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2 Porter's generic competitive strategy model

2 Porter's generic competitive strategy model

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Diagram of Porter’s model

Competitive scope

Competitive advantage

Narrow target

e.g. particular

Broad target

segment only e.g. industry-wide



Lower cost


e.g. uniqueness perceived

by the customer






Cost focus

Differentiation focus

Figure 6.3 Porter’s three generic strategies model. Adapted with the permission of

The Free Press, a division of Simon & Schuster Adult Publishing Group from Competitive

Strategy: Techniques for Analyzing Industries and Competitors by Michael E. Porter. © 1980,

1998 by The Free Press. All rights reserved


Competitive advantage

Porter’s strategic prescriptions are rooted in his analysis of the impact of five competitive

forces on a firm’s profits. He argues that a firm must adopt a strategy that combats these

forces better than the strategy developed by its rival, if it is to deliver superior shareholder

value. If the firm is successful in this, its improved profitability will arise from the combination of two effects:

1. Each year it will enjoy a higher margin than its rivals operating in the same market.

2. As the product life cycle unfolds and prices start to fall during the mature stage, it will

survive longer in the market than its rivals.

Adding these two together means better long-term profitability. This in turn equates

to superior shareholder value, that is, higher present value of future financial returns than

rivals in the same industry.

The Porter Five Forces model has been discussed earlier.

1. Lower cost. Achieving the industry’s ‘lowest delivered cost to customer’ provides a

number of competitive advantages to the firm:

● reduces the impact of competitive rivalry by allowing the firm to make superior profit

margins at the prevailing level of industry prices – the firm can also become the price

leader because no other firm is able to undercut it;

● reduces the impact of buyer and supplier power by giving the firm a unique cushion

of profits against cost increases and price cuts – indeed, buyer and supplier power will

be the forces which drive rivals from the industry;

● low costs provide a barrier to entry against potential new entrants and hence safeguard

long-term profits.



Competitive scope

Porter suggests that a firm can choose to spread its resources across the entire industry or it

can focus on just one section of the industry. The latter is a focus strategy and is based on

a narrow competitive scope. Focus has the following dimensions:

1. Buyer group: for example, try to supply all households or just one type?

2. Product: for example, make a whole range of cars or just executive limousines?


Porter recognises that cost reduction strategies are widespread due to management’s

adherence to the experience curve concept. He criticises this by pointing out that it

only considers production costs, and recommends analysis of the entire value chain to

achieve substantial cost savings.

2. Differentiation. This is a premium perceived value in the eyes of the buyer. This will

normally result in a number of competitive advantages:

● premium prices can be charged for the product to give better margins in the short run,

while in the long run exempting the firm from the price wars of the mature stage;

● differentiation is a barrier to entry;

● buyer power from retailers and manufacturers may be reduced if the differentiation of

the product makes it an essential element in attracting their customers;

● the cushion of better profits reduces the impact of buyer and supplier power.

Differentiation of the product can be achieved in terms of functionality,

compatibility (to other products), richness of information provided, appearance

or build quality and reliability. It is worth remembering that it is also possible to

differentiate at the level of the firm. This can be done by reputation or brand,

levels of support for customers (and clients) and the reach of the operating

network. We can determine if a firm is successfully differentiating in that they will be

able to sustain a price premium, enjoy high brand valuation and above average customer loyalty.

3. Stuck in the middle. Porter argues that a firm must decide whether to concentrate on

differentiation or whether it wishes to be a cost leader. Failure to do so leaves the firm

‘stuck in the middle’ with the following results:

● it cannot access the high-volume customers who demand low costs (or must reduce

its margins to attract them which leaves it vulnerable in the long run);

● it cannot appeal to the high-margin customers because it is also associated

with cheaper offerings and customers – this will detract from its appeal and perceived


● it will have a confused corporate culture which tries to combine excellence with


● its management style and control systems will become contradictory. For example, a

cost leader will focus on cost accounting controls, whereas a differentiator will have

more interest in controlling innovation and brands. This will affect the relative power

and influence of factions in the management teams and of the functions they head

up. The marketing and research and development functions may predominate under

a differentiation strategy. To combine both strategies will dilute control and invites


● However, there are critics of these arguments and these have been discussed in

Section 6.2.8



3. Geographical area: for example, supply the product throughout the country (world) or

just a selected area?

4. Technology: for example, research and develop all pharmaceutical products or just antiviral products?

To be successful in pursuing either cost leadership or differentiation the firm must be

better than all its rivals. Porter recognises that there are few firms in any industry with sufficient resources to do this. The rest should follow focus strategies.


