Low Cost or Differentiation

Numerous studies have proved that firms with a high market share enjoy above average returns over extended periods of time. Customers are usually reluctant to switch their loyalty to a competing brand unless that brand has something unique to offer. Low cost firms can bring about pricing discipline within the industry as other firms are aware that they cannot carry out a price war with the low cost leader. The price cutting power acts as a powerful entry barrier for firms contemplating entry into the industry. Low cost firms are generally in a better position to absorb increase in prices of inputs from time to time and keep the prices of their products somewhat steady.

The cost leadership strategy is not risk free. A cost leader has to lock up his resources in fixed assets and equipment. After investing in such inflexible production and distribution technologies, it becomes difficult for the firm to embrace a more innovative technological process. For example when quartz and digital watches became popular during the late 1970, Timex was so committed to its mechanical watch and process technology that it could not adapt to technological change.

Cost reduction methods can be easily copied by rival firms as cost advantages in standardized production processes are somewhat easily copied by competitors. Firms obsessed with low costs may find themselves suddenly attacked by competitors talking a different strategy designed to beat a dominant industry player. When other firms also enter the industry to reap the benefits, competition increases to such a level, that they do not hesitate to take the prices to un-remunerative levels. Excess capacity build up coupled with depressing price levels would force many players to draw the shutters down in the end.

In actual practice many firms have succeeded in achieving cost reductions in operating costs by focusing on those activities in which the firm has a cost advantage and outsourcing from others and by extensively re-engineering manufacturing and administrative processes. Given multiple drivers of relative cost, the cost leadership strategy requires multiple initiatives at different organizational levels. Careful examination of existing operations relative to rivals can indicate cost reduction opportunities by lowering input cost and better utilizing capacity. At the same time the firm must actively seek opportunities for innovation and process design with a view to exploit new sources of efficiency.

The attraction of differentiation over low cost as a basis for competitive advantage is its potential for sustainability. It is susceptible to being overturned by changes in the external environment and it is more difficult to copy. Differentiation strategies are based on offering buyers something unique or different that makes the firm’s products or services distinct from that of its rivals. The important assumption behind differentiation strategies is that customers are ready to pay a premium price for a product that is distinct in some important way. Like superior quality special appeal, better services etc.

Strategy is about selling yourself apart from the competition. It’s not just a matter of being better at what you do but it’s a matter of being different at what you do.

Differentiation strategies can be pursued by firms when the market is too large to be served by a few firms offering standardized products / services, the customer needs and preferences are too different to be met through standardized products / services, the firm is able to charge a premium for an advantage that is valued by customers and the product is such that customer loyalty can be obtained and sustained.

The potential for differentiation in any business is vast. It may involve physical differentiation of the product, it may be through complementary services, or it may even be through things that cannot be counted. Differentiation extends beyond technology, design, and marketing to include all aspects of a firm’s interactions with its customers. Thus, McDonald’s differentiation advantage within the fast food business depends not just on the characteristics of the food (physical) it serves or the associated services (speed of service, cleanliness etc.) but also the values it projects (intangible) such as happiness and interest in children.

Thus, products can be differentiated along any dimension that is valued by some group of customers. Any competitive advantage must be seen by customers as a customer advantage. For example, if a company delivers faster than its competitors, this will not be a customer advantage if customers do not value speed. Companies therefore must focus attention on building and sustaining customer advantages through differentiation. The products thus differentiated attracts customers who do not hesitate to buy the product again and again.