In any normal market, there are many companies that compete with each other. In the fight for more customers, companies rely on different strategies. Some emphasize quality, others price, still others something different.
What should be the strategy of a company that wants to develop sustainably and successfully in its market? How exactly to compete with other companies? What should I bet on?
These questions are answered by Michael Porter and his concept of the three main competitive strategies. Let’s look at it.
The concept of the three main competitive strategies is the work of Michael Porter – American professor of strategic management and the most authoritative expert on competitiveness in the world. Porter first substantiated his idea in 1985. in his book “Competitive Advantage: Creating and Sustaining Superior Performance”.
Michael Porter is of the opinion that every company should focus on those areas of its activity in which it has a distinctive competitive advantage in the target market.
According to Porter, there are three main competitive strategies, and if you want to grow sustainably and successfully, each company should focus on just one of them.
Porter’s three main competitive strategies are:
- Cost leadership – the company strives to achieve an advantage by minimizing its production and distribution costs and accordingly offers customers lower prices;
- Differentiation – the company strives to achieve an advantage by offering something unique in the product and thus satisfies specific needs of customers;
- Focus – the company seeks to achieve an advantage by focusing on meeting the needs of narrower market segments or niches that it knows better than the competition.
- Michael Porter’s competitive business strategies have two dimensions in which they exist. These are the source of competitive advantage (low cost or product differentiation) and the scope of competitive advantage (narrow or wide).
As a result of the intersection of the two dimensions, Porter divides the Focus strategy into two parts, and this in practice shapes the following competing strategies:
Let’s take a closer look at Porter’s three main competitive strategies.
Cost leadership Strategies
The Cost Leadership strategy is appropriate in situations where a company has the opportunity to reduce its production and distribution costs to the lowest possible levels compared to all other competitors in the target market.
Some people confuse the strategy of cost leadership with the strategy of offering lower prices to customers. This is a mistake, as the prices at which the company sells are a separate topic from the production and distribution costs that this company maintains.
There are two types of cost leadership strategies:
The company maintains low costs and at the same time offers customers standard market prices, which gives a higher return.
The company maintains low costs and at the same time offers customers lower prices, thus increasing its market share.
It is critical that the company is truly a leader in terms of costs, and not just have low costs like other competitors. You need to be the spending leader in the industry, otherwise, you become very vulnerable to the moves of competitors who can reduce their sales prices at any time and thus block your attempts to expand your market share.
Therefore, relying on the strategy “Cost Leadership” makes sense only in cases where the company actually has a very strong competitive advantage and can maintain them sustainably over time. These can be things like:
Access to technologies that allow cost reduction;
Very low basic costs – for raw materials, labor, buildings;
Very efficient logistics that outperform the competition.
The main risk in using the Cost Leadership Strategy comes from competitors who may also choose to take this path. They can acquire similar technologies, resources or distribution or simply copy the cost leader in the industry.
Therefore, cost leadership is a position that must be defended and developed through continuous improvement in order to keep all key costs as low as possible.
The strategy “Differentiation” means the company to offer unique or different products (goods or services) that are more attractive to customers than the products of the competition.
The characteristics of the product, the service and even the image that the brand has in the eyes of the customers can be unique or different.
Relying on the strategy “Differentiation” makes sense in cases where the company has strong competitive advantages, such as:
Serious achievements in the development and implementation activity;
Ability to offer a high-quality product (good or service);
Effective marketing, branding, and sales activities to make customers aware of exactly what is being offered to them and what are the benefits of this offer compared to competing products.
The main risk in using the “Differentiation” strategy comes from more flexible competitors who oppose the “Focus on Differentiation” strategy. If a company is not vigilant about this, it may be that it creates high-quality products, but at the same time, customers choose to buy from the competition because it more precisely captures certain specific needs and desires in narrower market niches.
The Focus strategy means that the company concentrates on serving narrower market niches that it knows and understands better. For these market niches, the company develops low-cost products or products with special distinctive features.
Companies that successfully implement the strategy of “Focus” are able to build closer relationships with their customers and they become loyal followers and even “lawyers” of the brand. This is a natural barrier to the entry of competitors in the relevant market niche.
Michael Porter notes that the Focus strategy is rarely enough on its own. It is important for the company to determine exactly how it will use such a strategy, with two options:
- Focus on costs
- Focus on differentiation
Some people are confused by these two terms. “Focus on costs” does not mean “Cost leadership”, nor does “Focus on differentiation” means “Differentiation”. The key difference lies in the word “focus” and in the narrow, not the wide range of the market. In this sense, “Focus on costs” means efforts to reduce costs within a specific niche market, and “Focus on differentiation” means seeking distinction within a specific niche market.
For FOCUS’s strategy to be successful in one of its two forms, the company needs to be somewhat better as a result of concentrating on the relevant niche market. It must either be able to reduce its costs (due to the fact that it has a better knowledge of the market niche) or increase its differentiation (through a deeper understanding of customer needs).
Application of Porter’s model of competitive strategies
For example, let’s imagine that we are a small company that appears in a certain market. We want to determine what strategy to use to compete successfully.
Of course, there are many variables here that will determine how to proceed. It is best to start with a SWOT analysis to identify your strengths and weaknesses, opportunities and threats.
The analysis may show that the Expenditure Leadership strategy will not be the right one. To successfully use such a strategy requires competitive advantages in terms of low costs, such as economies of scale. Usually, large companies are the ones who can expect significant economies of scale.
The other two options remain – “Differentiation” and “Focus”.
The strategy of differentiation is a good possible choice, but we must have the potential to implement it. Our company will have to be able to offer an excellent high-quality product in the context of a wide range of markets.
However, what will happen if our analysis shows that despite the high quality of the product, our company does not have the resources to offer sufficiently effective marketing, branding, and sales activities to all customers in the target market? There is a risk that we produce a really quality product, but customers in the wide market never find out about it.
Therefore, for our small company, the Focus strategy may be the most appropriate. In particular, we could choose to follow a Focus on Differentiation strategy, focus on one or narrower market niches, and offer customers a distinctive combination of product quality, service, marketing, and sales.
According to Michael Porter, there are three main competitive strategies – cost leadership, differentiation, and focus. These are three fundamental strategic paths that any organization can take.
Each of the three strategies is possible and appropriate, as long as the organization has certain competitive advantages.
What is important to understand is that the organization must choose a strategy and follow it. It is not possible to follow all three strategies at the same time. Trying to be everything to all customers will not lead to success.