Focus strategies

A focus strategy (sometimes called a niche strategy) relies on the firm being able to address

itself better to a segment of an industry than its broader scope rivals can.

Porter (1985) argues that a consequence of compromises to meet the needs of the broader

market means that broad-scope players sub-optimise in one of the following two ways:

1. Underperformance: They do not understand or make a product which fully meets the

needs of the buyer in a segment. This provides the opportunity for a smaller rival to

develop a differentiation focus strategy by meeting these customers’ needs better and at

a premium price.

2. Overperformance: The broad-scope competitor is giving the segment more than it really

requires and in the process is incurring extra costs. This provides the opportunity for

smaller rivals to develop a cost-focus strategy by stripping the product back to its basics

and providing it at a lower cost and more attractive price.

Porter warns that a focus strategy cannot be successful unless there is a substantial underperformance or overperformance. However in a given industry there is the possibility for

several firms each pursuing focus strategies, provided that each pursues a different segment

to focus on.


An illustration of Porter’s model – automobiles

The world automobile industry provides an interesting example of Porter’s model

(Figure 6.4).

Broad target

Competitive scope

Competitive advantage

Lower cost


Narrow target












Ambassador (India)

Reliant (fiberglass)


Figure 6.4

Ferrari (sports)

Morgan (traditional


Black taxicabs


The world auto industry


Using Porter’s model

Like the rest of Porter’s models it is intended as a way to help the management team

arrange and classify its thoughts. This can be useful in several ways:

1. To help analyse the competitive position of rivals. This will help management to avoid head-on

conflict and also to spot gaps in the industry. This may involve additional data collection:

● information or estimates of rivals’ cost structures;

● market research information on product and brand perception;

● competitor information on their strategies.

2. To decide on a competitive strategy for the firm. According to Porter, commercial success

demands that one of these strategies be followed.

3. To analyse the risks of the present strategy. Porter suggests that each generic strategy carries

intrinsic risks:

(a) Differentiation:

● Brand loyalty may fail if the cost differential between it and the cost leader

becomes too great. This fate has befallen branded fast-moving consumer goods

firms, cars and airlines.

● Buyer becomes more sophisticated and needs the differentiating factor less.

Buyers are now more willing to buy generic computers and will also arrange their

own foreign holidays rather than relying on the security offered by package tour


● Imitation reduces the differentiation of the brand. Porter argues that this is very

common in mature markets. Examples would include bottled mineral water,

denim jeans and motorcycles.

(b) Cost leadership:

● technological change could eliminate a low-cost base or past learning effects;

● imitation of low-cost techniques by industry entrants;

● product becomes out of date because firm will not invest in it;

● domestic inflation or exchange rate changes destroy cost advantage at home and


(c) Focus:

● broad-target firm develops economies of scale which overtake the cost-focus


● differences between needs or tastes in the market narrow, for example, the

invention of the word processor destroyed the niche strategies of typewriter


● competitors find subsegments within the focus segment and out-compete the


● segment collapses and leaves the firm with no other source of earnings.

Clearly management must focus on these threats and develop strategies to

guard against them. They must maintain their competitive advantages (i.e. apply

resources to maintain them).


Limitations of Porter’s model

We are still using and discussing Porter’s model more than 20 years after its publication.

This indicates its impact and value in the strategy process. It is an accessible model that

concentrates thinking and its influence continues to be profound.







However, like all models in strategy it has its limitations and distortions. These will be

illustrated in relation to the analysis of the car industry in Figure 6.4.

1. Lack of clarity on the concept of ‘industry’. Consider Figure 6.4: it takes the definition

of industry to mean cars only and ignores trucks and motorcycles. From the customer

differentiation perspective this makes sense. However from the perspective of possible

advantages in technology development and production costs it is less sensible. Some car

firms also make trucks and motorcycles. Does its truck manufacturing and shared R&D

give Mercedes-Benz cost advantages in addition to its advantages as a differentiated car

company (or perhaps association with panel vans and truckers harms its image)? If we

broaden the scope of Figure 6.4 to ‘automotive industry’, then BMW turns into a

differentiation-focus player (it only makes cars and bikes) alongside Ferrari. Is this any

more meaningful? What would be the impact if we were to define the industry as ‘personal


Porter argues that competitive advantage derives from the firm’s position in an industry. If we cannot decide what level of industry to consider, it is hard to see how we can

use his theory. This criticism also calls into question the value of his Five Forces model.

A car company conducting an environmental analysis needs to decide what industry it

is in to apply that model also (cars or automotive or manufacturing or transportation?).

