By: Tracy Porter
Copyright 2007
Michael Eugene Porter is an American academic based at the Harvard Business School, where he leads the Institute for Strategy and Competitiveness. His major academic objectives focus on how a firm or region can develop a competitive advantage through the development of a competitive strategy (Wikipedia, 2007).
In 1980 Porter published the work entitled, “Competitive Strategy: Techniques for Analyzing Industries and Competitors”. It is in this work that he identified the three best strategies that he theorized would work in a business environment. The three strategies he identified are (1) cost leadership, (2) differentiation, and (3) market segmentation, which are often called focus.
Cost Leadership Differentiation
Market Segmentation
A company strategy of cost leadership occurs when a company achieves lower costs than its rivals and is able to compete across a broad range of segments (University of Leicester, 2001). There are many companies that identify a strategy of cost leadership, and a walk down any high street in the United Kingdom will provide evidence of these businesses that have been successful at that particular strategy.
One company that has been a successful cost leader is the cut-price fashion chain Primark. In the 25th April 2007 edition of Daily Express’s City and Business section, it was revealed that Primark had boosted its sales by more than a third. It had achieved this by opening 24 new shops in the past six months, to include a flagship shop in London’s Oxford Street. Primark also plans to open an additional seven shops in 2007. It currently has 123 shops, but George Weston, chief executive of the parent company, Associated British Foods, envisages that there is sufficient room to open us at least 50 more shops. Primark’s half-year results saw sales rise from £530 million to £721 million, with profits rising from £20 million to £91 million.
Although Primark is a cost leader that produces cheap and cheerful clothing, soft furnishing and accessories for people who are cost conscious, the fact that its products are produced at a very low cost means there will invariably be concerns about the quality of the products that company sells. For example, this writer purchased a pair of reading glasses for £2.00 at Primark, and when she opened the packaging she discovered the glasses had not been assembled properly. On another occasion, she purchased a costume necklace for £1.00, and when she opened the package she discovered the stones that had been glued to the necklace had fallen off. On both occasions, it was necessary to return the faulty products to the retailer and ask for a refund. Therefore, when a business endeavours to use cost leadership as their competitive strategy, it will need to pay particular attention to detail to ensure that quality does not suffer.
A company strategy of differentiation occurs when the business has a range of clearly differentiated products that appeal to different segments of the market (University of Leicester, 2001). A strategy of differentiation appeals to those individuals who perhaps have a little more money to spend and would like to purchase a product that is better quality and less widely available than those items that cost less. Quite often, however, differentiation adds costs in order to add values for which customers are willing to pay premium prices (University of Leicester, 2001). It is for that reason, however, when an individual’s income is restricted either through personal out outside economic factors, he will sacrifice differentiation in favour of cost.
Austin Reed is a group that uses differentiation as its strategy. It sells quality clothes for men and women in 280 stores in the United Kingdom, the United States, Japan, India and the Far East. The Austin Reed brand has long been synonymous with quality tailoring aimed at successful men and women with the mindset of thirty-something. A look at Austin Reed’s annual report reveals that its 2006 group sales were £103.2 million, as opposed to the January 2005 restated group sales of £110.5 million, which results in a decrease of £7.3 million in group sales from 2005 to 2006. Retails sales in 2006 were £101.5 million, as opposed to January 2005 restated as £108.4 million, resulting in £6.9 million reduction from 2005 to 2006. Despite the reduction in sales, the group’s overall profit before tax from the retail business was £0.2 million, which is an improvement from January 2005 restated loss of £1.9 million, resulting in an overall improvement of £2.1 million from 2005 to 2006. This improvement in profit was due to improved margins and tightly controlled costs (Austin Reed, 2007). It is interesting to note that although Austin Reed uses differentiation as its competitive strategy, it has still resorted to tightly controlling its costs in an effort to stay profitable in today’s global economy.
