the problem with porter's generic strategies …

HENDRY: THE PROBLEM WITH PORTER’S GENERIC STRATEGIES 443

John Hendry Director, MBA Programme University of Cambridge

F or most people involved in the strategic management field, teaching competitive strategy involves teaching Porter’s model of generic strategies. Critics of the model have however exposed some severe limitations to its application. There are also some serious sources of confusion, both within the model itself and in its relationship with the other principal concepts and models used in the teaching of competitive strategy. This paper explores some of the pedagogic problems that can result and makes some tentative suggestions as to how Porter’s model may be used without giving rise to confusion.

Introduction

It would not be much of an exaggeration to say that wherever the subject of competitive strategy is taught, so too is Porter’s (1980) model of generic strategies. If any model of strategic options can be said to have attained the status of a “standard” model it is surely this one. But though standard it is not straightforward. A number of writers have criticized it, both on empirical grounds (Phillips, Chang and Buzzell, 1983; Miller and Friesen, 1986; Dess and Davis, 1984; Chrisman, 1986; White, 1986), and on theoretical ones (Murray, 1988; Hill, 1988; Wright, 1987; Sandberg, 1985; Chrisman, Hoffer and Boulton, 1988). And while some of these criticisms are wide of the mark,’ they do reflect a number of limitations and ambiguities inherent in the model. Some aspects of the model also sit uneasily alongside the conceptual frameworks characteristic of strategic management teaching today, providing a further source of confusion in the

classroom. This paper, framed as a dialogue between a strategy teacher and his or her class, is intended to highlight some of the problems that can be encountered trying to teach Porter’s generic strategies to a relatively percipient bunch of students.

Teacher: Good morning! This morning we are going to look at competitive strategy options, using the framework provided by Michael Porter’s model of generic strategies and the case examples from his recent videotape. You have all seen this videotape (Porter, 1988), and you have also had a chance to read both his original exposition of the model (Porter, 1980), and the slightly revised version in his book on Competitive Advantage (1985). Since one or two of you have told me that you found the texts confusing, however, and since a number of Porter’s critics have clearly misunderstood them, I shall begin by summarizing the main features of the model.

The central concept of Porter’s approach to competitive strategy is a firm’s profit or economic rent, and in his view this is measured primarily by industry attractiveness, as determined by his well known “five forces” model of the determinants of industry profitability (Porter, 1985:4). The generic strategies model is then concerned with the relative profitability of a firm with respect to its industry average, and in particularly with the means by which a firm may attain profits above the industry average in the long run. If a firm is to achieve such above average profit performance, it must possess a “sustainable competitive advantage” compared with its competitors, which allows it to cope with the five forces

444 EMJ VOL. 8 NO. 4: December 7990

better than they do. According to Porter, there are just two basic types of competitive advantage a firm can possess: low cost and differentiation. When combined with the scope of activities for which a firm seeks to achieve them these lead to the generic strategies shown

in figure 1 (Porter, 1985: 11-12; 1988).

In his original exposition of the model Porter (1980) talked of just three generic strategies: overall cost leadership, differentiation, and focus. But in subsequent expositions he first divided the focus strategy into two variants (Porter, 1985) and subsequently treated these variants as, in effect, generic strategies in their own right (Porter, 1988). Figure 1 reproduces the most recent and clearest representation.

The generic strategies are:

Cost leadership (also referred to as Low cost, Broad cost, Overall cost leadership). “If a firm can achieve and sustain overall cost leadership, then it will be an above- average performer in its industry provided it can command prices at or near the industry average” (Porter, 1985:13). The logic is that a firm with lower than average costs, but commanding about average prices, will earn above average profits. Since the presence of more than one low-cost competitor is likely to lead to fierce rivalry over market share and consequent price cutting, however, Porter argues that the cost leader must be not merely a low cost producer, but the lowest cost producer in the industry (Porter, 1985:13).