2. Strategic unit not defined. The model is set up to help the firm decide its competitive

strategy against other firms in the same industry. But it is not clear whether this means

the corporation as a whole or whether it is one particular business unit.

In Figure 6.4, Seat, Audi, Bentley and Skoda each appear in separate quadrants. Yet

all are part of the same company, the Volkswagen-Audi Group ( VAG). This raises a

number of questions:

(a) Does each division map a matrix appropriate to the industry it is in? In this case,

Seat would see itself as in fact a differentiator in the economy-car industry.

(b) Can a corporation follow different competitive strategies in different business units?

If not, then VAG is doomed.

This again causes problems for Porter’s theory because he has said that having

more than one competitive strategy will dilute the firm’s competitive advantage. But

is he seriously suggesting that VAG will risk putting Skoda parts on a Bentley and

sell it through the same outlets (or increase the costs of Skoda by mounting a large

chrome grille on the front)?

This observation calls into question the value of Porter’s model as a whole:

(a) If we use it at corporate level it implies that the whole group must follow a single

competitive strategy. However, this generic strategy is meaningless at the level of

individual products and markets. Differentiation in trucks is about reliability, economy,

load capacity and manoeuvrability. This is a different differentiation from that required

to be successful in executive cars and grand tourers where styling and comfort are paramount. Moreover how can the low costs of supply-chain management and assembly at

a truck assembly plant in Spain be transferred to executive car production in Germany?

(b) If we use it at a business unit level (as seems inevitable) we overlook sources of

competitive advantage that we (or rivals) may enjoy from being part of a larger group.

(c) Separation of business units and careful management of brands can avoid this problem for the company (a fact which Porter seems to overlook when he asserts that

dilution is inevitable). However, the management accountant in particular should be



wary of this situation. The management accounting controls used to minimise costs

and evaluate divisional performance in a division pursuing a cost leadership strategy

(say tight budgets and performance measures based on return to net assets) would be

harmful if also applied to a division that was a pursuing differentiation where measured efficiency may be much lower and expenditure on promotion, development and

human resources much higher.

3. Lack of empirical evidence. Porter’s model purports to be more than a system of

classification – it makes predictions that particular strategies will lead to better profitability

and that a stuck-in-the-middle strategy will cause poor profits. However, the survey evidence

of real firms is unconvincing and muddied by the definitional problems mentioned already.

This is a serious issue because Porter is taking the role of the doctor, prescribing therapies and cures. Managers will invest resources, sell businesses and dismiss staff on this

advice. If the evidence for his prescriptions is weak, perhaps they should think again?

4. What’s wrong with the middle ground? Porter seems to suggest that markets can only be

successfully exploited at the extremes of low-cost provision or premium provision. He

suggests that the volume market is always a low-cost one.

But people do not only live in tents or palaces, eat either rice or chocolates and travel

only by bicycle or by limousine. In most markets the consumer is drawn to the middle in search of acceptable quality and an affordable price. In denying this point Porter

makes use of the product lifecycle and observes that, as the mature stage progresses,

the margins in the middle will get squeezed even if customers do not split into the two

extreme segments he envisages.

This opens him up to several further criticisms:

(a) Industry life-cycles and profits tend to be driven by technological changes not competitive ones. None of his strategies can offset technological obsolescence.

(b) All firms accept that products will become mature and will sustain their profits by

launching new products.

5. Competitive prescriptions may be misleading. Porter’s model is very abstract and many

managers struggle to understand how his terms and prescriptions apply to their industry.

(a) Differentiation strategy: Porter roots this in the customer’s perception of the firm’s

position in the market. This encourages some managers to equate it with ‘hype’ not


● Managers may replace a sound resource-based strategy with promotion and

‘hype’ that is shallow and too easily seen through or imitated.

● Managers may wrongly perceive of their rivals’ strategies as likewise ‘smoke and dust’

and not see the resources underlying it. For example, we frequently forget that CocaCola’s differentiation is not just about its brand image. There is also an awesome

supply-chain capability in place to put their product to within ‘an arm’s reach of desire’.

Porter seeks to dispel this problem by discussing the need to use the entire

value chain to develop competitive advantage.

(b) Cost leadership: this is based on the notion of the firm having lower costs and

hence attracting the mass market where the economies of scale exist. There is a serious flaw in this strategy:

● Cost leadership is not a competitive strategy because the customer is not influenced to buy a product by the nature of a firm’s cost structure. They are looking

at benefits and prices.

● Therefore a cost leadership strategy must involve cutting price if it is to attract the

mass end of the market.