Primark and Austin Reed are both clothing retailers, but they have adopted completely different strategies. While Primark endeavours to be a cost leader, Austin Reed instead prefers to compete through differentiation. Both companies, however, still use elements of other strategies in their overall strategy. For example, although Primark’s overall strategy is that of cost leadership, it still targets the younger people, presumably because they will be more conscious of cost. While Austin Reed uses differentiation, it has nevertheless been forced to adopt cost controls, internally at least, in order to stay competitive with its rivals.
Market segmentation, or focus, is the third generic strategy that Porter identified as a route to giving a business a competitive edge. A business is likely to adopt a focus strategy when it cannot compete directly on cost or differentiation, so will indeed endeavour to focus on a niche market. The niche market will be smaller than the target market of the business that adopts a strategy of cost or differentiation, which means its sales will be lower. The customer requirements, however, will be different, so the business needs only to focus on those customer requirements to make their strategy a success (Kelly, 2007).
One example of a company that has been successful at finding a niche market is Evans, which is a high street retailer of clothes, accessories, and shoes for women who wear a UK size 16 to 32. Evans has special expertise in designing, fitting, and styling the latest fashions to flatter curvy women (Evans, 2007).
Evans is part of the Arcadia Group, which is a British company that owns several of the most well known clothing retailers in the United Kingdom, to include Burtons, Dorothy Perkins, Miss Selfridge, Outfit, Topshop, Topman and Wallis. Each particular retailer within the Arcadia Group focuses on a specific niche market, with Evans perhaps being the most highly focused, targeting its market to the larger sized woman.
A look at the financial information posted on Arcadia Group’s corporate website reveals that in the 53 weeks ended 2 September 2006, the group had an operating profit of £300.6 million, which is down 8.1% from £327.2 million the previous period. Total sales were up 1.8% at £1,801.1 million from £1.769.7 million the previous reporting period. It is interesting to note the Arcadia Group has a Goodwill calculated at £17.5 million, which is up from £16.3 million the previous reporting period. Goodwill is an intangible asset of the company that is not recorded in the ledger accounts, and is awarded to a company due to the excellence or reputation of the business. It is the value of a business as a whole over and above the value of the recorded net assets. The fact that Arcadia Group’s Goodwill is annotated in their financial overview reveals they place a very high emphasis on their reputation with in the retail community.
A fourth strategy, which was not among Porter’s original three, is that of being in the middle of the three strategies. Being stuck in the middle, a concept called the sweet spot by Allen Kelly, combines elements of the generic strategies as identified by Porter. The competitive strategy of being stuck in the middle can be profitable because customers don’t always want the best or the cheapest, so a product that combines elements of differentiation with reasonable cost would be suitable for their needs (Kelly, 2007).
Cost leadership Differentiation Stuck in the middle Market segmentation
Sainsburys has typically been sited as an example of one company that has been able to successfully place its strategy in the middle of the Porter model. Sainsburys, along with other companies, have chosen to place their strategy in the middle of the Porter model, combining elements of cost leadership, differentiation, and focus, because that is the best market position to give them a competitive advantage. Sainsbury’s attempts to position its target market to people who are cost conscious, yet at the same time place a high value on good quality food (University of Leicester, 2001). This middle strategy is in contrast to Asda, which has an advertising campaign based on cost leadership, or perhaps Waitrose, which has a strategy based on differentiation.
In 1990, Sainsburys had made strenuous efforts to keep its costs down and maintain high quality, while at the same time increasing its margins. It has extended its range of private labels to cover the up-market convenience foods, as well as improving its fruit range to cover more exotic fare (University of Leicester, 2001).
The 12 January 2007 edition of the Daily Express’s City and Business section revealed the success of Sainsbury’s Christmas 2006 record breaking sales, as they served more than 20 million customers. Sainsburys has a three-year target to add £2.5 billion in sales, and has commissioned a new warehouse to achieve this goal. The week before Christmas, Internet sales soared by 60%. Shoppers purchased organic food and champagne. Their own Taste the Difference brand had an increase in sales of one-fifth. This resulted in a 5% increase in like for like sales in the three months leading to 30 December 2006.
