Generic Strategy

Porter's Generic Strategies
If the primary determinant of a firm's profitability is the attractiveness of the

industry in which it operates, an important secondary determinant is its position
within that industry. Even though an industry may have below-average
profitability, a firm that is optimally positioned can generate superior returns.
A firm positions itself by leveraging its strengths. Michael Porter has argued that
a firm's strengths ultimately fall into one of two headings: cost advantage and
differentiation. By applying these strengths in either a broad or narrow scope,
three generic strategies result: cost leadership, differentiation, and focus. These
strategies are applied at the business unit level. They are called generic
strategies because they are not firm or industry dependent. The following table
illustrates Porter's generic strategies:
Advantage
Target Scope
Low Cost Product Uniqueness
Broad Cost Leadership Differentiation

(Industry Wide) Strategy Strategy
Focus Focus
Narrow
(Market Segment) Strategy Strategy
(low cost) (differentiation)
Cost Leadership Strategy
This generic strategy calls for being the low cost producer in an industry for a
given level of quality. The firm sells its products either at average industry prices
to earn a profit higher than that of rivals, or below the average industry prices to
gain market share. In the event of a price war, the firm can maintain some
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profitability while the competition suffers losses. Even without a price war, as the
industry matures and prices decline, the firms that can produce more cheaply will
remain profitable for a longer period of time. The cost leadership strategy usually
targets a broad market.
Some of the ways that firms acquire cost advantages are by improving process
efficiencies, gaining unique access to a large source of lower cost materials,
making optimal outsourcing and vertical integration decisions, or avoiding some
costs altogether. If competing firms are unable to lower their costs by a similar
amount, the firm may be able to sustain a competitive advantage based on cost
leadership.
Firms that succeed in cost leadership often have the following internal strengths:
• Access to the capital required to make a significant investment in

production assets; this investment represents a barrier to entry that many
firms may not overcome.
• Skill in designing products for efficient manufacturing, for example, having
a small component count to shorten the assembly process.
• High level of expertise in manufacturing process engineering.
• Efficient distribution channels.
Each generic strategy has its risks, including the low-cost strategy. For example,
other firms may be able to lower their costs as well. As technology improves, the
competition may be able to leapfrog the production capabilities, thus eliminating
the competitive advantage. Additionally, several firms following a focus strategy
and targeting various narrow markets may be able to achieve an even lower cost
within their segments and as a group gain significant market share.
Differentiation Strategy
A differentiation strategy calls for the development of a product or service that

offers unique attributes that are valued by customers and that customers
perceive to be better than or different from the products of the competition. The
value added by the uniqueness of the product may allow the firm to charge a
premium price for it. The firm hopes that the higher price will more than cover the
extra costs incurred in offering the unique product. Because of the product's
unique attributes, if suppliers increase their prices the firm may be able to pass
along the costs to its customers who cannot find substitute products easily.
Firms that succeed in a differentiation strategy often have the following internal
strengths:
• Access to leading scientific research.

• Highly skilled and creative product development team.
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• Strong sales team with the ability to successfully communicate the
perceived strengths of the product.
• Corporate reputation for quality and innovation.
The risks associated with a differentiation strategy include imitation by

competitors and changes in customer tastes. Additionally, various firms pursuing
focus strategies may be able to achieve even greater differentiation in their
market segments.
Focus Strategy
The focus strategy concentrates on a narrow segment and within that segment
attempts to achieve either a cost advantage or differentiation. The premise is that
the needs of the group can be better serviced by focusing entirely on it. A firm
using a focus strategy often enjoys a high degree of customer loyalty, and this
entrenched loyalty discourages other firms from competing directly.
Because of their narrow market focus, firms pursuing a focus strategy have lower
volumes and therefore less bargaining power with their suppliers. However, firms
pursuing a differentiation-focused strategy may be able to pass higher costs on
to customers since close substitute products do not exist.
Firms that succeed in a focus strategy are able to tailor a broad range of product
development strengths to a relatively narrow market segment that they know very
well.
Some risks of focus strategies include imitation and changes in the target
segments. Furthermore, it may be fairly easy for a broad-market cost leader to
adapt its product in order to compete directly. Finally, other focusers may be able
to carve out sub-segments that they can serve even better.
A Combination of Generic Strategies

- Stuck in the Middle?
These generic strategies are not necessarily compatible with one another. If a
firm attempts to achieve an advantage on all fronts, in this attempt it may achieve
no advantage at all. For example, if a firm differentiates itself by supplying very
high quality products, it risks undermining that quality if it seeks to become a cost
leader. Even if the quality did not suffer, the firm would risk projecting a confusing
image. For this reason, Michael Porter argued that to be successful over the
long-term, a firm must select only one of these three generic strategies.
Otherwise, with more than one single generic strategy the firm will be "stuck in
the middle" and will not achieve a competitive advantage.
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Porter argued that firms that are able to succeed at multiple strategies often do
so by creating separate business units for each strategy. By separating the
strategies into different units having different policies and even different cultures,
a corporation is less likely to become "stuck in the middle."
However, there exists a viewpoint that a single generic strategy is not always
best because within the same product customers often seek multi-dimensional
satisfactions such as a combination of quality, style, convenience, and price.
There have been cases in which high quality producers faithfully followed a
single strategy and then suffered greatly when another firm entered the market
with a lower-quality product that better met the overall needs of the customers.
Generic Strategies and Industry Forces
These generic strategies each have attributes that can serve to defend against
competitive forces. The following table compares some characteristics of the
generic strategies in the context of the Porter's five forces.
Generic Strategies and Industry Forces
Industry Generic Strategies

