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Comparing three different theories of competitive strategies.

COMPARING THREE DIFFERENT THEORIES OF COMPETITIVE STRATEGIES

For a number of years, there has been considerable elaboration in the literature on gaining competitive advantage at the business unit level.

Three competitive strategies that have been widely discussed are low cost, differentiation and niche. The low cost strategy refers to the achievement and the provision of no-frills outputs at low prices to broadly based buyers. The outputs of the low cost strategy are relatively indistinguishable from competitors' outputs. That is, the outputs have minimal differentiation associated with them.

The differentiation strategy refers to the provision of exceptional outputs at higher prices to broadly based buyers. The outputs of the differentiation strategy are meant to be distinguishable from the outputs of the competitors. Both the low cost strategy and the differentiation strategy have a broad approach to the market.

The niche strategy takes a focused approach to the market. And the niche strategy has a low cost variant and a differentiation variant (see Chrisman, et al; Porter). The low cost niche strategy and the low cost strategy are similar in that the bottom line to both strategies is the lowering of costs. The difference between these strategies is that the low cost niche strategy lowers costs for narrowly based buyers while the low cost strategy lowers costs for broadly based buyers (see Wright). The differentiation niche strategy refers to the offering of specialized, highly differentiated outputs at premium prices to fewer buyers with particular needs.

The differentiation niche strategy may be viewed as a strategy with more depth utility vs. the differentiation strategy since the differentiation niche strategy attempts to fulfill the particular needs of a narrow buyer group. The degree of differentiation in the niche strategy is more intense than that of the broadly based differentiation strategy.

There is a debate currently going on in the literature between two schools of thought that have dealt with the adoption of the low cost strategy and the differentiation strategy. This debate has centered on whether the low cost strategy and the differentiation strategy are mutually exclusive or whether they can be adopted simultaneously. On the one hand, it has been proposed that efficiency and differentiation are generally incompatible (see Dess & Davis, Hambrick and Porter).

Hence, depending on the industry setting and a firm's strengths and weaknesses either the differentiation or the low cost may be adopted as a primary strategy, not both. On the other hand, it has been argued that the differentiation strategy and the low cost strategy may be adopted simultaneously (see Buzzell & Wiersema; Hall; Hill; Jones and Butler; Philips, Chang and Buzzell; and White). Accordingly, improved or innovative products promote a firm's differentiation. And better quality products would likely channel higher market demand to the firm competing with differentiation. Higher market demand allows the firm to assume greater market share, which would lower production costs due to scale economies. In other words, differentiation influences profitability indirectly by its positive effects on market share. Both sides of the debate have merit, but they also have some shortcomings.

Reviewing the literature

Two schools of thought have emerged on the conceptualization and adoption of competitive strategies. One school of thought has predominantly considered that viable firms can either seek efficiency or differentiation. The more efficiency is sought by management, the less differentiated the firm would be. While the more differentiation is sought by management, the less efficient the firm would be (see Dess & Davis; Hambrick; and Porter). Porter, representing this school of thought, has even conceptualized low costs vs. differentiation in terms of a continuum, with low costs at one end and differentiation at the other end. According to Porter, "a firm will ultimately reach the point where further cost reduction requires a sacrifice in differentiation. It is at this point that generic strategies become inconsistent and a firm must make a choice."

Within this context, the members of this school of thought have considered that the value chain required for a low cost strategy is qualitatively different from the value chain required for the differentiation strategy. The emphasis of the differentiation strategy would be on gaining (even at considerable costs) superior quality and image throughout the value chain while the emphasis of the low cost strategy would be on the lowering of costs wherever possible. Because of different thrusts of the strategies, according to this school of thought, viable firms tend to compete with one strategy only. For example, Porter has submitted: "...sustained commitment to one of the strategies as the primary target is usually necessary to achieve success." However, Porter has hedged his position by stating that, "A cost leader must achieve parity or proximity in the bases of differentiation even though it relies on cost leadership for its competitive advantage ...A differentiator can not ignore its cost position, because its premium prices will be nullified by a markedly inferior cost position." Murray has regarded this hedging by Porter as implying an inconsistent logic - "that a cost leader that competes against a product differentiator must also be a product differentiator, and vice versa."