In 1979, one year before Michael Porter developed the generic strategies, he developed the five forces analysis as a framework for business management. Also known as Fullerton’s Five Forces (FFF), it uses concepts developed in industrial organization economics to derive five forces that determine the attractiveness of a market. A change in any one of the five forces normally requires a company to re-assess its market place (Wikipedia, 2007). The five forces identified by Porter are:-
1. Bargaining power of customers,
2. Bargaining power of suppliers,
3. Threat of new entrants,
4. Threat of substitute products,
5. The level of competition in the industry.
The five forces analysis is an extremely helpful, straightforward tool used in diagnosing the principal economic pressures in a market (University of Leicester, 2001). It is important for any company to analyse the five forces that exist before determining a strategy. It goes without saying that if the market place has not been fully analysed then a company’s competitive strategy could very well prove unsuccessful. For example, it would be unrealistic to attempt to sell woolen scarves, hats and jumpers to people who live in tropical climates because they simply would have no need for such garments unless they were traveling to a cooler climate. Any one of the generic strategies would not prove successful in such an enterprise because there would simply be no market to it.
French Connection is an example of a company misjudging the marketplace and consequently incorporating an incorrect strategy. The 15 March 2007 edition of the Daily Express City and Business section states that French Connection selected the wrong range of clothing a year ago and had to pay the price for it. Annual profits fell from £12.2 million to £4 million after customers decided to shop elsewhere last spring. The lack of sales has also been the result of controversy about its FCUK logo and advertisements featuring a lesbian kiss. Clearly, the fall in sales over the previous two years indicates they misjudged their target market, believing them to be much more liberal than the actually were.
Michael Porter’s generic strategies and other works have received much criticism over the years. Several commentators on his generic strategies have claimed they are unspecific, lack flexibility, and are limiting. Much of his work lacks empirical evidence to support it and is justified with selective case studies, which are not seen as a broad spectrum of the business (Wikipedia, 2007). For example, he urged companies not to become stuck in the middle and justified his argument with the empirical research that revealed firms with a high market share were quite profitable, as were many firms with a low market share. The least profitable firms were those with moderate profit share, and this is what he referred to as the whole in the middle (Wikipedia, 2007).
Porter’s theory that those firms that are stuck in the middle are not very profitable is contradicted by Michael Cronshaw, Evan Davis, and John Kay in their work entitled, “On Being Stuck in the Middle or Good Food Costs Less at Sainsburys”, published in 1990. Using Sainsburys as a model, they showed there are many profitable firms that adopt a middle of the road strategy, such as Barclays, British Airways, Ford, Halifax Building Society, Marks & Spencers, and Prudential (University of Leicester, 2001).
Many economists believe that in today’s world successful strategies must combine different mixes of cost leadership, product differentiation, and focus in order to build up an optimum position within the industry.
IKEA is a modern example of a company that combines all three of Porter’s generic strategies. It keeps costs low by manufacturing its furniture in low cost countries and requiring customers to collect the furniture and assemble it themselves. It differentiates itself by using a Scandinavian design and displaying all of its items in a warehouse. It has a clear focus on who its target market is, as its customers are primarily young and price conscious (Brealey et al, 2006). IKEA becomes more successful each year, as it has 253 retail outlets in 35 countries. A look at its website reveals that is had a turnover of E17,658 million in 2006, which is up from 2005’s totals of E15,212 million (IKEA, 2007).
Whilst Michael Porter’s work may have been relevant in 1980, globalisation and advances in technology mean that businesses have evolved dramatically since that time. Advances in computer technology and the Internet alone mean that to conduct their business in significantly less than it would have taken them before workstations and email became a standard feature of virtually every office. Because the nature and practices of companies are gradually changing with changes in the world economy, his theories need to evolve as well.