Differentiation (also referred to as Broad differentiation). “Differentiation . . . derives. fundamentally from creating value for the buyer through a firm’s impact on the buyer’s value chain.” (Porter, 1985:53) Differentiation is defined as uniqueness in some

dimension important to buyers across the industry, and recognized as such. This allows a firm to charge an above average price for its product, and providing that it can produce at average or near-average costs, to earn an above average profit (Porter, 1985:14).

Cost Focus and Differentiation Focus. Focus strategies rest on the choice of a particular target market segment with unusual or distinctive needs, and on the optimization of the firm’s activities to serve those needs (Porter, 1985:15). In a cost focus strategy the firm identifies a segment whose needs can be met at a lower cost by a dedicated producer than by broadly targeted competitors, and exploits this cost advantage to earn above average profits. In a differentiation focus strategy the firm identifies a segment with different or more extensive needs than are provided for by the broad market competitors, and dedicates itself to meeting those needs, commanding enough of a premium price to earn above average profits, even though the costs of meeting the needs may themselves be above the industry average (Porter, 1985:15; 1988).

The thrust of Porter’s argument is that in order to attain a sustainable competitive advantage and so earn above average industry profits, a firm must concentrate on one of the generic strategies: it must make a clear choice about both the type of advantage it is seeking and the scope within which it is seeking it, and must avoid being “stuck in the middle”. This does not mean that a differentiator should ignore costs, or a cost leader ignore product differentiation. If it is to command prices near the industry average, a successful cost leader must pursue any differentiatioin opportunities that do not add to the cost base. A successful differentiator must, if it is to keep its cost base near to the industry average, pursue any cost reductions that do not sacrifice differentiation. But “being all things to all people is a recipe for strategic mediocrity

Strategic

Broad (Industrywide)

Target

I Focus 1 Narrow

cost I I Differentiation I

(Particular Segment Only)

La Quinta Inns 1 1 Cray Research, Inc. ]

Low cost

Figure 1 Porter’s Generic Strategies Source: Porter (1988)

Differentiation


and below average performance, because it often means that a firm has no competitive advantage at all” (Porter, 1985: 12).

Student: Why?

Teacher: Well, this is never discussed at length, but the suggestion is that the different generic strategies each require a different mix of skills, resources, and organizational structures, and that any compromise will necessarily lead to organizational inefficiencies (Porter, 1980: 40-41; 1985: 23-25). The benefits of optimising for a particular segment will not be gained if the firm is simultaneously serving the broad market, and differentiation will generally be costly (Porter, 1985:17).

Student: I can see that differentiation may cost money, but the other bit seems very vague. Why can’t a firm differentiate on one product line and go for cost leadership on another?

Teacher: It can, and Porter himself gives an example of this (1985:18). But he argues that this can only work if the products are located in separate business units, with a danger even then that the culture from one side will spill over into the other and compromise its strategy.

Student: So are we talking about a firm or a business unit?

Teacher: In theory about a firm. But it will be much easier to understand the generic strategies if we stick to business units, or firms with single product groups.

Student: But how can you have an industry wide positioning if you’ve only got a single product group?

Teacher: Ah! There you’re misunderstanding what Porter means by “industry-wide”. He doesn‘t mean that a firm is necessarily serving every segment, merely that it has a broad customer base. If . . .

Studenf: Hold on. Before we get onto that, could we just clear up this bit about cost leadership and differentiation being incompatible? Surely there are some cases where they are compatible - what about the impact of new technologies?

Teacher: Of course. If a firm can introduce a significant new innovation, it may be able to enhance differentiation and reduce costs at the same time, and even to combine cost leadership and differentiation strategies. Porter himself quotes this as one exception to his rule, and also identifies two other exceptions. If all the competitors are stuck in the middle, they may allow one firm to achieve both lowest cost and

differentiation advantages, albeit only temporarily. And where cost is heavily determined by market share, the low cost market leader may open up a sufficient cost advantage to allow it to differentiate without sacrificing its low cost position. A similar situation would arise if one firm could exploit inter-industry relationships to reduce costs in a way that was not open to its competitors.

