What is Strategy?

Strategic management, strategy for short, is essentially about choice — in terms of what an organization will do and won’t do to achieve specific goals and objectives. Strategy is also about making choices that provide the organization with some measure of a sustainable competitive advantage (Video 5.1). The concept of strategy is relevant to all types of organizations, from large, public companies to nonprofits.

Generating Advantage

There are countless variations in the competitive strategies that companies employ, mainly because each company’s strategic approach entails custom-designed actions to fit its own circumstances and industry environment. The custom-tailored nature of each company’s strategy is also the result of management’s efforts to uniquely position the company in its market.

Competitive strategies that provide distinctive industry positioning and competitive advantage in the marketplace involve choosing between a target market that is either broad or narrow, and whether the company should pursue a competitive advantage linked to low costs or product differentiation. These two factors give rise to four primary competitive strategy options: cost leadership, focused low cost, broad differentiation, and focused differentiation. ^[1] These four strategies are also referred to as generic strategies, because they can be applied to any size or form of business (Video 5.2). A fifth strategy, best-cost provider, is a hybrid option that combines elements of both cost leadership and differentiation. Each of these five strategies will be described in the sections that follow.

Cost Leadership

Cost leadership, also referred to as low-cost provider, is a low-cost market strategy. Firms pursuing this type of strategy must be particularly efficient in engineering tasks, production operations, and physical distribution; they must also be able to minimize costs in marketing and research and development (R&D). A low-cost leader can gain significant market share enabling it to procure a more powerful position relative to both suppliers and competitors. A firm employing this strategy uses product price as its primary competitive edge, minimizing its cost to enable it to provide an acceptable product at the lowest possible price while still maintaining a positive margin. This strategy is particularly effective for organizations in industries where there is limited possibility of product differentiation and where buyers are very price sensitive as with commodities and similar products or services.

Focused Low Cost

A focused low-cost strategy is a low-cost, narrowly-focused market strategy. Firms employing this strategy may focus on a particular buyer segment or a particular geographic segment and must locate a niche market that wants or needs an efficient product and is willing to forgo extras to pay a lower price for the product. A company’s costs can be reduced by providing little or no service, providing a low-cost method of distribution, or producing a no-frills product.

Challenges in Pursuing a Low-Cost Strategy

Perhaps the biggest challenge of a low-cost provider strategy is getting carried away with overly aggressive price cutting and ending up with lower, rather than higher, profitability. A low-cost, low-price advantage results in superior profitability only if (1) prices are cut by less than the size of the cost advantage or (2) the added volume is large enough to bring in a bigger total profit despite lower margins per unit sold. Thus, a company with a 5 percent cost advantage cannot cut prices 20 percent, end up with a volume gain of only 10 percent, and still expect to earn higher profits!

A second challenge is relying on an approach to reduce costs that can be easily copied by rivals. If rivals find it relatively easy or inexpensive to imitate the leader’s low-cost methods, then the leader’s advantage will be too short-lived to yield a valuable edge in the marketplace. Thus, cost leaders must maintain their investment in state-of-the-art equipment or face the possible entry of more cost-effective competitors. Furthermore, major changes in technology may drastically change production processes so that previous investments in production technology are no longer advantageous.

A third challenge is becoming too fixated on cost reduction. Low costs cannot be pursued so zealously that a firm’s offering ends up being too features-poor to gain the interest of buyers. Furthermore, a company driving hard to push its costs down has to guard against misreading or ignoring increased buyer preferences for added features or declining buyer price sensitivity. Even if these mistakes are avoided, a low-cost competitive approach still carries risk. Cost-saving technological breakthroughs or process improvements by rival firms can nullify a low-cost leader’s hard-won position.

Differentiation

A differentiation strategy involves offering a unique product; because this type of strategy involves a unique product, price is not the most significant factor. In fact, consumers may be willing to pay a high price for a product that they perceive as different. The product difference may be based on product design, method of distribution, or any aspect of the product (other than price) that is significant to the consumer. A company choosing this strategy must develop and maintain a product perceived as different enough from the competitors’ products to warrant the asking price.

Differentiation does not allow a firm to ignore costs; it makes a firm’s products less susceptible to cost pressures from competitors because customers see the product as unique and are willing to pay extra to have the product with the desirable features. Differentiation can be achieved through real product features or through advertising that causes the customer to perceive that the product is unique.

