Reading Task Week 1 Class 2.
(HL Only)
Instructions: Read through the following packet and answer the questions posed to you on MB.
"Strategy is about making choices, trade-offs; it's about deliberately choosing to be different."
– Michael E. Porter, management guru
Professor Michael E. Porter (b.1947) of Harvard Business School, in Boston,
Massachusetts, is known throughout the world for his academic work on business strategy. One
of his most used tools is Porter's generic strategies, featured in his best-seller "Competitive
Advantage" (1985), which outlines the ways that any business - of any size and operating in any
industry - can gain a competitive advantage.
If a profitable product or idea can be copied easily, then other firms will simply take
advantage by entering the market and taking market share from the existing firm(s) in the
industry. Rival businesses might offer an improved product or charge more competitive prices.
Hence the original firm in the market loses its competitive advantage.
Porter argued that every successful business must have a competitive advantage to
prevent profits being eroded by rival businesses entering the market. A Competitive advantage
refers to any factor that enables a business to be more appealing to customers, such as having a
unique selling point, or being able to produce goods or services better or cheaply than its rivals.
Porter suggested that there are three generic or broad strategies that any business can use to
sustain a competitive advantage: (i) cost leadership, (ii) differentiation, and (iii) focus.
Porter's four generic strategies for competitive advantage
Cost Leadership:
Cost leadership is a generic strategy that aims to establish a competitive advantage by achieving
the lowest operational costs in the market for a particular good or service. It means to become
the lowest cost supplier of a product within the market. Examples include providers of low-cost
accommodation (such as youth hostels) and budget airlines.
Provide 4 examples of businesses who use a cost leadership strategy. (4 marks)
Adopting a cost leadership strategy means the business can price its products the same
as its competitors but earn a higher profit (because the firm's costs are lower). Alternatively, the
cost leader can lower its prices below those charged by its rivals in order to attract more
customers and therefore gain higher market share.
Although these firms might charge low prices, they are highly profitable and market
leaders in their respective industries. They do not compete with firms that offer higher-quality
products since this would require price hikes. The only way to directly compete with these firms
is by using penetration or predatory pricing strategies. Alternatively, firms might choose to use
technology to cut wastage and to improve productivity, thereby reducing unit costs of
production. Hence, cost leaders can enjoy greater profit margins.
However, to become and remain a cost leader can mean the business has to continually
innovate and create new ways to reduce costs. Furthermore, the strategy can be risky as rivals
with similar market power can simply try to match the price cuts, which could lead to a price
war. Also, cost leaders might develop a reputation for low quality, due to the low prices. This is
not necessarily a perception that the business wants to earn. Finally, cost leaders are dependent
on a high volume of sales to generate profit, due to the relatively low profit margins.
Methods to achieve cost leadership
Economies of scale - Operating on a larger scale can enable firms to gain from lower unit
costs of production. These cost-saving benefits of being large enable the business to
charge lower prices whilst maintaining their profit margins.
Improved supply chains - Having more efficient methods of distribution also help to
reduce costs of production. Some businesses own their suppliers, thereby avoiding the
profit margins in the form of higher prices otherwise charged by their suppliers. Some
supermarket chains, for example, own their own farms that supply their products. Zara,
the Spanish clothes retail giant, also owns many of its suppliers. IKEA, the world's largest
furniture retailer, designs and develops all its own products.
Relocation - A business can be located nearer to its suppliers and/customers in order to
reduce transportation and distribution costs.
Insourcing production - Firms may be able to manufacture goods and/or provide
services in-house at a lower cost than an outsourced third-party provider. This may be
due to efficiency gains by insourcing and/or due to the profit margin imposed by
outsourced providers.
Differentiation:
A second generic strategy is differentiation. This happens when a firm makes its mass-
market products distinct from those of its competitors, e.g., by packaging or branding. Attention
is on the quality rather than the cost (and hence the price) of a product. Successful
differentiation enables a business to build brand loyalty and to charge a premium price, which in
turn raises the firm's profit margins.