Prudential is a company that was cited by Cronshaw, Davis and Kay in their 1990 working paper as being a successful company that operated a strategy of middle of the road. This company has had to make significant changes in its strategy in order to stay competitive in the globalised economy of the 21st century. Up until 2002, Kings Road and Queen’s Road in the Reading’s town center were overshadowed by the majestic presence of the huge company that provided so much employment for people who lived in Reading and the surrounding area. Beginning in 2002, however, they very subtly changed their strategy away from being middle of the road to being more cost conscious. It all began innocently enough when they closed down their premises in Queen’s Road. This move involved many people being made redundant, dismissed, or not having their contracts renewed, but it was to be expected because the Pension Review, which was dictated by the Financial Services Authority, was nearing completion. Five years later, Prudential seems like a shadow of the company it was up until just after the turn of the century, as it no longer commands the prestigious presence in Reading’s center that it once did.
In the 16 March 2007 edition of the Daily Express’s City and Business section, it was reported that Prudential is ready to axe up to 3,000 jobs as part of its long awaited plans to slim down its United Kingdom operations. Chief Executive Mark Tucker said their cost cutting targets could go as high as £195 million a year by 2010, with the likelihood that the jobs involved will be outsourced.
A little more than a month later, the 27 April 2007 edition of the Daily Express’s City and Business section further clarified Prudential’s position on its cost cutting exercise. Prudential is planning to outsource hundreds of highly skilled, white-collar jobs to India to service the company in the United Kingdom. The outsourced jobs involve accountants, underwriters, financial advisors, actuaries, and analysis. Indians in such jobs earn 70% less than their British counterparts, which means Prudential could save millions of pounds a year. Prudential employs 1,500 staff in its Mumbai call center and back office functions, and the outsourcing division is keen to do more complex work, such as financial and regulatory reporting, risk management, and UK strategy development.
In conclusion, Michael Porter’s generic strategies may have been relevant in 1980 when he initially devised them. At that time in the 20th century, the cold war was still going strong, as the United States and the Soviet Union were vying of the support of uncommitted nations. Since that time however, the Berlin Wall fell and Germany was reunified, glasnost brought about the fragmentation of the Soviet Union, and the cold war ended. Advances in technology and efforts to globalise the world economy mean that his theories will need to be revisited to stay in line with the unprecedented global changes that have occurred in the last quarter century.
Consumers today expect more from their money, so in order for a company to stay competitive, virtually all companies must utilize the technology and resources available to them in order to provide a cost effective product or service and stay profitable. Therefore, elements of cost strategy should be incorporated into other strategies that a company proposes to implement if it wants to stay competitive.
A variation of Porter’s generic strategies is the value disciplines developed by Michael Tracey and Fred Wiersma in 1993. The three value disciplines are (1) operational excellence, (2) product leadership, and (3) customer intimacy (Value Based Management, 2007). Perhaps Tracey and Wiersma’s modification of Porter’s generic strategies more accurately reflects that needs of the rapidly changing 21st century globalised economy.
References
Arcadia Group (2007)
URL://http//www.arcadiagroup.co.uk
[12 May 2007]
Austin Reed (2007)
URL://http//www.austinreedgroup.co.uk
[12 May 2007]
Brealey, R. et al. (2006). Corporate Finance: International Edition, McGraw-Hill: New York, New York
Daily Express Newspaper (2007). City and Business, Northern and Shell Media Publications: London, England
Evans (2007)
URL://http//www.evans.co.uk
[12 May 2007]
IKEA (2007)
URL://http//franchisor.ikea.com
[12 May 2007]
Kelly, A (2005)
URL://http//www.allankelly.net
[12 May 2007]
University of Leicester (2001). Module 5 MSc in Finance 2504 Strategic Financial Management, Learning Resources: Cheltenham, England
Value Based Management (2007)
URL://http//www.valuebasedmanagement.net
[12 May 2007]
Wikipedia (2007)
URL://http//www.wikipedia.org
[12 May 2007]