Creating a defendable position

Structure

1. Motivation

2. Basic ideas
2.1. Porter's five forces
2.2. The three strategies

3. Differentiation creates a defendable position
3.1. Competitive Rivalry
3.2. Suppliers
3.3. Buyers
3.4. New entrants
3.5. Substitutes

4. Conclusion

5. List of references

1. Motivation

Competitive advantage is the basis for most strategic decisions and its’ creation a key issue of management. The most important concepts of competitive strategy are Michael Porter's "five forces" and "generic strategies", published in his books Competitive Strategy (1980) and Competitive Advantage (1985). The first sections will describe his basic ideas and explain how the five forces are connected to the generic strategies. This is followed by arguments in which way one strategy helps to create a defendable position in an industry.

2. Basic ideas

2.1. Porter's five forces

A company is not isolated, but exists in a complex network. "The five forces framework helps identify the sources of competition in an industry or sector"^[1] and the important factors in the environment of a company are: Competitive Rivalry, purchasing power of supplier, purchasing power of buyer, threat of new entrants and of substitutes^[2] (à Figure 1).

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Figure 1 - Five Forces^[3]

2.2. The three strategies

2.2.1. Fight back with strategy

To "find a position in the industry where the company can best defend itself against"^[4] the "competitive forces" is a key issue of management. But to achieve this "defendable position"^[5] a strategy must be accomplished, regarding processes, structure and policy. "Strategy is the direction and scope of an organisation over the long term, which achieves advantage (...)." ^[6] There are three generic strategies^[7] building on different competences: overall cost leadership, differentiation and focus. The criteria on which separation is based are the target market and type of advantage (à Figure 2). The strategies are mutually exclusive. Though only products are mentioned in the following, the concepts could also be applied to services.

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Figure 2 – The three generic strategies^[8]

2.2.2. Cost leadership

The cost leader is operating with the lowest costs of all and there can only be one in a market. The company can sacrifice its profit margins, finance production through subsidies from other units or be the lowest cost producer^[9]. Activities to achieve cost efficiency are the exploitation of economies of scale (mass production), the reduction of inventory and time-to-market or the exploitation of the experience curve (best practices)^[10]. The cost leader sells standardized products in the whole market with the same value like competitors, but at lower costs. So profits should be above the average (à Figure 3).

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Figure 3 - Increased profits of cost leader^[11]

2.2.3. Differentiation

"A differentiation strategy seeks to provide products or services unique (...) in terms of dimensions widely valued by buyers"^[12]. The company is best in satisfying the needs of specific customer groups in the whole market with the underlying concept of market segmentation^[13]. Due to the product's uniqueness, the customers have no alternative to the product or high switching costs. So they pay a premium price compared to the average in the market because they "believe the product's differentiated qualities to be worth the difference"^[14].

Differentiation can be archived for example through:

- using high quality or "luxurious materials"^[15]
- providing "better levels of service"^[16]
- branding, excellent design and company image^[17]
- innovation and research.

Though these activities create extra costs, the differentiator must try to keep the cost near of the average costs in the market. It "is crucial that costs are only added in areas that customers perceive as important"^[18]. The difference between the premium price and the increased costs is the greater than average profit (à Figure 4).

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Figure 4 - Increased profits of differentiator^[19]

[...]

^[1] Johnson (2002), p. 112.

^[2] Porter (1980).

^[3] Adapted from Porter (1980), p. 4, and Johnson (2002), p. 113.

^[4] Porter (1980), p. 4.

^[5] Porter (1980), p. 29.

^[6] Johnson (2002), p. 10.

^[7] Porter (1980), p. 35.

^[8] Adapted from Porter (1980), p. 39, figure 2.1.

^[9] Bowman (1996), p. 38.

^[10] Parts from Bowman (1996), p. 38-40.

^[11] Adapted from Lynch (1997), p. 488.

^[12] Johnson (2002), p. 329.

^[13] Lynch (1997), p. 488.

^[14] Hill (1995), p. 174.

^[15] Lynch (1997), p. 488.

^[16] Lynch (1997), p. 488.

^[17] Gordon (Jul/Aug 2002).

^[18] Thompson (1993), p. 218, 216.

^[19] Adapted from Lynch (1997), p. 489.