Competitive Advantage

Chapter 1

Chapter 1: Competitive Strategy: The Core Concepts

Stuck in the Middle

A firm that engages in each generic strategy but fails to achieve any of them is "stuck in the middle." It possesses no competitive advantage. This strategic position is usually a recipe for below-average performance. A firm that is stuck in the middle will compete at a disadvantage because the cost leader, differentiators, or focusers will be better positioned to compete in any segment. If a firm that is stuck in the middle is lucky enough to discover a profitable product or buyer, competitors with a sustainable competitive advantage will quickly eliminate the spoils. In most industries, quite a few competitors are stuck in the middle.

A firm that is stuck in the middle will earn attractive profits only if the structure of its industry is highly favorable, or if the firm is fortunate enough to have competitors that are also stuck in the middle. Usually, however, such a firm will be much less profitable than rivals achieving one of the generic strategies. Industry maturity tends to widen the performance differences between firms with a generic strategy and those that are stuck in the middle, because it exposes ill-conceived strategies that have been carried along by rapid growth.

Becoming stuck in the middle is often a manifestation of a firm's unwillingness to make choices about how to compete. It tries for competitive advantage through every means and achieves none, because achieving different types of competitive advantage usually requires inconsistent actions. Becoming stuck in the middle also afflicts successful firms, who compromise their generic strategy for the sake of growth of prestige. A classic example is Laker Airways, which began with a clear cost focus strategy based on no-frills operation in the North Atlantic market, aimed at a particular segment of the traveling public that was extremely price-sensitive. Over time, however, Laker began adding frills, new services, and new routes. It blurred its image, and suboptimized its service and delivery system. The consequences were disastrous, and Laker eventually went bankrupt.

The temptation to blur a generic strategy, and therefore become stuck in the middle, is particularly great fora focuser once it has dominated its target segments. Focus involves deliberately limiting potential sales volume. Success can lead a focuser to lose sight of the reasons for its success and compromise its focus strategy for growth's sake. Rather than compromise its generic strategy, a firm is usually better off finding new industries in which to grow where it can use its generic strategy again of exploit interrelationships.

Pursuit of More Than One Generic Strategy

Each generic strategy is a fundamentally different approach to creating and sustaining a competitive advantage, combining the type of competitive advantage a firm seeks and the scope of its strategic target. Usually a firm must make a choice among them, or it will become stuck in the middle. The benefits of optimizing the firm's strategy fora particular target segment (focus) cannot be gained if a firm is simultaneously serving a broad range of segments (cost leadership of differentiation). Sometimes a firm may be able to create two largely separate business units within the same corporate entity, each with a different generic strategy. A good example is the British hotel firm Trusthouse Forte, which operates five separate hotel chains each targeted at a different segment. However, unless a firm strictly separates the units pursuing different generic strategies, it may compromise the ability of any of them to achieve its competitive advantage. A suboptimized approach to competing, made likely by the spillover among units of corporate policies and culture, will lead to becoming stuck in the middle.

Achieving cost leadership and differentiation are also usually inconsistent, because differentiation is usually costly. To be unique and command a price premium, a differentiator deliberately elevates costs, as Caterpillar has done in construction equipment. Conversely, cost leadership often requires a firm to forego some differentiation by standardizing its product, reducing marketing overhead, and the like.

Reducing cost does not always involve a sacrifice in differentiation. Many firms have discovered ways to reduce cost not only without hurting their differentiation but while actually raising it, by using practices that are both more efficient and effective or employing a different technology. Sometimes dramatic cost savings can be achieved with no impact on differentiation at all if a firm has not concentrated on cost reduction previously. However, cost reduction is not the same as achieving a cost advantage. When faced with capable competitors also striving for cost leadership, a firm will ultimately reach the point where further cost reduction requires a sacrifice in differentiation. It is at this point that the generic strategies become inconsistent and a firm must make a choice.