Several studies have shown that a differentiation strategy is more likely to generate higher profits than a cost-leadership strategy, because differentiation creates stronger entry barriers. However, a cost-leadership strategy is more likely to generate increases in market share.

Focused Differentiation

A focused differentiation strategy is the marketing of a differentiated product to a narrow market. This strategy is viable for a company that can convince consumers that its narrow focus allows it to provide better goods and services than its competitors.

Challenges in Pursuing a Differentiation Strategy

Differentiation strategies can fail for any of several reasons. A differentiation strategy keyed to product or service attributes that are easily and quickly copied is always suspect. Rapid imitation means that no rival achieves meaningful differentiation, because whatever new feature one firm introduces that strikes the fancy of buyers is almost immediately added by rivals. This is why a firm must search out sources of uniqueness that are time-consuming or burdensome for rivals to match if it hopes to use differentiation to win a sustainable competitive edge over rivals.

Differentiation strategies can also falter when buyers see little value in the unique attributes of a company’s product. Thus even if a company sets the attributes of its brand apart from its rivals’ brands, its strategy can fail because of trying to differentiate on the basis of something that does not deliver adequate value to buyers. Any time many potential buyers look at a company’s differentiated product offering and conclude “so what,” the company’s differentiation strategy is in deep trouble; buyers will likely decide the product is not worth the extra price and sales will be disappointingly low.

Overspending on efforts to differentiate is a strategy flaw that can erode profitability. Company efforts to achieve differentiation nearly always raise costs. The trick to profitable differentiation is either to keep the costs of achieving differentiation below the price premium the differentiating attributes can command in the marketplace or to offset thinner profit margins by selling enough additional units to increase total profits. If a company goes overboard in pursuing costly differentiation, it could be saddled with unacceptably thin profit margins or even losses. The need to contain differentiation costs is why many companies add little touches of differentiation that add to buyer satisfaction but are inexpensive to institute.

The Risks of a Market Niche Strategy

Focusing, either in terms of a cost leadership or differentiation strategy, carries several risks. The first major risk is the chance that competitors will find effective ways to match the focused firm’s capabilities in serving the target niche. In the lodging business, large chains such as Marriott and Hilton have launched multi-brand strategies that allow them to compete effectively in several lodging segments simultaneously. Marriott has flagship hotels with a full complement of services and amenities that allow it to attract travelers and vacationers going to major resorts; it has J.W. Marriott and Ritz-Carlton hotels that provide deluxe comfort and service to business and leisure travelers; it has Courtyard by Marriott and SpringHill Suites brands for business travelers looking for moderately priced lodging; it has Marriott Residence Inns and TownePlace Suites designed as a “home away from home” for travelers staying five or more nights; and it has more than 650 Fairfield Inn locations that cater to travelers looking for quality lodging at an “affordable” price.

Similarly, Hilton has a lineup of brands (Waldorf Astoria, Conrad Hotels, Doubletree Hotels, Embassy Suites Hotels, Hampton Inns, Hilton Hotels, Hilton Garden Inns, and Homewood Suites) that enable it to compete in multiple segments and compete head-to-head against lodging chains that operate only in a single segment. Multi-brand strategies are attractive to large companies such as Marriott and Hilton precisely because they enable a company to enter a market niche and siphon business away from companies that employ a focus strategy.

A second risk of employing a focus strategy is the potential for the preferences and needs of niche members to shift over time toward the product attributes desired by the majority of buyers. An erosion of the differences across buyer segments lowers entry barriers into a focused market niche and provides an open invitation for rivals in adjacent segments to begin competing for the focuser’s customers. A third risk is that the segment may become so attractive it is soon inundated with competitors, intensifying rivalry and splintering segment profits.

Best-cost Provider Strategy

Can forms of competitive advantage be combined? That is, can a firm straddle strategies so that it is simultaneously the low-cost leader and a differentiator? Some strategy experts have asserted that a successful strategy requires a firm to stake out a market position aggressively and that different strategies involve distinctly different approaches to competing and operating the business. Some research suggests that a combination strategy — also known as a best-cost provider strategy — is a recipe for below-average profitability compared to the industry, and that such a strategy indicates that the firm’s managers have not made necessary choices about the business and its strategy.

