Integrated Cost and Differentiation Competitive Strategies - Coursework Example

Examining the suitability of integrated cost & differentiation competitive strategies: Evidence from some real-life examples Organizational Strategy Management Table of Contents 1. Introduction……………………………………………………………………………3 2. Generic competitive strategies………………………………………………………...3 3. Divergence of the three generic competitive strategies……………………………….7 4. Hybrid competitive strategy……………………………………………………..........9 5. In support of integrated cost and differentiation competitive strategies………………9 6. Arguments against integrated cost and differentiation strategies…………………….12 7. Conclusion……………………………………………………………………………13 8. References……………………………………………………………………………15 1. Introduction Competitive strategy consists of a firm’s attempt to achieve a favorable position in respect of industry competition and essentially seeks to attain a profitable position that is sustainable against the industry’s competitive forces (Porter, 1980). In formulating a suitable competitive strategy, a firm has to first know its strengths and weaknesses, the opportunities existing in a market as also the possible threats to its existence. It thus has to understand both its external and internal environments in order for any strategy to succeed. The external environment is made up of social, political, technological, economical, ecological, technological and legal factors that bear upon the firm and its strategy evolution. Indeed, there are five principle forces that affect the firm and its competitive position in the industry. These are buyers’ bargaining power, suppliers’ bargaining power, threat of substitution, threat of new firm entry, and rivalry between existing firms (Porter, 1980). The existence of the five forces in particular markets and industries as well as their strength in negating a firm’s competitive efforts varies and the most crucial force (s) determine the primary direction and content of competitive strategy of the firm. Porter (1980; pp. 29-30) envisions competitive strategy to consist of any one of three possible alternatives viz., positioning, influencing balance of the forces or exploiting change. While competitive strategy essentially consists of adopting a defensive or offensive action that aims to defend the firm’s profitable position in the industry, broadly speaking, there are three generic strategies that are adopted for achieving such end. They are overall cost leadership strategy, differentiation strategy and strategy of focus (Porter, 1980; pp. 34-35). 2. Generic competitive strategies (Porter, 1980) In seeking to achieve a profitable and sustainable competitive position in an industry, a firm adopts any one or more of the aforesaid strategies of cost leadership, differentiation and focus. The three ‘pure’ competitive strategies are examined below in some detail for arriving at a better understanding of hybrid strategies or integrated cost and differentiation competitive strategies. Cost leadership By this strategy, the firm seeks to reduce costs at all levels. This may mean stringent control over overheads, avoiding capital or start-up costs, minimizing costs by way of R&D, advertising, etc. The cost leader pursues scale economies and benefits from learning curves, manages capacity utilization more strictly, controls the mix of products or services offered, and also seeks to minimize wage or salary costs. A low cost structure means that the firm achieves above average price revenues. It can achieve this end through various strategies fro tackling the five competitive forces like better supplier management for reducing raw material costs, providing low priced products for preventing customer exits, better pricing position amongst rival competitors, prevent entry of new firms in the industry and favorable position vis-à-vis possible substitute products. In practice, firms identify and analyze the stages in the value chain where cost savings can be affected and then model the value chain for deriving overall cost benefits. The downsides of following a cost leadership competitive strategy include heavy initial capital investments, aggressive pricing wars, the necessity of producing a wider range of products for satisfying diverse and broad customer segments, etc. One example of a successful cost leader is Asda, a successful global retailer, which follows a cost control strategy at all levels although it still strives to deliver quality of products and services to its customers. Another cost leader is McDonalds, a restaurant and food chain. By using standard products and processes, providing self-service system, etc., this restaurant major achieves high cost savings through these factors and economies of scale. Again, to cite another example, IKEA is a cost leader in the manufacture of traditional non-lifetime furniture and achieves its cost leadership by following a standard product range across all its stores, a simple design of products, a volume centric self-assembly model, outsourcing supply sourcing, perfecting logistics, as well as pick up by customers themselves. Cost leaderships works well when customer switching costs are low, are significantly large in number and enjoy marked bargaining powers over the firm. Standardized products and intense pricing competition are other factors that often make a firm chose cost leadership as a competitive strategy. However, other competitors in an industry can well duplicate the cost leadership strategy and hence effectively negate its entire efforts. Other downsides include too much emphasis on cost cutting with resulting fall in product quality, sudden technological changes or changes in the way a product is used by customers and declining buyer sensitivity to prices. It is also commonly evidenced that such cost leadership strategy appears to succeed in cases where the firm is able to achieve such leadership through market leadership via attaining of economies of scale; also there is limit to cost reduction unless product quality can be affected. Additionally prices that may well decline in the long term that can negate any cost advantages gained through such strategy. Differentiation A differentiation strategy seeks to distinguish the firm product or service offering and make it into something unique