By “only two strategies,” I mean what if there are only two general ways of creating a sustainable competitive advantage?

I’ve read a lot of the business and management literature on strategy (believe me…) and this thought first surfaced when I read Michael Porter’s seminal Competitive Strategy a couple of decades ago.  Before I tell you why I’m entertaining the notion that there are two and only two, let me tell you what they are so you can start thinking about where this is going.  They are:

  • Cost leadership, and
  • Differentiation.

Perhaps I should back up for a moment and tell you what I mean by “strategy,” emphasizing that it’s easier said than done. To borrow from the equally classic Playing to Win (A.G. Lafley and Roger Martin, Harvard Business: 2013), it’s:

an integrated set of choices that uniquely positions the firm in its industry so as to create sustainable advantage and superior value relative to the competition.

The low cost strategy is often assumed to apply only to true commodities; goods that are fungible regardless of source at something approaching a chemical level: Copper, crude oil, wheat, copy paper.  In the real world, I think that assumption is too strict.  Indeed, far more common are markets where products are distinguishable enough that one can be priced higher than another and still find willing buyers–maybe lots of willing buyers. This is actually the playing field where national brands and house brands fight it out every day in supermarkets across the country.

But even with this relaxed assumption, it’s still a market where the key players’ strategy has to be one of producing at low cost relative to the rest of the industry, and in the case of pure commodities, absolute cost leadership.  Why?  Otherwise, your margins will be perennially lower than your competitors, they will be able to invest more in continually lowering costs or expanding their distribution or bolstering their brand reputation or any of a number of desirable functions where you by contrast will be strained for resources.

Note that this means that pursuing cost leadership does not mean you have to price your offerings absolutely as low as possible.  You can choose to invest in your business in ways your competition can’t match,

A real-world example is Mars vs. Hershey’s in the candy bar market.  Mars has structured its portfolio of candy bar products such that all can be produced on the same very high-speed lines, while Hershey’s product lineup requires multiple manufacturing techniques and corresponding equipment.  Given the realities of convenience-store distribution and pricing conventions, both companies know their products will be priced identically when they come face to face with the consumer; and that’s probably fine with them both.  Query whether 10 or even 25 cents more for, say, an Almond Joy (Hershey’s) would matter if you really didn’t want a Snickers (Mars)–or vice versa.

So Mars has deployed its higher margins from its position of cost leadership to buy the best shelf space in every candy bar rack across the country. Hershey’s can’t match that spending and buy the quality ingredients it wants to and maintain its advertising spend and pay its workers as it’s accustomed to and invest in R&D and still offer its shareholders the returns they have historically expected and received.

Differentiation  is the alternative to cost leadership.  Obviously, it means customers are willing to pay more for your firm’s product or service than the “same” thing from someone else, because to them it’s not the same.  As with the unspoken and, I posited, mistaken assumption that cost leadership had to be absolute, the unspoken and mistaken assumption people can make about differentiation is that your firm’s particular flavor of differentiation will appeal equally across the entire marketplace.  Not so: Differentiation is in the eye of the beholder.

No question that Four Seasons Hotels are strongly differentiated; but what if I prefer to stay in a boutique hotel with a quirkier downtown-vibe, eclectic design and minimalist rooms?  Also differentiated, but not to everyone’s taste. Or maybe I prefer a mix of both: Sometimes one and sometimes the other. The economic point is that whichever flavor of differentiation a customer might prefer, they will pay a premium for it over generic, if perfectly competent and safe, alternatives.

Before getting into a few of the implications for a firm of these two strategies, back to where we came in: Is it really possible that these are the only two?  What about firms, and we hear about them all the time, that describe their strategy using terms like client insights, operational effectiveness, or (Law Land’s most very favorite) our “culture.”  Not to take you by surprise, but we’re looking at this from the economic perspective.  However you choose to describe your strategy, if ultimately it doesn’t translate into a lower cost structure or higher revenue from clients, is it a strategy you want to have?

The choice between “low cost” and “differentiated” plays itself out powerfully in the internal dynamics of the firm.  Here are just a few examples:

  • Management’s day to day preoccupation:
    • Drivers of cost, operational optimization, taking expenses out;
    • Building the brand.
  • “Nonconforming” clients–those who want something special:
    • Sacrificed; standardized processes to maximize cost-effectiveness are paramount.
    • Catered to: the firm will go to great lengths to please a key client and losing one resounds throughout the firm .
  • Critical business competence:
    • Process optimization
    • Innovation
  • Intense focus on understanding:
    • Costs
    • Clients

Now, to most readers the concept of “sacrificing” “nonconforming” clients may seem a concept from one of the outer planetary orbits, but let’s abstract from Law Land to understand it better.  Lafley and Martin give Southwest Airlines as an example of the “low cost” strategic choice, and posit this hypothetical conversation:

Customer: “I really would like advance seat selection, interline baggage checking, and to fly into O’Hare not Midway in Chicago.”

Southwest: “Great, you should try United Airlines.”

Two final observations.

First, both strategies require your firm to be distinctive.  You won’t be a cost leader by benchmarking your operations against what every peer firm does, and of course you won’t be differentiated if you try the same thing with your practice mix, attorney recruitment and professional development programs, and client value offering.  If your go-to move when facing a key business choice is to ask, “Who else is doing it?”, you will immediately fail at either strategy.

Second, no strategy is forever.  Walmart and Dell were low-cost leaders until dollar stores/Amazon showed up and until Acer/HP/Lenovo smartened up.  Cadillac was distinctive until Audi/BMW/Lexus/Mercedes blitzkrieg’ed it.  You can also argue that every self-satisfied incumbent inflicted  a lot of damage on itself, and I would be the first to agree; that’s just another window into the same dynamic.

So take your pick: Higher margins through lower costs, or higher margins through differentiation.  I don’t think there is any substantive third way.

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