Competitive Advantage-Porter’s Generic Strategies 

Competitive Advantage-Porter’s Generic Strategies 

Types of Competitive Advantage and Sustainability

LO5.1

The central role of competitive advantage in the study of strategic management, and the three generic strategies: overall cost leadership, differentiation, and focus.

Michael Porter presented three generic strategies that a firm can use to overcome the five forces and achieve competitive advantage.2 Each of Porter’s generic strategies has the potential to allow a firm to outperform rivals in their industry. The first, overall cost leadership, is based on creating a low-cost-position. Here, a firm must manage the relationships throughout the value chain and lower costs throughout the entire chain. Second, differentiation requires a firm to create products and/or services that are unique and valued. Here, the primary emphasis is on “nonprice” attributes for which customers will gladly pay a premium.3 Third, a focus strategy directs attention (or “focus”) toward narrow product lines, buyer segments, or targeted geographic markets and they must attain advantages either through differentiation or cost leadership.4 Whereas the overall cost leadership and differentiation strategies strive to attain advantages industrywide, focusers have a narrow target market in mind.

The Experience Curve (page 165),

trategy spotlight 5.1: The Experience Curve

The experience curve, developed by the Boston Consulting Group in 1968, is a way of looking at efficiencies developed through a firm’s cumulative experience. In its basic form, the experience curve relates production costs to production output. As output doubles, costs decline by 10 percent to 30 percent. For example, if it costs $1 per unit to produce 100 units, the per unit cost will decline to between 70 to 90 cents as output increases to 200 units.

What factors account for this increased efficiency? First, the success of an experience curve strategy depends on the industry life cycle for the product. Early stages of a product’s life cycle are typically characterized by rapid gains in technological advances in production efficiency. Most experience curve gains come early in the product life cycle.

Second, the inherent technology of the product offers opportunities for enhancement through gained experience. High-tech products give the best opportunity for gains in production efficiencies. As technology is developed, “value engineering” of innovative production processes is implemented, driving down the per unit costs of production.

Third, a product’s sensitivity to price strongly affects a firm’s ability to exploit the experience curve. Cutting the price of a product with high demand elasticity—where demand increases when price decreases—rapidly creates consumer purchases of the new product. By cutting prices, a firm can increase demand for its product. The increased demand in turn increases product manufacture, thus increasing the firm’s experience in the manufacturing process. So by decreasing price and increasing demand, a firm gains manufacturing experience in that particular product, which drives down per unit production costs.

Fourth, the competitive landscape factors into whether or not a firm might benefit from an experience curve strategy. If other competitors are well positioned in the market, have strong capital resources, and are known to promote their product lines aggressively to gain market share, an experience curve strategy may lead to nothing more than a price war between two or more strong competitors. But if a company is the first to market with the product and has good financial backing, an experience curve strategy may be successful.

In an article in the Harvard Business Review, Pankaj Ghemawat recommended answering several questions when considering an experience curve strategy.

• Does my industry exhibit a significant experience curve?
• Have I defined the industry broadly enough to take into account interrelated experience?
• What is the precise source of cost reduction?
• Can my company keep cost reductions proprietary?
• Is demand sufficiently stable to justify using the experience curve?
• Is cumulated output doubling fast enough for the experience curve to provide much strategic leverage?
• Do the returns from an experience curve strategy warrant the risks of technological obsolescence?
• Is demand price-sensitive?
• Are there well-financed competitors who are already following an experience curve strategy or are likely to adopt one if my company does?

Michael Porter suggested, however, that the experience curve is not useful in all situations. Whether or not to base strategy on the experience curve depends on what specifically causes the decline in costs. For example, if costs drop from efficient production facilities and not necessarily from experience, the experience curve is not helpful. But as Sharon Oster pointed out in her book on competitive analysis, the experience curve can help managers analyze costs when efficient learning, rather than efficient machinery, is the source of cost savings.

Sources: Ghemawat, P. 1985. Building Strategy on the Experience Curve. Harvard Business Review, March–April: 143–149; Porter, M. E. 1996. On Competition. Boston: Harvard Business Review Press; and Oster, S. M. 1994. Modern Competitive Analysis (2nd ed.). New York: Oxford University Press.