An organization pursuing a differentiation strategy seeks competitive advantage by offering products or services that are unique from those offered by rivals, either through design, brand image, technology, features, or customer service. Alternatively, an organization pursuing a cost-leadership strategy attempts to gain competitive advantage based on being the overall low-cost provider of a product or service. To be “all things to all people” can mean becoming “stuck in the middle” with no distinct competitive advantage. The difference between being “stuck in the middle” and successfully pursuing a combination, or best-cost provider, strategy merits discussion, as some firms have been able to succeed using combination strategies, such as by being a cost leader while maintaining a differentiated product.

Some industries may actually call for such combination strategies. Trends suggest that highly complex environments do not have the luxury of choosing exclusively one strategy over another. The hospital industry may represent such an environment, as hospitals must compete on a variety of fronts. Combination (i.e., more complicated) strategies are both feasible and necessary to compete successfully. For instance, reimbursement to diagnosis-related groups, and the continual lowering of reimbursement ceilings have forced hospitals to compete on the basis of cost. At the same time, many of them jockey for position with differentiation based on such features as technology and birthing rooms. Thus, many hospitals may need to adopt some form of hybrid strategy to compete successfully.^[2]

Best-cost provider strategies are a hybrid of low-cost provider and differentiation strategies that aim at satisfying buyer expectations on key quality, feature, performance, or service attributes and beating customer expectations on price. Companies pursuing best-cost strategies aim squarely at the mass of value-conscious buyers looking for a good-to-very-good product or service at an economical price. The essence of a best-cost provider strategy is giving customers more value for the money by satisfying buyer desires for appealing product attributes in terms of features, performance, quality, service, or related characteristics and charging a lower price for these attributes compared to rivals with similar caliber product offerings. Alternatively, the firm could provide a superior product at a comparable price. Either approach yields a comparable best-cost product.

When a Best-Cost Provider Strategy Works Best

A best-cost provider strategy works best in markets where product differentiation is the norm and attractively large numbers of value-conscious buyers can be induced to purchase midrange products rather than the basic products of low-cost producers or the expensive products of top-of-the-line differentiators. A best-cost provider usually needs to position itself in the middle of the market with either a medium-quality product at a below-average price or a high-quality product at an average or slightly higher-than-average price. Best-cost provider strategies also work well in recessionary times when great masses of buyers become value-conscious and are attracted to economically priced products and services with especially appealing attributes.

Challenges in Pursuing a Best-Cost Provider Strategy

A company’s biggest vulnerability in employing a best-cost provider strategy is not having the requisite core competencies and efficiencies in managing value chain activities to support the addition of differentiating features without significantly increasing costs. A company with a modest degree of differentiation and no real cost advantage will most likely find itself squeezed between the firms using low-cost strategies and those using differentiation strategies. Low-cost providers may be able to siphon customers away with the appeal of a lower price (despite having marginally less appealing product attributes). High-end differentiators may be able to steal customers away with the appeal of appreciably better product attributes (even though their products carry a somewhat higher price tag). Thus, a successful best-cost provider must offer buyers significantly better product attributes to justify a price above what low-cost leaders are charging. Likewise, it has to achieve significantly lower costs in providing upscale features so that it can outcompete high-end differentiators on the basis of a significantly lower price.

Generic Strategies Summary

Before moving on to the next section, click on each information icon in the interactive matrix below to review each of the five strategy options described above:

Facets of Strategy

The strategy diamond was developed as a framework for checking and communicating a strategy.^[3] A strategy consists of an integrated set of choices, but it isn’t a catchall for every important choice a manager or organization faces.

The following sections will introduce the three traditional strategy facets of arenas, differentiators, and economic logic, as well as the facets of vehicles and staging and pacing. The first three facets of the strategy diamond—arenas, differentiators, and economic logic—are labeled as traditional in the sense that they address three longstanding hallmarks of strategizing. Specifically, strategy matches up market needs and opportunities (located in arenas) with unique features of the firm (shown by its differentiators) to yield positive performance (economic logic).

Click on each information icon in the interactive strategy diamond below to learn more about each component:

Arenas

Strategy questions about arenas tell managers and employees where the firm will be active and with how much emphasis.

• Which product categories?
• Which channels?
• Which market segments?
• Which geographic areas?
• Which core technologies?
• Which value-creation strategies?

Beyond geographic-market and product-market arenas, an organization can also make choices about the value-chain arenas in its strategy. To emphasize the choice part of this value-chain arena, Nike’s competitor New Balance manufactures nearly all the athletic shoes that it sells in the United States. Thus, these two sports-shoe companies compete in similar geographic- and product-market arenas but differ greatly in terms of their choice of value-chain arenas.

