WHICH IS THE BEST GENERIC STRATEGY FOR START-UPS & SMES?
As we wrote in last week’s post, “An Intro to Strategy”, one of the elements of a well-formed strategy is knowing who your business is serving, and what value it will provide to those customers.
Michael Porter, the founder of competitive strategic theory, breaks these into three ‘generic strategies’, which are:
- Cost Leadership – where a business lowers its cost base below any of its competitors and passes these savings onto the customer in the form of the lowest price.
- Differentiation – where a business provides a unique offering (a product, a service, or a feature of either) to provide additional value, and in turn will usually receive a higher price
- Focus – where a business will target a particular subsection of the market (a ‘niche’), tailoring its offering to the particular needs of that niche. A business with a ‘Focus’ strategy should be either targeting cost leadership or differentiation within their particular niche.
Let’s go through each, one by one, with examples of real-world businesses that use each strategy.
Examples: Wal-Mart, Virgin, SouthWest Airlines, Payless, Supercuts
Businesses with a cost leadership strategy sell ‘no-frills’ services or products, with the intent of providing the minimum acceptable product value to its customers at the minimum price.
While this strategy makes products and services more accessible to more people, it also provides the lowest levels of customer loyalty, as this strategy attracts customers that are very price-conscious.
This means that customers are highly likely to leave as soon as better value can be found; if another business provides the same offering at a lower price, or a better offering at the same price, there is little else preventing that customer from switching. (Note that this is why businesses with a cost-leadership strategy typically also have rewards programs – a topic for another post). A business with a cost-leadership strategy will continually have to lower prices to compete and eventually erode its own profitability over time.
While this strategy was effective at a time where industries were less fragmented, slower-moving, and less responsive to changes in price, it is very challenging to enter a market using a broad cost-leadership strategy today, as the barriers to starting a new business are lower and customers are looking for offerings that are more customised.
Examples: Microsoft, Apple, Starbucks, Afterpay, Nike
This type of strategy is used when a business has a clearly unique product, service, or feature, and its customers value this at a premium to other offerings in the market.
This strategy can lead to higher profitability because the cost of the additional offering is typically less than what the customer values that offering at. It also leads to greater loyalty because the customer sees that business providing greater value to them personally, which leads to them coming back.
A note here: if you are looking at building an offer to entice people to work with you or buy your product or service, NEVER just offer a discount on price as it devalues your offering immediately. Offer value-added benefits instead, which builds loyalty and increases the likelihood of repeat business.
Whether to use broad differentiation strategy or a focus strategy depends of the resources you have access to and the speed at which you wish to grow. A broad differentiation strategy is typically employed when substantial resources are available, as a wider range of customers will need to be engaged and serviced.
Focus – Differentiation
Examples: Harley Davidson, Rolls Royce, Whole Foods, many small online businesses
Before I start on this one, the literature also has a “Focus – Cost Leadership” strategy, which I’m not going to discuss (I believe that this strategy is insufficient in itself to build sustainable advantage).
The reason why is that offerings from businesses with a ‘focus’ strategy are targeting a particular segment of a larger market that is currently under-served. It is unlikely that a business with a focus strategy can provide an offering similar to an offering from a company with a broad cost leadership or differentiation strategy at a lower price, to a smaller market, and still be profitable. This means that a focus strategy usually works only when differentiation is part of the strategy.
OK, where was I…
A focused differentiation strategy is the strategy that thousands of entrepreneurs and small business owners use to begin their business journey. It is a strategy that aims to provide an offering that has a sustainable advantage and value to particular market segments.
There are many benefits to implementing a focused differentiation strategy. These include:
- Quick and relatively inexpensive to research wants and needs of a smaller group,
- Lower (gross) cost of advertising
- Faster feedback cycles and speed to market
- Tailored service often results in price premiums
- Greater customer loyalty
- Lower regret cost
- Reduced buyer power
The main drawbacks to a focused differentiation strategy are reduced economies of scale and a limited market size; however, these can be overcome through unique business model strategies and use of brand or offering in a different market.
Of the three ‘generic’ strategies above, I believe that most SMEs and new businesses should begin with a focused differentiation strategy. This builds loyalty and understanding within a segment of the market as the business grows, during which time the business can discover other avenues for expansion. It also minimises regret cost should the need for a strategic change arise.
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Until next time,