Force Cost Leadership Differentiation Focus
Ability to cut price in Customer loyalty can Focusing develops core
Entry
retaliation deters discourage potential competencies that can act as an
Barriers potential entrants. entrants. entry barrier.
Ability to offer lower Large buyers have less Large buyers have less power to
Buyer
price to powerful power to negotiate because negotiate because of few
Power buyers. of few close alternatives. alternatives.
Suppliers have power because of
Better able to pass on low volumes, but a
Supplier Better insulated from
supplier price increases to differentiation-focused firm is
Power powerful suppliers.
customers. better able to pass on supplier
price increases.
Customer's become attached
Threat of Can use low price to to differentiating attributes, Specialized products & core
defend against competency protect against
Substitutes substitutes. reducing threat of
substitutes.
substitutes.
Rivals cannot meet
Better able to Brand loyalty to keep
Rivalry compete on price. customers from rivals.
differentiation-focused customer
needs.
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Porter generic strategies
Michael Porter has described a category scheme consisting of three general
types of strategies that are commonly used by businesses to achieve and
maintain competitive advantage. These three generic strategies are defined
along two dimensions: strategic scope and strategic strength. Strategic scope is
a demand-side dimension (Porter was originally an engineer, then an economist
before he specialized in strategy) and looks at the size and composition of the
market you intend to target. Strategic strength is a supply-side dimension and
looks at the strength or core competency of the firm. In particular he identified
two competencies that he felt were most important: product differentiation and
product cost (efficiency).
He originally ranked each of the three dimensions (level of differentiation, relative
product cost, and scope of target market) as either low, medium, or high, and
juxtaposed them in a three dimensional matrix. That is, the category scheme was
displayed as a 3 by 3 by 3 cube. But most of the 27 combinations were not
viable.
In his 1980 classic Competitive Strategy: Techniques for Analysing Industries

and Competitors, Porter simplifies the scheme by reducing it down to the three
best strategies. They are cost leadership, differentiation, and market
segmentation (or focus). Market segmentation is narrow in scope while both cost
leadership and differentiation are relatively broad in market scope.
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Empirical research on the profit impact of marketing strategy indicated that firms
with a high market share were often quite profitable, but so were many firms with
low market share. The least profitable firms were those with moderate market
share. This was sometimes referred to as the hole in the middle problem.
Porter’s explanation of this is that firms with high market share were successful
because they pursued a cost leadership strategy and firms with low market share
were successful because they used market segmentation to focus on a small but
profitable market niche. Firms in the middle were less profitable because they did
not have a viable generic strategy.
Combining multiple strategies is successful in only one case. Combining a

market segmentation strategy with a product differentiation strategy is an
effective way of matching your firm’s product strategy (supply side) to the
characteristics of your target market segments (demand side). But combinations
like cost leadership with product differentiation are hard (but not impossible) to
implement due to the potential for conflict between cost minimization and the
additional cost of value-added differentiation.
Since that time, some commentators have made a distinction between cost
leadership, that is, low cost strategies, and best cost strategies. They claim that a
low cost strategy is rarely able to provide a sustainable competitive advantage. In
most cases firms end up in price wars. Instead, they claim a best cost strategy is
preferred. This involves providing the best value for a relatively low price.
Cost Leadership Strategy

This strategy emphasizes efficiency. By producing high volumes of standardized
products, the firm hopes to take advantage of economies of scale and
experience curve effects. The product is often a basic no-frills product that is
produced at a relatively low cost and made available to a very large customer
base. Maintaining this strategy requires a continuous search for cost reductions
in all aspects of the business. The associated distribution strategy is to obtain the
most extensive distribution possible. Promotional strategy often involves trying to
make a virtue out of low cost product features.
To be successful, this strategy usually requires a considerable market share

advantage or preferential access to raw materials, components, labour, or some
other important input. Without one or more of these advantages, the strategy can
easily be mimicked by competitors. Successful implementation also benefits
from:
• process engineering skills

• products designed for ease of manufacture
• sustained access to inexpensive capital
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• close supervision of labour
• tight cost control
• incentives based on quantitative targets.
always ensure that the costs are kept at the minimum possible level.
Examples include retailers such as Wal-Mart and KwikSave as well as IT firms

such as Dell and Lenovo.
When a firm designs, produces and markets a product more efficiently than
competitors such firm has implemented a cost leadership strategy (Allen et al.
2006, p.25,). Cost reduction strategies across the activity cost chain will
represent low cost leadership (Tehrani 2003, p.610, Beheshti 2004, p. 118).
Attempts to reduce costs will spread through the whole business process from
manufacturing to the final stage of selling the product. Any processes that do not
contribute towards minimization of cost base should be outsourced to other
organisations with the view of maintaining a low cost base (Akan et al. 2006,
p.48). Low costs will permit a firm to sell relatively standardised products that
offer features acceptable to many customers at the lowest competitive price and
such low prices will gain competitive advantage and increase market share
(Porter 1980 cited by Srivannboon 2006, p.88; Porter 1979;1987;1986, Bauer
and Colgan 2001; Hyatt 2001; Anon 1988; Davidson 2001; Cross 1999 cited by
Allen and Helms 2006, p.435). These writings explain that cost efficiency gained
in the whole process will enable a firm to mark up a price lower than competition
which ultimately results in high sales since competition could not match such a
low cost base. If the low cost base could be maintained for longer periods of time
it will ensure consistent increase in market share and stable profits hence
consequent in superior performance. However all writings direct us to the
understanding that sustainability of the competitive advantage reached through
low cost strategy will depend on the ability of a competitor to match or develop a
lower cost base than the existing cost leader in the market.
A firm attempts to maintain a low cost base by controlling production costs,

increasing their capacity utilization, controlling material supply or product
distribution and minimizing other costs including R&D and advertising (Prajogo
2007,p.70). Mass production, mass distribution, economies of scale, technology,
product design, learning curve benefit, work force dedicated for low cost
production, reduced sales force, less spending on marketing will further help a
firm to main a low cost base (Freeman 2003, p.86; Trogovicky et al. 2005, p.18).
Decision makers in a cost leadership firm will be compelled to closely scrutinise
the cost efficiency of the processes of the firm. Maintaining the low cost base will
become the primary determinant of the cost leadership strategy. For low cost
leadership to be effective a firm should have a large market share (Robinson and
Chiang 2000, p.857; Hyatt 2001 cited by Allen and Helms 2006, p.435). New
entrants or firms with a smaller market share may not benefit from such strategy
since mass production, mass distribution and economies of scale will not make
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an impact on such firms. Low cost leadership becomes a viable strategy only for
larger firms. Market leaders may strengthen their positioning by advantages
attained through scale and experience in a low cost leadership strategy. But is
their any superiority in low cost strategy than other strategic typologies? Can a
firm that adopts a low cost strategy out perform another firm with a different
competitive strategy? If firms costs are low enough it may be profitable even in a
highly competitive scenario hence it becomes a defensive mechanism against
competitors (Kim et al. 2004, p.21). Further they mention that such low cost may
act as entry barriers since new entrants require huge capital to produce goods or
services at the same or lesser price than a cost leader. As discussed in the
academic frame work of competitive advantage raising barriers for competition
will consequent in sustainable competitive advantage and in consolidation with
the above writings we may establish the fact that low cost competitive strategy
may generate a sustainable competitive advantage. However, this is not true in
all cases.
Further in consideration of factors mentioned above that facilitate a firm in