Hambrick has also theoretically excluded the possibility of firms competing with more than one strategy. He has furthermore proposed that even though the competitive strategies may be found among various industries, not all of them would be found within any one industry setting. For instance, Hambrick has argued that the low cost strategy would be unlikely to be found in a dynamic industry environment.

Dess and Davis have explicitly considered that the competitive strategies represent broad strategy types of strategic groups. Consequently, the choice of strategy can be viewed as the choice of which strategic group to compete in.

The second school of thought has considered that the low cost strategy and the differentiation strategy may be adopted simultaneously by an enterprise (see Buzzell & Wiersema; Hall; Hill; Jones & Butler; Philips, et al.; and White). Accordingly, the adoption of the differentiation strategy would entail promoting higher product quality. This would likely mean higher costs across a number of the functional areas in order to support the differentiation strategy. And quality products would presumably channel greater market demand toward the firm.

Greater market demand gives the firm the possibility to also adopt the low cost strategy through the attainment of higher market shares and cumulative volume of production. Viewed in this context, the adoption of the differentiation strategy would mainly consist of bearing higher costs in a number of functional areas in order to support differentiation and the adoption of the low cost strategy would primarily consist of achieving lower per unit cost of production through the attainment of scale economies.

Production and transaction costs

Jones and Butler have explained costs in terms of production costs and transaction costs. Production costs include costs involved in the manufacturing process while transaction costs include costs related to the "transfer and exchange of goods and services across organizational boundary." Total costs are viewed as the addition of production costs and transaction costs which are costs of differentiation, involving other functional areas of the firm besides the production function.

Jones and Butler have proposed that a firm competing mainly with the low cost strategy would have lower average total costs (that are comprised of lower average production costs and lower average transaction costs) vs. a firm competing chiefly with the differentiation strategy. And a firm simultaneously competing with the low cost strategy and differentiation strategy would have lower average total costs (addition of average production and average transaction costs) than a firm which primarily competes with the differentiation strategy. The firm simultaneously competing with the low cost differentiation strategy would have higher average total costs than a company primarily emphasizing the low cost strategy.

Jones and Butler specify that the simultaneous adoption of the low cost strategy and the differentiation strategy consists of a combination of low cost production and high cost transactions, involving other functions of the firm. Implicit in this is that higher transaction costs improve product quality/image which would channel more demand to the firm, enabling the firm to enchance its market share and thus achieve scale economies (lower per unit cost of production). These are similar thoughts which have been also offered by other members of this school of thought (see Buzzell & Wiersema; Hall; Hill; and Philips, et al.). For instance, Hall has argued that some leading enterprises tend to combine low cost production with higher transaction costs to simultaneously achieve low cost and differentiation. "In at least three cases, the leading companies in my sample chose to combine the two approaches [low cost production and high cost transaction or differentiation], and each has had spectacular success. Caterpillar has combined lowest cost manufacturing with higher cost but truly outstanding distribution and after-market support to differentiate its line of construction equipment."

Similarly, Hill has proposed that differentiation can be a means for a firm to achieve a low cost position. Thus, "contrary to Porter's statement, cost leadership and differentiation are not necessarily inconsistent ... the immediate effect of differentiation will be to increase unit costs. However, if costs fall with increasing volume, the longrun effect may be to reduce unit costs." Also, Phillips, et al found a significant and positive relationship between product quality and market share. Since increased market share allows lower production costs due to scale economies, the study suggested that differentiation may be a fundamental way to lower a firm's cost position.

Jones and Butler have summarized the theme of this school of thought by criticizing Porter's conceptualization of a continuum of low cost vs. differentiation. These authors have submitted that "the real underlying dimension is cost (low to high), not low cost vs. differentiation," hence visualizing a different kind of continuum - one in which low cost and high cost are at opposite ends of the continuum.

The low cost at one end of the continuum represents the low cost strategy and the high cost at the opposite end represents high transaction costs of the differentiation strategy. Hambrick has also criticized Porter's contention that low cost and differentiation are at opposite ends of a continuum. But he agrees with Porter that the low cost strategy is generally incompatible with the differentiation strategy.

