The unique feature of management studies is that it converts the abstract into reality, and simplifies the complex so that appropriate conceptual and analytical constructs can be developed to solve hard to comprehend problems. One of the most successful applications of this approach has been in the esoteric field of strategy. Michael Porter’s work on ”Competitive Strategy: Techniques for Analyzing Industries and Competitors”(1980) has been a runaway success in the field of strategic management publications. The reason is not far to seek. Porter’s Competitive Strategy provides a very simple and elegant framework for analyzing industry and competition, and developing a strategy for the incumbent firm. Unfortunately, however, much water has flowed under the bridge over the last three decades, and the changed competitive landscape calls into question the simple paradigms of Porter.
The author in his previous blog post “Structural Analysis and Industry Definition: Moving Targets in an Evolving Environment?” (Strategy Musings, www.cbrao2008.blogspot.com, July 24, 2011) has discussed how a new learning needs to be incorporated to reinforce the frameworks of structural analysis and industry definition. This post focuses on the next sequential chapter in Porter’s work on generic competitive strategies. More than structural analysis, Porter’s articulation of three simple generic competitive strategies as a panacea of strategy formulation has found favor with strategists and leaders. While Porter qualifies that the best strategy for a given firm is ultimately a unique construction reflecting its particular circumstances, Porter’s advocacy as well as the followers’ loyalty has been to the elegant macro approach. This post questions the fallibility and inappropriateness of the rather simplistic approach rooted in the days of simpler industrial competition and slower technological change.
Three generic strategies
Porter advocates that at the broadest level we can identify three internally consistent generic strategies (which can be used singly or in combination) for creating a defendable position in the long run and outperforming competitors in an industry. According to him, in coping with the five competitive forces, there are three potentially successful generic strategic approaches to outperforming other firms in an industry: overall cost leadership, differentiation and focus. Porter holds that sometimes the firm can successfully pursue more than one approach as its primary target, although he also feels that it would be rarely possible. According to him, implementing any of these generic strategies usually requires total commitment and supporting organizational arrangements could be diluted if there is more than one primary target. The returns that a firm can reap by pursuing any of the three strategies could range from acceptable to high depending on the nature of the industry.
The key to Porter’s proposition on the uniqueness of the competitive strategies is the hypothesis that each of the three strategies requires a different set of functional policies. For example, he considers that cost leadership requires aggressive construction of efficient scale facilities, vigorous pursuit of cost reductions from experience, tight cost and overhead control, avoidance of marginal customer accounts, and cost minimization in functions such as R&D, service, sales force, advertising, and so on. A great deal of managerial attention to cost control is necessary to achieve these aims. Low cost relative to competitors becomes the theme running through the entire strategy, though quality, service, and other areas cannot be ignored. Cost leadership usually provides the firm above-average returns; a cost leader is usually the last to exit a declining industry. Cost leadership is held to require high relative market share.
In contrast, differentiation requires a different set of functional policies, according to Porter. These are: design or brand image, technology, features, customer service, dealer network, or other dimensions, with the firm usually differentiating across multiple dimensions. Differentiation earns for the firm above average to high margins but Porter postulates that differentiation often requires dilution of market share and cost objectives. Porter proposes focus as a third generic strategy that creates specific strategies around serving a chosen target, such as a buyer group, product segment, geographic market, particularly well. All functional strategies are developed around serving the target. The focus strategy enables above average returns, and involves a trade-off between profitability and sales volume while it may or may not involve a trade-off with overall cost position.
According to Porter, the three generic strategies are alternative, viable approaches to dealing with the competitive forces. A firm failing to develop its strategy in at least one of the three directions is considered by Porter as a firm that is “stuck in the middle”. Such a firm is said to lack the market share, capital investment, and resolve to play the low-cost game, the industry -wide 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. According to Porter, a stuck-in-the-middle firm is almost guaranteed low profitability. He considers that such a firm must make a fundamental strategic decision to adopt one of the three generic strategies but almost inevitably faces an uphill task in trying which generic strategy marks the best shift and in marshalling the resources for that.
Generic strategies and competitive advantage
The goal of all firms is to grow. Growth can be achieved only through competitive advantage. According to Porter and various others, competitive advantage is the ability of a firm to utilize its attributes and resources in such a manner that it has a superior and sustainable position in the industry or market relative to its competitors. The thrust of Porter’s competitive strategy framework is that the three generic strategies provide the firm with a strategic approach to gain competitive advantage. The paradox, however, is that any knowledge that is available at a generic level hardly provides the wherewithal for a firm to generate a firm-specific competitive advantage. In today’s competitive world, any industry or market is typically composed of several players, many of them well endowed with resources and capabilities. To assume, as Porter does, that firms can easily achieve competitive advantage through the pursuit of any of the three generic competitive strategies is overly simplistic, if not intrinsically fallacious.
Commoditization and genericization are the developments that reflect low entry barriers and high competition in mature or declining industries and markets. The same applies to strategy formulation too. Commodity like marketing of simplistic strategic prescriptions would make good reading but could spell bad business. The underlying determinants of competitive strategy are not as simple and superficial factors as scale and features but rather are the complex and embedded competencies such as technology and talent. The transformation of generic competitive strategies into firm specific competitive advantage can occur only through integration of technology and talent in strategy formulation. Technology and talent would be the tools to go beyond Porter’s high level, and either-or approaches of generic competitive strategies.
