What are the 3 main competitive advantage strategies described by Michael Porter? How to use them effectively in business? Why is it worth planning the WOW effect?
What are the 3 main competitive advantage strategies described by Michael Porter? How to use them effectively in business? Why is it worth planning the WOW effect? What can we learn from Honda’s success, and how to avoid getting stuck?
Let’s start with the creator of the 3 competitive advantage strategies. Who is Michael Porter? He is an American economist, management guru, professor at Harvard Business School, a respected expert in enterprise strategy and competition analysis. He conducts teaching and research activities. He is a world-renowned expert in organizational and competition strategy.
Three types of strategy
What is a competitive advantage? According to Philip Kotler’s definition, it is an advantage of an organization over its competitors that offers a customer better value by offering a lower price or guaranteeing more benefits justifying a higher price.
Porter distinguished 3 types of strategies that allow you to achieve a competitive advantage in business; they can be used individually or combined. They are cost leadership (total cost leadership), differentiation, and concentration.
A company can skillfully combine all strategies, but according to Porter, it is rarely possible. Effective implementation of one of them requires a full commitment, and it is not worth getting distracted. What are the concepts created by Porter? What should you know to use them in your business? What are the risks?
The first strategy, which consists of achieving a leading position in total costs, was popularized in the seventies. It is based on gaining an advantage by minimizing direct and overhead costs.
What activities are involved in obtaining cost leadership?
- Investing in production equipment on an efficient scale;
- striving to reduce costs by gaining experience;
- strict control of direct and overhead costs;
- avoiding marginal customers;
- cost minimization, including in areas such as: advertising, sales team, service, research and development; and at the same time taking care of the quality of products and services.
Therefore, the leitmotif is achieving the lowest possible costs and gaining an advantage over competitors in this aspect. The cost position protects the company from competition from competitors – lower costs mean it will be profitable even when competitors lose theirs.
- Minimizing costs protects the company from powerful buyers who can afford to lower the prices of products and services;
- low costs protect the company from suppliers who can use their power to bring prices down to the level offered by a competitor;
- the low cost position places the company in an advantageous position in terms of substitutes compared to its competitors in the sector;
- the low cost position protects the company from all 5 competitive forces (hereinafter, we recall Porter’s 5 competitive forces model).
When implementing each of Porter’s competitive advantage strategies, two things should be borne in mind: the risk of not achieving the strategy’s goals or ceasing to implement it, as well as the risk that the strategic advantage obtained as part of the strategy’s implementation, will disappear along with the development of a given sector. From the beginning of planning a cost leadership strategy, knowing the risks associated with its implementation is worth knowing. Their awareness makes it possible to prepare and prevent before a serious “business fire” breaks out.
Risks can be related to 4 issues:
- a technical change negatively affecting previous investments.
- The pursuit of low costs through new entrants into the sector or by competitors as a result of imitation.
- Failure to recognize the need to make changes to products, marketing or other areas due to the 100% focus on costs.
- Cost inflation, which will limit the maintenance of the price difference by the company, counterbalancing the prestige of the trademarks of competitors.
One example of the risks associated with implementing this strategy is Sharp (electronics manufacturer), which has been forced to conduct an intensive campaign for its trademark. As a result, it had higher costs and lost the ability to offer lower prices than Sony and Panasonic.
Another company that shows the importance of predicting risks ahead of time is the 1920s Ford Motor Company, which achieved a leading cost position by limiting the number and variety of models. However, as personal income grew, some buyers wanted to buy more cars, and their expectations grew, so they were ready to pay more. Ford was not able to respond with a tailor-made offer, as it previously incurred significant investment in minimizing the production costs of the obsolete model. As a result, this automotive brand has fallen victim to its strategy and lost its competitive advantage. What is worse, it had to invest many financial resources to adapt to the situation strategically. In turn, one of the competing companies – General Motors,
Another competitive advantage strategy proposed by Porter – differentiation, consists of creating something that will become unique. The most effective implementation of this strategy is possible when the company diversifies in several respects. For example, Caterpillar Tractor, which produces construction and mining machinery and diesel engines, and gas turbines, is known for its sales network and spare parts and the outstanding quality of its products. In the case of this type of equipment, it is of great importance. The company cannot fight for cost leadership simultaneously, but this is not a strategic goal. The principle of something for something applies here.
- A chance for a profit rate higher than the average in a given sector (thanks to being in a position to defend against five competitive forces);
- protection against competition related to customer loyalty to the brand;
- increasing the profit margin that relieves you from a low cost position;
- a company that has diversified in order to gain the trust and loyalty of customers will gain a better position against substitute products than its competitors;
- Provides higher profit margins to counter supplier forces while reducing the power of buyers who do not have comparable products and are therefore less price sensitive
It happens that differentiation makes it impossible to gain a large market share and requires many times to give up mass sales. More often, however, differentiation is achieved at the expense of a worse market position because the steps required to achieve it are usually expensive. You need to invest in, among other things, promotion, high-quality products, and research.
