A CRITIQUE OF PORTER’S COST LEADERSHIP AND DIFFERENTIATION STRATEGY

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S O N I RA ID E E P I KA J E T LYI L A T R I V E D IS W E TA S I N G HA JAY KU M A RR I M J H I M B I S H N O I

INTRODUCTION Michael E Porter the name in itself needs no identity as

any management student will be very well aware of this name.

As stated above being a management guru porter is the genius behind a lot of theories and the same theories are very successful in their approach.

But we cannot look at just one side of the coin and have to evaluate the other side also.

In process of doing the same this presentation is about the positive as well as negative aspect of porter’s strategy of differentiation and cost leadership strategy.

COST LEADERSHIP STRATEGY

According to Porter:

• The cost leadership strategy requires the sale of a “standard no frills” product combined with “aggressive pricing” thus the strategy involves making a fairly standardized product and underpricing everybody else.

• An important requirement of it is the investment of heavy capital in the state of art equipment

• According to this theory the market share leader can underprice competition because of its lower cost due to its cumulative experience.

COST LEADERSHIP CONTINUED

The cost reduction effort of this strategy can be classified under three categories:

1. Reducing unit manufacturing costs through higher unit volume, efficient scale facilities and experience curve

2. Exercising strict control over engineered costs

3. Minimizing discretionary costs like R&D, service, sales force, advertising, quality control and so on.

DIFFERENTIATION STRATEGY

• Differentiation as the name suggest calls for a product or service that is perceived industry wide as being unique

• In this strategy a firm seeks to be unique in its industry along some dimensions which are widely valued by customers

• It selects one or more attributes that many buyers in an industry perceive as important and uniquely positions itself to meet those needs and it is rewarded for its uniqueness with a premium price.

CRITIQUE OF COST LEADERSHIP• According to the Kiechel:

• Major reliance on modern capital equipment:

• the firm need a heavy upfront capital investment in the state of art equipment which means that in order to maintain cost leadership a firm should therefore buy the largest most modern plant in the industry so with such high stakes only the most stout hearted can play.

• Reliance on the experience curve:

• According to this theory the market share leader can underprice competition because of its lower costs due its cumulative experience thus further hastening its drive down the curve.

• A frequent result of such an aggressive strategy can be kick- em, punch- em, wrestle- em to the ground war. Wars like these often end without winners because price cuts are easy to imitate and they may not result in long term advantage.

HIGH MARKET SHARE A PRIOR CONDITION FOR COST LEADERSHIP?

• Porter maintains that achieving a low overall cost position often requires a high relative market share or other advantages such as favorable access to raw materials but how does one acquire high market share in the first place?

• As Gale suggests market share leader accomplish this distinction via a strategy of differentiation higher quality rather than through cost leadership.

• Porter cites General Motors(low cost) and Mercedes(differentiation) as the profit leaders in the industry, but GM’s success raises two important questions.

• First it is not clear, how GM achieved low cost? Was it because of the persistent pursuit of cost leadership strategy as suggested by porter or was low cost mainly the result of high market share GM enjoyed or both.

• GM came with the idea of a car for every purse and purpose and rationalized its cars into five price quality segments and dominated the market with a 50% of market share.

• It was GM’s differentiation strategy that spelled the doom of Henry ford’s model t and his cost leadership strategy. So it is ironic that even the most prestigious handiwork Cadillac of the man wrote the book on market segmentation and differentiation failed the threshold of a differentiated product in porter’s scheme of things.

• Behind the success of GM and whirlpool there are both the differentiated and as well as cost leadership strategy

• Porter has shown that GM is a successful practitioner of cost leadership strategy another example is of whirlpool but the fact is that their success is not just the result of cost leadership strategy but followed by differentiation strategy.

“LOW COST” OR “LOW PRICE” STRATEGY

• Cost leadership requires aggressive construction of efficient scale facilities, vigorous pursuit of cost reduction from experience, tight cost and overhead control, avoidance of marginal customer accounts and cost minimization in areas like R&D, services, sales force, advertising, and so on. Low cost relative to competition becomes theme running through quality, services and other areas.

• The above philosophy of cost leadership on the cost side thoroughly matches porter’s earlier advocacy of aggressive pricing on the revenue front however in his later book he seems to suggests a different pricing posture.

• According to Mintzberg: price differentiation may have to follow cost leadership, implied as a necessary evil

• Mintzberg made an interesting statement ,he calls cost leadership a differentiation strategy as differentiation strategy means differentiation of product from its competitors whether physical or non physical that means the basis of differentiation is not quality but low price.