maintaining a low cost base; some factors such as technology which may be
developed through innovation (mentioned as creative accumulation in
Schumpeterian innovation) and some may even be resources developed by a
firm such as long term healthy relationships build with distributors to maintain
cost effective distribution channels or supply chains (inimitable, unique, valuable
non transferable resource mentioned in RBV). Similarly economies of scale may
be an ultimate result of a commitment made by a firm such as capital
investments for expansions (as discussed in the commitment approach). Also
raising barriers for competition by virtue of the low cost base that enables the low
prices will result in strong strategic positioning in the market (discussed in the IO
structural approach). These significant strengths align with the four perspectives
of sustainable competitive advantage mentioned in the early parts of this
literature review. Low cost leadership could be considered as a competitive
strategy that will create a sustainable competitive advantage.
However, low cost leadership is attached to a disadvantage which is less

customer loyalty (Vokurka and Davis 2004, p. 490, Cross 1999 cited by Allen and
Helms 2006, p.436). Relatively low prices will result in creating a negative
attitude towards the quality of the product in the mindset of the customers (Priem
2007, p.220). Customer’s impression regarding such products will enhance the
tendency to shift towards a product which might be higher in price but projects an
image of quality. Considering analytical in depth view regarding the low cost
strategy, it reflects capability to generate a competitive advantage but
development and maintenance of a low cost base becomes a vital, decisive task.
Differentiation Strategy
Differentiation is aimed at the broad market that involves the creation of a
product or services that is perceived throughout its industry as unique. The
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company or business unit may then charge a premium for its product. This
specialty can be associated with design, brand image, technology, features,
dealers, network, or customers service. Differentiation is a viable strategy for
earning above average returns in a specific business because the resulting brand
loyalty lowers customers' sensitivity to price. Increased costs can usually be
passed on to the buyers. Buyers loyalty can also serve as an entry barrier-new
firms must develop their own distinctive competence to differentiate their
products in some way in order to compete successfully. Examples of the
successful use of a differentiation strategy are Hero Honda, Asian Paints, HLL,
Nike athletic shoes, Perstorp BioProducts, Apple Computer, and Mercedes-Benz
automobiles. Research does suggest that a differentiation strategy is more likely
to generate higher profits than is a low cost strategy because differentiation
creates a better entry barrier. A low-cost strategy is more likely, however, to
generate increases in market share. This may or may not be true.
Variants on the Differentiation Strategy
The shareholder value model holds that the timing of the use of specialized
knowledge can create a differentiation advantage as long as the knowledge
remains unique. This model suggests that customers buy products or services
from an organization to have access to its unique knowledge. The advantage is
static, rather than dynamic, because the purchase is a one-time event.
The unlimited resources model utilizes a large base of resources that allows
an organization to outlast competitors by practicing a differentiation strategy. An
organization with greater resources can manage risk and sustain losses more
easily than one with fewer resources. This deep-pocket strategy provides a short-
term advantage only. If a firm lacks the capacity for continual innovation, it will
not sustain its competitive position over time.
Focus Strategy
The firm focuses on a few target markets (also called a segmentation strategy or
niche strategy). It is hoped that by focusing your marketing efforts on one or two
narrow market segments and tailoring your marketing mix to these specialized
markets, you can better meet the needs of that target market. The firm typically
looks to gain a competitive advantage through product innovation and/or brand
marketing rather than efficiency. It is most suitable for relatively small firms but
can be used by any company. A focus strategy should target market segments
that are less vulnerable to substitutes or where a competition is weakest to earn
above-average return on investment.
Examples of firm using a focus strategy include Southwest Airlines, with provides
short-haul point-to-point flights in contrast to the hub-and-spoke model of
mainstream carriers, and Family Dollar, which targets poor urban American
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families who can not drive to Wal-Marts in the suburbs because they do not own
a car.
Recent developments
Michael Treacy and Fred Wiersema (1993) have modified Porter's three
strategies to describe three basic "value disciplines" that can create customer
value and provide a competitive advantage. They are operational excellence,
product leadership, and customer intimacy.
Criticisms of generic strategies

Several commentators have questioned the use of generic strategies claiming
they lack specificity, lack flexibility, and are limiting.
In particular, Miller (1992) questions the notion of being "caught in the middle".
He claims that there is a viable middle ground between strategies. Many
companies, for example, have entered a market as a niche player and gradually
expanded. According to Baden-Fuller and Stopford (1992) the most successful
companies are the ones that can resolve what they call "the dilemma of
opposites".
A popular post-Porter model was presented by W. Chan Kim and Renée

Mauborgne in their 1999 Harvard Business Review article "Creating New Market
Space". In this article they described a "value innovation" model in which
companies must look outside their present paradigms to find new value
propositions. Their approach fundamentally goes against Porter's concept that a
firm must focus either on cost leadership or on differentiation. They later went on
to publish their ideas in the book Blue Ocean Strategy.
An up-to-date critique of generic strategies and their limitations, including Porter,

appears in Bowman, C. (2008) Generic strategies: a substitute for thinking? [1]
From the three generic business strategies Porter stress the idea that only
one strategy should be adopted by a firm and failure to do so will result in “
stuck in the middle” scenario (Porter 1980 cited by Allen et al.
2006,Torgovicky et al. 2005). He discuss the idea that practising more than
one strategy will lose the entire focus of the organisation hence clear direction
of the future trajectory could not be established. The argument is based on
the fundamental that differentiation will incur costs to the firm which clearly
contradicts with the basis of low cost strategy and in the other hand relatively
standardised products with features acceptable to many customers will not
carry any differentiation (Panayides 2003, p.126) hence, cost leadership and
differentiation strategy will be mutually exclusive ( Porter 1980 cited by
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Trogovicky et al. 2005, p.20). Two focal objectives of low cost leadership and
differentiation clash with each other resulting in no proper direction for a firm.
However, contrarily to the rationalisation of Porter, contemporary research has