in the industry (Porter, 1980). A product can become unique because of its brand value or image (e.g. Mercedes and Volkswagen in the automobile industry). Differentiation consists of building up better brand value of products or services over that of rival firms in the industry, creating of entry barriers, and adopting a premium pricing for products and services that can be carried through by enhanced brand value. The success of differentiation is due to the creation of value for buyers that cannot be easily imitated by rival firms. It is also due to keeping costs down so as to afford enhanced revenues in spite of increased product prices. Firms that successfully differentiate their products or services include Amazon.com (one-stop shopping experience), FedEx (superior servicing), Caterpillar (ready spares availability), BMW (engineering design excellence), Rolex (prestige watches), Toyota (TQM in production), 3M Corporation (technology), Chanel (brand image), etc. Differentiation essentially seeks to build in product or service features that either lower overall costs for the customer, enhances the performance of the product or service, increases customer or buyer satisfaction or improves the firm’s capabilities. A product or service may be unique in an industry owing to such perception by customers. In the banking industry, which is service oriented, a bank may become a leader due to its strong customer servicing. Again, a strong dealer network also can make a firm’s products or position unique in the industry. For instance, Maruti Suzuki Ltd in the automobile industry has built up an elaborate dealer network for selling spares and servicing its cars. Again, in the luxury tourism destination market, St Moritz has successfully evolved itself as a high-end tourist spot in Switzerland by cultivating an up-market image and destination brand value for celebrities and VIP visitors. The benefit of effective product differentiation arises from perceived brand value or utility to the customers. The success of such a strategy relies on customer loyalty and resulting low price sensitivity (Porter, 1980). Differentiation, also, is based on an image awareness or exclusivity because of high quality or uniqueness of products or superiority of customer services (Brennan & Lundsten, 2000). A new firm needs to breach strong entry barrier due to such unique product positioning of the firm. The firm can also use higher revenues for better managing supplier demands, customer demands as also threat from substitute products. The value chain of a firm that follows a differentiation competitive strategy often incorporates high outsourcing levels, a cost-focused product design, premium product range and brand image building. The downsides include often high costs for achieving product branding and design, a relatively narrow market for differentiated products, price sensitivity of consumers in the long term and so on. Again, unlike a cost leadership strategy, differentiation attempts to achieve better revenues through improved R&D, adopting flexible, demand based production, investing hugely in advertising, acquiring highly skilled workforce at enhanced wage or salary costs, and so on. Differentiation has been found to work well in an industry where there are few rivals following similar competitive model, where the customer or buyer needs and use of products are diverse and where changes in technology and innovations are very fast-paced. The downsides of differentiation include the possibility of duplication of product attributes by rival firms, spending more on differentiating the products so as to reduce profitability, exceeding customer needs, charging too high price premium on products, and so on. Focus Here the firm focuses on a specific market segment, product line or customer segment. The effort is only to provide the best in product or service to the chosen segment. Such a competitive strategy means that unlike its other mass-market oriented rivals in the industry, the focus oriented firm attempts to target a particular group by providing either lower prices, or better product or service quality or both. Thus, such a strategy can mean a combined cost and differentiation strategy albeit in respect of a narrow market segment. For example, Martin-Brower is a food retail distributor in the USA that supplies to only few select customers or retail chains. It specially targets those few customers via cost reduction through selective and standardized approach by catering to fixed group of customers. Quoting another example, when Porsche found its market share dipping, it adopted a differentiated product model i.e. it manufactured up-segment, stylish cars for select customers in the luxury segment. An obvious downside is that the firm neglects the larger, broader industry in focusing on a specific segment. Also, the firm may be out-focused by rivals, buyer preferences may change and larger firms can enter the market. 3. Divergence of the three generic competitive strategies It is also found that adoption of cost leadership, focus or differentiation competitive strategies require different skills and resources as well as certain basic things to be done in order for them to succeed. Thus, an overall cost leadership requires sustained access to capital, good skills in process technology, strong workforce management, low-cost distributor arrangement, stringent cost control, etc. A differentiation strategy requires strong marketing capabilities, innovative production, strong R&D, efficient quality control, strong activity coordination, highly skilled workforce, etc. A focus on a particular segment requires an efficient combination of the various activities and processes that make either cost leadership or differentiation a success, albeit in respect of a narrow target segment (Porter, 1980). Porter, to whom the very concept of competitive advantage is due, also emphasizes that a firm needs to choose only one of the three generic strategies mentioned above. His view is that a firm can generally only choose either cost leadership or differentiation, not both (Porter, 1985). In his view, while such choice of competitive strategy depends largely on the industry in which the firm operates, in general, cost leadership strategy is incompatible with a differentiation