If a firm can achieve cost leadership and differentiation simultaneously, the rewards ate great because the benefits are additive -- differentiation leads to premium prices at the same time that cost leadership implies lower costs. Ah example of a firm that has achieved both a cost advantage and differentiation in its segments. is Crown Cork and Seal in the metal container industry. Crown has targeted the so-called "hard to hold" uses of cans in the beer, soft drink, and aerosol industries. It manufactures only steel cans rather than both steel and aluminum. In its target segments, Crown has differentiated itself based on service, technological assistance, and offering a full line of steel cans, crowns, and canning machinery. Differentiation of this type would be much more difficult to achieve in other industry segments which have different needs. At the same time, Crown has dedicated its facilities to producing only the types of cans demanded by buyers in its chosen segments and has aggressively invested in modern two-piece steel canning technology. As a result, Crown has probably also achieved low-cost producer status in its segments.

There are three conditions under which a firm can simultaneously achieve both cost leadership and differentiation:

Competitors are stuck in the middle. Where competitors are stuck in the middle, none is well enough positioned to force a firm to the point where cost and differentiation become inconsistent. This was the case with Crown Cork. Its major competitors were not investing in low-cost steel can production technology, so Crown achieved cost leadership without having to sacrifice differentiation in the process. Were its competitors pursuing an aggressive cost leadership strategy, however, an attempt by Crown to be both low-cost and differentiated might have doomed it to becoming stuck in the middle. Cost reduction opportunities that did not sacrifice differentiation would have already been adopted by Crown's competitors.

While stuck-in-the-middle competitors can allow a firm to achieve both differentiation and low cost, this state of affairs is often temporary. Eventually a competitor will choose a generic strategy and begin to implement it well, exposing the tradeoffs between cost and differentiation. Thus a firm must choose the type of competitive advantage it intends to preserve in the long run. The danger in facing weak competitors is that a firm will begin to compromise its cost position or differentiation to achieve both and leave itself vulnerable to the emergence of a capable competitor.

Cost is strongly affected by share or interrelationships, Cost leadership and differentiation may also be achieved simultaneously where cost position is heavily determined by market share, rather than by product design, level of technology, service provided, or other factors. If one firm can open up a big market share advantage, the cost advantages of share in some activities allow the firm to incur added costs elsewhere and still maintain net cost leadership, of share reduces the cost of differentiating relative to competitors (see Chapter 4). In a related situation, cost leadership and differentiation can be achieved at the same time when there are important interrelationships between industries that one competitor can exploit and others cannot (see Chapter 9). Unmatched interrelationships can lower the cost of differentiation of offset the higher cost of differentiation. Nonetheless, simultaneous pursuit of cost leadership and differentiation is always vulnerable to capable competitors who make a choice and invest aggressively to implement it, matching the share of interrelationship.

A firm pioneers a major innovation. Introducing a significant technological innovation can allow a firm to lower cost and enhance differentiation at the same time, and perhaps achieve both strategies. lntroducing new automated manufacturing technologies can have this effect, as can the introduction of new information system technology to manage logistics or design products on the computer. Innovative new practices unconnected to technology can also have this effect. Forging cooperative relations with suppliers can lower input costs and improve input quality, for example, as described in Chapter 3.

The ability to be both low cost and differentiated is a function of being the only firm with the new innovation, however. Once competitors also introduce the innovation, the firm is again in the position of having to make a tradeoff. Will its information system be designed to emphasize cost or differentiation, for example, compared to the competitor's information system? The pioneer may be at a disadvantage if, in the pursuit of both Iow cost and differentiation, its innovation has not recognized the possibility of imitation. It may then be neither low cost nor differentiated once the innovation is matched by competitors who pick one generic strategy.

A firm should always aggressively pursue all cost reduction opportunities that do not sacrifice differentiation. A firm should also pursue all differentiation opportunities that are not costly. Beyond this point, however, a firm should be prepared to choose what its ultimate competitive advantage will be and resolve the tradeoffs accordingly.

Sustainability

A generic strategy does not lead to above-average performance unless it is sustainable vis-à-vis competitors, though actions that improve industry structure may improve industrywide profitability even if they are imitated. The sustainability of the three generic strategies demands that a firm's competitive advantage resists erosion by competitor behavior or industry evolution.