shown evidence of firms practising such a “hybrid strategy”. Hambrick (1983
cited by Kim et al. 2004, p.25) identified successful organisations that adopt a
mixture of low cost and differentiation strategy (Kim et al. 2004, p.25). Research
writings of Davis (1984 cited by Prajogo 2007, p.74) state that firms employing
the hybrid business strategy (Low cost and differentiation strategy) outperform
the ones adopting one generic strategy. Sharing the same view point, Hill (1988
cited by Akan et al. 2006, p.49) challenged Porter’s concept regarding mutual
exclusivity of low cost and differentiation strategy and further argued that
successful combination of those two strategies will result in sustainable
competitive advantage. As to Wright and other (1990 cited by Akan et al. 2006,
p.50) multiple business strategies are required to respond effectively to any
environment condition. In the mid to late 1980’s where the environments were
relatively stable there was no requirement for flexibility in business strategies but
survival in the rapidly changing, highly unpredictable present market contexts will
require flexibility to face any contingency (Anderson 1997, Goldman et al. 1995,
Pine 1993 cited by Radas 2005, p.197).After eleven years Porter revised his
thinking and accepted the fact that hybrid business strategy could exist (Porter
cited by Projogo 2007, p.70) and writes in the following manner
…Competitive advantage can be divided into two basic types: lower costs than
rivals, or the ability to differentiate and command a premium price that exceeds
the extra costs of doing so. Any superior performing firm has achieved one type
of advantage, the other or both ( 1991,p.101).
Though Porter had a fundamental rationalisation in his concept about the

invalidity of hybrid business strategy, the highly volatile and turbulent market
conditions will not permit survival of rigid business strategies since long term
establishment will depend on the agility and the quick responsiveness towards
market and environmental conditions. Market and environmental turbulence will
make drastic implications on the root establishment of a firm. If a firm’s business
strategy could not cope with the environmental and market contingencies, long
term survival becomes unrealistic. Diverging the strategy into different avenues
with the view to exploit opportunities and avoid threats created by market
conditions will be a pragmatic approach for a firm.
Critical analysis done separately for cost leadership strategy and differentiation strategy
identifies elementary value in both strategies in creating and sustaining a competitive
advantage. Consistent and superior performance than competition could be reached with
stronger foundations in the event “hybrid strategy” is adopted. Depending on the market
and competitive conditions hybrid strategy should be adjusted regarding the extent which
each generic strategy (cost leadership or differentiation) should be given priority in
practise.
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Choosing Your Route to Competitive Advantage
Which do you prefer when you fly: a cheap, no-frills airline, or a more expensive
operator with fantastic service levels and maximum comfort? And would you ever
consider going with a small company which focuses on just a few routes?
The choice is up to you, of course. But the point we're making here is that when
you come to book a flight, there are some very different options available.
Why is this so? The answer is that each of these airlines has chosen a different
way of achieving competitive advantage in a crowded marketplace.
The no-frills operators have opted to cut costs to a minimum and pass their
savings on to customers in lower prices. This helps them grab market share and
ensure their planes are as full as possible, further driving down cost. The luxury
airlines, on the other hand, focus their efforts on making their service as
wonderful as possible, and the higher prices they can command as a result more
than make up for their higher costs.
Meanwhile, smaller airlines try to make the most of their detailed knowledge of
just a few routes to provide better or cheaper services than their larger,
international rivals.
These three approaches are examples of "generic strategies", because they can
be applied to products or services in all industries, and to organizations of all
sizes. They were first set out by Michael Porter in 1985 in his book Competitive
Advantage: Creating and Sustaining Superior Performance. Porter called the
generic strategies "Cost Leadership" (no frills), "Differentiation" (creating uniquely
desirable products and services) and "Focus" (offering a specialized service in a
niche market). He then subdivided the Focus strategy into two parts: "Cost
Focus" and "Differentiation Focus". These are shown in Figure 1 below.
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The terms "Cost Focus" and "Differentiation Focus" can be a
little confusing, as they could be interpreted as meaning "A
focus on cost" or "A focus on differentiation". Remember that
Cost Focus means emphasizing cost-minimization within a
focused market, and Differentiation Focus means pursuing
strategic differentiation within a focused market.
The Cost Leadership Strategy

Porter's generic strategies are ways of gaining competitive advantage - in other
words, developing the "edge" that gets you the sale and takes it away from your
competitors. There are two main ways of achieving this within a Cost Leadership
strategy:
• Increasing profits by reducing costs, while charging industry-average

prices.
• Increasing market share through charging lower prices, while still making
a reasonable profit on each sale because you've reduced costs.
Remember that Cost Leadership is about minimizing the cost

to the organization of delivering products and services. The
cost or price paid by the customer is a separate issue!
The Cost Leadership strategy is exactly that - it involves being the leader in
terms of cost in your industry or market. Simply being amongst the lowest-cost
producers is not good enough, as you leave yourself wide open to attack by other
low cost producers who may undercut your prices and therefore block your
attempts to increase market share.
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You therefore need to be confident that you can achieve and maintain the
number one position before choosing the Cost Leadership route. Companies that
are successful in achieving Cost Leadership usually have:
• Access to the capital needed to invest in technology that will bring costs
down.
• Very efficient logistics.
• A low cost base (labor, materials, facilities), and a way of sustainably
cutting costs below those of other competitors.
The greatest risk in pursuing a Cost Leadership strategy is that these sources of
cost reduction are not unique to you, and that other competitors copy your cost
reduction strategies. This is why it's important to continuously find ways of
reducing every cost. One successful way of doing this is by adopting the
Japanese Kaizen philosophy of "continuous improvement".
The Differentiation Strategy

Differentiation involves making your products or services different from and more
attractive those of your competitors. How you do this depends on the exact
nature of your industry and of the products and services themselves, but will
typically involve features, functionality, durability, support and also brand image
that your customers value.
To make a success of a generic Differentiation strategy, organizations need:
• Good research, development and innovation.

• The ability to deliver high-quality products or services.
• Effective sales and marketing, so that the market understands the benefits
offered by the differentiated offerings.
Large organizations pursuing a differentiation strategy need to stay agile with

their new product development processes. Otherwise, they risk attack on several
fronts by competitors pursuing Focus Differentiation strategies in different market
segments.
The Focus Strategy

Companies that use Focus strategies well concentrate on particular niche
markets and, by understanding the dynamics of that market and the unique
needs of customers in it, develop uniquely low cost or well-specified products for
the market. Because they serve customers in their market uniquely well, they
tend to build strong brand loyalty amongst their customers. This makes their
particular market segment less attractive to competitors.
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As with broad market strategies, it is still essential to decide whether you will
pursue Cost Leadership or Differentiation once you have selected a Focus
strategy as your main approach: Focus is not normally enough on its own.
But whether you use Cost Focus or Differentiation Focus, the key to making a
success of a generic Focus strategy is to ensure that you are adding something
extra as a result of serving only that market niche. It's simply not enough to focus
on only one market segment because your organization is too small to serve a
broader market (if you do, you risk competing against better-resourced broad
market companies' offerings.)
The "something extra" that you add can contribute to reducing costs (perhaps
through your knowledge of specialist suppliers) or to increasing differentiation
(though your deep understanding of customers' needs).
Generic strategies apply to not-for-profit organizations too. A

not-for-profit can use a Cost Leadership strategy to minimize
the cost of getting donations and achieving more for their
income, while one with pursing a Differentiation strategy will be
committed to the very best outcomes, even if the volume of
work they do as a result is lower. Local charities are great
examples of organizations using Focus strategies to get
donations and contribute to their communities.
Choosing the Right Generic Strategy