Student: I can see all that. But what if the competition for market share is driven by differentiation rather than cost? Surely the situation you have described could work in reverse too, with a successful differentiator gaining enough market share to estabhsh itself as cost leader as well?

Teacher: Yes. This point has been raised by some of Porter’s critics. If competition is quality driven, for example, . . .

Sfudent: Which is what all the books you’ve asked us to read say it is.

Teacher: Quite. Then this could be another exception to the rule.

Student: And in manufacturing industry, surely quality and low cost often go together anyway, as in the Japanese car and electronics firms?

Teacher: Yes.

Student: And what about brand competition? Surely the most successful brand differentiator will also gain cost leadership through market share?

Teacher: Yes, provided of course that increased market share does bring cost economies.

Student: Which you said only the other day, when talking about experience curves, that it usually does.

Teacher: Usually, yes.

Student: So we seem to have an awful lot of exceptions! What about commodity industries, where there’s no room for differentiation at all?

Teacher: Well they’re not so much exceptions as, I suppose, trivial examples. If you can’t differentiate you can’t combine differentiation with cost leadership.

Student: But surely most commodity markets have more than one producer earning above average profits, and only one of them can be the cost leader, so how are they competing?

Teacher: Well, yes, that is another exception to the


general model; if the cost leader’s production capacity is limited, then that opens the way for other firms to compete on cost without being cost leaders.

Student: And there must be some industries where cost is largely irrelevant, and competition is based purely on differentiation - as in professional services such as architecture or management consultancy perhaps?

Teacher: Another trivial case.

Student: So if we exclude the trivial cases, and rule out the exceptions, are there any industries to which Porter’s model does apply, in full so to speak?

Teacher: But of course: it applies to ordinary industries: ones where the cost structure and buyer needs are such that cost leadership and differentiation are incompatible - like Porter’s examples!

Student: Like the soap industry, for example, or the airline industry?

Teacher: Yes, but . . ,

Student: But isn’t American Airlines the cost leader as well as . . .

Teacher: . . . before we go . . .

Student: Surely Ivory is an example of differentiation as well as cost . .

Teacher: . . . on to the . .

Student: Are we talking about Ivory Soap, or Proctor and Gamble Soaps, or Proctor and Gamble . . .

Teacher: . examples, could we just make sure that we all understand Porter’s other distinction, between broad scope and narrow scope. Is everybody clear on this?

Student: Well I don’t want to seem stupid, but what exactly is the difference between differentiation and focus?

Teacher: Not stupid at all - a lot of Porter’s commentators have had problems with this one. But it’s really quite straightforward. The broad differentiator competes by providing a superior, or non-standard productor line of products, the benefits of which are perceived throughout the industry, while the focused competitor concentrates on the needs of a particular industry segment.

Student: But not everyone is prepared to pay for the differentiated product, so what are the group of

customers who are prepared to pay, if not a market segment? It may be a large segment, or a poorly defined segment, or a shifting segment. But surely from a marketing point of view the basis of a differentiation strategy consisting precisely in recognizing it as an identifiable segment. Isn’t that what market segmentation is all about?

Teacher: Yes, that is what its all about, but there’s still a difference. Perhaps it would help if we called Porter’s segment a niche. What he means is a segment that’s relatively small, with very well defined needs.

Student: But doesn’t he talk of differentiators as having low market share as well?

Teacher: Yes, but its not constrained in the same way. A niche market will always be a niche market, but the broad scope differentiator always hopes that the number of buyers prepared to pay for his product will grow, and that his differentiation will, in effect, become the industry standard.

Student: But doesn’t that bring us back to the situation where competition is differentiation led, and the cost leadership - differentiation distinction breaks down?

Teacher: Not necessarily . .

Student: And what about multi-segment differentiation? Porter says you have to compete across the industry or focus on a single segment, but might it not be possible to identify a differentiation opportunity common to a range of market segments, or even to differentiate in different ways in different segments, and to compete there against broad market competitors in terms of differentiation, but against competitors targeted on single segments in terms of cost?

