STRATEGIC MANAGEMENT

Topic 5: Business-Level Strategy

LOW COST AND DIFFERENTIATION

Strategy is about the search for competitive advantage. At the most fundamental level, a company
has a competitive advantage if it can lower costs relative to rivals and/or if it can differentiate its
product offering from those of rivals, thereby creating more value.

I. Lowering Costs
• Imagine that all enterprises in an industry offer products that are very similar in all
respects except for price, and that each company is small relative to total market
demand so that they are unable to influence the prevailing price.
• This is the situation that exists in many commodity markets, such as the market for oil,
or wheat, or aluminum, or steel. Low costs will enable a company to make a profit at
price points where its rivals are losing money.
• Low costs can also allow a company to undercut rivals on price, gain market share,
and maintain or even increase profitability. Being the low-cost player in an industry can
be a very advantageous position.

II. Differentiation
• Differentiation implies distinguishing yourself from rivals by offering something that
they find hard to match. There are many ways that a company can differentiate itself
from rivals.
• A product can be differentiated by superior reliability (it breaks down less often, or not
at all), better design, superior functions and features, better point-of-sale service,
better after sales service and support, better branding, and so on.
• Differentiation gives a company two advantages:
o It can allow the company to charge a premium price for its good or service, should
it choose to do so.
o It can help the company to grow overall demand and capture market share from
its rivals.

It is important to note that differentiation often (but not always) raises the cost structure of
the firm.

WHO ARE OUR CUSTOMERS?

✓ Business-level strategy begins with the customer.
✓ It starts with deciding who the company is going to serve, what needs or desires it is
trying to satisfy, and how it is going to satisfy those needs and desires.
✓ Answering these questions is not straightforward, because the customers in a market are
not homogenous. They often differ in fundamental ways.
Market segmentation refers to the process of subdividing a market into clearly identifiable groups
of customers with similar needs, desires, and demand characteristics. Customers within these
segments are relatively homogenous, whereas they differ in important ways from customers in
other segments of the market.
o For example, Nike segments the athletic shoe market according to sport (running,
basketball, football, soccer, and training) and gender (men’s shoes and women’s shoes).
It does this because it believes that people participating in different sports need different
things.

Three Approaches to Market Segmentation

1. One is to choose not to tailor different offerings to different segments, and instead produce
and sell a standardized product that is targeted at the average customer in that market.
(standardization strategy)
2. A second approach is to recognize differences between segments and create different
product offerings for the different segments. (segmentation strategy)
3. A third approach is to target only a limited number of market segments, or just one, and
to become the very best at serving that particular segment. (focus strategy)

Market Segmentation, Costs and Revenues

It is important to understand that these different approaches to market segmentation have
different implications for costs and revenues. Consider first the comparison between a
standardization strategy and a segmentation strategy. A standardization strategy is typically
associated with lower costs than a segmentation strategy. A standardization strategy involves the
company producing one basic offering, and trying to attain economies of scale by achieving a
high volume of sales. In contrast, a segmentation strategy requires that the company customize
its product offering to different segments, producing multiple offerings, one for each segment.
Customization can drive up costs.
Although a standardization strategy may have lower costs that a segmentation strategy, a
segmentation strategy does have one big advantage: it allows the company to capture
incremental revenues by customizing its offerings to the needs of different groups of consumers,
and thus selling more in total. As for a focus strategy, here the impact on costs and revenues is
subtler. Companies that focus on the higher-income or higher-value end of the market will tend to
have a
higher cost structure for two reasons. First, they will have to add features and functions to their
product to appeal to higher-income consumers, and this will raises costs. Second, the relatively
limited nature of demand associated with serving just a segment of the market may make it harder
to attain economies of scale.

BUSINESS-LEVEL STRATEGY CHOICES

We now have enough information to be able to identify the basic business-level strategy choices
that companies make. These basic choices are sometimes called generic business-level
strategy.

