4. Competitive Strategies: Porter s Generic Strategies

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1 4. Competitive Strategies: Porter s Generic Strategies According to Tang (1984, MIT Working Paper), generic strategy may be defined as the most basic decision made by an SBU in the hierarchy of its decision making. It is also the highest decision which integrates and creates internal consistency among decisions. One of the most abiding theories of strategy in these times has emanated from Michael Porter. Porter postulates that firms follow any of the three following strategies: differentiation, cost leadership, and focus. Differentiation is followed by firms who are capable of either manufacturing distinct products or have a completely unique marketing strategy. They are capable of standing apart from their competitors in the marketplace, and more importantly has a distinct positioning in the minds of the consumers. Cost leadership strategy is followed by firms who are usually leaders in the market place in terms of volumes and gain large market share with very low pricing of their products. This is usually achieved through control of costs which are a result of a very efficient supply chain. Focus strategy is pursued by firms which does not saddle the entire market, but concentrates in a particular niche by satisfying the needs of that particular set of customer segment. Porter (1980), in his book on competitive strategy, says that competition is at the core of the success or failure of firms. The appropriateness of a firm s activities that can contribute to its performance, such as innovations, a cohesive culture, or good implementation is determined by competition. Competitive strategy is the search for 50

2 a favorable competitive position in the industry, the fundamental arena in which competition occurs. According to Porter, competitive strategy aims to establish a profitable and sustainable position against the forces that determine industry competition. The choice of competitive strategy is determined by two central issues. The first issue is the attractiveness of industries for long-term profitability and the factors that determine it. Not all industries offer equal opportunities for sustained profitability, and the inherent profitability of its industry is one essential ingredient in determining the profitability of a firm. The second issue in competitive strategy is the determinants of relative competitive position within an industry. In most industries, some firms are much more profitable than others, regardless of what the average profitability of the industry may be. The fundamental basis of above-average performance in the long run is sustainable competitive advantage. Porter postulates that there are two basic types of competitive advantage a firm can possess: low cost or differentiation. This is irrespective of the strengths and weaknesses that a firm may possess. The significance of any strength or weakness a firm possesses is ultimately a function of its impact on relative cost or differentiation. Industry structure determines cost advantage and differentiation, which, in turn, is a result of the firm s ability to cope with the five forces better than its rivals. According to Porter, the two basic types of competitive advantage, when combined with the scope of activities for the firm, leads to three generic strategies for achieving above-average performance in an industry. They are: cost leadership, differentiation, and focus. The focus strategy has two variants, cost focus and differentiation focus. The cost leadership and differentiation strategies seek competitive advantage in a broad range of industry segments, while focus strategies 51

3 aim at cost advantage (cost focus) or differentiation (differentiation focus) in a narrow segment. The implementation of each generic strategy varies widely from industry to industry. Feasible generic strategies in a particular industry also vary. According to Porter, selection and implementation of a generic strategy is far from simple. However, they are the logical routes to competitive advantage that must be probed in any industry. Wright & Parsinia (1988) critiqued Porter s generic strategies on four fundamental issues. According to them, choices of generic strategies have limitations in terms of the size of the company, its access to resources, and industry and competitive analyses. Larger firms in industries with greater access to resources may compete primarily with the cost leadership or differentiation strategies, while smaller firms can only viably compete with the focus strategy. The authors feel that Porter s viewpoint that successful businesses should compete on the basis of only one of the generic strategies, regardless of the size of the firm, is not correct. The larger enterprises that compete with cost leadership would use that as their only strategy. The larger firms that compete with differentiation strategy, however, may do so in conjunction with focus strategy. Those firms using the cost leadership strategy could use only that one because the emphasis of this strategy is on cutting costs throughout all the functional areas of the organization. Consequently, the economics and the technologies of functional supports involved with this strategy would normally be incompatible with other strategies. The authors do not agree with Porter s contention that the focus strategy may be a viable single strategy adoption possibility. As a single strategy adoption, the focus strategy is only appropriate for the smaller firms. With regard to larger firms, focus may only be logically adopted in conjunction with the differentiation generic strategy. The authors further suggest 52

4 that in fragmented industries, the differences in sizes of firms are not pronounced. Firms of various sizes might compete with a low-cost strategy or differentiation strategy and/or focus strategy. Whereas in established and mature industries, firms achieve low costs through cumulative volume of operations, in fragmented industries companies achieve low costs through low initial investments and, subsequently, low operating costs. In a study (Baack & Boggs, 2007) regarding the difficulties in using a cost leadership strategy (for MNCs) in emerging markets, it is argued that implementation of a cost-leadership strategy by developed-country MNCs is rarely effective in emerging markets, and that MNCs may benefit from using different strategies in different markets. For effective cost-leadership strategy, target customers need to be industry-wide; i.e. demand should be market wide, not segmented. The authors conclude that there is powerful evidence of the substantial environmental obstacles to the successful implementation by developed-country MNCs of a cost leadership strategy in emerging markets. In these markets, focus, differentiation, or other strategies, such as those based upon personal or political relationships (Peng and Luo, 2000), may provide a better fit with the environment than cost leadership. In a study (Long, Fu; 2001) on differentiation focus strategy in the Insurance industry in USA, the author analyzes the shift that took place from traditional strategies for the white-male dominated market to an ethnocentric one, focusing on Asian-Americans. New strategies were formulated, innovative operations were designed, and distinctive market campaigns were launched. The social-economicdemographic changes in the 1980s had an intriguing impact on the insurance industry. Marked changes took place in crossover competition within the industry, 53

