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MGMT 670: Week 7 Lecture

Week 7: Generic and Corporate Strategies. Learn the three generic strategies used for building competitive advantage and delivering value to customers. Learn why and how companies diversify and how diversification can deliver competitive advantage. 

Learning Objectives:

  1. Understand what distinguishes each of the three generic strategies and why some of these strategies work better in certain industries and competitive conditions.
  2. Identify the ways to achieve competitive advantage based on lower costs.
  3. Identify ways to develop competitive advantage based on differentiation.
  4. Identify ways to develop competitive advantage based on focus.
  5. Understand when and how diversifying into multiple businesses can enhance shareholder value. 
  6. Understand how related diversification strategies can produce competitive advantage.

Introduction

A company’s competitive strategy is management’s plan for competing successfully. The chances are remote that any two companies—even those in the same industry—will employ the exact same competitive strategy. However, Michael Porter developed three generic competitive strategies, which can be used singly or in combination, that consist of whether a company’s target market is broad or narrow and whether the company is pursuing a competitive advantage related to lower costs or differentiation (Porter, 1996). “Porter states that the strategies are generic because they are applicable to a large variety of situations and contexts.... The generic strategies provide direction for firms in designing incentive systems, control procedures, and organizational arrangements” (“Generic competitive strategies,” 2009).

According to Porter, “To position itself against its rivals, a firm must decide whether to perform activities differently or perform different activities. ... A firm’s business-level strategy is a deliberate choice in regard to how it will perform the value chain’s primary and support activities in ways that create unique value” (Carpenter & Dunung, 2012).

The strategies are (1) cost leadership; (2) differentiation; and (3) focus on a particular market niche. 

Cost Leadership

In a cost leadership strategy, a company tries to become and remain the lowest-cost producer and/or distributor in the industry. “The strategy is especially important for firms selling unbranded commodities such as beef or steel” (“Generic competitive strategies,” 2009).

Companies using this strategy strive for lower costs than their rivals, but not necessarily the lowest cost. The products/services being sold must include features that buyers consider essential. It’s possible to be too “low frills” and risk being seen as offering little value. There are other potential downfalls to this strategy: “Two or more firms competing for cost leadership may engage in price wars that drive profits to very low levels. Ideally, a firm using a cost leader strategy will develop an advantage that is not easily copied by others. Cost leaders also must maintain their investment in state-of-the-art equipment or face the possible entry of more cost-effective competitors” (“Generic competitive strategies,” 2009).

Remember from our examination of Internal Factors that Porter identified 10 cost drivers in a company’s value chain:

Value chain

Source: “Porter's value chain: understanding how value is created within organizations,” n.d.

 

The goal of the value chain activities is to offer customers value that exceeds the cost of activities, resulting in profit (“The value chain,” 2010).

There are two major ways of achieving low-cost leadership: (1) Performing essential value chain activities more cost-effectively than rivals, and (2) changing the value chain to bypass or eliminate cost-producing activities. “Firms achieve cost leadership by building large-scale operations that help them reduce the cost of each unit by eliminating extra features in their products or services, by reducing their marketing costs, by finding low-cost sources or materials or labor, and so forth” (“Generic competitive strategies,” 2009).

Differentiation

Differentiation is creating something that is perceived as unique in the industry “through advanced technology, high-quality ingredients or components, product features, [or] superior delivery time” (Carpenter & Dunung, 2012). Customers must be at least somewhat insensitive to price for this strategy to be effective. “Adding product features means that the production or distribution costs of a differentiated product may be somewhat higher than the price of a generic, non-differentiated product. Customers must be willing to pay more than the marginal cost of adding the differentiating feature if a differentiation strategy is to succeed (“Generic competitive strategies,” 2009). However, “differentiation does not allow a firm to ignore costs; it makes a firm's products less susceptible to cost pressures from competitors because customers see the product as unique and are willing to pay extra to have the product with the desirable features” (“Generic competitive strategies,” 2009). 

Focus

What sets a focused strategy apart from cost leadership or differentiation is its “concentration on a particular customer, product line, geographical area, channel of distribution, stage in the production process, or market niche” (“Generic competitive strategies,” 2009). With a focus strategy, the idea is that they firm is better able to serve a limited segment more efficiently than its competitors can serve a wide range of customers.

Firms using a focus strategy simply apply a cost leader or differentiation strategy to a segment of the larger market. Firms may thus be able to differentiate themselves based on meeting customer needs, or they may be able to achieve lower costs within limited markets. Focus strategies are most effective when customers have distinctive preferences or specialized needs. (“Generic competitive strategies,” 2009)

Combined strategies

It is also possible to combine these strategies, and firms that combine strategies often do better than firms that pursue one strategy. “An integrated cost-leadership and differentiation strategy is a combination of the cost leadership and the differentiation strategies. … To succeed with this strategy, firms invest in the activities that create the unique value but look for ways to reduce cost in nonvalue activities” (Carpenter & Dunung, 2012). 

Diversification

Diversification is when a firm enters an entirely new industry, moving into new value chains ("Selecting corporate-level strategies," 2012). Diversification is a growth strategy. Many firms accomplish diversification through a merger or an acquisition, whereas others expand into new industries without the involvement of another firm. When considering whether to diversify, a firm must ask how attractive the industry is, how much it will cost to enter the industry, and whether the new firm will be better off. Diversification can be either related or unrelated. 

Related Diversification

Related diversification is when a firm moves into a new industry that has important similarities with the firm’s existing industry or industries ("Selecting corporate-level strategies," 2012). Often, the goal of firms that engage in related diversification is to develop and exploit a core competency to become more successful. The goal is often synergy, "the ability of two or more parts of an organization to achieve greater total effectiveness together than would be experienced if the efforts of the independent parts were summed" ("Diversification strategy," 2009).

Unrelated Diversification

Unrelated diversification is when a firm enters an industry that lacks any important similarities with the firm’s existing industry or industries. The primary goal of unrelated diversification is improved profitability for the acquiring firm ("Diversification strategy," 2009). Often, the opportunities for growth in the firm's current industry is limited. So, diversifying into a new industry may offer improved profits. However, operating unrelated businesses will result in increased administrative costs for the acquiring firm.  

Grow or Buy? 

When deciding to diversify, a firm must consider whether it's better to diversify internally (e.g., by creating a new company or division within the current company) or to expand externally (e.g., by merger or acquisition) ("Diversification strategy," 2009). 

If a firm decides to diversify internally, it could, for example, broaden its geographical market, sell to new users, market new products in existing markets, or market new products to new customers in new markets.  

If a firm decides to externally diversify, the most common ways are through merger or acquisition. In a merger, the firm gets access to management, technology, and processes and both firms retain their identities. In an acquisition, the firm being acquired loses its identity. Acquisitions can be either friendly or hostile. 

Conclusion

Firms must choose which of the generic strategies they will pursue and then whether to diversify. These decisions are essential to how a firm will achieve competitive advantage.

References

From the UMUC library: (Note: You must search for these articles in the UMUC library.  In the case of video links in the UMUC library, exact directions are given on how to find the video.)

  • Diversification strategy. (2009). In Encyclopedia of management (6th ed., pp. 194-197). Detroit: Gale.
  • Generic competitive strategies. (2009). In Encyclopedia of management (6th ed., pp. 337-341). Detroit: Gale.
  • Porter, M. E. (1996). What is strategy? Harvard Business Review, 74(6), 61-78.

From other webpages:

The value chain. 2010. NetMBA. Retrieved from http://www.netmba.com/strategy/value-chain/