strategy. A cost leader tries and minimizes costs and hence derives price advantage in the industry. In contrast, a differentiation strategy seeks to deliver unique and distinct products or services at significantly higher costs such that the higher costs are useful in earning above average returns in the industry. Porter views any effort to combine cost leadership and differentiation by a firm as inviting trouble and difficult to succeed and can well mean that the firm gets “stuck in the middle” (porter, 1985). In contrast, newer theorists like Johnson, et al, (2008) aver that cost (price) based strategies build upon acceptance of reduced margins, winning price wars, reducing costs, and focusing on specific segments whereas differentiation is based upon creating barriers to product imitation, achieving imperfect mobility of resources and capabilities, and attaining a reinvestment margin (pp. 232-233). These authors consider hybrid competitive strategies acceptable and capable of succeeding and view strategy as being made up of various bases of competitive strategy or competitive strategy options which include the following: No frills, Low price, Hybrid, Differentiation, Focused differentiation, Increased price/standard value, Increased price/low value, and low value/standard price (Johnson, et al, 2008 as derived from Faulkner & Bowman, 1996)). 4. Hybrid competitive strategy A hybrid or integrated competitive strategy that combines cost, price and differentiation (Johnson, et al, 2008) is often followed by firms. Such hybrid strategies are facilitated by flexible production, strong information networks across firms, and total quality management. However, successful integrators are rare as it is quite difficult for firms to follow such strategies. Integrated strategies seek to provide better value for money to customers or a value-added product at lower costs. Firms successfully following hybrid competitive strategies deliver superior value by factoring in customer demands and expectations with regards to product attributes or pricing. The firms may even resort to under-pricing product brands compared to rival firms. The failure of hybrid strategies is a result of lack of commitments from top management in making the strategy a success. It may also occur due to insufficiency of organizational structure, incentive systems, leadership styles, etc, to meet the exacting demands for making such strategy a success. Generally, cost focused strategy and differentiation strategy are divergent approaches that require different organizational structure, managerial approach, etc. 5. In support of integrated cost and differentiation competitive strategies Research indicates that an integrated low cost and differentiation strategy works well in global markets and can even be critical in achieving sustainable competitive advantage for a firm (Lei, et al, 1996). Indeed it is felt by many experts that in contrast to basing a firm’s competitive strategy on a single dominant factor like cost leadership or differentiation, a firm adopting an integrated cost and differentiation model can better be able to adapt quickly to any changes in the environment, learn quickly all newer skills and emerging technologies and also better leverage core competencies (Haarla, 2003). The benefits of an integrated strategy are also accumulative (Haarla, 2003) and indeed an integrated competitive strategy combines the benefits of cost leadership and product or service differentiation in as much as “differentiation leads to premium prices and cost leadership lowers costs” (Porter, 1985). An integrated competitive strategy creates value for the customer by way of certain differentiated features or attributes in the products and relatively lower costs. A certain degree of reliance on R&D and flexibility of approach is required to successfully implement such a strategy. Commonly used implements in furthering an integrated cost and differentiation strategy include TQM, flexible manufacturing systems or FMS and reliance on IT. There are various ways and stages in the value chain in which such an integrated low cost and differentiation strategy is implemented. Thus, the product line comprises a product with few frills, wider selection and multiple product variations. The products also contain many upscale attributes and reasonably good or excellent features. They are also tailor made in order to cater to demands of the target customer segment and also retain essential quality features in spite of continuous cost reduction during production stages. Essentially, the products incorporate superior features at lower costs to the firm and hence the customers. The marketing stage involves under pricing rivals via comparable product prices, resorting to advertising so as to highlight superior product attributes, highlight the addition of value for money at comparable lower prices, etc. The few differential attributes in the product are focused upon and used to build brand value and hence enhance revenues while at the same time the firm seeks to reduce costs at all stages of the value chain. The information networks help in better coordination between suppliers and the firm enable lower time to market products as well as reduce stock out at stores. An integrated low cost and differentiation strategy has been found successful in many industries and market conditions. Such a strategy can indeed deliver above average returns for the firm. However, there is a high risk of being stuck in the middle (Porter, 1980). In such an eventuality, the firm cannot effectively tackle the five forces of the environment and cannot also achieve a position of either cost leader or successful differentiator. Where an industry favors all firms equally and where its rivals are able to adapt to external competitive forces well, using an integrated strategy requires lot of skill and total commitment. A study of rural retailers by several researchers reveal how an integrated cost and differentiation competitive strategy can successfully achieve competitive advantage for a firm. Indeed such a strategy appears superior to pure generic strategies (Rubach & McGee, 1998). While some believe purely generic strategies as being mutually exclusive (Porter, 1980, 1985; Hambrick, 1983; Dess & Davis, 1984), other