Teacher: This point has been made before (Sandberg, 1985), but it’s not clear where it gets us. If you try to compete in different ways in different segments, then you get back to the problem of maintaining different skills and resources, or different structures or cultures, within the same organization. And even if you compete in the same way in a variety of segments there’s a danger you’ll get stuck in the middle. But it might be possible in exceptional cases.

Student: If you competed through multiple brand differentiation, for example, wouldn’t that be a case in which the different types of differentiation might be organizationally compatible?

Teacher: Yes, it might. But as I said earlier generic strategies are much easier to understand if we stick to the case of a single business unit.


Student: Which is presumably why Porter uses Ivory Soap rather than Proctor and Gamble!

Teacher: Yes, perhaps - though I am sure he could apply his model to a broader industry definition if he wished: it would just get a bit complicated, that’s all. Now, we’ve been through some of the general issues, so let’s move on to the case studies. The first one we looked at on the video was Ivory Soap, and this provides a classic example of a cost leadership strategy.

Student: But Ivory’s a brand. Surely that’s differentiation?

Teacher: No. If the standard product was unbranded soap, then a branded soap like Ivory would represent a differentiation strategy: and that is of course how Ivory originated historically. But nowadays it makes more sense to look at Ivory and other relatively low- priced brands as the standard products.

Student: So ordinary soap, unbranded soap, is a niche product?

Teacher: Yes.

Student: OK, if you say so, but it must be a pretty big niche. And you never answered the bit about industry- wide. How can you say that one brand, like Ivory, competes “industry-wide”?

Teacher: Well it’s not industry-wide strictly speaking, but it has a very broad appeal. It competes in what you might call the core market.

Student: OK. and what about Dial and Dove? They’re both very well defined products. If unbranded soap is a market segment, surely deodorant soap is one too, and skin care another one?

Teacher: You could argue that, yes, but there is a difference, because if you define that core market, then Dial and Dove are in it loo. They compete directly with Ivory. Indeed Dove is now the market leader.

Student: So why isn’t it the standard product then?

Teacher: Because you’ve got to remember we’re talking about averages here. The standard product is one which commands an average price, and that’s still Dove.

Student: But if Dove and Dial and the luxury soaps were to gain market share at the expense of the no- name brands, that would shift the average up, and Ivory could be left earning a below average price, but still making above average profits.

Teacher: Yes: it would then move into the cost focus category.

Student: Of course - I see! But does that mean that any producer selling at below average prices is a cost focuser, whatever its market share?

Teacher: No, because we’ve still got to take account of all the firms which make below average profits, so . . .

Student: I’d almost forgotten! So if we look at the firms pursuing successful generic strategies in the soap industry, they’re all supposed to be making above average profits. But that’s the unbranded soaps, the three dominant brand leaders, and the luxury soaps: who’s left to make the below average profits?

Teacher: Well, this particular example may be a bit skewed, but if we address the question in general terms there clearly are some producers left, because there are all the less successful brands. And if I can go back to the more general question about the products commanding less than the average price, there will be the failed cost leaders: those whose cost- cutting has left them with a product which fails to meet the industry standard.

Student: You mean those who have failed to differentiate sufficiently?

Teacher: Precisely.

Student: So the mark of a failed cost leader is the failure to differentiate?

Teacher: Yes - or of course the failure to achieve lowest costs.

Student: But this brings us back to that business about low costs versus lowest costs, and I’m afraid I’m still a bit confused. Surely you can be, for example, the second lowest cost producer, and still earn above average profits?

Teacher: Only if there’s no price competition!

Student: OK. But that’s another problem. Are these producers of standard products competing on price or not? In a commodity market they obviously are, but generally Porter seems to assume they’re not.

Teacher: And in general that’s a fair assumption. But if cost is related to market share, and you try to operate as a second low cost producer, you can only do so by taking market share, and so profits, away from the cost leader. And in those circumstances the cost leader may well fight back on price to eliminate you from the


market. So even though price may not be the primary competitive weapon, it can still pose a competitive threat. Now, are there are more questions relating to Ivory Soap?

