers. This stance is risky because of the lower margins the company will earn and, more significantly, because of the fragility of this market position. First, it will have to compete on price (because of its low perceived value) while, over time, almost all markets buy on value, i.e., consumers maximise their economic utility which is a trade-off between price and value (Doyle, 2008). As we mentioned in the lists presented above, by definition there can only be one cost leader in an industry whereas the scope for differentiation is as broad as managerial imagination. Second, other firms in the industry will constantly strive to drive down cost, thus removing Firm 4’s flimsy advantage. Porter’s original ‘danger list’ associated with the cost leader position remains applicable today:
- ‘Disruptive’ technological and business process change that nullifies past investments or learning;
- Low-cost learning by industry newcomers or followers, through imitation or through their ability to invest in state-of-the-art facilities;
- Inability to see required product or marketing changes because of the organizational attention placed on cost;
- Inflation in costs that narrow the firm’s ability to maintain enough of a price differential to offset competitors’ brand images or other approaches to differentiation.
Firm 6 we also describe as a Chancer. It does have high perceived value, but its wafer-thin margins threaten the stability of its position, with other firms constantly striving to raise their own perceived value. The danger for Firm 6 is of drifting into the Bungler box or, in the worst case, becoming a No-hoper. Firm 6’s approach is similar to Porter’s differentiation strategy and the primary pitfall he identified for them remains valid today: the cost gap between low-cost competitors and the differentiated firm becomes too great for differentiation to hold brand loyalty. In this case buyers sacrifice some of the features, services, or image possessed by the differentiated firm for large cost savings; furthermore, buyers’ need for the differentiating factor falls, a common occurrence as buyers become more sophisticated; and finally, imitation narrows perceived differentiation, a common occurrence as industries mature.
Firm 5 is quite clearly ‘stuck in the middle’ in Porter’s original sense:
The firm lacks the market share, capital investment, and resolve to play the low-cost game, the industrywide differentiation necessary to obviate the need for a low-cost position, or the focus to create differentiation or a low-cost position in a more limited sphere.
Firms 7, 8 and 9 form the rump of our industry, a ‘Third Division’ who are extremely vulnerable to take-over or extinction.
The above scenario of ‘differentiation erosion’ is becoming a distinguishing characteristic of global industries. In an extensive examination of the world automobile industry first reported in the early 1990s, Womack, Jones and Roos identified ‘lean production’ as a new industrial paradigm to replace traditional mass manufacturing modes of operation. Lean production combines the talents of multi-skilled workers with highly automated machinery and, though developed initially by Japanese automobile manufacturers, it is an applicable approach for all companies in all sectors. As the authors note:
Lean production is ‘lean’ because it uses less of everything compared with mass production – half the human effort in the factory, half the manufacturing space, half the investment in tools, half the engineering hours to develop a new product in half the time. Also, it requires keeping far less than half the needed inventory on site, results in many fewer defects, and produces a greater and ever-growing variety of products.
As the quote suggests, a corollary of lean production in terms of output is higher quality, greater variety and lower costs, a combination of product characteristics which had proven irresistible to Japanese consumers (who had come to expect it) and European and North American consumers (to who it was new) and which has underpinned the success of many Japanese companies in world markets, regardless of where the products are manufactured (see Pascale and Athos, 1986, for a classic discussion of how Japanese companies not only exported their products but also their ‘way-of-working’ to the foreign countries where they established manufacturing operations).
The quotation above also closely reflects one of the four key themes of this book which we introduced in Chapter One: Operational Excellence (efficiency); and it does so without compromising another, Strategic Clarity (effectiveness). An equivalent opportunity in service sectors lies within the potential of ‘big data’, algorithmic knowledge platforms, artificial intelligence (AI) (see Economist, 2018, March 31st, Special Briefing: AI in business – GrAIt Expectations, for insights and dreams) and, across many industrial and service sectors, robotics.
Outside Fortress Europe Excerpt References
Doyle, P. (2008). Value-Based Marketing: Marketing Strategies for Corporate Growth and Shareholder Value (2 ed.). Chichester: John Wiley & Sons.
Economist. (2018, March 31st). Briefing: AI in Business – GrAIt expectations. The Economist, 1-12.
Economist. (2018, April 28th). Briefing: Global Logistics – Thinking outside the box. The Economist, 18-20.
Jobber, D., & Ellis-Chadwick, F. (2016). Principles and Practice of Marketing (8 ed.). London: McGraw Hill.
Johnson, G., Whittington, R., Scholes, K., Angwin, D., & Regner, P. (2017). Exploring Strategy: Text and Cases (11 Ed.). Harlow: Pearson.
Pascale, R. T., & Athos, A. J. (1986). The Art of Japanese Management. New York: Penguin.
Porter, M. E. (1980). Competitive Strategy: Techniques for Analysing Industries and Competitors. New York: Free Press.
Slack, N., Brandon-Jones, A., & Johnston, R. (2016). Operations Management (8 ed.). Harlow: Pearson.
Womack, J. P., Jones, D. T., & Roos, D. (2007). The Machine that Changed the World: How Lean Production Revolutionised the Global Car Wars. London: Simon & Schuster.
Please click/tap your browser ‘Back’ button to return to the location navigated from. Alternatively, click/tap the ‘Antique Keyboard’ graphic below to navigate to The Global Business Strategy Blog page.