researchers aver that they are not so mutually exclusive (Hill, 1988; Murray, 1988). Still others consider a hybrid strategy as not only possible but also profitable (Miller & Dess, 1993). Indeed, in the retail industry, such a combined cost and differentiation strategy may be capable of achieving significant competitive advantage (Pitelis & Taylor, 1996). Differentiation can also be a means to achieving overall cost leadership particularly in emerging industries as also in cases of technological advances; such a strategy may be effective in select mature industries (Hill, 1988). Various others also aver that an integrated cost and differentiation competitive strategy may be advantageous and lead to better firm performance whereas a single generic strategy when followed can often lead to low performance (Wright, 1987; Murray, 1988; Miller, 1992). For instance, in the screw machine tools industry, firms adopting integrated strategies by combining product differentiation and low costs were found to better successful (Wright, et al, 1991). This was also confirmed by others in other industries (Miller & Friesen, 1986). A combination of low cost and differentiation was found possible and profitable as also the most effective in the manufacturing sector also (Miller & Dess, 1993). In their study on rural retailers, Rubach and McGee go so far as to assert and prove a hypothesis that firms that adopt a combined low cost and differentiation competitive strategy outperform firms that rely on a single generic strategy (1998, p. 8). The research by these authors also discounts Porter’s theory that each generic strategy is mutually exclusive of one another (p. 19) although they too support Porter in case of “stuck in the middle strategies” that do perform badly (Porter, 1985). 6. Arguments against integrated cost and differentiation strategies Some researchers aver that each generic strategy is envisioned as a distinct strategy and as such appear to be mutually exclusive (Porter, 1985). Differentiation is costly and consists of increased costs that go towards building special attributes in the product or service. Hence, it basically goes against a cost leadership strategy. It is also true that it is very difficult to adopt or sustain a hybrid strategy by combining low costs and prices with differentiation. The firm often finds itself stuck between two opposing generic strategies if it attempts to achieve both cost leadership and product differentiation, particularly in the manufacturing sector (Porter, 1985). While many firms can follow low cost and differentiation together, particularly in cases of technology change. However, firms can follow cost and differentiation strategies together in those cases where the market share strongly influences cost considerations rather than by any product design related, technology or other such factors. It is also followed by firms which introduce technologically innovative new products in the market. Examples of such technology can include information technology or automated production techniques. Often, firms need to trade off cost for differentiation or differentiation for cost in case rivals introduce their own technological innovations (Porter, 1985). Again, each generic strategy can be a potential threat to others and also involve diverse risks (Porter, 1985). By far the greatest risk faced by a firm pursuing combined cost and differentiation competitive strategy is that it may find itself “stuck in the middle”. In such a condition, it cannot tackle the five competitive forces effectively and there is every possibility of firm failure or low profitability. Also, such a firm lack market share, cannot effectively pursue low cost approach or differentiated strategy singly, and cannot even focus on a specific segment. However, firms have adopted a hybrid strategy with often significant success and improved profitability. Another argument that can be advanced against using a combined cost and differentiation strategy is the fact that each generic strategy requires different key resources, different organizational structures and different production arrangements. There are also some examples that appear to support Porter’s generic typology. Thus some research found evidence of single generic strategy being followed by firms in the capital goods industry (Hambrick, 1983). It was also fund in case of the paint industry that such pursuit of single generic strategies was more successful than being stuck in the middle (Dess & Davis, 1984). However, rather than discount hybrid strategies, such research only upheld the fundamental assumptions of Porter’s generic competitive strategy and also considered single generic approach more sustainable than a combined one that resulted in a “stuck in the middle” situation. The studies also have not been able to satisfactorily discount the superiority of integrated cost and differentiation strategies over singular generic strategies. Also, other than in the manufacturing sector, the mutual exclusivity of each generic strategy is not observed to any appreciable extent. 7. Conclusion To sum up, this paper seeks to examine the integrated cost and differentiation competitive strategies with respect to their application in various industries. It also attempts to understand the underlying theory behind strategy formulation of a business enterprise and how well a hybrid strategy helps a firm to achieve (or not achieve) sustainable competitive advantage in an industry. While there is substantial research across sectors and industries that vouchsafe for Porter’s basic assumptions regarding generic competitive approaches like product differentiation and cost leadership, research on the performance of firms adopting hybrid competitive strategies appear to be relatively fewer. However, on analysis of existing research, the paper arrives at the conclusion that a hybrid strategy is both successful and a profit improver. Hence, it goes along with support for adopting such a strategy by firms in all industrial sectors. At the same time, sufficient care and risk management is also necessary in order for the strategy to succeed and this is to be emphasized unless firms want to be “stuck in the middle” and suffer low profitability. 8. 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