Companies that target the broad market can either concentrate on lowering their costs so that
they can lower prices and still make a profit, in which case we say they are pursuing a broad low-
cost strategy or they can try to differentiate their product in some way, in which case they are
pursuing a broad differentiation strategy.
Companies that target a few segments, or more typically, just one, are pursuing a focus or niche
strategy. These companies can either try to be the low-cost player in that niche as Costco has
done, in which case we say that they pursuing a focus low-cost strategy, or they can try to
customizing their offering to the needs of that particular segment through the addition of features
and functions in which case we say that they are pursuing a focus differentiation strategy.

BUSINESS-LEVEL STRATEGY, INDUSTRY AND COMPETITIVE ADVANTAGE

Properly executed, a well-chosen and well-crafted business-level strategy can give a company a
competitive advantage over actual and potential rivals. More precisely, it can put the company in
an advantageous position relative to each of the competitive forces—specifically, the threat of
entrants, the power of buyers and suppliers, the threat posed by substitute goods or services, and
the intensity of rivalry between companies in the industry.

Consider first the low-cost company; by definition, the low-cost enterprise can make profits at
price points that its rivals cannot profitably match. This makes it very hard for rivals to enter its
market. In other words, the low-cost company can build an entry barrier into its market. It can, in
effect, erect an economic moat around its business that keeps higher-cost rivals out. A low-cost
position and the ability to charge low prices and still make profits also give a company protection
against substitute goods or services. Low costs can help a company to absorb cost increases that
may be passed on downstream by powerful suppliers. Low costs can also enable the company
to respond to demands for deep price discounts from powerful buyers and still make money. The
low-cost company is often best positioned to survive price rivalry in its industry. Indeed, a low-
cost company may deliberately initiate a price war in order to grow volume and drive its weaker
rivals out of the industry.

Now consider the differentiated company. The successful differentiator is also protected against
each of the competitive forces. The brand loyalty associated with differentiation can constitute an
important entry barrier, protecting the company’s market from potential competitors. Because the
successful differentiator sells on non-price factors, such as design or customer service, it is also
less exposed to pricing pressure from powerful buyers. Indeed, the converse may be the case—
the successful differentiator may be able to implement price increases without encountering
much, if any, resistance from buyers. The differentiated company can also fairly easy absorb price
increases from powerful suppliers and pass those on downstream in the form of higher prices for
its offerings, without suffering much, if any, loss in market share.

IMPLEMENTING BUSINESS–LEVEL STRATEGY

For a company’s business-level strategy to translate into a competitive advantage, it must be well
implemented. This means that actions taken at the functional level should support the business-
level strategy, as should the organizational arrangements of the enterprise. There must, in other
words, be alignment or fit between business-level strategy, functional strategy, and organization.
COMPETING DIFFERENTLY: SEARCHING FOR A BLUE OCEAN
Sometimes companies can fundamentally shift the game in their industry by figuring out ways to
offer more value through differentiation at a lower cost than their rivals.

We referred to this as value innovation, a term that was first coined by Chan Kim and Renee
Mauborgne. Kim and Mauborgne developed their ideas further in the best-selling book Blue
Ocean Strategy.

Their basic proposition is that many successful companies have built their competitive advantage
by redefining their product offering through value innovation and, in essence, creating a new
market space. They describe the process of thinking through value innovation as searching for
the blue ocean—which they characterize as a wide-open market space where a company can
chart its own course.

When thinking about how a company might redefine its market and craft a new business-level
strategy, Kim and Mauborgne suggest that managers ask themselves the following questions:
1. Eliminate:
Which factors that rivals take for granted in our industry can be eliminated, thereby
reducing costs?
2. Reduce
Which factors should be reduced well below the standard in our industry, thereby
lowering costs?
3. Raise
Which factors should be raised above the standard in our industry, thereby
increasing value?
4. Create
What factors can we create that rivals do not offer, thereby increasing value?

This is a useful framework, and it directs managerial attention to the need to think differently than
rivals in order to create an offering and strategic position that are unique. If such efforts are
successful, they can help a company to build a sustainable advantage.