The sustainability of a generic strategy requires that a firm possess some barriers that make imitation of the strategy difficult. Since barriers to imitation are never insurmountable, however, it is usually necessary for a firm to offer a moving target to its competitors by investing in order to continually improve its position. Each generic strategy is also a potential threat to the others, for example, focusers must worry about broadly-targeted competitors and rice versa. The factors that lead to sustainability of each of the generic strategies will be discussed extensively in Chapters 3, 4, and 7.

Table 1-1 can be used to analyze how to attack a competitor that employs any of the generic strategies. A firm pursuing overall differentiation, for example, can be attacked by firms who open up a large cost gap, narrow the extent of differentiation, shift the differentiation desired by buyers to other dimensions, of focus. Each generic strategy is vulnerable to different types of attacks, as discussed in more detail in Chapter 15.

In some industries, industry structure of the strategies of competitors eliminate the possibility of achieving one of more of the generic strategies. Occasionally no feasible way for one firm to gain a significant cost advantage exists, for example, because several firms are equally placed with respect to scale economies, access to raw materials, or other cost drivers. Similarly, ah industry with few segments or only minor differences among segments, such as low-density polyethylene, may offer few opportunities for focus. Thus the mix of generic strategies will vary from industry to industry.

In many industries, however, the three generic strategies can profitably coexist as long as firms pursue different ones of select different bases for differentiation of focus, Industries in which several strong firms are pursuing differentiation strategies based on different sources of buyer value are often particulary profitable. This tends to improve industry structure and lead to stable industry competition. If two or more firms choose to pursue the same generic strategy on the same basis, however, the result can be a protracted and unprofitable battle. The worst situation is where several firms are vying for overall cost leadership. The past and present choice of generic strategies by competitors, then, has an impact on the choices available to a firm and the cost of changing its position.

The concept of generic strategies is based on the premise that there are a number of ways in which competitive advantage can be achieved, depending on industry structure. If all firms in an industry followed the principles of competitive strategy, each would pick different bases for competitive advantage. While not all would succeed, the generic strategies provide alternate routes to superior performance. Some strategic planning concepts have been narrowly based on only one route to competitive advantage, most notably cost. Such concepts not only fail to explain the success of many firms, but they can also lead all firms in an industry to pursue the same type of competitive advantage in the same way -- with predictably disastrous results.

Generic Strategies and Industry Evolution

Changes in industry structure can affect the bases on which generic strategies are built and thus alter the balance among them. For example, the advent of electronic controls and new image developing systems has greatly eroded the importance of service as a basis for differentiation in copiers. Structural change creates many of the risks.

Structural change can shift the relative balance among the generic strategies in an industry, since it can alter the sustainability of a generic strategy or the size of the competitive advantage that results from it. The automobile industry provides a good example. Early in its history, leading automobile firms followed differentiation strategies in the production of expensive touring cars. Technological and market changes created the potential for Henry Ford to change the rules of competition by adopting a classic overall cost leadership strategy, based on low-cost production of a standard model sold at low prices. Ford rapidly dominated the industry worldwide. By the late 1920s, however, economic growth, growing familiarity with the automobile, and technological change had created the potential for General Motors to change the rules once more -- it employed a differentiation strategy based on a wide line, features, and premium prices. Throughout this evolution, focused competitors also continued to succeed.

Another long-term battle among generic strategies has occurred in general merchandising. K Mart and other discounters entered with cost leadership strategies against Sears and conventional department stores, featuring low overhead and nationally branded merchandise. K Mart, however, now faces competition from more differentiated discounters who sell fashion-oriented merchandise, such as Wal-Mart. At the same time, focused discounters have entered and are selling such products as sporting goods (Herman's), health and beauty aids (CVS), and books (Barnes and Noble). Catalog showrooms have also focused on appliances and jewelry, employing low-cost strategies in those segments. Thus the bases for K Mart's competitive advantage have been compromised and it is having difficulty outperforming the industry average.

Another more recent example of the jockeying among generic strategies has occurred in vodka. Smirnoff has long been the differentiated producer in the industry, based on early positioning as a high-class brand and heavy supporting advertising. As growth has slowed and the industry has become more competitive, however, private label vodkas and low price brands are undermining Smirnoff's position. At the same time, PepsiCo's Stolichnaya vodka has established an even more differentiated position than Smirnoff through focus. Smirnoff is caught in a squeeze that is threatening its long-standing superior performance. In response, it has introduced several new brands, including a premium brand positioned against Stolichnaya.