Differentiators

Differentiators are the things that are unique to the firm such that they give it a competitive advantage in its current and future arenas. Differentiators are concerned with the question, how will the firm win?

• Image?
• Customization?
• Price?
• Styling?
• Product reliability?
• Speed to market?

A differentiator could be asset based, that is, it could be something related to an organization’s tangible or intangible assets. A tangible asset has a value and physically exists. Land, machines, equipment, automobiles, and even currencies, are examples of tangible assets. For instance, the oceanfront land on California’s Monterey Peninsula, where the Pebble Beach Golf Course and Resort is located, is a differentiator for it in the premium golf-course market. An intangible asset is a nonphysical resource that provides gainful advantages in the marketplace. Brands, copyrights, software, logos, patents, goodwill, and other intangible factors afford name recognition for products and services. Differentiators can also be found in capabilities, that is, how the organization does something. Walmart, for instance, is very good at keeping its costs low.

Economic Logic

Economic logic explains how the firm makes money above its cost of capital.

• Lowest costs through scale advantages?
• Lowest costs through scope and replication advantages?
• Premium prices due to unmatchable service?
• Premium prices due to proprietary product features?

While economic logic can include environmental and social profits (benefits reaped by society), the strategy must earn enough financial profits to keep investors (owners, taxpayers, governments, and so on) willing to continue to fund the organization’s costs of doing business. A firm performs well (i.e., has a strong, positive economic logic) when its differentiators are well-aligned with its chosen arenas.

Vehicles

You can see why the first three facets of the strategy diamond—arenas, differentiators, and economic logic—might be considered the traditional facets of strategizing in that they cover the basics: (1) external environment, (2) internal organizational characteristics, and (3) some fit between them that has positive performance consequences. The fourth facet of the strategy diamond is called vehicles. If arenas and differentiators show where an organization wants to go, then vehicles communicate how the strategy will get it there.

• Internal development?
• Joint ventures?
• Licensing/franchising?
• Alliances?
• Acquisitions?

Specifically, vehicles refer to how an organization might pursue a new arena through internal means, through help from a new partner or some other outside source, or even through acquisition. In the context of vehicles, this is where an organization determines whether it is going to grow organically, through acquisition, or a combination of both. Organic growth is the growth rate of a company excluding any growth from takeovers, acquisitions, or mergers. Acquisitive growth, in contrast, refers precisely to any growth from takeovers, acquisitions, or mergers.

Vehicles are considered part of the strategy because there are different skills and competencies associated with different vehicles. For instance, acquisitions fuel rapid growth, but they are challenging to negotiate and put into place. Similarly, alliances are a great way to spread the risk and let each partner focus on what it does best. But at the same time, to grow through alliances also means that an organization must be really good at managing relationships in which it is dependent on another organization over which it does not have direct control.

Staging and Pacing

Staging and pacing constitute the fifth and final facet of the strategy diamond and reflect the sequence and speed of strategic moves. This powerful facet of strategizing helps an organization think about timing and next steps, instead of creating a strategy that is a static, monolithic plan. The staging and pacing facet also helps to reconcile the designed and emergent portions of an organization’s strategy.

Chapter Review

Optional Resources to Learn More 

	Articles
	“Building a Winning Business Model Portfolio” https://sloanreview.mit.edu/article/building-a-winning-business-model-portfolio/
	Videos
	“What Is Strategy? It’s a Lot Simpler Than You Think” https://www.youtube.com/watch?v=o7Ik1OB4TaE
	Websites
	Learn Strategy https://learnstrategy.byu.edu/
	Understanding Competition and Strategy https://www.isc.hbs.edu/strategy/Pages/default.aspx

Chapter Attribution

This chapter incorporates material from the following sources:

Units 1, 5 and 6 of Morris, J. (2021). Strategic management (2nd ed.). Oregon State University. https://open.oregonstate.education/strategicmanagement2e/. Licensed with CC BY-NC 4.0.

Media Attributions

Video 5.1: Harvard Business Review (2019, July 2). The explainer: What is a business model? [Video]. YouTube. https://www.youtube.com/watch?v=_C-vGu2mL38

Video 5.2: Kryscynski, D. (2012, November 8). Generic strategies [Video]. YouTube. https://www.youtube.com/watch?v=V14kuqYEsxE