• Based on these arguments Mintzberg takes the position that business strategy has only two dimensions: differentiation and scope.

• Speed agrees with this and argues that if a cost leader is unwilling to compete on a lower price then it must retain enough appeal to induce customers to buy its products at a price equivalent to those of its competitors.

CRITIQUE OF DIFFERENTIATION STRATEGY

• Two types of differentiation strategy:

• Broad differentiation strategy: presents a view of differentiation that is far more inclusive because they do not make distinction between the premium price quality segment on the one hand and mid price segment on the other.

• E.g. Mercedes and BMW as premium price segment and Toyota and Honda

• Best cost provider strategy : a hybrid version that adopts a middle ground between low cost and differentiation

• E.g. Lexus

• Differentiation better than cost leadership:

• Both the strategies are said to be equally successful but for the success of most of the firms differentiation plays a more important role as companies tend to be oriented more on customer value than to the cost side of the profitability .

• The foundation of differentiation strategy generally is to provide superior quality compared to the competition.

DIFFERENTIATION AND HIGH MARKET SHARE INCOMPATIBLE

• At first Porter says that differentiation and high market share doesn’t go together and it is generally because differentiation is usually costly

• Contrary to porter’s thinking high market share can be achieved by pursuing a strategy of differentiation. Market share leadership can provide three major benefits/;

• It can dramatically lower cost and may even lead to cost leadership

• It can be a major contributor to long term competitive advantage

• It can be a significant source of differentiation.

• Differentiation strategy can often lead to a low cost position and such a favorable outcome is brought about by increase in sales volume, the learning curve and economies of scale and scope.

• Even higher quality can lead to lower cost:

• porter says that differentiation is usually costly and low overall cost position may not be incompatible with differentiation

• But a product design aimed at ease of manufacturing can reduce the production cost.

• Simplifying product design by reducing the no of parts can also result into lower cost and it may improve quality also.

• E.g. 1997 Toyota Camry had 7 fewer parts than in 1996 still its much better than its counterpart.

• Innovative process technology can also lead to lower cost, in some cases it may even produce higher standards of quality simultaneously with lower cost.

• E.g. introduction of solid technology in TV sets

• Process technology in mobile phones

• Quality assurance can also result in reducing the cost.

COST REDUCTION VERSUS COST ADVANTAGE

• There is a big difference between cost reduction and cost advantage as cost reduction being a temporary and easily imitated phenomenon can face a phase where it has to sacrifice its position to the highly competitive leaders seeking cost leadership hence proving it to be short term strategy.

• High market share as a result of long term competitive advantage:

• High market share is a key player in achieving competitive advantage as if the market share of a company is low then it will be marginal in the market and also the sales volume of the marginal supplier may be too low to provide the customer with the appropriate and satisfying service.

• Market share leadership enhances the differentiation:

• Once a brand attains a position of market share leader then it can create the halo in the market and transcend the product with quality as it is believed that the best selling product have the best quality.

PURE COST LEADERSHIP STRATEGY VERSUS COST LEADERSHIP AS A RESULT OF DIFFERENTIATION

• Cost leadership and differentiation are not dichotomy but a part of broad continuum and can be combined to gain competitive advantage

• E.g. global TV set industry which Japanese firms were able to achieve higher quality and lower cost at the same time.

• Pure cost leadership incompatible with differentiation strategy:

• Porter have constantly maintained that each generic strategy represents a fundamentally different route to competitive advantage and hence a firm can select one among the generic strategies otherwise it will be stuck in the middle.

• Porter states that each firm has its own style of management, culture, resources structures and philosophies so the strategic of cost leadership usually requires that a firm to be a cost leader, so it has been labeled as pure cost leadership in order to differentiate from cost leader that may come as a result of pursuing differentiation strategy.

• These both strategies are not merely dimensions that could be mixed or matched but a set of strategies that are both coherent and logically consistent

Need to redefine porter’s narrow view of differentiation:

• So in order to change porter’s perspective of differentiation we should focus on other points also as a lot of brands come with a mid ranged price and better customer perceived quality than the competition

• Following this companies need not to adopt porter’s rigid culture and philosophy of pure cost leadership to achieve high market share.

• Organizational culture can play an important role in shaping firm behavior that is why porter has cautioned against the pitfalls of the pure cost leadership.