Student: Yes. I’m still not happy about the place of price in all this. It’s all very well to talk about average prices and below average costs earning above average profit - you can’t quibble with the equation - but why is the customer buying the product? Everyone keeps telling us about the importance of added customer value, and Porter stresses this too when he talks about differentiation. But he never tells us why anyone should buy a standard product. Surely the important thing in competitive strategy is to look at things from the customer’s perspective, and if he’s to buy a particular product it must be because it meets his needs better, or adds more value to his own operations, than do rival products. Which means it must be better in some way, or cheaper. Now differentiation is all about supplying a better product: everybody seems to be agreed on that. Isn’t cost leadership all about supplying a cheaper one?

Teacher: That’s a very tempting way of looking at it, of course, especially if there really is a standard product. But it may be only very slightly cheaper, and remember the cost leader must also achieve parity of differentiation. In many industries the customer’s choice between producers of near-standard products may rest more on small items of differentiation than on price per se.

Student: Assuming of course that there are several firms competing for the low cost position, but no price competition.

Teacher: Yes, well . . .

Student: So what it comes down to really is good value for money: the best combination of price and performance to meet the customer’s needs.

Teacher: Yes.

Student: Just like differentiation.

Teacher: Yes - look, can we move on now. What about La Quinta Inns? Here we have a clear example of a focused cost strategy. La Quinta has identified a clear market segment - and none of you I trust will quarrel with this - in which it can meet buyer needs at significantly lower cost than the broad industry competitors. Agreed?

Student: Agreed. But isn’t this also an example of differentiation? It seemed apparent from the video that the absence of certain facilities in the La Quinta motels

was not just a source of cost saving but a positive advantage for most of their customers.

Teacher: But they’re not charging a premium price!

Student: So perhaps it’s inefficient differentiation. Or perhaps they’re trying to attract customers from outside their niche, and getting stuck in the middle? OK, I accept that they’re making above average profits, that they’re pursuing a focused strategy, and that they’re cost leaders. It just seems unnatural to say that it isn’t differentiation.

Teacher: Well maybe that’s another confusion of terminology: we seem to have had several of them today. Are you all happy that the American Airlines strategy is one of differentiation?

Student: I thought I was a minute ago. But then you said La Quinta wasn‘t differentiation because it didn’t charge a premium price. But surely American Airlines doesn’t charge a premium price either?

Teacher: Well not exactly. But it does earn a premium revenue, as its differentiated product appeals to enough customers - across the industry, mind you: you’re all happy with that? good - to give it well above average seat occupancy. So each flight, though it costs more to run than the equivalent flight of a rival airline, commands a significantly higher total price.

Student: But it’s a bit artificial to price it by the flight surely: the customers are the individuals, not planes full. And doesn’t it make more sense to treat seat occupancy as part of the cost structure? You could say American Airlines was the cost leader, with the lowest costs per passenger, and that it was that which earned it above average profits.

Teacher: But you can’t deny that it’s a differentiated product.

Student: So maybe it’s another one of those exceptions: better products, average price, lowest costs. Just like La Quinta in fact!

Teacher: Anybody have any comments on the Cray case?

Student: Not really. It seems like a very good example. But I’ve been thinking about all this while we’ve been discussing it, and I wonder if we might have a problem here. May I try and sum it up?

Teacher: Please do!

Student: Thank you. In terms of basic economics it seems clear to me that some firms will have profits


above the industry average and others below it, and that if a firm is to earn above average profits then it must have either below average costs or above average prices. I’m also prepared to assume, for the sake of argument, that above average profits are a good thing, though in practice I think many firms will be more interested in other objectives, such as growth. But I cannot understand why a cost leader should not be able to translate that leadership into lower prices and still earn above average profits: Porter’s refusal to consider price as a variable for low cost producers (except, rather artificially, to rule out the possibility of successful second lowest cost producers) might perhaps be justified in terms of the simplicity of the model (see figure 2), but it bears no relation to economic reality.