Industry Life Cycle Stages (pages 187–189)

Industry Life Cycle Stages: Strategic Implications

LO5.7

The importance of considering the industry life cycle to determine a firm’s business-level strategy and its relative emphasis on functional area strategies and value-creating activities.

The industry life cycle refers to the stages of introduction, growth, maturity, and decline that occur over the life of an industry. In considering the industry life cycle, it is useful to think in terms of broad product lines such as personal computers, photocopiers, or longdistance telephone service. Yet the industry life cycle concept can be explored from several levels, from the life cycle of an entire industry to the life cycle of a single variation or model of a specific product or service.

industry life cycle

the stages of introduction, growth, maturity, and decline that typically occur over the life of an industry.

Why are industry life cycles important?64 The emphasis on various generic strategies, functional areas, value-creating activities, and overall objectives varies over the course of an industry life cycle. Managers must become even more aware of their firm’s strengths and weaknesses in many areas to attain competitive advantages. For example, firms depend on their research and development (R&D) activities in the introductory stage. R&D is the source of new products and features that everyone hopes will appeal to customers. Firms develop products and services to stimulate consumer demand. Later, during the maturity phase, the functions of the product have been defined, more competitors have entered the market, and competition is intense. Managers then place greater emphasis on production efficiencies and process (as opposed to the product) engineering in order to lower manufacturing costs. This helps to protect the firm’s market position and to extend the product life cycle because the firm’s lower costs can be passed on to consumers in the form of lower prices, and price-sensitive customers will find the product more appealing.

Exhibit 5.12 illustrates the four stages of the industry life cycle and how factors such as generic strategies, market growth rate, intensity of competition, and overall objectives change over time. Managers must strive to emphasize the key functional areas during each of the four stages and to attain a level of parity in all functional areas and value-creating activities. For example, although controlling production costs may be a primary concern during the maturity stage, managers should not totally ignore other functions such as marketing and R&D. If they do, they can become so focused on lowering costs that they miss market trends or fail to incorporate important product or process designs. Thus, the firm may attain low-cost products that have limited market appeal.

Exhibit 5.12: Stages of the Industry Life Cycle

Stage Factor Introduction Generic strategies Differentiation Differentiation Differentiation Overall cost leadership Overall cost leadership Focus Market growth rate Low Very large Low to moderate Negative Number of segments Very few Some Many Few Intensity of competition Low Increasing Very intense Changing Emphasis on product design Very high High Low to moderate Low Emphasis on process design Low Low to moderate High Low Major functional area(s) of concern Research and development Sales and marketing Production General management and finance Overall objective Increase market awareness Create consumer demand Defend market share and extend product life cycles Consolidate, maintain, harvest, or exit

It is important to point out a caveat. While the life cycle idea is analogous to a living organism (i.e., birth, growth, maturity, and death), the comparison has limitations.65 Products and services go through many cycles of innovation and renewal. Typically, only fad products have a single life cycle. Maturity stages of an industry can be “transformed” or followed by a stage of rapid growth if consumer tastes change, technological innovations take place, or new developments occur. The cereal industry is a good example. When medical research indicated that oat consumption reduced a person’s cholesterol, sales of Quaker Oats increased dramatically.66

Strategies in the Introduction Stage

In the introduction stage, products are unfamiliar to consumers.67 Market segments are not well defined, and product features are not clearly specified. The early development of an industry typically involves low sales growth, rapid technological change, operating losses, and the need for strong sources of cash to finance operations. Since there are few players and not much growth, competition tends to be limited.

introduction stage

the first stage of the industry life cycle, characterized by (1) new products that are not known to customers, (2) poorly defined market segments, (3) unspecified product features, (4) low sales growth, (5) rapid technological change, (6) operating losses, and (7) a need for financial support.

Success requires an emphasis on research and development and marketing activities to enhance awareness. The challenge becomes one of (1) developing the product and finding a way to get users to try it, and (2) generating enough exposure so the product emerges as the “standard” by which all other rivals’ products are evaluated.

There’s an advantage to being the “first mover” in a market.68 It led to Coca-Cola’s success in becoming the first soft-drink company to build a recognizable global brand and enabled Caterpillar to get a lock on overseas sales channels and service capabilities.