If a firm chooses to compete only with the low cost strategy, all the functional areas of the firm should ideally have their costs approach the low cost end of the continuum. If a firm chooses to compete only with the differentiation strategy, all the functional areas of the firm would probably have their costs approach the high cost end of the continuum. And a firm simultaneously competing with the low cost strategy and the differentiation strategy would ordinarily have its production cost approach the low cost end of the continuum while a number of its other functional areas would probably approach the high cost end of the continuum.

Although the assessments of both schools of thought might accurately reflect the strategic postures of some firms in a variety of industries, the strategic postures of other firms in a number of industries do not fit the scheme of such assessments in the literature.

Shortcoming and imperfections

Some of the theories in the literature which deal with the adoption of competitive strategies have a number of shortcomings and imperfections. To recapitulate, the one school of thought has suggested that costs tend to increase with more differentiation (see Dess & Davis; Hambrick; and Porter). Therefore, successful firms tend to compete with one strategy primarily - and the chosen strategy would determine whether low costs are emphasized or whether progressively higher levels of differentiation are emphasized. The contentions of this school of thought are valid with regard to some firms in specific industries. For example, a firm only competing with the low cost advantages, allowing pricing below the industry level. Alternatively, a firm only competing with the differentiation strategy may do well, if its basis for differentiation is not attainable by other firms - in the case of a firm with strong patent protection or one with well established name recognition and quality image.

These contentions, however, do not hold validity with regard to numerous other cases. The shortcoming of this school of thought is that it does not recognize that some firms in specific industries may perform well, if they compete with more than one strategy.

However, it should be emphasized that even when faced with contrary results in their own studies, some of the members of this school of thought have nevertheless maintained that competing with one strategy is normally a requirement for success.

For example, Hambrick found, "There are market share leaders who compete through quality rather than price. Even though they might have the cumulative experience that would allow them to be cost leaders (offering low prices), they have opted for the higher margin route of competing on image and service (offering higher prices)." Given that Hambrick's results point to high performing firms simultaneously adopting the low cost strategy and the differentiation strategy, he has nevertheless stuck to the premise that the low cost strategy and the differentiation strategy are incompatible. "It may be true, as Porter argues, that efficiency (low cost) and differentiation are generally incompatible, but they are not the opposite ends of a single continuum."

Hambrick also states, "A common trap for differentiated businesses is that they are poor asset managers, but businesses in a specific cluster have avoided this trap. They hold down their capital intensity, manage their receivables and inventories well, and strive to operate at full capacity." Given that high performing businesses in Hambrick's cluster simultaneously compete with the low cost strategy and the differentiation strategy, in his syntheses and conclusions section, Hambrick states that Porter's "strategic types, or close variations of them represented among the high profit clusters. One of the clusters is a |pure' cost leadership strategy. Three ... are differentiation strategies. One ... has elements of focus strategy."

Furthermore, Hambrick submits that, on average, "differentiation strategies are more profitable than cost leadership strategies," rather than concluding that businesses which simultaneously compete with the differentiation strategy and the low cost strategy outperform those which either compete with low costs only or differentiation only.

As another example, Dess and Davis have submitted the following, based on their results: "An important finding of the study is the apparent lack of singularity in strategic orientation that characterizes the highest performance group ... Given Porter's caution against the commitment to multiple generic strategies, the high performance exhibited by the members of this cluster may appear inconsistent." But Dess and Davis have also discounted their own finding. Rather than accepting the merit of their results, i.e., adopting multiple strategies leads to high performance, they turn around the relationship. They argue that "high performance may generate slack resources that can be used to enable firms to expand their present scope of operations" and allow for the adoption of more than one competitive strategy.

The members of the second school of thought have considered the possibility of a firm's simultaneous adoption of the low cost strategy and the differentiation strategy. The adoption of the low cost strategy, as suggested before, is fundamentally viewed by them in terms of achieving scale economies while the adoption of the differentiation strategy is viewed by them in terms of bearing higher costs in select functions of the firm. More specifically, accomplishing a low cost position is chiefly viewed by the members of this school of thought as the attainment of greater market share and scale economies, made possible by the firm's quality products/services.