When implementing a differentiation strategy, 3 risky situations may arise when:
- the cost difference between the company and competing brands becomes too great (buyers, despite brand loyalty, give up on it to minimize their costs);
- activities related to imitation reduce the differentiation;
- the demand for products or services, which are the main differentiating elements, decreases (this happens, for example, when the sophistication of buyers increases).
If a diversified firm lags too far behind its competitors in terms of cost, the low-cost firm can step into its “territory” and win the battle for customers. Japanese manufacturers have succeeded in this, including Kawasaki, which has successfully attacked diverse competitors such as Harley-Davidson. It won by offering large savings.
The third basic competitive advantage identified by Porter is concentration. Focus on a specific group of buyers, a specific segment of the assortment, or the geographic market. It is similar to differentiation in terms of being able to take different forms. When the two strategies outlined above attempt to achieve sector-wide goals, the focus strategy focuses on serving a specific segment well.
The idea behind this strategy is that a company can more efficiently and effectively serve its selected narrow and strategic segment than competitive companies that operate on a larger scale. The effect may be to achieve differentiation by better meeting the needs of a particular sector, or by reducing the cost of servicing it, or both. Although the concentration strategy does not pursue cost leadership and differentiation objectives, it often achieves its chosen and narrow market segment.
An example of a company applying a concentration strategy? Porter Paint focuses on the professional painters market rather than the DIY market, basing its strategy on services for professionals in the form of free color matching, quick deliveries to the workplace, and free catering services that painters can use for free when shopping at Porter Paint stores.
Limitations? Lower share in the entire market and resignation from part of the sales volume in favor of profitability.
What risks is it worth being prepared for when implementing concentration strategies? A situation that is dangerous for the brand may arise when:
- The cost difference between large-scale competitors and the concentrated company increases, which rules out the cost benefits that the brand was reaping from serving a narrow market.
- Competitors gain greater concentration by finding narrower sub-segments.
- The differences in the products and services desired by the selected strategic segment are narrowing.
What do you need to get started?
Successful implementation of a specific strategy in your organization requires specific resources and skills and appropriate management. Some of these dependencies can be found in the table below.
Requirements related to the basic strategies are presented in the following table:
|Type of strategy||Usually needed skills and resources||Organizational needs|
|Leading position in terms of total costs||Continuous investment outlays and access to capital technology design skills close supervision of the workforceTechnologization of product construction.||Tight cost controlFrequent and detailed audit reports structured organization and cost range incentives based on strict implementation of quantitative plans|
|Differentiation||Great marketing skillDesigning products creative talentsLarge opportunities for basic research high reputation or leading position of the corporation in the field of technology long tradition in a given sector or a particular combination of skills of people attracted from other companies||Close coordination of R&D, product development, and marketing functionsSubjective evaluations and incentives instead of quantitative measurementsAttractive conditions attracting highly qualified employees, scientists, and creative people|
|Concentration||A combination of the above rules of conduct, aimed at a specific strategic segment||A combination of the above rules of conduct, aimed at a specific strategic segment|
Porter’s Model 5 Forces of Competition
Each of the 3 above-mentioned strategies (in general) aims to create defense mechanisms against the 5 competitive forces. What comprises 5 competing forces?
- Strength number 1 – analysis of the intensity of competition within the sector – analysis of competition within the sector. It is worth starting with a precise diagnosis of the market in which a given company already operates. And then analyze the most key players and find out how much competition there is in a given market. As much as possible, you should look at the marketing strategies used by competing companies.
- Strength number 2 – the danger of the appearance of new products and services – it is worth taking into account the fact that new players may appear on the market. The risk of their joining the market is related to the “barrier to entry”, the lower the entry threshold, the greater the probability that the market will become richer in new brands.
- Strength number 3 – the threat of the appearance of substitutes for products and services – it must be remembered that the customer may give up the services / products of a given brand in favor of something that will meet his needs in a similar way, and will, for example, be cheaper.
- Strength number 4 – the bargaining position of suppliers – the greater the choice of suppliers, the stronger the position against them. Is the company dependent on one supplier or does it have a choice? Or maybe he can manage to a large extent “in house” within his own company and does not need external help?
- Strength number 5 – the bargaining position of buyers – it is worth knowing if a product is unique, checking customer loyalty and increasing the quality of products and services, and positively influencing their trust. Does your company have a monopoly in a given sector? Do customers have a huge choice and they are the ones who deal the cards?