However, there can also be a benefit to being a “late mover.” Target carefully considered its decision to delay its Internet strategy. Compared to its competitors Walmart and Kmart, Target was definitely an industry laggard. But things certainly turned out well:69

By waiting, Target gained a late mover advantage. The store was able to use competitors’ mistakes as its own learning curve. This saved money, and customers didn’t seem to mind the wait: When Target finally opened its website, it quickly captured market share from both Kmart and Walmart Internet shoppers. Forrester Research Internet analyst Stephen Zrike commented, “There’s no question, in our mind, that Target has a far better understanding of how consumers buy online.”

Examples of products currently in the introductory stages of the industry life cycle include electric vehicles, solar panels, and high-definition television (HDTV).

Culture (pages 322–330)

Attaining Behavioral Control: Balancing Culture, Rewards, and Boundaries

LO9.4

The benefits of having the proper balance among the three levers of behavioral control: culture, rewards and incentives, and boundaries.

Behavioral control is focused on implementation—doing things right. Effectively implementing strategy requires manipulating three key control “levers”: culture, rewards, and boundaries (see Exhibit 9.3). There are two compelling reasons for an increased emphasis on culture and rewards in a system of behavioral controls.11

Exhibit 9.3: Essential Elements of Behavioral Control

First, the competitive environment is increasingly complex and unpredictable, demanding both flexibility and quick response to its challenges. As firms simultaneously downsize and face the need for increased coordination across organizational boundaries, a control system based primarily on rigid strategies, rules, and regulations is dysfunctional. The use of rewards and culture to align individual and organizational goals becomes increasingly important.

Second, the implicit long-term contract between the organization and its key employees has been eroded.12 Today’s younger managers have been conditioned to see themselves as “free agents” and view a career as a series of opportunistic challenges. As managers are advised to “specialize, market yourself, and have work, if not a job,” the importance of culture and rewards in building organizational loyalty claims greater importance.

Each of the three levers—culture, rewards, and boundaries—must work in a balanced and consistent manner. Let’s consider the role of each.

Building a Strong and Effective Culture

Organizational culture is a system of shared values (what is important) and beliefs (how things work) that shape a company’s people, organizational structures, and control systems to produce behavioral norms (the way we do things around here).13 How important is culture? Very. Over the years, numerous best sellers, such as Theory Z, Corporate Cultures, In Search of Excellence, and Good to Great,14 have emphasized the powerful influence of culture on what goes on within organizations and how they perform.

organizational culture

a system of shared values and beliefs that shape a company’s people, organizational structures, and control systems to produce behavioral norms.

Collins and Porras argued in Built to Last that the key factor in sustained exceptional performance is a cultlike culture.15 You can’t touch it or write it down, but it’s there in every organization; its influence is pervasive; it can work for you or against you.16 Effective leaders understand its importance and strive to shape and use it as one of their important levers of strategic control.17

The Role of Culture

Culture wears many different hats, each woven from the fabric of those values that sustain the organization’s primary source of competitive advantage. Some examples are:

• Federal Express and Southwest Airlines focus on customer service.
• Lexus (a division of Toyota) and Hewlett-Packard emphasize product quality.
• Newell Rubbermaid and 3M place a high value on innovation.
• Nucor (steel) and Emerson Electric are concerned, above all, with operational efficiency.

Culture sets implicit boundaries—unwritten standards of acceptable behavior—in dress, ethical matters, and the way an organization conducts its business.18 By creating a framework of shared values, culture encourages individual identification with the organization and its objectives. Culture acts as a means of reducing monitoring costs.19

Sustaining an Effective Culture

Powerful organizational cultures just don’t happen overnight, and they don’t remain in place without a strong commitment—both in terms of words and deeds—by leaders throughout the organization.20 A viable and productive organizational culture can be strengthened and sustained. However, it cannot be “built” or “assembled”; instead, it must be cultivated, encouraged, and “fertilized.”21

Storytelling is one way effective cultures are maintained. Many are familiar with the story of how Art Fry’s failure to develop a strong adhesive led to 3M’s enormously successful Post-it Notes. Perhaps less familiar is the story of Francis G. Okie.22 In 1922 Okie came up with the idea of selling sandpaper to men as a replacement for razor blades. The idea obviously didn’t pan out, but Okie was allowed to remain at 3M. Interestingly, the technology developed by Okie led 3M to develop its first blockbuster product: a waterproof sandpaper that became a staple of the automobile industry. Such stories foster the importance of risk taking, experimentation, freedom to fail, and innovation—all vital elements of 3M’s culture.