Although the propositions of this school of thought hold true with a variety of enterprises across a number of industries, they do not hold validity with regard to numerous other enterprises. The shortcoming of the assessments of the members of this school of thought is that they have too narrowly conceptualized the simultaneous adoption of the low cost strategy and the differentiation strategy. As will be discussed, strategic alternatives are available for firms to lower costs and/or heighten differentiation in several of their functional or conduct areas. And the combination of low costs and differentiation is feasible in many cases, without necessarily having to gain significant market share and cumulative volume of production.

The propositions of the first school of thought may be depicted as in Figure 1. According to this school of thought, viable firms should stress low costs or differentiation. The more low costs are emphasized, the less differentiated the firm would be, while the more differentiation is sought, the less efficient the firm would be.

The propositions of the second school of thought may be depicted as in Figure 2. According to this school of thought, the low cost strategy and the differentiation strategy may be adopted simultaneously. As shown in Figure 2, the firm simultaneously competing with the differentiation strategy and the low cost strategy would have average total costs (ATC) that are comprised of relatively higher average transaction costs (ATRC) - higher costs involving a number of functional areas in order to support the differentiation - and relatively lower average production costs (APC), while ideally producing at quantity Q and cost C. Presumably, the higher transaction costs increase the market demand for the firm's differentiated outputs, which allows the firm greater market share and hence lower production costs due to scale economies.

An alternative perspective

Although the propositions of the aforementioned two schools of thought accurately reflect the strategic profiles of some firms in a number of industries, the strategic postures of numerous other firms do not fit the theoretical frameworks of these schools of thought. The following proposals present an alternative perspective on how firms could lower costs and/or heighten differentiation. First, certain strategic accomplishments may advantageously shift the demand curve for the firm so that for the same quantity produced, a higher price may be charged. That is, certain accomplishments may promote or enhance a firm's differentiation. Differentiation decreases elasticity of demand for a firm's outputs. But differentiation need not translate into higher market share (because of higher market demand for the firm's quality products) and scale economies in order to be beneficial for the firm. If differentiation translates into higher market demand for the firm's products, so that the firm's demand curve pivots about x from D2 to D1, the same quantity (Q) can be sold at a higher price (from P1 to P2). This could mean higher margins for the firm, since higher differentiation need not always involve higher average total costs.

Second, it is proposed that certain strategic accomplishments may beneficially shift the firm's average total cost curve so that for the same quantity produced, lower costs would be borne by the business unit. If average total costs are lowered so that the firm's average total cost curve shifts from ATCI to ATC2, the same quantity (Q) can be produced at a lower average total cost (from C1 to C2). And in many industries, efficient volumes of production are reached at very low levels of production and market shares of less than two percent (see Scherer, Beckenstein, Kaufer & Murphy; and Silberston). The shift in average total costs to a lower level could also mean higher margins for the firm, since lower costs need not always mean a sacrifice in differentiation.

Third, certain strategic accomplishments may favorably and simultaneously shift the demand curve for the firm and the average total cost curve of the firm so that for the same quantity produced, not only might higher prices be charged, but also lower costs would be borne by the enterprise.

Low cost inputs

Lower costs may be pursued by exploring possibilities for gaining access to lower cost inputs. The level of a firm's differentiation need not be compromised if access to low cost inputs can be established. On this theme, Karnani has argued that a low cost position may lead to a low differentiation position. Conversely, a highly differentiated position may lead to a high cost position, but "this relationship need not necessarily hold. For example, if a low cost position is achieved by locating in an area where labor costs are low, then it need not lead to a low differentiation position."