5 market contention imposed by other industries, varying public attitudes towards insurance products, the changing American family structure and income sources, and economic-demographic increases of ethnic groups. The development of differentiation focus strategy had a distinctive feature an ingenious incorporation of cultural and ethnic elements into the equation of the strategic formulation and its market execution. The firms changed their strategy from being ethno-centric to pluralistic. Strategies were no longer uniform, but took on cultural and ethnic specificity. For example, the mainstream mass media that the industry relied on in the past was not effective for reaching Asian American clients. Rather, ethnic media sources were turned to for market promotion, ethnic languages were used in advertising, and public relationships were built with ethnic communities for companies name recognition (Novak et al 1992). Instead of emphasizing the death benefit attached to life insurance products, new policies highlighted the education benefit and the love for dear ones. Dess and Davis (1984) studied strategic group membership and organizational performance, based on Porter s generic strategies. The survey identified differentiation and cost leadership clearly, while there was some ambiguity about focus strategy. An important implication is that equifinality (von Bertalanffy, 1955) may characterize focus strategies, that is, there is a broad range of different but internally consistent sets of competitive methods available to firms employing a focus strategy. In cluster analysis, two of the clusters that emerged in the three cluster solution did appear to represent Porter's differentiation and focus strategies. However, the overall low cost dimension did not appear as significant in determining the composition of organizational strategies. An important finding of the study is the apparent lack of singularity in strategic orientation that characterizes 54

6 the highest performance group. While this cluster was identified as primarily oriented towards an overall low cost strategy, this group also emerged with the highest centroid score on the focus strategy. Given Porter's (1980) caution against the commitment to multiple generic strategies, the high performance exhibited by the members of this cluster may appear inconsistent. However, as Cyert and March (1963) suggest, high performance may generate slack resources that can be used to enable firms to expand their present scope of operations. Also, constraints posed by budget limitations may require that a firm limit its emphasis to only one market segment. Miller and Dess (1993) studied Porter s model where they assessed the strategies from the point of view of strategic positioning. They conceptualized the three generic strategies as continuous dimensions of strategic positioning. They found that businesses follow strategies which fall somewhere along a continuum on all three dimensions. This type of conceptualization of Porter's model leads to the concept of 'combination' strategies which are evident in many highly successful firms such as Toyota and Lincoln Electric. The study found support for the following strategic options suggested by Porter (1980): 1) Combination of differentiation as well as cost-leadership strategies. However, the differentiation is broad meaning, the product will appeal to a broad range of buyers. 2) Combination of differentiation as well as cost-leadership strategies. However, the differentiation is narrow meaning, the product will appeal to a limited number of buyers. 3) Broad differentiation 55

7 4) Cost-leadership and broad range of buyers 5) Narrow differentiation 6) Combination of cost-leadership and narrow range of buyers 7) Stuck-in-the-middle meaning, strategy is not clear (formulation as well as implementation). Kotha and Vadlamani (1995) compared Mintzbergs (1988) typology of generic strategies with that proposed by Porter. Mintzberg labels cost leadership strategy as differentiation by price. Additionally, he disaggregates Porter's differentiation strategy into differentiation by marketing image, product design, quality, support, and undifferentiation. The authors postulate that although, Porter's three dimensions may have captured adequately the intended strategies of managers in the samples of earlier studies (Dess and Davis, 1984; Robinson and Pearce, 1988), this study indicated that more fine-grained strategies are required to capture the intended strategies of managers in the current environment. Despite the increased number of generic strategy options, Mintzberg's typology simplifies all generic strategies as different means of achieving differentiation. In a study (Gopalakrishna and Subramanian, 2001) on Porter s Generic Strategies of overall cost leadership and differentiation across all major industry sectors in the Indian context, the authors examined the effect of these strategies in their pure and hybrid forms, on a combination of performance parameters both, financial as well as non-financial. Results indicated that organizations that followed a combination of cost leadership and differentiation strategies, in general, had the best performance of all groups on a variety of performance measures. They found the following four groups: differentiators, cost leaders, undeveloped, and comprehensive (combination of differentiation and cost leadership). The differentiation cluster (44% of total 56