Your choice of which generic strategy to pursue underpins every other strategic
decision you make, so it's worth spending time to get it right.
But you do need to make a decision: Porter specifically warns against trying to
"hedge your bets" by following more than one strategy. One of the most
important reasons why this is wise advice is that the things you need to do to
make each type of strategy work appeal to different types of people. Cost
Leadership requires a very detailed internal focus on processes. Differentiation,
on the other hand, demands an outward-facing, highly creative approach.
So, when you come to choose which of the three generic strategies is for you, it's
vital that you take your organization's competencies and strengths into account.
Use the following steps to help you choose.
Step 1: For each generic strategy, carry out a SWOT analysis of your strengths
and weaknesses, and the opportunities and threats you would face, if you
adopted that strategy.
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Having done this, it may be clear that your organization is unlikely to be able to
make a success of some of the generic strategies.
Step 2: Use Five Forces Analysis to understand the nature of the industry you
are in.
Step 3: Compare the SWOT analyses of the viable strategic options with the
results of your Five Forces analysis. For each strategic option, ask yourself how
you could use that strategy to:
• Reduce or manage supplier power.

• Reduce or manage buyer/customer power.
• Come out on top of the competitive rivalry.
• Reduce or eliminate the threat of substitution.
• Reduce or eliminate the threat of new entry.
Select the generic strategy that gives you the strongest set of options.
Porter's Generic Strategies offer a great starting point for

strategic decision making. Once you've made your basic
choice, though, there are still many strategic options available.
Bowman's Strategy Clock helps you think at the next level of
details, in that it splits Porter's options into eight sub-strategies.
Key Points:
According to Porter's Generic Strategies model, there are three basic strategic
options available to organizations for gaining competitive advantage. These are:
Cost Leadership, Differentiation and Focus.
Organizations that achieve Cost Leadership can benefit either by gaining market
share through lowering prices (whilst maintaining profitability,) or by maintaining
average prices and therefore increasing profits. All of this is achieved by reducing
costs to a level below those of the organization's competitors.
Companies that pursue a Differentiation strategy win market share by offering

unique features that are valued by their customers. Focus strategies involve
achieving Cost Leadership or Differentiation within niche markets in ways that
are not available to more broadly-focused players.
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Apply This to Your Life
• Ask yourself what your organization's generic strategy

is. How does this affect the choices your make in your
job?
• If you're in an organization omitted to achieving Cost

Leadership, can you reduce costs by hiring less
expensive staff and training them up, or reducing
turnover? Can you reduce training costs by devising in-
house schemes for sharing skills and knowledge
amongst team members? Can you reduce expenses by
using technology such as video conferencing over the
Internet?
• If your organization is pursuing to Differentiation, can

you improve customer service? Customer Experience
Mapping may help here. Can you help to foster a
culture of continuous improvement and innovation in
your team?
• And if you're working for a company that has a chosen a

Focus strategy, what knowledge or expertise can you
use or develop to add value for your customers that isn't
available to broad market competitors?
17
Strategy and Marketing Primer
CONTENTS
PORTER GENERIC STRATEGIES...........................................................................................................5

COST LEADERSHIP STRATEGY.............................................................................................................................6
DIFFERENTIATION STRATEGY..............................................................................................................................8
Variants on the Differentiation Strategy.....................................................................9
FOCUS STRATEGY..............................................................................................................................................9
RECENT DEVELOPMENTS...................................................................................................................................10
CRITICISMS OF GENERIC STRATEGIES...................................................................................................................10
PORTER'S GENERIC STRATEGIES......................................................................................................12
Choosing Your Route to Competitive Advantage....................................................12
THE COST LEADERSHIP STRATEGY....................................................................................................................13
THE DIFFERENTIATION STRATEGY.....................................................................................................................14
THE FOCUS STRATEGY.....................................................................................................................................14
CHOOSING THE RIGHT GENERIC STRATEGY.........................................................................................................15
KEY POINTS:..................................................................................................................................................16
GENERIC STRATEGY: TYPES OF COMPETITIVE ADVANTAGE................................................19
CONCEPTUAL STRATEGY FRAMEWORKS: HOW COMPETITIVE ADVANTAGE IS
CREATED.....................................................................................................................................................21
PORTER'S 5 FORCES & INDUSTRY STRUCTURE....................................................................................................22
CORE COMPETENCE AND CAPABILITIES...............................................................................................................26
RESOURCE-BASED VIEW OF THE FIRM (RBV)...................................................................................................27
ALTERNATIVE FRAMEWORKS: EVOLUTIONARY CHANGE AND HYPERCOMPETITION.....................................................29
ADDITIONAL TOOLS FOR STRATEGIC THINKING AND ANALYSIS.........................................32
GAME THEORY...............................................................................................................................................32
OPTIONS........................................................................................................................................................33
STRATEGIC SCENARIOS.....................................................................................................................................37
OTHER PARTICULARLY RELEVANT EES&OR CORE CONCEPTS............................................................................38
MARKETING MODELS FOR PRODUCT STRATEGY.......................................................................39
NEW PRODUCT DIFFUSION MODELS..................................................................................................................39
CONJOINT ANALYSIS.......................................................................................................................................41
CONCEPTUAL MARKETING FRAMEWORKS...................................................................................44
THE FOUR P’S OF THE MARKETING MIX............................................................................................................44
MARKET-ORIENTED STRATEGIC PLANNING.........................................................................................................45
MARKET SEGMENTATION, TARGETING, AND POSITIONING.....................................................................................47
ANALYZING INDUSTRIES AND COMPETITORS........................................................................................................49
THE TECHNOLOGY ADOPTION LIFE CYCLE: DISCONTINUOUS INNOVATIONS.............................................................51
18
Generic Strategy: Types of
Competitive Advantage
Basically, strategy is about two things: deciding where you want your business to
go, and deciding how to get there. A more complete definition is based on
competitive advantage, the object of most corporate strategy:
Competitive advantage grows out of value a firm is able to create for its buyers
that exceeds the firm's cost of creating it. Value is what buyers are willing to pay,
and superior value stems from offering lower prices than competitors for
equivalent benefits or providing unique benefits that more than offset a higher
price. There are two basic types of competitive advantage: cost leadership and
differentiation.
-- Michael Porter, Competitive Advantage,
1985, p.3
The figure below defines the choices of "generic strategy" a firm can follow. A
firm's relative position within an industry is given by its choice of competitive
advantage (cost leadership vs. differentiation) and its choice of competitive
scope. Competitive scope distinguishes between firms targeting broad industry
segments and firms focusing on a narrow segment. Generic strategies are
useful because they characterize strategic positions at the simplest and broadest
level. Porter maintains that achieving competitive advantage requires a firm to
make a choice about the type and scope of its competitive advantage. There are
different risks inherent in each generic strategy, but being "all things to all
people" is a sure recipe for mediocrity - getting "stuck in the middle".
Treacy and Wiersema (1995) offer another popular generic framework for gaining
competitive advantage. In their framework, a firm typically will choose to
emphasize one of three “value disciplines”: product leadership, operational
excellence, and customer intimacy.
Porter's Generic Strategies (source: Porter, 1985, p.12)
19
COMPETITIVE ADVANTAGE
Lower Cost Differentiation
Broad 1. Cost Leadership 2. Differentiation