This argument could be expanded to include other factors besides low labor costs (gaining access to low cost raw materials, energy, freight, semi-finished goods). Gaining access to low cost inputs could favorably shift the firm's average total cost curve. On the other hand, higher differentiation may be pursued in a number of ways, such as gaining access to preferential distribution channels, without necessarily increasing costs (See Karnani; and Wright). This could favorably shift the demand curve for a firm's output. Some strategic accomplishments may favorably and simultaneously shift the demand curve for the firm's products and the average total cost curve of the firm. For example, although process improvements or innovations are normally thought of in the context of lowering costs, lower costs and an increase in differentiation may be the simultaneous outcomes of process improvements or innovations. Haas has noted: "U.S. manufacturers ... have taken it for granted that higher quality means higher manufacturing cost ... Sometimes it does take that kind of tradeoff ... but it usually does not ... Recently, a computer manufacturer invested $20 million in a flexible assembly system. The investment made good operational sense because it paid for itself in less than a year. Strategically, the investment was even more attractive. Production time was cut by 80 percent, and product quality improved tenfold..."

The above example demonstrates that process innovations may not only lower costs, but such innovations might at times even heighten differentiation.

Although product improvements or innovations are usually thought of in the context of heightening differentiation, it should be noted that higher levels of differentiation as well as lower costs may be the outcomes of product innovations. Here, the demand curve for the firm and the average total cost curve of the firm may beneficially shift, as a result of product improvements or innovations. For instance, according to Miles, innovative product-markets developed by Philip Morris have allowed this firm to use greater portions of reconstituted tobacco sheet, shorter tobacco columns, and a freeze-drying process in order to reduce the quantity of tobacco usage per cigarette.

Furthermore, the use of reconstituted tobacco sheet has made it possible to utilize not only a smaller amount of tobacco, but also to use lower quality tobacco in cigarette production. The above measures have combined to dramatically reduce the per unit cost of cigarette manufacturer. However, these measures became possible only after Philip Morris developed new product market scopes - first by developing the filter cigarette and then by developing cigarettes with significantly lower tar and nicotine levels. Put in other words, with the older non-filter cigarettes, it was neither feasible to reduce the amount of tobacco per cigarette nor was it feasible to use lower quality tobacco without detrimentally affecting the taste and the aroma of the cigarette.

Systems innovations

Simultaneous increases in differentiation and decreases in costs offer the possibility of achievement through the undertaking of systems improvements or innovations. In fact, some of the most rewarding strategic advantages may hinge not on new products or services, but rather on changing conventional systems for getting existing products to the market. Such systems innovations may maintain or even heighten product quality while lowering costs of operations. Higher product quality might favorably shift the demand curve for the firm while lower operation costs might advantageously shift the average total costs of the firm. Gluck has illustrated the possibility of this accomplishment with an example of an enterprise that at virtually every link of the business system did something different from the competition. The name of the firm is Savin Business Machines. According to Gluck:

"Savin accomplished this feat by taking a radically different approach in every element of the copier business system (vs. Xerox). It developed and patented a new liquid toner technology. Then, while most Xerox machines were made up of costly customized components Savin designed its product around standardized components ... Savin lowered the cost of the machine so dramatically ... and at the same time the Savin copier was more reliable ... Rather than building a direct sales force to parallel that of the competition, Savin aggressively recruited office-products dealers."

The above mentioned instances tend to demonstrate the viability of the third proposal that lower costs and differentiation are not necessarily incompatible as proposed by the one school of thought. And, the low cost strategy and the differentiation strategy may be combined through other means, aside from product quality enabling the firm to command a significant market share and achieve scale economies, as proposed by the other school of thought.

The concept of competitive strategies is important to researchers and managers because this concept can discriminate between higher performing firms and lower performing firms. The analyses of different views taken by two schools of thought on the conceptualization and adoption of competitive strategies and the imperfections of these schools have been discussed because otherwise it is possible that some of the efforts of researchers and managers may be misdirected. For instance, Hill has stated: "By popularizing the idea that differentiation and low costs are normally incompatible, Porter's work may have served to misdirect both managers and researchers."

Similarly, it may be argued that the simultaneous adoption of the low cost strategy and the differentiation strategy, as conceptualized by the other school of thought, may also in some cases misdirect managers and researchers. What has been proposed here is that firms can lower costs and/or heighten differentiation through strategic accomplishments that do not necessarily involve significant market shares and cumulative volume of production gained because of quality outputs.