8 sample) had a favorable impact on most of the performance measures, except in the case of control of operational expenses. Their best performance was in retaining customers. They exhibited good performance in terms of growth in overall revenue, success of new products/services, and return on capital. The cost-focused firms (25% of total sample) have the best performance in terms of cost control and yields average performance on the remaining measures. The undeveloped group (17% of total sample) has the poorest performance of all groups on all the performance measures. The comprehensive (14% of sample firms) cluster exhibited the best performance of all groups in terms of growth in revenue, ability to retain customers, success of new products/services, return on capital and superior performance in terms of controlling expenses. The difference between the above-mentioned study (Gopalakrishna et al 2001) and this dissertation is that this dissertation is trying to establish a relationship between contextual factors and strategy of the firm. Marketing mix elements are brought in as it is felt that strategy influences marketing mix decisions, which then affects business performance. Additionally, this dissertation also tries to find out if there is at all any difference in performance which is attributable to contextual factors of firms or industries. Miller and Friesen (1986) undertook a study of Porter s Generic Strategies based on PIMS database of consumer durable business units. The differentiation clusters score very high on differentiation and are unfocussed. However, the generic strategies are not mutually exclusive: these consumer durable businesses also pursue an auxiliary cost leadership strategy. From Porter's (1980) discussion of the cost leadership strategy, the authors expected corresponding clusters to score high on the 57

9 cost leadership variables, to have low to moderate focus, and to be undifferentiated. Again, these expectations were not entirely borne out. All three successful generic strategies for consumer durable businesses include cost leadership as a component. Porter's (1980) focus strategy concentrates the firm's attention on one specific type of product, service, customer type, or geographic location. Porter believes that firms that pursue this strategy must employ an auxiliary strategy of differentiation or cost leadership, or some combination of the two. The focus businesses in this study followed an auxiliary strategy of cost leadership, this time supporting Porter's description. These findings differ from Hambrick's (1983a) clusters of capital goods producers which often reflected only one strategic competence differentiation or cost leadership but never both. The authors believe that the discrepancies between these results and these earlier findings were due to the selection of consumer durable industries. Here marketing advertising, brand name and manufacturing economies of scale can be pursued simultaneously, making cost leadership, marketing differentiation, and even (via these economies) quality or innovative differentiation compatible. Allen, Richard S., et al (2007) did an exploratory study on the use of Porter s Generic Strategies in Japan. In the study, Japanese managers were questioned about their firm s current strategic practices. Analysis revealed that Japanese firms are following only two of Porter s strategies. Cost leadership strategy was used by 41.4% of the firms and is the most frequently used strategy. The least used was the differentiation strategy. Focus strategy was ot being used at all. Product Differentiation Strategy was being used by only 7.6% of the firms surveyed. The Japanese placed a lot of emphasis on Supply Chain strategy. This is not unexpected 58

10 as the Japanese are well known for their passion of managing supply chains to optimize efficiency through such tactics as long-term supplier relationships, inventory minimization, and providing suppliers with predictable schedules of stable orders and regular demand (Liker & Yu, 2000; Helper & Sako, 1995). Japanese firms also placed a lot of importance on training strategy. Almost 35% of the firms followed this strategy which emphasized on training of front-line personnel and their intense supervision, along with extensive training of marketing personnel. Gonzalez-Benito and Suarez-Gonzalez (2010) studied the relationship between Porter s Generic Strategies and business performance, against the backdrop of manufacturing strategies. It was found that the firms following cost-leadership strategy emphasizes on prioritization of cost in the manufacturing function; this prioritization brings in greater efficiency. This functional capability has a positively impacts commercial and financial performance. Similarly, differentiation strategy leads to flexibility as a manufacturing competitive priority. This prioritization again results in superior commercial and financial performance. Shah (2007) attempts to study the concept of strategic groups in particular relation to the retail sector. Analysis (Cluster) from the survey showed five clusters. Based on their characteristics, firms in the first two clusters are competing based on low cost, but they concentrate on different factors to achieve low cost. Firms belonging to the next cluster are following a niche strategy. Firms belonging to the fourth cluster are using the differentiation strategy, while firms that are part of the fifth cluster do not seem to be using a coherent strategy, and are thus labeled as stuck in the middle. Moreover, customers of the different strategic groups are significantly 59

11 different from each other on the four variables (price sensitivity, brand consciousness, willingness to pay more for extra service, and shopping experience). This research aims to test whether there is a correlation between these strategies and business performance. It is also to be verified whether contextual factors determine the adoption of a particular strategy and whether these strategies influence the marketing mix decisions of the firms. While many attempts has been made in extant literature to link strategy and performance, there is an absence of relevant literature studying whether generic strategies lead to emphasis on particular marketing mix decisions. For example, there is a gap in literature of the phenomenon that cost leadership strategy indeed makes the firm emphasize more on competitive/penetration pricing and value-for-money products while, differentiation strategies emphasize more on product quality/design/features and premium pricing. One of the major objectives of this study is also to observe whether firms operating in India do follow the categorization of generic strategies, and whether these strategies lead to relevant marketing mix decisions. In this research study, in keeping with existing literature, marketing strategy has been operationalized through marketing mix decisions. So, the interesting phenomenon of generic strategies influencing marketing strategy decisions is also being studied. However, it may be pertinent here to state that the objective here is not to study whether firms group themselves according to generic strategies. 60