Differentiation versus Cost Leadership Strategy - Research Proposal Example

Differentiation versus Cost Leadership Strategy Introduction Differentiation and cost leadership strategies are popular study topics in the area of strategy and have been widely researched on. Whether the two strategies are mutually exclusive is a far less studied issue, however, as shown by the relatively limited literature on the topic. Strategic management practitioners and researchers have both recognised the importance of the differentiation and cost leadership strategies for efficient and effective organisational performance (Boone, 2012:43). In recent times, many large firms in different parts of the world have been using both strategies simultaneously rather than use a single one during a specific period of time. The implementations of both strategies are often used by giant corporations where their business operation levels range from local, regional, international and global. As a result, the primary objective of this paper is to explore the theoretical and practical aspects of differentiation and cost leadership. In contrast to Porter’s views, research shows that differentiation is more profitable than cost leadership, since market share leaders like to compete on differentiation more than low cost. Research also shows that the two strategies can co-exist, although they are mutually exclusive (Bothma, 2013:19). According to Porter, each strategy needs a different culture and philosophy. He argues that cost leadership often requires that a company be the cost leader. Nevertheless, the flaw is not in Porter’s rationale but in his fundamental premise that relates to premium prices and uniqueness. This is a situation that cannot gel with high market share. Contemporary studies show that the two strategies differ in their theoretical aspects, but it is their practical element which is the focus of this paper. The Differentiation Concept Differentiation basically comprises creating a market position that is viewed as being distinct market-wide, and that can be sustained in the long-term. Differentiation can be based on brand image or design, distribution, etc. Differentiator companies particularly create customer value through offering high-quality products that are supported by excellent service at premium rates. The effectiveness of differentiation relies on how well an organisation can juggle product benefits and product costs for the consumer, vis-à-vis competitive offerings (Hitt and Ireland, 2013:33). Firms employing differentiation strive to develop and market unique products for different consumer groups. They strive to develop a superior satisfaction of consumer needs in one or multiple product features in order to create customer satisfaction and loyalty, which can always in turn be applied in charging a minimum price for goods. A business that implements a differentiation strategy aims to inspire a perception in the minds of consumers that their goods or services have superior features that are distinct from those of its rivals in terms of quality, image and reputation, design features and reliability. A business creates this perception by adding real qualitative difference in its services and products, charging premium prices and using advertising programs and marketing techniques (Ireland and Hoskisson, 2009:36). Differentiation companies are also able to gain competitive advantage over their rivals because of the perception that their products and services are unique. Porter argued that competitive strategies involve the creation of features that define a company and differentiate the value it develops and offers vis-à-vis its rivals. Further, the primary idea is about how the business can best compete in the industry. Differentiation has been successfully adopted in firms of developed countries like France, Canada and Sweden, and these firms are likely to enter the less developed countries as foreign firms. As foreign firms, they have an inherent advantage over local firms in terms of adopting a differentiation strategy. The foreign firms having advantage in terms of skilled human capital, innovative production methods, financial and technological resources and new and advanced management systems better meet the conditions required to adopt a differentiation strategy successfully (Ireland and Hoskisson, 2009:39). As a backup for price competition, a firm can differentiate its products and services from its rivals. Studies show that the emergence of professional and efficient chain store operations causes lower cost differentials between them; this simultaneously increases the need to employ non-price features to distinguish and classify firms. In retail business, for example, differentiation can be viewed as a strategy with the aim of adapting specific store features more closely to the specific demands of targeted consumer segments. In retail, just like manufacturing, two main arguments opposing Porter’s model have arisen: a) The reduction of potential competitive advantages to two fundamental types is simplistic, and particularly differentiation advantages can be achieved in multiple different ways. b) Porter does not take into account strategies that involve several competitive advantages. Differentiation can also be suitable for transition economies such as Ghana, in which customers have been exposed to foreign products with more variety and high quality due to economic liberalisation (Ireland and Hoskisson, 2009:42). Cost Leadership Strategy This is the foundation for the long-term, sustainable competitive approach to the price competition. The price competition is easily replicated. For example, in the retail business, stores like Giant and Carrefour work towards cost leadership strategy; all sources associated with cost reduction must be tapped. A retail business firm must reduce the cost across its value chain – and potential inter-firm chain – activities. Consequently, the most important issue in the retail business firm is to identify the sources associated with the Cost of Goods Sold (COGS). Large retail forms often achieve cost leadership more easily compared to smaller ones. This is because the large firms often have more influence over suppliers that allow them to secure low purchase prices for bought goods (Hansen and Mowen, 2013:22). Tony Fernandez, the CEO of AirAsia, stated that his business philosophy is very clear: A business can only grow if it brings its costs under control. It must be not only cost-efficient and profitable, but must also create value. Based on these sentiments, AirAsia can be growing in the industry if it can control its cost; its management of its recurrent costs must be reliable and efficient (Hansen and Mowen, 2013:22). The company is a market leader in Malaysia, Indonesia and Thailand, but will face stiff competition from both current and new players. To maintain its competitive advantage, it should leverage its ability to create cost advantages across numerous value chains. The company should make a consideration and focus more on being the lowest-cost carrier in the industry. The demand for cheap carriers is rapidly growing, and it can be a great opportunity for AirAsia to increase its market share. Differentiation Concept versus Cost Leadership Application/Practice This comparison will be made using a similar approach to the