Generic Strategies and Organizational Structure

Each generic strategy implies different skills and requirements for success, which commonly translate into differences in organizational structure and culture. Cost leadership usually implies tight control systems, overhead minimization, pursuit of scale economies, and dedication to the learning curve; these could be counterproductive for a firm attempting to differentiate itself through a constant stream of creative new products.

The organizational differences commonly implied by each generic strategy carry a number of implications. Just as there are often economic inconsistencies in achieving more than one generic strategy, a firm does not want its organizational structure to be suboptimal because it combines inconsistent practices. It has become fashionable to tie executive selection and motivation to the "mission" of a business unit, usually expressed in terms of building, holding, or harvesting market share. It is equally -- if not more -- important to match executive selection and motivation to the generic strategy being followed.

The concept of generic strategies also has implications for the role of culture in competitive success. Culture, that difficult to define set of norms and attitudes that help shape an organization, has come to be viewed as an important element of a successful firm. However, different cultures are implied by different generic strategies. Differentiation may be facilitated by a culture encouraging innovation, individuality, and risk-taking (Hewlett-Packard), while cost leadership may be facilitated by frugality, discipline, and attention to detail (Emerson Electric). Culture can powerfully reinforce the competitive advantage a generic strategy seeks to achieve, if the culture is an appropriate one. There is no such thing as a good or bad culture per se. Culture is a means of achieving competitive advantage, not an end in itself.

The link between generic strategy and organization also has implications for the diversified firm. There is a tendency for diversified firms to pursue the same generic strategy in many of their business units, because skills and confidence are developed for pursuing a particular approach to competitive advantage. Moreover, senior management often gains experience in overseeing a particular type of strategy. Emerson Electric is well known for its pursuit of cost leadership in many of its business units, for example, as is H. J. Heinz.

Competing with the same generic strategy in many business units is one way in which a diversified firm can add value to those units, a subject I will discuss in Chapter 9 when I examine interrelationships among business units. However, employing a common generic strategy entails some risks that should be highlighted. One obvious risk is that a diversified firm will impose a particular generic strategy on a business unit whose industry (or initial position) will not support it. Another, more subtle risk is that a business unit will be misunderstood because of circumstances in its industry that are not consistent with the prevailing generic strategy. Worse yet, such business units may have their strategies undermined by senior management. Since each generic strategy often implies a different pattern of investments and different types of executives and cultures, there is a risk that a business unit that is "odd man out" will be forced to live with inappropriate corporate policies and targets. For example, an across-the-board cost reduction goal or firmwide personnel policies can be disadvantageous to a business unit attempting to differentiate itself on quality and service, just as policies toward overhead appropriate for differentiation can undermine a business unit attempting to be the low-cost producer.

Generic Strategies and the Strategic Planning Process

Given the pivotal role of competitive advantage in superior performance, the centerpiece of a firm's strategic plan should be its generic strategy. The generic strategy specifies the fundamental approach to competitive advantage a firm is pursuing, and provides the context for the actions to be taken in each functional area. In practice, however, many strategic plans are lists of action steps without a clear articulation of what competitive advantage the firm has or seeks to achieve and how. Such plans are likely to have overlooked the fundamental purpose of competitive strategy in the process of going through the mechanics of planning. Similarly, many plans are built on projections of future prices and costs that are almost invariably wrong, rather than on a fundamental understanding of industry structure and competitive advantage that will determine profitability no matter what the actual prices and costs turn out to be.

As part of their strategic planning processes, many diversified firms categorize business units by using a system such as build, hold, or harvest. These categorizations are often used to describe or summarize the strategy of business units. While such categorizations may be useful in thinking about resource allocation in a diversified firm, it is very misleading to mistake them for strategies. A business unit's strategy is the route to competitive advantage that will determine its performance. Build, hold, and harvest are the results of a generic strategy, or recognition of the inability to achieve any generic strategy and hence of the need to harvest. Similarly, acquisition and vertical integration are not strategies but means of achieving them.

