Which functional strategy for operations is most appropriate for a business following a differentiation strategy?

M Dana Baldwin, Senior Consultant

Strategic Planning Expert

When your organization does strategic planning, what strategies do you consider for each of your market segments?  It is likely that you may select different bases for competing in different segments, because your competitive atmosphere is different in each segment, and what you bring to the market is different in each segment.

The two approaches to strategies we are going to examine are: differentiation (specialty) and low cost strategies (commodity).  In a low cost strategy, the true winner is the company with the actual lowest cost in the market place.  For example, if two companies make essentially identical products that sell at the same price in the market place, the one with the lower costs has the advantage of a higher level of profit per sale.  By having this advantage, the low cost company is able to do a number of things to maintain or increase its market share.  It can invest more in marketing.  It can pay for better positions in retail stores relative to its higher cost competitor.  It can lower price, thus squeezing its competitor’s margins and profits.  It can invest more in research and development, allowing it to improve the performance of its product.  The bottom line here is that the higher cost competitor is allowed to stay in the market at the sole discretion of the lower cost competitor, because, if it so choses, the lower cost competitor could drop its price to the point where the higher cost competitor would have to sell at a loss in order to remain in the market.  Eventually, the higher cost competitor could be driven out of that business.  You need to understand what percentage of the market is buying solely on price.  This often happens with mature products.

In the low cost strategy, a company must have a thorough understanding of costs and how to continually reduce them.  The company must be willing to standardize its offerings in order to manage costs, which implies that exceptions requested by prospective customers must be limited or excluded in order to keep costs down.

The other approach we are examining is differentiation.  Differentiation involves being perceived by the market place as having a relatively higher value to the customer or user than the offerings of its competitors, and often at the same or even higher pricing levels.  These are different customers – not buying just on price.

In a differentiation strategy, the company must totally understand its customers’ needs and preferences.  It must be driven to innovate to continually address those wants and needs.  And, it must build its brand to maintain its position and visibility.

Years ago, Sony sold the Walkman radios and disc players at a higher price than any of its competitors, yet dominated the market place.  The reasons for this seemed to be that they provided the highest quality, most consistent performance and the best sound delivery in the market place.  The interesting thing here is that, due to both volume and to good design and engineering of the products, Sony also was, for a very long time, the low cost producer as well.  This gave Sony the distinct advantage of having sufficient resources available to effectively out-market its competitors, as well as having the resources to do more product development and refinement to keep Sony at the forefront.

The Sony example is actually a combination of low cost and differentiation strategies, which, done well, can be extremely effective in the market place.  To do this requires a high level of commitment to both approaches, but the benefits can be outstanding.  For years, Sony was by far the leader in personal musical devices, with the highest volume and profitability.  Eventually its position was overcome by advances in other technologies like the smart phone and MP3 players, and, most likely, Sony’s eventual loss of concentration on what got them to the top.

Interested in more ways to improve your strategic planning process?  Download our Strategic Planning Tune-up book by clicking on Tune-up.

M. Dana Baldwin is a Consultant with Center for Simplified Strategic Planning, Inc. He can be reached by email at: 

© Copyright 2014 by Center for Simplified Strategic Planning, Inc., Ann Arbor, MI — Reprint permission granted with full attribution.

Every business must find a strategy that enables it to achieve a competitive advantage in the marketplace. That choice of strategy is based on the strengths and weaknesses of the company's products and the position it wants to have in the minds of its customers. The best strategy is the one that leverages the company's strengths for the greatest profits and the highest return on investment.

Companies try to gain a competitive advantage by offering consumers something better for their money. That could be the lowest price in the market or offering a product with better benefits to justify a higher price.

Michael Porter, a professor at Harvard Business School, wrote several well-known books about competitive strategies for businesses. His works on generic strategies are popular worldwide,and are used by all levels of management. Porter believed that a business must identify and implement a clear strategy to beat the competition and survive in the long term.

Porter's generic strategies are as follows:

• Cost Leadership Strategy.
• Differentiation Strategy.
• Cost Focus.
• Differentiation Focus.

Cost Leadership

A cost leadership strategy works if the company can produce its products at the lowest cost in the industry. This strategy is commonly used in markets with products that are not distinctly different from each other. They are "standard" products in a broad market, frequently purchased and universally accepted by most consumers.