Firms that would strategically combine low costs with differentiation intuitively seem more prone to success. On the other hand, enterprises that compete with only one competitive strategy, with some exceptions, may have inherent vulnerabilities. For instance, ordinarily if firms only compete on the basis of low costs and prices, their profit margins would likely be squeezed, since managements' possibilities to undertake measures to improve outputs or augment products with superior services or to expend more on marketing activities are limited.

Alternatively, firms that only compete on the basis of differentiation, while not stressing low cost operations seem to be vulnerable to competitors that may offer similar products, but at lower prices. The threat of substitute products is also greater for such companies. However, enterprises that stress low cost positions, while offering differentiated outputs seem likely to benefit by achieving higher profit margins. This is not to say that all businesses in various industries could combine low costs with differentiation. It is entirely possible that only some of the enterprises in any one industry may possess special talents and opportunities to beneficially compete with more than one competitive strategy. The less talented competitors with limited opportunities in the industry may find it impossible to compete effectively with more than one strategy.

PHOTO : Figure 1 "Either/Or" School of Thought

PHOTO : Figure 2 "Simultaneous" School of Thought For further reading Buzzell, R. D. & Wiersema, F. D. (1981) "Successful share building strategies." Harvard Business Review, 59. Chrisman, J. J., Hofer, C. W., & Boulton, W. R. (1988) "Toward a system for classifying business strategies." Academy of Management Review, 13. Dess, G. G. & Davis, P. S. (1982) "An empirical examination of Porter's generic strategies." Academy of Management Best Paper Proceedings. Dess, G. G. & Davis, P. S. (1984) "Porter's (1980) generic strategies as determinants of strategic group membership and organizational performance." Academy of Management Journal, 27. Gluck, F. W. (1980) "Strategic choice and resource allocation." The McKinsey Quarterly, I. Gumpert, D. (1986) "Porsche on nichemanship." Harvard Business Review, 64. Haas, E. A. (1987) "Breakthrough manufacturing." Harvard Business Review, 65. Hall, W. K. (1983) "Survival strategies in a hostile environment," R. G. Hamermesh (ed.) Strategic Management. New York: John Wiley & Sons, Inc. Hambrick, D. C. (1983) "High profit strategies in mature capital goods industries: A contingency approach." Academy of Management Journal, 26. Hamermesh, R. G., Anderson, M. J. & Harris, J. E. (1978) "Strategic market share businesses." Harvard Business Review, 56, 95-102. Hill, C. W. (1988) Differentiation versus low cost or differentiation and low cost. Jones, G. R. & Butler, J. E. (1988) "Costs, revenue, and business-level strategy." Academy of Management Review, 13. Karnani, A. (1984) "Generic competitive strategies - an analytical approach." Strategic Management Journal, 5. Miles, R. H. (1982) Coffin nails and corporate strategies. Englewood Cliffs: Murray, A. I. (1988) "A contingency view of Porter's generic strategies." Academy of Management Review, 13. Phillips, L. W., Chang, D. R. & Buzzell, R. D. (1983) "Product quality, cost position and business performance: A test of some key hypotheses." Journal of Marketing, 47 (2). Porter, M. E. (1980) Competitive strategy. New York: Free Press. Porter, M. E. (1985) Competitive advantage - Creating and sustaining superior performance. New York: Free Press. Scherer, F. M., Beckenstein, A., Kaufer, E. & Murphy, R. D. (1975) The Economies of Multiple Operations. Cambridge, MA: Harvard University Press. Silbertson, Z. A. (1972) "Economies of scale in theory and practice." Economic Journal, 82. White, R. E. (1986) "Generic business strategies, organizational context and performance: An empirical investigation." Strategic Management Journal, 7. Woo, C. Y. (1984) "Market share leadership: not always so good." Harvard Business Review, 62. Wright, P. (1987) "A refinment of Porter's strategies. Strategic Management Journal," 8.
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Author:Wright, Peter; Nazemzadeh, Asghar; Parnell, John; Lado, Augustine
Publication:Industrial Management
Date:Nov 1, 1991
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