Another common practice in strategic planning is to use market share to describe a business unit's competitive position. Some firms go so far as to set the goal that all their business units should be leaders (number one or number two) in their industries. 'This approach to strategy is as dangerous as it is deceptively clear. While market share is certainly relevant to competitive position (due to scale economies, for example), industry leadership is not a cause but an effect of competitive advantage. Market share per se is not important competitively; competitive advantage is. The strategic mandate to business units should be to achieve competitive advantage. Pursuit of leadership for its own sake may guarantee that a firm never achieves a competitive advantage or that it loses the one it has. A goal of leadership per se also embroils managers in endless debates over how an industry should be defined to calculate shares, obscuring once more the search for competitive advantage that is the heart of strategy.

In some industries, market leaders do not enjoy the best performance because industry structure does not reward leadership. A recent example is Continental Illinois Bank, which adopted the explicit goal of market leadership in wholesale lending. It succeeded in achieving this goal, but leadership did not translate into competitive advantage. Instead, the drive for leadership led to making loans that other banks would not, and to escalating costs. Leadership also meant that Continental Illinois had to deal with large corporations that are extremely powerful and price-sensitive buyers of loans. Continental Illinois will be paying the price of leadership for some years. In many other firms, such as Burlington Industries in fabrics and Texas Instruments in electronics, the pursuit of leadership for its own sake seems to have sometimes diverted attention from achieving and maintaining competitive advantage.

Overview of This Book

Competitive Advantage describes the way a firm can choose and implement a generic strategy to achieve and sustain competitive advantage. It addresses the interplay between the types of competitive advantage -- cost and differentiation -- and the scope of a firm's activities. The basic tool for diagnosing competitive advantage and finding ways to enhance it is the value chain, which divides a firm into the discrete activities it performs in designing, producing, marketing, and distributing its product. The scope of a firm's activities, which I term competitive scope, can have a powerful role in competitive advantage through its influence on the value chain. I describe how narrow scope (focus) can create competitive advantage through tailoring the value chain, and how broader scope can enhance competitive advantage through the exploitation of interrelationships among the value chains that serve different segments, industries or geographic areas. While this book addresses competitive advantage, it also sharpens the ability of the practitioner to analyze industries and competitors and hence supplements my earlier book.

This book is organized into four parts. Part I describes the types of competitive advantage and how a firm can achieve them. Part II discusses competitive scope within an industry and its affect on competitive advantage. Part III addresses competitive scope in related industries, or how corporate strategy can contribute to the competitive advantage of business units. Part IV develops overall implications for competitive strategy, including ways of coping with uncertainty and to improve or defend position.

Chapter 2 presents the concept of the value chain, and shows how it can be used as the fundamental tool in diagnosing competitive advantage. The chapter describes how to disaggregate the firm into the activities that underlie competitive advantage, and identify the linkages among activities that are central to competitive advantage. It also shows the role of competitive scope in affecting the value chain, and how coalitions with other firms can substitute for performing activities in the chain internally. The chapter also briefly considers the use of the value chain in designing organizational structure.

Chapter 3 describes how a firm can gain a sustainable cost advantage. It shows how to use the value chain to understand the behavior of costs and the implications for strategy. Understanding cost behavior is necessary not only for improving a firm's relative cost position but also for exposing the cost of differentiation.

Chapter 4 describes how a firm can differentiate itself from its competitors. The value chain provides a way to identify a firm's sources of differentiation, and the fundamental factors that drive it. The buyer's value chain is the key to understanding the underlying basis of differentiation -- creating value for the buyer through lowering the buyer's cost or improving buyer performance. Differentiation results from both actual uniqueness in creating buyer value and from the ability to signal that value so that buyers perceive it.

Chapter 5 explores the relationship between technology and competitive advantage. Technology is pervasive in the value chain and plays a powerful role in determining competitive advantage, in both cost and differentiation. The chapter shows how technological change can influence competitive advantage as well as industry structure. It also describes the variables that shape the path of technological change in an industry. The chapter then describes how a firm can choose a technology strategy to enhance its competitive advantage, encompassing the choice of whether to be a technological leader and the strategic use of technology licensing. The idea of first-mover advantages and disadvantages is developed to highlight the potential risks and rewards of pioneering any change in the way a firm competes.