Target
COMPETITIVE
SCOPE
Narrow 3A. Cost Focus 3B. Differentiation
Target Focus
References:
• Porter, Michael, Competitive Advantage, The Free Press, NY, 1985.
• Porter, Michael, "What is strategy?" Harvard Business Review v74, n6 (Nov-
Dec, 1996):61 (18 pages).
• Treacy, M., F. Wiersema, The Discipline of Market Leaders, Addison-Wesley,
1995.
20
Conceptual Strategy Frameworks:
How Competitive Advantage is
Created
Frameworks vs. Models
We distinguish here between strategy frameworks and strategy models. Strategy
models have been used in theory building in economics to understand industrial
organization. However, the models are difficult to apply to specific company
situations. Instead, qualitative frameworks have been developed with the
specific goal of better informing business practice. In another sense, we may
also talk about “frameworks” in this class as referring to the guiding analytical
approach you take to your project (i.e. decision analysis, economics, finance,
etc.).
Some Perspective on Strategy Frameworks: Internal and External Framing for

Strategic Decisions
It may be helpful to think of strategy frameworks as having two components:
internal and external analysis. The external analysis builds on an economics
perspective of industry structure, and how a firm can make the most of
competing in that structure. It emphasizes where a company should compete,
and what's important when it does compete there. Porter's 5 Forces and Value
Chain concepts comprise the main externally-based framework. The external
view helps inform strategic investments and decisions. Internal analysis, like
core competence for example, is less based on industry structure and more in
specific business operations and decisions. It emphasizes how a company
should compete. The internal view is more appropriate for strategic organization
and goal setting for the firm.
Porter's focus on industry structure is a powerful means of analyzing competitive

advantage in itself, but it has been criticized for being too static in an increasingly
fast changing world. The internal analysis emphasizes building competencies,
resources, and decision-making into a firm such that it continues to thrive in a
changing environment. Though some frameworks rely more on one type of
analysis than another, both are important. However, neither framework in itself is
sufficient to set the strategy of a firm. The internal and external views mostly
frame and inform the problem. The actual firm strategy will have to take into
account the particular challenges facing a company, and would address issues of
financing, product and market, and people and organization. Some of these
strategic decisions are event driven (particular projects or reorgs responding to
the environment and opportunity), while others are the subject of periodic
strategic reviews.
21
Porter's 5 Forces & Industry Structure
What is the basis for competitive advantage?
Industry structure and positioning within the industry are the basis for models of
competitive strategy promoted by Michael Porter. The “Five Forces” diagram
captures the main idea of Porter’s theory of competitive advantage. The Five
Forces define the rules of competition in any industry. Competitive strategy must
grow out of a sophisticated understanding of the rules of competition that
determine an industry's attractiveness. Porter claims, "The ultimate aim of
competitive strategy is to cope with and, ideally, to change those rules in the
firm's behavior." (1985, p. 4) The five forces determine industry profitability, and
some industries may be more attractive than others. The crucial question in
determining profitability is how much value firms can create for their buyers, and
how much of this value will be captured or competed away. Industry structure
determines who will capture the value. But a firm is not a complete prisoner of
industry structure - firms can influence the five forces through their own
strategies. The five-forces framework highlights what is important, and directs
manager's towards those aspects most important to long-term advantage. Be
careful in using this tool: just composing a long list of forces in the competitive
environment will not get you very far – it’s up to you to do the analysis and
identify the few driving factors that really define the industry. Think of the Five
Forces framework as sort of a checklist for getting started, and as a reminder of
the many possible sources for what those few driving forces could be.
22
Porter's 5 Forces - Elements of Industry Structure (source: Porter, 1985, p.6)
Entry Barriers Rivalry Determinants

• Economies of scale • Industry growth
• Proprietary product differences • Fixed (or storage) costs / value added
• Brand identity • Intermittent overcapacity
• Switching costs • Product differences
• Capital requirements
New Entrants • Brand identity
• Access to distribution • Switching costs
• Absolute cost advantages • Concentration and balance
Proprietary learning curve Threat of • Informational complexity
Access to necessary inputs • Diversity of competitors
Proprietary low-cost product design
New Entrants • Corporate stakes
• Government policy • Exit barriers
• Expected retaliation
Industry
Bargaining Power Competitors Bargaining Power
of Suppliers of Buyers
Suppliers Buyers
Intensity
of Rivalry
Determinants of Buyer Power
Determinants of Supplier Power
• Differentiation of inputs
• Switching costs of suppliers and firms in the industry Threat of Bargaining Leverage Price Sensitivity
• Presence of substitute inputs • Buyer concentration vs. • Price/total purchases
• Supplier concentration
Substitutes
firm concentration • Product differences
• Importance of volume to supplier • Buyer volume • Brand identity
• Cost relative to total purchases in the industry • Buyer switching costs • Impact on quality/
• Impact of inputs on cost or differentiation relative to firm performance
• Threat of forward integration relative to threat of Substitutes switching costs • Buyer profits
backward integration by firms in the industry • Buyer information • Decision maker’s
• Ability to backward incentives
Determinants of Substitution Threat
integrate
• Relative price performance of substitutes
• Substitute products
• Switching costs
• Pull-through
• Buyer propensity to substitute
How is competitive advantage created?