Rallies or “pep talks” by top executives also serve to reinforce a firm’s culture. The late Sam Walton was known for his pep rallies at local Walmart stores. Four times a year, the founders of Home Depot—former CEO Bernard Marcus and Arthur Blank—used to don orange aprons and stage Breakfast with Bernie and Arthur, a 6:30 a.m. pep rally, broadcast live over the firm’s closed-circuit TV network to most of its 45,000 employees.23

Southwest Airlines’ “Culture Committee” is a unique vehicle designed to perpetuate the company’s highly successful culture. The following excerpt from an internal company publication describes its objectives:

The goal of the Committee is simple—to ensure that our unique Corporate Culture stays alive…. Culture Committee members represent all regions and departments across our system and they are selected based upon their exemplary display of the “Positively Outrageous Service” that won us the first-ever Triple Crown; their continual exhibition of the “Southwest Spirit” to our Customers and to their fellow workers; and their high energy level, boundless enthusiasm, unique creativity, and constant demonstration of teamwork and love for their fellow workers.24

Motivating with Rewards and Incentives

Reward and incentive systems represent a powerful means of influencing an organization’s culture, focusing efforts on high-priority tasks, and motivating individual and collective task performance.25 Just as culture deals with influencing beliefs, behaviors, and attitudes of people within an organization, the reward system—by specifying who gets rewarded and why—is an effective motivator and control mechanism.26 Consider how Starbucks uses its stock option plan as an incentive to motivate its employees.27 By introducing a stock option plan called “bean stock” to managers, baristas, and other employees, Starbucks has turned every employee into a partner. Starbucks’ managers began referring to all employees as partners, an appropriate title because all staff, including part-timers working at least 20 hours per week, were eligible for stock options after six months with the company. By turning employees into partners, Starbucks gave them a chance to share in the success of the company and make the connection between their contributions and the company’s market value very clear. There was a pronounced effect on the attitudes and performance of employees because of the bean stock program. They began coming up with many innovative ideas about how to cut costs, increase sales, and create value.

reward system

policies that specify who gets rewarded and why.

The Potential Downside

Generally speaking, people in organizations act rationally, each motivated by their personal best interest.28 However, the collective sum of individual behaviors of an organization’s employees does not always result in what is best for the organization; individual rationality is no guarantee of organizational rationality.

As corporations grow and evolve, they often develop different business units with multiple reward systems. They may differ based on industry contexts, business situations, stage of product life cycles, and so on. Subcultures within organizations may reflect differences among functional areas, products, services, and divisions. To the extent that reward systems reinforce such behavioral norms, attitudes, and belief systems, cohesiveness is reduced; important information is hoarded rather than shared, individuals begin working at cross-purposes, and they lose sight of overall goals.

Such conflicts are commonplace in many organizations. For example, sales and marketing personnel promise unrealistically quick delivery times to bring in business, much to the dismay of operations and logistics; overengineering by R&D creates headaches for manufacturing; and so on. Conflicts also arise across divisions when divisional profits become a key compensation criterion. As ill will and anger escalate, personal relationships and performance may suffer.

Creating Effective Reward and Incentive Programs

To be effective, incentive and reward systems need to reinforce basic core values, enhance cohesion and commitment to goals and objectives, and meet with the organization’s overall mission and purpose.29

At General Mills, to ensure a manager’s interest in the overall performance of his or her unit, half of a manager’s annual bonus is linked to business-unit results and half to individual performance.30 For example, if a manager simply matches a rival manufacturer’s performance, his or her salary is roughly 5 percent lower. However, if a manager’s product ranks in the industry’s top 10 percent in earnings growth and return on capital, the manager’s total pay can rise to nearly 30 percent beyond the industry norm.