one employed by Porter when estimating the correlation between organisational performance and the degree of the forces in his popular five-force model framework analysis of the competitive environment. It will focus on the economy of Germany and how the country has implemented both differentiation and cost leadership strategies. For a list of products this comparison will be concentrated on the price level associated with the evolution and dynamism of competitive advantage portrayed in the market share between 2009 and 2013, compared to its level between 2004 and 2004 and 2006. It is presumed that the price represents, relatively accurately, the cost level. The selected products have the following important features: i) They have been domestically produced before 1990. ii) They are meant for final consumption. iii) They feature in the household budget. iv) For every product, there has been at least one new entrant after 1990. For example, importers or proprietors of German production facilities. The list of selected products to be studied: Refrigerators Medicines (general use) Typographical products Detergents Cars Tourist services Beer Chocolate Textiles Soft drinks Each of these products symbolises an industry with a different history of the change of the competitive background. For some of them – cars, beers and refrigerators – a brief presentation could indicate points the main features and some important progress in their history for an analysis of the impact of a strategy based on cost, cost focus or cost leadership. The remaining products also have their own unique history, with many interesting attributes for a case study (Hansen and Mowen, 2013:29). The products are analysed from the perspective of differentiation, differentiation based on cost and the degree of competitive advantage based on cost. It is assumed that if the value is mediated during a period of between 1 and 2 years, the price will follow the cost. The last decade of economic development in Germany is marked, from the point of view of theoretical analysis, by industries in accelerated processes of differentiation. The vertical differentiation of products is only a dimension of the differentiation that defines, as a general approach, the efforts of certain firms to gain competitive advantage. From the perspective related to the theory of industrial economy, the aspects of horizontal and vertical differentiation of products are simple to point out (Griffin, 2012:24). In the case of the first group, specific concretisations are not only remarked but also remarkable when correlated to the spatial trends of horizontal differentiation and to the products. This is with regards to retail services dealing in basic commodities meant for household use (e.g. food). The confrontation, in the perspective of gaining a significant discriminatory feature, occurs through the medium of the cost, after a previous phase elapsed, associated with the choice of the most rewarding physical location (Boone, 2012:47). Product Differentiation Price differentiation Competitive advantage based on cost Refrigerators Medium Medium Low Detergents Low Medium Low Beer Medium High Low Soft drinks Low High Medium Medicines (for general use) Low High High Cars High High High Chocolate Medium High Medium Tourist services Medium High Low Typographical products Low Low Low Textiles High High Low Figure 1. Competitive advantage for different products Strategy Where it has been applied Products/Services it has been Applied to Cost leadership Developing, transition and developed economies (globally) Automotive industry (Toyota) Airline industry (AirAsia) Retail industry (Carrefour and Giant stores) Differentiation Developing, transition and developed economies (globally) Automobiles and motorcycles (Mercedes Benz and Harley Davidson – by brand) Watches (Titan Watches – by design) Domino Pizza (by positioning) Apple Computers (by technology) 3M (by innovation) The data presented in figure 1 shows the following: a) A small number of goods represent a positive connection between the difference in price (compared to the prices of new entrants) and the competitive advantage that already exists. As a result, a cost leadership strategy appears quite inconsistent; at least at this moment in Germany. b) For some goods it is apparent that a differentiation strategy is used alongside a cost leadership strategy, so differentiation and low cost are not mutually exclusive. Conclusions This paper shows that many studies, analyses, observations and assessments have been conducted by scholars and academicians. There is no doubt that cost leadership defers from the concept of differentiation in terms of application. In addition, the results are also different, but complimentary in some cases. The hybrid strategy (combination of differentiation and cost leadership) is an efficient and effective way for companies to harness the power of both strategies. Studies show that the cost leadership strategy (and cost leaders) cannot ignore differentiation (Peng, 2014:21). Porter’s critics postulate that cost leadership and differentiation are part of a homogenous continuum – not a dichotomy. Many economists have presented theoretical arguments that support the idea that the two strategies can be combined to gain competitive advantage. Scientific research also supports the idea that some firms excel in the implementation of both strategies. For example, the worldwide TV set industry in which Japanese companies were able to realise higher quality and lower cost, simultaneously, shows that the two strategies can function together (Schermerhorn, 2010:32). More studies show that firms can also pursue both differentiation and cost leadership strategy without their financial performance suffering. According to scholars, differentiation and cost leadership are the two fundamental generic strategies that provide equally successful routes to edging out the competition. However, some scholars disagree, arguing that differentiation is more profitable than cost leadership because market share leaders prefer to operate more on the basis of differentiation than low cost. Organisations must learn how to distinguish between the two strategies discussed in this paper. They must also learn how to interpret and apply them in order to gain competitive advantage. This paper shows that the theoretical and practical aspects of marketing are all important, but companies tend to focus on the theoretical element. Cost leadership, for example, requires more practicality than theory in order to exploit its true potential. References Boone, L. (2012) Contemporary marketing, 2013 update, S.l., Cengage Learning. Bothma, N. (2013) Product management, Cape Town, Juta. Griffin, R. (2012) Management fundamentals, Australia, South-Western Cengage Learning. Hansen, D. & Mowen, M. (2013) Cornerstones of cost management, Mason, OH, South-Western Cengage Learning. Hitt, M. & Ireland, R. (2013) Strategic management: competitiveness & globalization, Mason, OH, South-Western Cengage Learning. Ireland, R. & Hoskisson, R. (2009) Understanding business strategy: concepts and cases, Mason, Ohio, South-Western Cengage Learning. Peng, M. (2014) Global strategic management, Mason, Ohio, South-Western Cengage Learning. Schermerhorn, J. (2010) Management foundations and applications, Milton, Qld., John Wiley. Read More