At the most fundamental level, firms create competitive advantage by perceiving
or discovering new and better ways to compete in an industry and bringing them
to market, which is ultimately an act of innovation. Innovations shift competitive
advantage when rivals either fail to perceive the new way of competing or are
unwilling or unable to respond. There can be significant advantages to early
movers responding to innovations, particularly in industries with significant
economies of scale or when customers are more concerned about switching
suppliers. The most typical causes of innovations that shift competitive
advantage are the following:
• new technologies
• new or shifting buyer needs
• the emergence of a new industry segment
• shifting input costs or availability
• changes in government regulations
How is competitive advantage implemented?

But besides watching industry trends, what can the firm do? At the level of
strategy implementation, competitive advantage grows out of the way firms
23
perform discrete activities - conceiving new ways to conduct activities, employing
new procedures, new technologies, or different inputs. The "fit" of different
strategic activities is also vital to lock out imitators. Porters "Value Chain" and
"Activity Mapping" concepts help us think about how activities build competitive
advantage.
The value chain is a systematic way of examining all the activities a firm performs
and how they interact. It scrutinizes each of the activities of the firm (e.g.
development, marketing, sales, operations, etc.) as a potential source of
advantage. The value chain maps a firm into its strategically relevant activities in
order to understand the behavior of costs and the existing and potential sources
of differentiation. Differentiation results, fundamentally, from the way a firm's
product, associated services, and other activities affect its buyer's activities. All
the activities in the value chain contribute to buyer value, and the cumulative
costs in the chain will determine the difference between the buyer value and
producer cost.
A firm gains competitive advantage by performing these strategically important

activities more cheaply or better than its competitors. One of the reasons the
value chain framework is helpful is because it emphasizes that competitive
advantage can come not just from great products or services, but from anywhere
along the value chain. It's also important to understand how a firm fits into the
overall value system, which includes the value chains of its suppliers, channels,
and buyers.
With the idea of activity mapping, Porter (1996) builds on his ideas of generic
strategy and the value chain to describe strategy implementation in more detail.
Competitive advantage requires that the firm's value chain be managed as a
system rather than a collection of separate parts. Positioning choices determine
not only which activities a company will perform and how it will configure
individual activities, but also how they relate to one another. This is crucial, since
the essence of implementing strategy is in the activities - choosing to perform
activities differently or to perform different activities than rivals. A firm is more
than the sum of its activities. A firm's value chain is an interdependent system or
network of activities, connected by linkages. Linkages occur when the way in
which one activity is performed affects the cost or effectiveness of other
activities. Linkages create tradeoffs requiring optimization and coordination.
Porter describes three choices of strategic position that influence the

configuration of a firm's activities:
• variety-based positioning - based on producing a subset of an industry's
products or services; involves choice of product or service varieties rather
than customer segments. Makes economic sense when a company can
produce particular products or services using distinctive sets of activities. (i.e.
Jiffy Lube for auto lubricants only)
24
• needs-based positioning - similar to traditional targeting of customer
segments. Arises when there are groups of customers with differing needs,
and when a tailored set of activities can serve those needs best. (i.e. Ikea to
meet all the home furnishing needs of a certain segment of customers)
• access-based positioning - segmenting by customers who have the same
needs, but the best configuration of activities to reach them is different. (i.e.
Carmike Cinemas for theaters in small towns)
Porter's major contribution with "activity mapping" is to help explain how different
strategies, or positions, can be implemented in practice. The key to successful
implementation of strategy, he says, is in combining activities into a consistent fit
with each other. A company's strategic position, then, is contained within a set of
tailored activities designed to deliver it. The activities are tightly linked to each
other, as shown by a relevance diagram of sorts. Fit locks out competitors by
creating a "chain that is as strong as its strongest link." If competitive advantage
grows out of the entire system of activities, then competitors must match each
activity to get the benefit of the whole system.
Porter defines three types of fit:

• simple consistency - first order fit between each activity and the overall
strategy
• reinforcing - second order fit in which distinct activities reinforce each other
• optimization of effort - coordination and information exchange across activities
to eliminate redundancy and wasted effort.
How is competitive advantage sustained?

Porter (1990) outlines three conditions for the sustainability of competitive
advantage:
• Hierarchy of source (durability and imitability) - lower-order advantages such
as low labor cost may be easily imitated, while higher order advantages like
proprietary technology, brand reputation, or customer relationships require
sustained and cumulative investment and are more difficult to imitate.
• Number of distinct sources - many are harder to imitate than few.
• Constant improvement and upgrading - a firm must be "running scared,"
creating new advantages at least as fast as competitors replicate old ones.
References:
• Porter, Michael, Competitive Advantage, The Free Press, NY, 1985.
• Porter, Michael, The Competitive Advantage of Nations, The Free Press, NY,
1990.
• Porter, Michael, "What is strategy?" Harvard Business Review v74, n6 (Nov-
Dec, 1996):61 (18 pages).
25
Core Competence and Capabilities
Proponents of this framework emphasize the importance of a dynamic strategy in
today's more dynamic business environment. They argue that a strategy based
on a "war of position" in industry structure works only when markets, regions,
products, and customer needs are well defined and durable. As markets
fragment and proliferate, and product life cycles accelerate, "owning" any
particular market segment becomes more difficult and less valuable. In such an
environment, the essence of strategy is not the structure of a company's products
and markets but the dynamics of its behavior. A successful company will move
quickly in and out of products, markets, and sometimes even business segments.
Underlying it all, though, is a set of core competencies or capabilities that are
hard to imitate and distinguish the company from competition. These core
competencies, and a continuous strategic investment in them, govern the long
term dynamics and potential of the company.
What are core competencies and capabilities?

• Prahalad and Hamel (1990) speak of core competencies as the collective
learning in the organization, especially how to coordinate diverse production
skills and integrate multiple streams of technology. These skills underlie a
company's various product lines, and explain the ease with which successful
competitors are able to enter new and seemingly unrelated businesses.
Three tests can be applied to identify core competencies: (1) provides
potential access to wide variety of markets, (2) makes significant contribution
to end user value, and (3) difficult for competitors to imitate.
• Examples of core competence: Sony in miniaturization, allowing it to make
everything from Walkmans to video cameras to notebook computers.
Canon's core competence in optics, imaging, and microprocessor controls
have enabled it to enter markets as seemingly diverse as copiers, laser
printers, cameras, and image scanners.
• Stalk, Evans, and Schulman (1992) speak of capabilities similarly, but defined
more broadly to encompass the entire value chain rather than just specific
technical and production expertise.
• Examples of capabilities: Wal-mart in inventory management, Honda in dealer
management and product realization.
Implications for strategy?