Further, I can see no purely economic reason why a firm should not be above to achieve bath below average costs and above average prices. Indeed the exceptions to Porter’s rule that cost leadership and differentiation are incompatible seem to me to be so many and so obvious as to make the rule virtually worthless.

In order to defend his position on this, and in order to make his point about not getting stuck in the middle between a focused scope and an industry-wide scope (whatever those are), it seems to me that Porter has to go beyond purely economic considerations, and as soon as he does so he seems to get into trouble. He seems to have a very restricted and, indeed, outdated conception of market segmentation; no concept at all of segment differentiation; and a very restricted concept of added customer value. This seems to be something that’s important to differentiators, but not to cost leaders. Linked with this, perhaps, he also seems to get into trouble whenever he tries to extend the model beyond the simplest single-product-group industries and business units.

Teacher: So what would you suggest?

Average price

Average cost

Differentiation Low’cost

Figure 2 The economic basis of Porter’s model

Student: Well don’t get me wrong. I’m still a great

admirer of this guy! And in general terms I find the generic strategies very useful. They make a valuable bridge between the five forces model, which seems to me an outstandingly useful way of looking at an industry, and the essential need to add customer value and to keep adding it by striving to be continually cheaper or better. As Porter says, it’s not much use adding customer value if the value you create is competed away to others (Porter, 1985:9), so you have to look at how a firm combats the five forces as well as how it adds customer value.

The idea of not getting stuck in the middle is very useful, too, if you take it simply as a warning to be clear about precisely what your market is and how you’re competing in it. But if you’re going to go beyond that, and ask what the strategic options are, it seems to me that it’s the concepts of market segmentation and targeted efficiency that you want, not a whole load of rules and restrictions that simply don’t work.

Teacher: (To himself). Next time I think I’ll just stick to the Cray case. You can’t not teach Porter!

NOTES

1. The most common criticism has been that while low cost and differentiation strategies are empirically identifiable (Hambrick, 1983; Dess and Davis, 1984), and are indeed linked with above average profitability (Hambrick, 1983; Phillips, Chang and Buzzell, 1984), Porter’s dichotomy of cost and differentiation cannot be maintained. Phillips, Chang and Buzzell(1983), Miller and Friesen (1986), Dess and Davis (1984), Chrisman (1986) and White (1986) have all found evidence of the successful combination of low cost and differentiation strategies, and Murray (1988). Hill (1988) and Wright (1987) have argued on theoretical grounds that joint low cost and differentiation strategies should not only exist but also be necessary for competitive success in a variety of circumstances. These conclusions appear at first sight to contradict Porter’s model, and several writers (Miller and Friesen, 1986; Chrisman, Hofer and Boulton, 1988; Hill, 1988; Murray, 1988) have interpreted them in this sense.

Porter does, however, allow for exceptions to his rule that cost leadership and differentiation are incompatible. He also states clearly that all competitors, including differentiators, should seek to minimize their costs, providing this does not threaten their source of differentiation, and that a successful differentiator must at least maintain a cost base near the industry average. The cost leadership is about “lowest cost”, not “low cost”. This distinction is, however, absent from the empirical investigations, which at best identify a mere intention, as part of a strategic profile, to lower costs. In these circumstances a correlation between cost and differentiation strategies is scarcely inconsistent with


Porter’s model, and even a correlation between successful differentiation and below average costs may say more about the inefficient or stuck in the middle firms (someone in the industry has to make below average profits) than about the correctness or otherwise of Porter’s model.

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Dess, G.G., & Davis, P.S. (1984) Porter’s (1980) generic strategies as determinants of strategic group membership and organizational performance. Academy of Management Review, 27, 467-488

Hambrick, D.C. (1983) High profit strategies in mature capital goods industries: a contingency approach. Acudemy of Management ~ournul, 26, 687-707

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Wright, P. (1987) A refinement of Porter’s strategies. Strategic Management journal, 8, 93-101

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