FRAMEWORK OF COMPETITION

Differentiation the cornerstone of competitive strategy:

• The competitive strategy has only two dimensions

• Differentiation and scope

• Road to market share leadership: differentiation at moderate prices:

• Providing a high quality product and charging a premium price is not the only way of to achieve successful differentiation in the consumer market. Another viable alternative is to seek market share leadership by catering to a broad middle class by offering higher quality relative to competition at moderate prices.

• E.g. Toyota Camry, Coleman, Kenmore and Zenith

• Segmentation versus differentiation:

• A firm is rewarded for uniqueness with a “premium price”

• Differentiation is inherently relative and so a firm’s value chain must be compared to that of the competitors. Thus the first step is to define what its competition is?

MERCEDES

• The case of Mercedes has often been cited as an example of a company pursuing a differentiation Strategy. As reported in the April 1996 issue of Consumer Reports, the luxury Mercedes-Benz E-Class model, the luxury BMW 5-series model, and the mid-price Ford Taurus – all medium sized cars, had a sticker price range, respectively, of $39,900-$49,900, $37900-$49,900, and $17,995-$22,000. it is clear from the example that Mercedes primary competition is BMW, not Ford Taurus. Buyers of the Mercedes and Ford represent different classes of customers that belongs to two distinct price-quality segments: Price segment for Mercedes and mid-price segment for Ford.

• From the above we cannot discuss differentiation separately from price-quality segmentation. Differentiation can be visualized two ways:

• Differentiation across or between segments and

• Differentiation within segments.

• Mercedes and Ford is the example of differentiation between segments and Mercedes and BMW is the example of differentiation within segments.

• From the above discussion it is not meaningful to say that a firm pursuing a differentiation strategy can charge “premium prices”.

IMPORTANCE OF POSITIONING

• A country’s geography play an important role in creating a cluster of native firms that compete generally on a common theme.

• E.g. America’s vast and open landscape has given rise to large cars boulevard ride.

• Germany produces high performance cars because of Europe’s narrow street.

• Consumer union recognizes four broad dimensions in rating cars:

• Performance, comfort, reliability, and fuel economy

• The two major German competitors in luxury cars have positioned themselves in the performance segment: Mercedes and BMW

• Volvo has positioned itself in the luxury automobile segment by consistently focusing on safety, Toyota provided Lexus 400 to provide the smoothest and quietest ride.

CRUCIAL OUTPACING STRATEGIES

• Just as low cost leader cannot ignore differentiation, leaders in differentiation too cannot ignore costs.

• Although there are differences in how technology and markets evolve, they share two common phases of transition:

1. Standardization of product or services, which marks the transition from a high perceived value strategy to low delivered cost strategy

2. Rejuvenation which marks the transition in the opposite direction, from an emphasis on delivered cost back to high perceived value

• In the evolving market success does nit come from a single minded pursuit of either cost leadership or differentiation strategy. Rather it comes from an outpacing strategy to outdistance the competition.

• An outpacing strategy involves an explicitly developed ability to add one strategy to the other as a market goes through a back and forth transition between standardization and rejuvenation.

• Outpacing strategy is not middle of the road strategy, depending upon the industry phase it is dominated by either product or process

• Second the timing of the shift from one phase to another involves an element of risk and even luck

• Third, the strategy may nit easy to implement because the organizational setting for creating product value is often the opposite of one for seeking low cost.

• A manufacturer needs a standard product to achieve a successful evolution of the learning curve

• Instead of introducing a stream of product continually, a follower of this strategy relies instead on setting the industry pace through major periodic model changes.

The Major themes that have emerged from this critique are:

• The cost leadership strategy is not really a low cost strategy but a differentiation strategy based on low price

• Differentiation and scope are the only two dimensions of business strategy

• Market share leaders compete more on the basis of differentiation than on low cost

• Differentiation strategy can lead to market share leadership which in turn can lead to low cost

• Cost leadership strategy as characterized by porter cannot be combined with differentiation strategy because the two are based on different organization cultures and philosophies

• We need to modify porter’s narrow view of differentiation that is grounded in uniqueness and premium price

CONCLUSION

Finally the research shows that differentiation and cost leadership strategy can coexist , however porter insists that each generic strategy requires a different culture and a totally different philosophy. He says that the strategic logic of cost leadership usually demand that a firm be the cost leader.

The flaw is not in porter’s logic but in his basic premise that associates differentiation with uniqueness and premium prices : a situation which is incompatible with high market share.