Technology and talent
In the past, the traditional product life cycle had a relatively high longevity because the pace of innovation was slow, consumer tastes were stable, brand loyalties were great, switching costs high and industry rivalry was comfortable. Today, technology is fast paced, not only because of high R&D expenditures aimed at both incremental and breakthrough innovations but also because several base technologies are continuously getting developed to be licensed and integrated with product technologies. This coupled with multi-functionality of products provides a great bandwidth for firms to attempt differentiation like never before. The central themes of a sustainable strategy for a contemporary firm are innovation and differentiation rather than scale and cost.
This does not mean that scale and cost have no place, on the other hand, they go hand in hand with innovation and differentiation. In fact, the challenge for the firms is to harness technology and talent in such a way that in spite of the contradictory needs of a shortening product life cycle and a lengthening investment cycle, the firm deploys the best of technology and talent, which obviously come with high costs, to achieve high levels of differentiation and low levels of cost. From a technology point of view, two streams of development are to be mandatorily followed. The first is a seamless upgrade of product and process technologies on a continuous basis to provide the benefits of continuous incremental innovation at the lowest incremental investments. This must occur annually, and in some cases even on a six monthly basis. The second is a breakthrough transformation of product and process technologies to take the products to an entirely new platform. This must occur at least every two or three years, and in some cases even on an annual basis.
The consequent demands on talent management are many as the contributions of a properly attuned talent base for such a technological approach could be manifold. By focusing on high levels of accomplishment in academic and industrial careers, and by providing a development environment that enables innovative thinking, firms can institutionalize technological innovation in day to day and strategic operations. This requires at times obtaining solutions from domains beyond the core field. One of the reasons for a spurt in insulin usage goes beyond the recognition of the benefits of early start of insulin regime or development of long acting insulin types. The more substantive reason relates to the bringing down of the pain and discomfort caused by injections through development of insulin needles that are shorter, thinner and less painful, thus bringing down the barrier to enhanced usage of insulins.
Extending the analogy further, it is seen that the development of easy to carry insulin pens, with insulins that do not require refrigerated storage, has expanded the scope for insulin even more. Clearly, an innovative product combined with an innovative delivery adds to product differentiation and enhances the overall product acceptance. The attendant benefit of higher scale easily overcomes the underlying need for higher investments for innovative products and delivery systems. The challenge, therefore, is one of deploying technology and talent in such a way that multiple industries are brought under one roof of providing a more enhanced value proposition to the user. Multi-disciplinary research, tie-ups with different divistions of universities and research institutions and an open approach to technology licensing are required to achieve such a transformational amalgam of technology and talent.
Cost leadership – product differentiation matrix
The above discussion not only negates Porter’s singular generic competitive strategy model but also reinforces the need for a new paradigm that fuses both the cost leadership and product differentiation approaches. Fundamentally, the new paradigm considers cost leadership occurring not in terms of singular price competitiveness numbers but in terms of broad cost bands. This approach allows firms to be categorized as cost leaders or cost followers on the cost dimension. Similarly, product differentiation is seen in terms of transformational innovation or incremental innovation, enabling firms to be categorized on product differentiation front as differentiation leaders or differentiation followers. Firms can then be categorized into four categories, each providing relevant value propositions.
A firm which is a differentiation leader and is also a cost leader achieves high market share rapidly, and enters a virtuous cycle of share and scale feeding more research and innovation. Such a firm truly masters the strategy of mass customization, which is the enviable task of offering the most differentiated product to the largest base of consumers. Apple is a classic example. A firm which is a differentiation leader but a cost follower is, on the other hand, a niche player with low share and scale but high acceptability. Jaguar and Rolls Royce fall in this category. A firm which is a cost leader but is a differentiation follower would usually start with an initial advantage of scale but quickly finds that the intrinsic inability to reap above average returns with severely limits the ability to invest in research for innovation. Many firms in emerging markets, and late starters in advanced markets fall in this bracket, mimicking technology trends through technological followership. The fourth cluster of firms which are both differentiation followers and cost followers tend to have low capability for achieving any type of competitive advantage. Firms specializing in commodity and generic markets, whether in advanced markets or emerging markets, exemplify this non-value adding cluster.
Each of the four clusters described above has a bearing on the industry evolution. The greater the proportion of firms with both differentiation and cost leadership, the greater is the prospect of the industry becoming a high growth industry transforming the society. The greater the proportion of firms with differentiation leadership and cost followership, the greater is the propensity of that industry aspiring to become a sunrise industry. The greater the proportion of firms with cost leadership and differentiation followership in an industry, the greater is the possibility of the industry turning mature, and needing the impetus of transformational inputs. The greater the proportion of firms with cost followership and differentiation followership in an industry, the greater is such industry being at the risk of being a terminally declining industry. Moreover, sunrise industries can become high growth industries by mastering cost leadership while mature industries would need to reinvent themselves on both cost and differentiation to prevent themselves from slipping into a stage of terminal decline.
From generic to specific
As the discussion above brings out, Porter’s generic competitive strategy framework, simple, elegant and popular that it is, has probably ceased to be relevant in today’s era of fast changing technologies, user needs and global shifts. An ability to integrate both the dimensions of cost leadership and product differentiation under one technology and talent driven competitive strategy framework is essential for the contemporary firm. Such an integrated competitive strategy would not only provide sustainable competitive advantage for a firm but also determine a more fundamental and epochal industry evolution.
Posted by Dr CB Rao on August 31, 2011