But if the firm needs to gain mass to get economies of scale, this implies that it is

not initially a low-cost player.

● So Porter is actually advising firms to risk sparking a price war without first having

the low-cost structure it needs to survive it.

6. It restricts the firm to its present industry. The model does not consider how the firm

might use its competitive advantages in new industries. Instead it looks only at how its

resources and strategy may be developed in its existing lines of business.

Hamel and Prahalad (1994) observe that superior shareholder value is earned by

‘breakthrough strategies’. These are ones that enable firms to create new markets and

industries through innovative use of the firm’s ‘distinctive competences’. One example of this is the way Sony creates new industries and markets through leveraging its

core competence of miniaturisation (e.g. personal stereos, compact discs, miniature and

portable televisions).

The authors would not dispute the need to perform well in the existing market,

but they criticise the excessive emphasis placed upon it by models like Porter’s at the

expense of genuine creativity and innovation. We will talk more of this when we come

to internal development in Section 6.4.2.


Alternatives to Porter: the resource-based view

Porter seeks to define competitive advantage in terms of factors within a particular industry that leads to the difficulties mentioned in points 1 and 2 above. The approach also

suffers from the uncertainty surrounding forecasting the threats and opportunities in particular industries.

This has led some strategists to take a resource-based view of strategy. This locates competitive advantage inside the firm by concentrating on the identification of the core competences of the firm, that is, those things which it is good at and which cannot easily be

copied by rivals. Management should then look for industries to which these competences

can be applied for the generation of competitive advantage or, better still, to create entirely

new industries based on finding new applications for the competences of the firm.

The resource-based view of strategy was discussed earlier in the pillar and will be

covered, briefly, later on.



Product-market strategies

The Ansoff matrix

Ansoff (1965) demonstrates the choices of strategic direction open to a firm in the form of

a matrix (Figure 6.5).


Market penetration strategy

Firm increases its sales in its present line of business. This can be accomplished by:

price reductions;

increases in promotional and distribution support;

acquisition of a rival in the same market;

modest product refinements.















Figure 6.5

The Ansoff product–market scope matrix (adapted from Ansoff, 1965)

These strategies involve increasing the firm’s investment in a product/market and so

are generally only used in markets which are growing, and hence the investment may be

recouped. In this respect the strategy is similar to the invest to build and holding strategy

discussed by the Boston Consulting Group.


Product development strategy

This involves extending the product range available to the firm’s existing markets. These

products may be obtained by:

investment in the research and development of additional products;

acquisition of rights to produce someone else’s product;

buying-in the product and ‘badging’ it;

joint development with owners of another product who need access to the firm’s distribution channels or brands.

The critical factor to the success of this strategy is the profitability of the customer group

for which the products are being developed. Also the firm’s present competitive advantages

in serving the market must confer on to the new good. These can include:

customer information that allows accurate targeting;

established distribution channels;

a brand which can be credibly applied to the new product.


Market development strategies

Here the firm develops through finding another group of buyers for its products. Examples


different customer segments, for example, introducing younger people to goods

previously purchased mainly by adults;

industrial buyers for a good that was previously sold only to households;

new areas or regions of the country;

foreign markets.








This strategy is more likely to be successful where:

the firm has a unique product technology it can leverage in the new market;

it benefits from economies of scale if it increases output;

the new market is not too different from the one it has experience of;

the buyers in the market are intrinsically profitable.


Diversification strategies

Here the firm is becoming involved in an entirely new industry, or a different stage in the

value chain of its present industry. Ansoff distinguishes several forms of diversification:

1. Related diversification. Here there is some relationship, and therefore potential synergy,

between the firm’s existing business and the new product/market space:

(a) Concentric diversification means that there is a technological similarity between the

industries which means that the firm is able to leverage its technical know-how to

gain some advantage. For example, a company that manufactures industrial adhesives might decide to diversify into adhesives to be sold via retailers. The technology would be the same but the marketing effort would need to change.

(b) Vertical integration means that the firm is moving along the value system of its

existing industry towards its customers (forward vertical integration) or towards its

suppliers (backward vertical integration). The benefits of this are assumed to be:

● taking over the profit margin presently enjoyed by suppliers or distributors;

● securing a demand for the product or a supply of key inputs;

● better synchronisation of the value system;

● reduction in buyer or supplier power.

However, it also means increasing the firm’s investment in the industry and

hence its fixed cost base. It should also be noted that Vertical integration may well

take the company into industries where the operating characteristics are significantly different. For instance, the oil industry can be considered, simplistically,

to have three stages in the industry value chain. Those stages can be described as

exploration and production, refining and, finally, marketing of petroleum and

other products. The business model and the critical success factors for each of

these industries are quite different and will require different types of management to be successful. They are sufficiently different to be described as unrelated

diversification. Shell is a typical vertically integrated company.

