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Cost Leadership, Differentiation and Focus

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Competitive Advantage

Summary of Cost Leadership, Differentiation and Focus (Porter). Abstract

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Michael Porter

The Competitive Advantage (CA) model of Porter learns that competitive strategy is about taking offensive or defensive action to create a defendable position in an industry, in order to cope successfully with competitive forces and generate a superior return on investment. According to Michael Porter, the basis of above-average performance within an industry is sustainable competitive advantage. There are 2 basics types of CA: Michael Porter

  1. Cost leadership (low cost), and
  2. Differentiation.

Both can be more broadly approached or narrow, which results in the third viable competitive strategy:

  1. Focus.

Approach 1 to CA: Cost leadership.

  • = a firm sets out to become the low cost producer in its industry.
  • A cost leader must achieve parity or at least proximity in the bases of differentiation, even though it relies on cost leadership for itís CA.
  • If more than one company aim for cost leadership, usually this is disastrous.
  • Often achieved by economies of scale

CA model 2: Differentiation.

  • = a firm seeks to be unique in itís industry along some dimensions that are widely valued by buyers.
  • A differentiator cannot ignore itís cost position. In all areas that do not affect itís differentiation it should try to decrease cost; in the differentiation area the costs should at least be lower than the price premium it receives from the buyers.
  • Areaís of differentiation can be: product, distribution, sales, marketing, service, image, etc.

CA model 3: Focus.

  • = a firm sets out to be best in a segment or group of segments.
  • 2 variants: cost focus and differentiation focus.

Stuck in the middle:

  • Usually a recipe for below-average profitability compared to the industry
  • Still attractive profits are possible if and as long as the industry as a whole is very attractive
  • Manifestation of lack of choice
  • Especially risky for focusers that have been successful and then to loose their focus. They must seek for other niches rather then compromise their focus strategy.

From a Value Based Management point of view, the CA approach to strategy helps to build a relative competitive advantage, together with Porter's Value Chain framework. Taken together, they can be seen as one of two dimensions in maximizing corporate value creation. The other value creation dimension is the Market/Industry Attractiveness for which another model from Porter is often used: the Competitive Forces model.

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