Strategy professor Michael Porter said:
Strategy is about choices: you can’t be all things to all people.
Porter, author of Competitive Strategy, is widely known in business circles and is thought of as the father of modern business strategy theory. His central thesis is that businesses can create and sustain a competitive advantage in the marketplace by following one of two strategic choices: 1) cost leadership or 2) differentiation. He also created the idea that firms can be either focused (niche) or broad (general) in their approach to the market in conjunction with cost leadership or differentiation.
While I generally subscribe to Porters’ ideas, there is often some confusion around the term “differentiation.” As I read Competitive Strategy, the word “differentiation” was intended to convey two ideas simultaneously: (1) providing superior benefits and (2) providing different benefits versus the competition. Porter argues that both ideas together can ensure strategic advantage. The trouble I have with this approach is two fold:
- The word “differentiation” embodies an inherent emphasis on the idea of “being different” compared to the competition. This wording often leads to the misinterpretation that being different alone (regardless if there are benefits associated with the differences or not) is sufficient to have an advantage
- He seems to dismiss the possibility of achieving a sustained advantage by simply providing superior benefits alone.
To offer a slightly different approach, I suggest there are three ways to provide benefits:
- Superior benefits versus the competition (e.g. if two cars are exactly alike but one has better gas mileage, the one with better gas mileage has superior benefits – superior gas mileage – and, in turn, the advantage in the market)
- Different benefits versus the competition (e.g. if all cars produced are only available in black, a new car that is the same as the other cars in every way except it is available in multiple colours, a different benefit, will have the advantage in the market)
A combination of superior and different benefits, or what Porter calls “differentiation” (e.g. the new car has both better gas mileage than other cars and is available in multiple colours)
Lets see if I can describe this in a model;
Because there are multiple ways to provide benefits, I like to think of these strategies as benefit leadership in general rather than jumping straight to “differentiation”. Another reason to think of it this way is because the cost leader or benefit leader dichotomy is simpler and easier to remember as it illustrates the basic cost/benefit analysis that every individual or organization goes through when evaluating a new purchase.
Now that we’ve cleared that up, let’s explore these ideas in more detail.
Cost/Benefit Analysis
Decisions, especially B2B purchase decisions, are only made after estimating the net result of a cost/benefit analysis. For corporations, this process can be extensive and well-documented. The reason is because for each dollar they invest into something, whether it be a newly hired employee or a new product, they must do so on the basis that the dollar will come back to them with a specified return or ROI.
The usual method for businesses and investors making this analysis is a “Net Present Value” calculation (or NPV). This analysis will generate a predicted amount of cash outflow and inflow over time as well as a projected ROI for that particular investment decision. If the analysis predicts a net positive gain from the investment, then the business will fund the endeavour.
For consumers, on the other hand, this analysis can be subtle and is often not documented. But even though the calculations aren’t documented or rigorously analysed, every person still does this analysis fairly quickly and usually in their mind prior to a purchase.
For example, when I go to the grocery store to buy ice cream I’ll first try to decipher through any marketing gimmicks presented. This includes things such as different pack sizes (1L vs. 0.75L) and the difference in price because of those different sizes. Manufacturers use these gimmicks in order to conceal the true comparable prices thus making competitive price comparisons a difficult task. Thankfully most grocery stores will display a normalised price in terms of $/L. If I can see that, then I’ll know exactly what the fundamental prices (or my costs) are for the product.
Once I understand the price differences, I then try to fully understand each product’s benefits. I’m a fan of Ben & Jerry’s and at the store I usually have Ben & Jerrys available.
Sometimes, Ben and Jerry’s is full price and occasionally new brands are available on special. For many there is lower risk in buying the brand name they know (Ben & Jerrys) because I’m assured to get an experience consistent with that I’ve enjoyed in the past – silky smooth creamy taste, thick pieces of chocolate and a good conscience from their good works. Conversely, I may be cautious about purchasing the new brand simply because I’m unsure of what to expect. In getting back to the analysis, the brand itself counts as a net benefit for the Ben & Jerry’s branded ice cream. I’ll then repeat this line-by-line analysis in my mind with reference to the packaging (how hard is it to open, how good does it look, etc.), flavour and taste profile (Chocloate from Ben & Jerry’s vs Thai Coconut and Mango for the new offering), etc. Once these are all analysed, keep in mind this all happens within seconds of seeing the product, an overall net cost or benefit will emerge and whichever provides the highest net benefit will be the one I purchase.
That’s a simple analysis with ice cream but the more expensive the investment decision is, the more time, thought and effort will be devoted to analysis. For example, buying a car, requires extensive investments. Usually, though not always, people will put much more effort into analysing the costs/benefits of these decisions than they will when deciding something as simple as which ice cream to buy.
So how does this impact organisations?
If you want to start a company or launch a new product, you can be more productive by focusing your efforts on accomplishing one objective – like cost leadership – rather than attempting to do everything all at once everywhere. This principle is what Porter was referring to in the opening quote.
Let’s now discuss how innovators and business managers can utilize this process to their advantage.
Cost Leadership
Cost leadership is about organising all your resources around producing acceptable goods and services at the lowest cost possible. By having the lowest costs associated with providing your products, you put your business in the unique position of being able to charge your customers the lowest price in the market for those products. Just to keep things straight, I’m referring to cost leadership (meaning the costs the business incurs to provide goods and services), not necessarily price leadership though the two usually go together.
The best example of cost leadership I can think of today is Amazon. CEO Jeff Bezos, summarises Amazon’s strategy:
There are two kinds of companies: Those that work to try to charge more and those that work to charge less. We will be the second.
The great part about this quote is Bezos’ dig at other companies, likely benefit leaders, who “try to charge more.” It’s a fantastic perspective to have for a company that is so single-mindedly focused on cost leadership.
