Lesson 1 of 10 · All lessons in this module
- Competitive strategy and positioning
- Strategy over the life cycle and addressable markets
- Generic strategies in practice: capacity, moats and two kinds of focus
- Revenue drivers: bottom-up and top-down
- Pricing power
- Operating costs and operating leverageVideo lesson
- Operating profitability and working capital
- Choosing a profit margin, cost components and price elasticity
- Capital investments and capital structure
- FCFE, net capex and financing across the life cycle
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Lesson 1 of 10 · 15 min
Competitive strategy and positioning
A company's strategy is judged by whether it defends against the five forces, fits the external influences and can be executed with the company's resources; most successful strategies are variants of cost leadership, differentiation or focus.
In short
- Every company has a strategy, intentional (planned, measured, refined) or unintentional (teams following habit or norms); unintentional strategies are rarely best.
- A strategy's effectiveness shows up only in hindsight (economic profit). Looking forward, ask three questions: does it defend against the five forces, does it fit the PESTLE influences, and does the company have the resources and capabilities to execute it?
- Cost leadership: scale, cheap inputs, cost discipline, aggressive pricing for volume, low-cost distribution, economies of scope. Suits capital-intensive industries with price-conscious customers who do not notice product differences.
- Differentiation: brand, service, quality, unique features, IP protection, premium pricing. Suits customers who value distinctiveness more than price and innovative industries.
- Focus: serve a particular group (customer, product or geography) closely, using cost and/or differentiation elements; works where others find that group hard to serve.
- Being stuck in the middle (none of the three) is a poor position.
Evaluating any strategy
All companies have a competitive strategy, whether intentional or not. An intentional strategy comes from company-wide planning, performance measurement and feedback. An unintentional one emerges from teams pursuing their own incentives, repeating last year or following industry norms. It is rarely the best, though loose management can work in discovery-oriented areas such as early drug research.
Ultimately, a strategy works if it adds value for stakeholders, such as economic profit, and that can be known only in hindsight. To judge it in advance, the analyst asks three questions, which tie together everything in this module.
- Defence: does the strategy protect the company against the five industry forces?
- Fit: does it benefit from, or at least not fight, the external influences identified by PESTLE?
- Capability: does the company have the resources and capabilities to execute it?
Cost leadership
A cost leader aims to be the lowest-cost producer. Means include economies of scale from fixed costs, favourable access to raw materials, a culture of strict cost control, aggressive pricing to win high volume, low-cost distribution and economies of scope.
It defends against new entrants (capital needs and scale deter them), against customers (they can push prices down only to the cost of the marginal producer, which leaves a margin for the low-cost firm) and against rivals (who cannot match its prices).
It suits capital-intensive industries with price-conscious customers who do not value or notice product differences, and little innovation. Risks: cost inflation or lost discipline, technological change that removes the cost advantage or share, and a customer shift toward premium products.
Differentiation
A differentiator offers something customers see as unique. Means include investment in advertising, brand, customer service and proprietary distribution, protection through trademarks, copyright and patents, superior quality or unique features, a culture of strong customer experience, premium pricing and integration of services, software and hardware.
It defends against new entrants and substitutes (loyalty to a unique product deters switching), against customers (they may be unable or unwilling to comparison-shop or switch) and against suppliers (the company can pass on price increases or has the margin to absorb them).
It suits industries where price is not the main concern, customers value distinctiveness, and products vary in features and form through innovation. Risks: imitation, buyers becoming sophisticated and no longer paying for the service level, a premium too high to bear, and a ceiling on market share because customers value exclusivity.
Focus, and being stuck in the middle
A focus strategy serves a particular group (a customer segment, product niche or geography) through proximity to customers and a strong understanding of their needs. It may borrow elements of both cost leadership and differentiation, but aimed at that group.
It defends against entrants and substitutes through loyalty and against customers who are unable or unwilling to shop around. It is appropriate when the group is difficult or uneconomical for other players to serve. Risks: larger competitors undercut on price, the niche's needs converge with the wider industry's, and buyers become sophisticated.
A company that is stuck in the middle, neither the low-cost producer, nor differentiated, nor focused, has no clear defence against the forces and tends to earn poor returns.
| Cost leadership | Differentiation | Focus | |
|---|---|---|---|
| Means | Scale, input access, cost culture, aggressive pricing, cheap distribution, scope | Brand, service, IP protection, quality, unique features, premium pricing | Proximity to and deep knowledge of a particular group |
| Defends against | Entrants, customers, rivals | Entrants and substitutes, customers, suppliers | Entrants and substitutes, customers |
| Fits when | Capital-intensive; price-conscious customers; differences unnoticed; little innovation | Price not foremost; distinctiveness valued; innovation in features and forms | Group is hard or uneconomical for others to serve |
| Risks | Cost inflation, lost discipline; technology shifts; premiumisation | Imitation; sophisticated buyers; premium too high; limited share | Bigger rivals undercut; niche converges with market; sophisticated buyers |
Formula
- Cost leader's margin when price falls to the marginal producer's cost
Illustrates why customers cannot squeeze a cost leader's margin to zero: price cannot fall below the marginal producer's cost for long.
Worked examples
Example 1 Which strategy fits?
Ravna Cement ASA is building its first plant. Cement production is capital-intensive, grades are standardised so builders see little difference between suppliers, and most buyers choose on price; a small group of architects pays more for decorative specialty cements. Which strategy could work?
Example 2 The cost leader's cushion
In a commodity chemical, unit costs are EUR 45 for Corvo AG (the lowest) and EUR 60 for the marginal producer. Fierce customers push the price down to the marginal producer's cost. What margin on price does Corvo earn?
Example 3 Should a differentiator match prices?
Sonora Audio sells premium headphones with distinctive design, long warranties and its own repair service. A mass-market rival cuts prices by 30%. Sonora's sales team proposes matching those prices. Is it wise?
On the exam
Expect items matching means, defences, industry fit and risks to the correct generic strategy, choosing a strategy for a described industry, and checking whether an initiative is consistent with a company's current strategy.
- Listing proximity to customers as a cost leadership tool; it is the hallmark of focus.
- Calling 'larger competitors undercut on price' a risk of differentiation; it is a risk of focus. Differentiation's risks are imitation, sophisticated buyers, an excessive premium and limited share.
- Calling customers' 'desire for premiumisation' a risk to differentiation; it threatens cost leadership.
- Judging a strategy only on whether it defends against the forces, and forgetting PESTLE fit and the company's capability to execute.
Check yourself
Q1Which of the following is least likely a means of executing a cost leadership strategy?
Q2Which is most likely a risk of a differentiation strategy?
Q3A 12-room island guesthouse caters to birdwatchers with guided dawn walks. Which expansion is most consistent with its current strategy?
Q4A cost leader has a unit cost of EUR 45 and the marginal producer EUR 60. If price falls to the marginal producer's cost, the cost leader's margin on price is closest to:
Q5When evaluating a company's competitive strategy on a forward-looking basis, an analyst should least likely ask whether the strategy:
Q6A cost leadership strategy is most appropriate for an industry with:
Answer the 6 questions: +10 XP for each one you get right first time.
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