2. Unrelated diversification. This is otherwise termed conglomerate growth because the

resulting corporation is a conglomerate, that is, a collection of businesses without any

relationship to one another. The strategic justifications advanced for this strategy are to:

● take advantage of poorly managed companies which can then be turned around and

either run at a gain to the shareholders or sold on at a profit;

● spread the risks of the firm across a wide range of industries;

● escape a mature or declining industry by using the positive cash flows from it to

develop into new and more profitable areas of business.

A typical conglomerate company would be Yamaha who manufacture amongst other

products pianos, musical organs and motorcycles.

There are a number of reasons why firms diversify;

to exploit their resources in related markets

● to capture the benefits of synergies



Strategic development and risk

Developing a firm beyond its present product/market space exposes it to a combination

of four sorts of risks. These risks are particularly acute where diversification is concerned

because of the simultaneous novelty of both product and market.

(a) Market risk: The firm has entered a new market where established firms already

operate. The risks here are:

● not correctly understanding the culture of the market or the needs of the customer;

● high distribution costs due to lack of economies of scale;


to learn from the industry into which they diversify

● to control supplies or markets – vertical integration

● to capture the value added in a different stage of the industry value system

● to spread risk

● because they have the cash to do so

● personal ambition of the board

When a company decides to diversify there will always be tradeoffs between;

● economies of scale – where the company can benefit from the overall size of the

organisation and from producing particular products in large quantities. As well as

higher throughput on expensive capital equipment this could result in purchasing

discounts, the further spreading of overheads and optimisation through greater

opportunities to specialise.

● economies of scope – where the company can benefit from being able to share

resources or link activities between different products or markets. The firm could

benefit from the sharing of fixed assets and overheads together with the sharing of

sunk costs such as brands and distribution networks. Where there are commonalities

amongst inputs purchasing discounts may also be available.

● learning by exploration – where a company may not only learn to do new things but

invent new products and processes and combine them with existing ones.

● exploitation – where a company, by gaining experience, may be able to modify and

improve particular processes over time.

● dependency – where a company mitigates its dependency on a particular product,

customer, market or technology.

● management attention – the extent to which senior management can continue to give

attention to a particular product, market or industry, understand the survival and

success factors, and make appropriate strategic decisions whilst learning to do exactly

the same for a new product, market or industry.

● customer responsiveness – the extent to which a company can respond quickly, and

correctly, to new and challenging customer needs whilst still responding to existing

customers to their satisfaction.

● overhead costs – the extent to which these will increase with the need to address a

completely different market.

● competition – the extent to which competitors will react to the company’s entry to an

additional industry – this is particularly important in the case of vertical integration.

For instance, in the case of backward integration those who were your competitors,

suppliers or customers become your customers, competitors and customers respectively, as you move up the industry value system.



failure to be seen as credible by the buyers in the market due to lack of track record

or brand;

● exposure to retaliation by established firms with more entrenched positions.

(b) Product risk: The firm is involving itself in a new production process which is already

being conducted by rival firms: The risks this poses are:

● higher production costs due to lack of experience;

● initial quality problems or inferior products causing irreparable harm to reputation

in the market;

● lack of established production infrastructure and supply-chain relations which will

make costs higher and may limit product innovation and quality.

(c) Operational and managerial risk : This boils down to the danger that management

will not be able to run the new business properly. This carries with it the second

danger that management will also be distracted from running the original business

effectively too.

(d) Financial risk: This relates to the share price of the business. Shareholders are generally suspicious of ‘radical’ departures (and particularly diversification) for the following


● the product and market risks lead to volatile returns;

● the firm may need to write off substantial new net assets if the venture fails;

● the investment needed will reduce dividend and/or necessitate new borrowing;

● a diverse and unique portfolio makes it harder to compare the firm with others in the

same industry when trying to evaluate its risks and returns.

The effect will be for the share price to decline to reflect the uncertainties created

by the strategy.



Alternative growth strategies

The expansion method matrix

This is the third element in Figure 6.2. It is the method by which the firm will gain access

to the products and markets it has selected from the Ansoff matrix. Lynch (1997) presents

the alternative growth strategies as shown in Figure 6.6.


Geographical location


Home country



Figure 6.6





Internal development



Joint venture




Overseas office

Overseas manufacture



Global operation



Joint venture




Lynch’s expansion method matrix (adapted from Lynch, 1997)

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