Occasionally, some entrepreneurs and even business leaders will come up with an idea and immediately revert to the plan of doing it for the lowest price. This may or may not be the right strategy. If you’re goal is to be a cost leader, it’s good to keep the following things in mind:
- Don’t lead on low price when you can’t lead on low cost. If your costs are fundamentally lower relative to the competition, then by all means lead with low prices to the consumer. If you’re costs are not fundamentally lower than the competition and you attempt to lead with low prices in the market, you better have a lot of cash lying around because that’s what you need to stay afloat for very long (1- discussion on Uber).
- Do what the talents of you and your employees lend your organization to do. If your company is full of people who are fantastic at accounting, process improvement, lean manufacturing, supply chain management and tend to be frugal individuals then become a cost leader. Employees like that are born with cost leadership in their blood and can be counted on to reduce costs for you. However, if your company consists of many highly creative people who excel in design then you probably ought to become a benefit leader.
- Realize that some markets (commodities) will force you to become a cost leader – or you could go out of business. You’re in the petrol business, then you better be a cost leader . Because petrol is a commodity (a commodity is something that can not easily be distinguished in terms of superior or different benefits) the only way to be profitable is by cutting costs as much as possible without impacting production and yield. It’s hard to claim that your petrol is better than somebody else’s petrol! To most people, petrol is petrol regardless of the brand, but location convenience is important.
The great thing about cost leadership is if you’re really good at it then you don’t necessarily need to be perfect at providing great benefits. For example Sheng Siong Supermarkets for example. Sheng Siong stores are not nearly as nice as ColdStorages and their store brand is arguably inferior to ColdStorage store brands. But that’s okay because what Sheng Siong can’t do in providing benefits they may make up for in low- low prices. Back to the original quote – strategy is about making a conscious choice to focus on excelling at one thing, usually at the expense of not doing another thing.
Benefit Leadership
At the other end of the spectrum is benefit leadership. This strategy entails organising all your resources around the goal of providing either superior benefits, different benefits or both – what I refer to as uniquely superior benefits, relative to the competition.
By providing the most benefits in the market, you are in a position to justify charging a higher price to your customers. There are many examples of benefit leading companies.
Benefit leaders constantly seek to out-innovate their competition in order to survive and maintain their high pricing. This is not to say that cost leading companies don’t innovate, usually they do but in different ways, enabling them to cut costs and lower pricing to customers. Benefit leading companies often innovate with regards to new technology, features and better user experiences.
If your plan is to create a new business or a new product as a benefit leader, it’s best to keep the following in mind:
- Benefit leadership means signing up for constant innovation. This means that your company’s products must be the lead of new technologies and experiences for the customer. This will become your brand promise and it must be continually kept in order to sustain growth and profitability.
- Providing superior benefits alone can be very difficult to maintain.Your products will always require the fastest processor, the highest resolution screen, the best camera etc. For many marketers and innovators, making things faster and with more features is the default solution. Because of this, providing superior benefits over the long-term can be very challenging due to intense competition.
- Providing different benefits requires more creativity but can be easier to maintain over the long run. An example of these different benefits is the role the Apple store plays for Apple products. It enables customers to try the new products in an beautiful environment of knowledgable staff. Its a different experience form buying an android phone (although Samsung are trying hard to copy.
- Providing uniquely superior benefits, i.e. a combination of superior and different benefits, is difficult to do but highly valuable when achieved. This is usually where many would categorize some of Apple’s products. All three revolutionary Apple products – the iPod, iPhone, and iPad – provided some level of both superior benefits and different benefits. With the iPhone, many things were clearly superior such as the processing power, ram and the touchscreen. Other things were clearly different such as the way you could order it online directly from Apple or in an Apple store rather than always having to go through a phone company.
The last thing I’ll mention with regards to benefit leadership is that if you’re going to deploy this strategy, it’s important to put a lot of resources into both your marketing and product development organizations. The reason is fairly straightforward: you need your marketing department to understand precisely what things people would like to see in terms of superior and different benefits. You also need that same marketing organization to be highly capable of communicating those benefits to the marketplace. With regards to engineering, you absolutely need the talent within the organization capable of actually creating and designing these high benefit (and in many cases high technology) products. Without them, you’ll have nothing tangible to show for all the effort put into the idea.
Can you Get Stuck In The Middle?
The last thing I’ll mention on this subject is the idea of getting stuck in the middle between benefit leadership and cost leadership.
The problem with being stuck in the middle is that this usually means the business (or product) isn’t good at either strategy and hence doesn’t provide the value that consumers demand. Unfortunately this malady plagues many businesses large and small. They are unsure whether they will win but being a cost leader or a benefit leader and try to do a little bit of both. Doing this is a real cause of failure.
A company that has tried and succeeded in this middle spot is IKEA. The products are certainly differentiated- they have great design and utility. But they are focused on really cutting costs. You assemble yourself, you deliver yourself. IKEA has to devote twice as much focus as other furniture firms… not only do they have to deploy marketing teams to know exactly how much people are willing to pay for a sofa – for example- but they then have the purchasing teams able to specify to external manufacturers exactly how to manufacture at below that cost so that everyone can make money. Being in the middle isn’t easy… its twice as difficult as you have to be a winner at cost leadership AND at differentiation.
Conclusion
A quote from Steve Jobs sums this strategy discussion up nicely:
People think focus means saying yes to the thing you’ve got to focus on. But that’s not what it means at all. It means saying no to the hundred other good ideas that there are. You have to pick carefully. I’m actually as proud of the things we haven’t done as the things I have done. Innovation is saying ‘no’ to 1,000 wrong things.
(1) Uber is a low-price leader without being a low cost leader… its costs his shareholders a few billion dollars each year for Uber to follow this strategy.