Successful differentiation will allow a business to charge a premium price (a price higher
than the industry average), thereby earning a higher profit margin. A key drawback of
differentiation is that it can be expensive, such as the amount of money needed to successfully
develop and promote a high-quality product that stands out from others available on the
market. These businesses might choose to use copyrights and patents to protect their
competitive advantage.
Provide 4 examples of businesses who use a differentiation strategy. (4 marks)
Focus:
The third generic strategic is called focus. A focus strategy has two variants - businesses gain a
competitive advantage by either focusing on being a low cost producer (cost focus), such as
discount bric-a-brac stores, or by differentiation within a particular segment (differentiation
focus)
Cost focus (a focused cost leadership strategy) requires businesses to compete based on
price to target a narrow market (niche market customers). An example is Claire's, the
American retailer of accessories, jewellery, and toys aimed toward tween and teen girls.
The strategy involves a business charging low prices relative to competitors that operate
within the target market. Costs can be kept low by concentrating on a limited number of
products or by focusing on a small geographical area.
Differentiation focus (a focused differentiation strategy) occurs when a business targets
a niche or single segment of the market. For example, InThinking focuses on (specializes
in) providing dedicated high-quality online resources to support IB Diploma, IGCSE, and
MYP teachers and students. IBID Press publishes textbooks specifically for the IB Diploma
Programme. It was the first publisher of a textbook dedicated to the IB DP Business
Management course, back in 2007. Differentiation focus can be a highly profitable
strategy due to the high prices that can be charged (and hence the high profit margins)
and due to the lack of competition. The drawback is that the market size is rather
limited. (These tend to be niche.)
Provide 4 examples of businesses who use a cost focus and 4 that use a differentiation
focus. (8 marks)
Stuck in the middle:
“The essence of strategy is choosing what not to do.”
- Michael E. Porter, management guru
Michael Porter suggests that it is not possible in the long term to adopt a mixture of
these three generic strategies. For example, it is not feasible or sustainable to maintain
high quality by using a cost leadership strategy, i.e., firms cannot expect to be highly
profitable and to have an image of outstanding quality by charging low prices. Porter
suggests that firms without a clear business strategy are stuck in the middle, with
detrimental consequences.
Being stuck in the middle means a business is neither a cost leader or a differentiator,
and that it is not focused either, i.e., it does not specialise in a narrow (niche) market or
a broad (mass) market. This would create confusion for both internal and external
stakeholders of the business, without any competitive advantages and the inability to
gain customer loyalty.
As a Business Management decision making tool, Michael Porter’s generic strategies help
managers and decision makers to concentrate on a specific strategy that best serves their
organizations. Porter's generic strategies (sometimes referred to as competitive strategies)
can help businesses to gain a competitive edge and increase profitability if executed
appropriately. The tool outlines the ways that any business can gain a competitive
advantage:
Cost leadership in mass markets
Differentiation in mass markets
Focus - Cost focus or differentiation focus in narrow (focused or niche) markets.
Professor Porter argued that every successful business must have a competitive advantage
to prevent profits being eroded by existing rivals or new firms entering the market.
Developed in 1980, and over 40 years later, Porter's generic strategies are still widely
applicable to almost any business around the world although perhaps with some slight
modifications and new perspectives.
Assignment:
Explain how a business can use Porter's Generic Strategies to achieve a competitive
advantage. In your answer, refer to at least two of the strategies.
The mark scheme will be as follows:
Level 1 (1–2 marks):
Basic identification or description of Porter's Generic Strategies with limited or no
development. May mention strategies such as cost leadership, differentiation, or focus
without explaining how they lead to competitive advantage.
Level 2 (3–4 marks):
Explanation of at least one generic strategy and how it helps a business gain a
competitive advantage. Response shows some application of business context or
examples and links strategies to competitive advantage clearly.
Level 3 (5–6 marks):
Clear and detailed explanation of at least two generic strategies. Demonstrates
understanding of how these strategies create and sustain competitive advantage,
supported by relevant and specific business examples or analysis.