Effective reward and incentive systems share a number of common characteristics.31 (see Exhibit 9.4). The perception that a plan is “fair and equitable” is critically important. The firm must have the flexibility to respond to changing requirements as its direction and objectives change. In recent years many companies have begun to place more emphasis on growth. Emerson Electric has shifted its emphasis from cost cutting to growth. To ensure that changes take hold, the management compensation formula has been changed from a largely bottom-line focus to one that emphasizes growth, new products, acquisitions, and international expansion. Discussions about profits are handled separately, and a culture of risk taking is encouraged.32

Exhibit 9.4: Characteristics of Effective Reward and Evaluation Systems

• Objectives are clear, well understood, and broadly accepted.
• Rewards are clearly linked to performance and desired behaviors.
• Performance measures are clear and highly visible.
• Feedback is prompt, clear, and unambiguous.
• The compensation “system” is perceived as fair and equitable.
• The structure is flexible; it can adapt to changing circumstances.

Setting Boundaries and Constraints

In an ideal world, a strong culture and effective rewards should be sufficient to ensure that all individuals and subunits work toward the common goals and objectives of the whole organization.33 However, this is not usually the case. Counterproductive behavior can arise because of motivated self-interest, lack of a clear understanding of goals and objectives, or outright malfeasance. Boundaries and constraints can serve many useful purposes for organizations, including:

boundaries and constraints

rules that specify behaviors that are acceptable and unacceptable.

• Focusing individual efforts on strategic priorities.
• Providing short-term objectives and action plans to channel efforts.
• Improving efficiency and effectiveness.
• Minimizing improper and unethical conduct.

Focusing Efforts on Strategic Priorities

Boundaries and constraints play a valuable role in focusing a company’s strategic priorities. A well-known example of a strategic boundary is Jack Welch’s (former CEO of General Electric) demand that any business in the corporate portfolio be ranked first or second in its industry. Similarly, Eli Lilly has reduced its research efforts to five broad areas of disease, down from eight or nine a decade ago.34 This concentration of effort and resources provides the firm with greater strategic focus and the potential for stronger competitive advantages in the remaining areas.

Norman Augustine, Lockheed Martin’s former chairman, provided four criteria for selecting candidates for diversification into “closely related” businesses.35 They must (1) be high tech, (2) be systems-oriented, (3) deal with large customers (either corporations or government) as opposed to consumers, and (4) be in growth businesses. Augustine said, “We have found that if we can meet most of those standards, then we can move into adjacent markets and grow.”

Boundaries also have a place in the nonprofit sector. For example, a British relief organization uses a system to monitor strategic boundaries by maintaining a list of companies whose contributions it will neither solicit nor accept. Such boundaries are essential for maintaining legitimacy with existing and potential benefactors.

Providing Short-Term Objectives and Action Plans

In Chapter 1 we discussed the importance of a firm having a vision, mission, and strategic objectives that are internally consistent and that provide strategic direction. In addition, short-term objectives and action plans provide similar benefits. That is, they represent boundaries that help to allocate resources in an optimal manner and to channel the efforts of employees at all levels throughout the organization.36 To be effective, short-term objectives must have several attributes. They should:

• Be specific and measurable.
• Include a specific time horizon for their attainment.
• Be achievable, yet challenging enough to motivate managers who must strive to accomplish them.

Research has found that performance is enhanced when individuals are encouraged to attain specific, difficult, yet achievable, goals (as opposed to vague “do your best” goals).37

Short-term objectives must provide proper direction and also provide enough flexibility for the firm to keep pace with and anticipate changes in the external environment, new government regulations, a competitor introducing a substitute product, or changes in consumer taste. Unexpected events within a firm may require a firm to make important adjustments in both strategic and short-term objectives. The emergence of new industries can have a drastic effect on the demand for products and services in more traditional industries.

Action plans are critical to the implementation of chosen strategies. Unless action plans are specific, there may be little assurance that managers have thought through all of the resource requirements for implementing their strategies. In addition, unless plans are specific, managers may not understand what needs to be implemented or have a clear time frame for completion. This is essential for the scheduling of key activities that must be implemented. Finally, individual managers must be held accountable for the implementation. This helps to provide the necessary motivation and “sense of ownership” to implement action plans on a timely basis. Strategy Spotlight 9.3 illustrates how action