In Competitive Strategy Michael Porter lists three commonly used, generic strategies. Most firms intuitively know which of the three they use, even if they are not familiar with Porter’s language. More important is the breakdown Porter provides of the skills, resources, and organizational requirements a company needs and should seek to leverage in its strategic execution. A firm also does well to be aware of the risks associated with each strategy.
The first strategy is cost leadership, where your cost to produce a good or service—not necessarily your price—is lower than your competitors. This is often the domain of big business (think Walmart) but can exist in smaller companies where the product or service is more niche. Cost leadership allows a firm to remain viable in a ‘race to the bottom’ environment.
Commonly required skills and resources to obtain and maintain cost leadership include sustained capital investment and access to capital, process engineering skills, intense supervision of labor, products designed for ease of manufacture, and low-cost distribution systems (the area where Walmart has particularly excelled—see the excellent summary in Richard Rumelt’s Good Strategy; Bad Strategy, pp. 23-28). Common organizational requirements include tight cost control, frequent and detailed cost control reporting, highly structured organization, and incentives based on strict quantitative targets.
Risks of cost leadership include technological change, imitation by competitors, missing needed product or marketing changes due to focus on cost, and inflation.
Though cost leadership is typically associated with big business, I am aware of exceptions. I personally had the opportunity to lead a small business that obtained cost leadership through the innovative use of technology. Another example is a middle-market manufacturer in the midwest who was able to combine the tactics of process engineering skills and ease of manufacture, specifically through the use of industrial robots.
In the next post, we will take a look at the other two general strategies, differentiation and focus.