No strategy = risk of “getting stuck”
In my view, Porter, a company that does not decide on one of the 3 strategies of achieving a competitive advantage, is at risk of “getting stuck.
A stuck company most likely has a poorly developed corporate culture and an internally contradictory set of organizational and motivational solutions. For these reasons, such an organization is forced to make a fundamental strategic decision. It must initiate actions that will allow it to gain leadership in terms of costs or be on an equal footing with competitors. This usually requires bold modernization investments, sometimes a decision to increase market share or focus on a specific segment (in line with the concentration strategy) or stand out in some respect (differentiation). Choosing the best solution is closely related
to the possibilities and limitations of a business that is in a crisis position anyway.
Honda’s Global Strategies and Success
A global company, regardless of nationality, tries to control the key points of advantage, from the economies of scale in domestic and foreign production to the sources of its foreign competitors’ financial flows. By taking unconventional actions, such as lowering the prices of an important product or prices in the most important markets, the company makes the competitor’s reaction difficult and costly. The main goal of a global company is to increase its own efficiency and undermine the effectiveness of competitors.
While the benefits of competing globally are enormous, there are also great risks, so not every company can and should use a global strategy.
Not all types of global companies are fit to participate in global competition. Many of them are individual and will remain so, competing in individual national markets. Before entering the global arena, it is necessary to determine whether the sector in which your company operates has characteristics favorable to a global competitor.
The marketing genius of Honda is a prime example. Before it became a global company, there were 2 separate sectors of the motorcycle industry worldwide:
- in Asia and other developing countries, many people commuted to work on small and simple motorcycles. The motorcycle was an inexpensive means of transport, so companies competed on price.
- in Europe and America, fewer people used large and sophisticated machines for entertainment. Manufacturers sought to diversify their products through unusual styling and brand image.
Honda has made its industry global by convincing middle-class Americans that motorcycling can be fun. Thanks to marketing innovations, the average annual growth rate of the company from the end of the 1950s to the end of the 1960s exceeded 20%. In the next step, the company became interested in Europe, achieving very similar results.
3 key moves influenced Honda’s success. First, it caused the market to take an interest in the properties of its products, giving up the products of its American and European competitors. The company focused on marketing and new customers. Secondly, it maintained its growth, successfully persuading buyers to purchase products from the upper segments of the assortment. Third, it took advantage of economies of scale by combining centralized production and logistics.
After all, economies of scale in marketing and distribution and low cost of production helped make high profits to enable Honda to manufacture cars!
While it is profitable to implement Porter’s competitive advantage strategy effectively in your business, to know the potential risks and not allow yourself to get stuck in a “stuck” state, as well as be inspired by big players such as the aforementioned Honda, it is usually worth having “something more” up your sleeve !
Jia Jang is a businessman who has worked in Texas and has heard too much “no” several times in response to funding for his start-up. In therapy, he asked people for absurd things to handle this form of rejection better. One day he went to a pastry shop and wished for donuts shaped like Olympic rings. His wish was granted, even the color sequence complied with the request. Because he expected to be ridiculed and refused, and a surprise awaited him, he reacted with the word: WOW. This moment was even immortalized in a YouTube video that over 5 million people have already watched.
Why are we writing about it here? Thanks to this story, it is easy to replace the 3 key elements for the WOW effect. These are:
- element of suprise;
- personal experience (of a specific person – client);
- “WOW” is contagious – a customer who has experienced such a moment will share it with others.
Although obtaining the WOW effect seems to be something completely random and spontaneous, it turns out that 4.0 companies and brands can design such an effect in the world of marketing. It’s good news.
How to do it? You can design a strategy and train the team so that the WOW effect will appear at every stage of the customer’s shopping path and will be something unique, which will distinguish your company from the competition. Brands should use creativity at every stage of their interaction with customers. It is worth remembering that on the buyers’ side, there are three levels of emotions related to interactions with the company:
- satisfaction – it is caused by brands focusing on improving their products, thus perfectly meeting the needs of customers;
- experience – it is about providing buyers with unique experiences;
- commitment – it is achieved by companies that are able to design a unique experience for their buyers.
Leading business players do not leave the WOW effect to chance. They lead the client on a well-thought-out path – from the awareness stage to the advocacy stage. It is worth joining this group!.”
- Michael Porter distinguished and described three strategies for achieving a competitive advantage: leading cost position (cost leadership), differentiation and concentration.
- The first – it gives a competitive advantage thanks to the reduction of incurred financial outlays, the second – thanks to the creation of a unique distinguishing feature, the third – thanks to focusing on a narrow segment.
- The goal of all strategies is to deal with the forces of competition. Each does it in a different way. They can be combined with each other.
- It is worth planning the WOW effect.
- It pays off to draw from companies which, thanks to numerous failures and successes, know well how to conquer the market and achieve above-average results.
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