Chapter 6 discusses competitor selection, or the role of competitors in enhancing competitive advantage and industry structure. The chapter shows why the presence of the right competitors can be beneficial to a firm's competitive position. It describes how to identify "good" competitors and how to influence the array of competitors faced, it also describes how a firm can decide what market share it should hold, an important issue since a very large share is rarely optimal.

Chapter 7 begins Part II of the book and examines how industries can be segmented. It draws on Chapters 3 and 4, since segments stem from intraindustry differences in buyer needs and cost behavior. Segmentation is clearly pivotal to the choice of focus strategies, as well as to assessing the risks borne by broadly-targeted firms. The chapter describes how profitable and defensible focus strategies can be identified.

Chapter 8 discusses the determinants of substitution, and how a firm can substitute its product for another or defend against a substitution threat. Substitution, one of the five competitive forces, is driven by the interplay of the relative value of a substitute compared to its cost, switching costs, and the way individual buyers evaluate the economic benef its of substitution. The analysis of substitution is of central importance in finding ways to widen industry boundaries, exposing industry segments that face a lower substitution risk than others, and developing strategies to promote substitution or defend against a substitution threat. Hence understanding substitution is important both to broadening and to narrowing scope. The analysis of substitution draws on Chapters 3 through 7.

Chapter 9 begins Part III of the book, and is the first of four chapters about corporate strategy for the diversified firm. The central concern of corporate strategy is the way in which interrelationships among business units can be used to create a competitive advantage. Chapter 9 explains the strategic logic of interrelationships. It describes the three types of interrelationships among industries, and why they have grown in importance over time. It then shows how the significance of interrelationships for competitive advantage can be assessed.

Chapter 10 addresses the implications of interrelationships for horizontal strategy, or strategy that encompasses multiple distinct business units. A firm with multiple business units in related industries must formulate strategies at the group, sector, and corporate levels that coordinate the strategies of individual units. The chapter describes the principles for doing so, as well as the implications of interrelationships for diversification into new industries.

Chapter 11 describes how interrelationships among business units can actually be achieved. Many organizational impediments stand in the way, ranging from the protection of turf to faulty incentives. The chapter identifies these impediments in detail, and shows how they can be overcome through what I call horizontal organization. Firms competing in related industries must have a horizontal organization that links business units together, that supplements but does not replace the hierarchical organization to manage and control them.

Chapter 12 treats a special but important case of interrelationships, where an industry's product is used or purchased with complementary products. The chapter describes the circumstances in which a firm must control complementary products rather than let other firms supply them. It also examines the strategy of bundling, or selling separate products together as a single package, and the circumstances in which such a strategy is appropriate. Finally, the chapter examines cross-subsidization, or pricing complementary products to reflect the relationship among them rather than setting each price separately.

Part IV of the book draws on the concepts in this book and Competitive Strategy to develop broad principles for offensive and defensive strategy. Chapter 13 discusses the problem of formulating competitive strategy in the face of significant uncertainty. It describes the concept of industry scenarios, and shows how scenarios can be constructed to illuminate the range of future industry structures that might occur. The chapter then outlines the alternative ways in which a firm can cope with uncertainty in its choice of strategy. Competitive strategy is more effective if there is explicit consideration of the range of industry scenarios that might occur, and recognition of the extent to which strategies for dealing with different scenarios are consistent or inconsistent.

Competitive Advantage concludes with a treatment of defensive and offensive strategy. Chapters 14 and 15 serve to pull together many of the other chapters. Chapter 14, on defensive strategy, describes the process by which a firm's position is challenged and the defensive tactics available to deter or block a competitor. The chapter then develops the implications of these ideas for a defensive strategy. Chapter 15 shows how to attack an industry leader. It lays out the conditions a firm must meet to challenge a leader, and the approaches to changing the rules of competition in order to do so successfully. The same principles involved in attacking a leader can be used in offensive strategy against any competitor.

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Copyright © 1985 by Michael E. Porter

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