To become a cost leader, a company strives to reach the lowest cost of production with the least distribution cost so that it can offer the cheapest price in the market. With the lowest price, the company hopes to attract the most buyers and dominate the market by driving competitors out.

A successful cost leadership strategy requires the optimization of all aspects of a company's operations. To becomes the lowest-cost producer, a business might pursue the following:

• Productivity: Study any process that uses labor and find ways to improve productivity and increase efficiency.
• Bargaining power: One way to lower the cost of production is to exploit the economies of scale. Higher volumes enable the business to negotiate lower prices from material suppliers and reduced costs for transportation.
• Technology: Improvements in technology happen rapidly, and a company must invest in the latest innovations to remain competitive.
• Distribution: As with technology, the methods of distribution are constantly evolving. Businesses must continuously analyze changes in distribution costs to find the lowest cost to transport their goods.
• Production methods: Lowering the cost of production is a continuous process. For example, implementing just-in-time inventory controls for raw materials is a way to reduce financing costs of assets.

Firms that are successful with a cost leadership strategy usually have the following advantages:

• They have access to the capital needed to large investments in manufacturing facilities that lower the cost of production. Weaker competitors may not have the financial strength to borrow large sums of money.
• More efficient producers will have highly-skilled engineering and production staff that work constantly to improve the manufacturing processes.
• Aggressive companies are always looking for ways to vertically integrate their processes by acquiring raw material suppliers, component manufacturers and distribution companies. Of course, this also requires having the financial strength to finance the purchases of these companies.

Walmart is one of the most well-known companies that has an effective cost leadership strategy. Their approach is to market to the largest number of customers with the lowest prices on all of its products.

The company has been able to dominate the low-cost market by negotiating price-volume discounts with suppliers and building an incredibly cost-efficient distribution system. Walmart works with all of its internal processes to operate at the lowest cost.

Differentiation Strategy

A differentiation strategy requires the company to offer products with unique characteristics that consumers believe have value and are willing to pay more for them. If consumers perceive that these unique properties are worthwhile, the company can charge premium prices for its products.

Ideally, the premium prices will be more than enough to offset the higher costs of production and allow the company to make a reasonable profit.

Companies that succeed with a differentiation generic marketing strategy need to have a talented and creative product development staff. These people must have the ability to survey the market and get into the minds of the potential buyers to identify the features that will attract consumers and make them willing to pay more for the products.

Having a unique product is not the end of the story. The implementation of a differentiation strategy requires a sales team that has the skills to effectively communicate the unique properties of the products and convince consumers that they are receiving more value for their money. At the same time, marketing campaigns should promote and establish the company as a reputable firm known for high-quality and innovative products.

A differentiation strategy has several risks. Competitors will not remain idle when losing market share; they will find ways to imitate products and begin their own differentiation campaigns.

Another risk is changing consumer tastes. Unique product characteristics that capture the minds of consumers at one time can fade away as competitors introduce other features that catch the eyes of buyers.

Cost Focus

A cost focus strategy centers on a limited market segment or a particular niche. It requires the company to understand the idiosyncrasies of that market and the unique needs of those specific customers.

Companies that pursue a cost focus strategy are taking a risk by abandoning the mass market. While concentrating on a specific demographic may develop a loyal pool of customers, the company is basing its fortunes on a small group of buyers. The features that are attractive to this niche market may not appeal to the broader market.

Differentiation Focus

Like a cost focus strategy, the differentiation focus approach aims for a narrow niche market. In this case, the company finds unique features of its products that appeal to a particular group of customers.

However, the company is depending on the spending habits of a small group of consumers for its profits. If this group changes its tastes, the company will have difficulty switching direction to start selling to the mass market.

A successful differentiation focus strategy depends on developing a strong brand loyalty from its customers and constantly finding unique features to stay ahead of the competition.

Choosing a Strategy

The first step in selecting a strategy for your company is to conduct a SWOT analysis of the business. This analysis will identify the strengths and weaknesses of the company in addition to highlighting market opportunities and threats.

To thoroughly understand the market, Porter developed another model known as the Five Forces Analysis. This analysis looks at the competitive position of the business and the factors that will adversely affect its profitability. Those factors are the

• Power of suppliers.
• Power of customers.
• Availability of similar products.
• Threat of new competitors.
• Internal competition.

The SWOT and Five Forces analyses will help to identify which one of these generic business strategies will work best for your company.

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