• Portfolio of competencies. An essential lesson of this framework is that
competencies are the roots of competitive advantage, and therefore
businesses should be organized as a portfolio of competencies (or
capabilities) rather than a portfolio of businesses. Organization of a company
into autonomous strategic business units, based on markets or products, can
cripple the ability to exploit and develop competencies - it unnecessarily
restricts the returns to scale across the organization. Core competence is
26
communication, involvement, and a deep commitment to working across
organizational boundaries.
• Products based on competencies. Product portfolios (at least in technology-
based companies) should be based on core competencies, with core
products being the physical embodiment of one or more core competencies.
Thus, core competence allows both focus (on a few competencies) and
diversification (to whichever markets firm's capabilities can add value). To
sustain leadership in their chosen core competence areas, companies should
seek to maximize their world manufacturing share in core products. This
partly determines the pace at which competencies can be enhanced and
extended (through a learning-by-doing sort of improvement).
• Continuous investment in core competencies or capabilities. The costs of
losing a core competence can be only partly calculated in advance - since the
embedded skills are built through a process of continuous improvement, it is
not something that can be simply bought back or "rented in" by outsourcing.
Wal-mart, for example, has invested heavily in its logistics infrastructure, even
if the individual investments could not be justified by ROR analysis. They
were strategic investments that enabled the company's relentless focus on
customer needs. While Wal-mart was building up its competencies, K-mart
was outsourcing whenever it was cheapest.
• Caution: core competencies as core rigidities. Bowen et al. talk about the
limitations to restricting product development to areas in which core
competencies already exist, or core rigidities. Good companies may try to
incrementally improve their competencies by bringing in one or two new core
competencies with each new major development project they pursue.
References:
• Bowen, Clark, Holloway, Wheelright, Perpetual Enterprise Machine, Oxford
Press, 1994.
• Prahalad, C.K. and Gary Hamel, "The Core Competence of the Corporation,"
Harvard Business Review, v68, n3 (May-June, 1990):79 (13 pages).
• Stalk, G., Evans, P., and L. Schulman, "Competing on Capabilities: the New
Rules of Corporate Strategy," v70, n2 (March-April, 1992):57 (13 pages).
Resource-Based View of the Firm (RBV)

What is RBV?
The RBV framework combines the internal (core competence) and external
(industry structure) perspectives on strategy. Like the frameworks of core
competence and capabilities, firms have very different collections of physical and
intangible assets and capabilities, which RBV calls resources. Competitive
advantage is ultimately attributed to the ownership of a valuable resource.
Resources are more broadly defined to be physical (e.g. property rights, capital),
27
intangible (e.g. brand names, technological know how), or organizational (e.g.
routines or processes like lean manufacturing). No two companies have the
same resources because no two companies have had the same set of
experience, acquired the same assets and skills, or built the same organizational
culture. And unlike the core competence and capabilities frameworks, though,
the value of the broadly-defined resources is determined in the interplay with
market forces. Enter Porter's 5 Forces. For a resource to be the basis of an
effective strategy, it must pass a number of external market tests of its value.
Collins and Montgomery (1995) offer a series of five tests for a valuable
resource:
1. Inimitability - how hard is it for competitors to copy the resource? A company
can stall imitation if the resource is (1) physically unique, (2) a consequence
of path dependent development activities, (3) causally ambiguous
(competitors don't know what to imitate), or (4) a costly asset investment for a
limited market, resulting in economic deterrence.
2. Durability - how quickly does the resource depreciate?
3. Appropriability - who captures the value that the resource creates: company,
customers, distributors, suppliers, or employees?
4. Substitutability - can a unique resource be trumped by a different resource?
5. Competitive Superiority - is the resource really better relative to competitors?
Similarly, but from a more external, economics perspective, Peteraf (1993)

proposes four theoretical conditions for competitive advantage to exist in an
industry:
1. Heterogeneity of resources => rents exist
A basic assumption is that resource bundles and capabilities are
heterogeneous across firms. This difference is manifested in two ways. First,
firms with superior resources can earn Ricardian rents (profits) in competitive
markets because they produce more efficiently than others. What is key is
that the superior resource remains in limited supply. Second, firms with
market power can earn monopoly profits from their resources by deliberately
restricting output. Heterogeneity in monopoly models may result from
differentiated products, intra-industry mobility barriers, or first-mover
advantages, for example.
2. Ex-post limits to competition => rents sustained
Subsequent to a firm gaining a superior position and earning rents, there
must be forces that limit competition for those rents (imitability and
substitutability).
3. Imperfect mobility => rents sustained within the firm
Resources are imperfectly mobile if they cannot be traded, so they cannot be
bid away from their employer; competitive advantage is sustained.
4. Ex-ante limits to competition => rents not offset by costs
Prior to the firm establishing its superior position, there must be limited
competition for that position. Otherwise, the cost of getting there would offset
the benefit of the resource or asset.
28
• Managers should build their strategies on resources that pass the above
tests. In determining what are valuable resources, firms should look both at
external industry conditions and at their internal capabilities. Resources can
come from anywhere in the value chain and can be physical assets,
intangibles, or routines.
• Continuous improvement and upgrading of the resources is essential to
prospering in a constantly changing environment. Firms should consider
industry structure and dynamics when deciding which resources to invest in.
• In corporations with a divisional structure, it's easy to make the mistake of
optimizing divisional profits and letting investment in resources take a back
seat.
• Good strategy requires continual rethinking of the company's scope, to make
sure it's making the most of its resources and not getting into markets where it
does not have a resource advantage. RBV can inform about the risks and
benefits of diversification strategies.
References:
• Collis, David J.; Montgomery, Cynthia A. "Competing on resources: strategy
in the 1990s", Harvard Business Review, v73, n4 (July-August, 1995):118 (11
pages).
• M.A. Peteraf, "The Cornerstones of Competitive Advantage: A Resource-
Based View," in Strategic Management Journal 1993, Vol. 14, pp. 179-191.
Alternative Frameworks: Evolutionary Change

and Hypercompetition
Recently, strategy literature has focused on managing change as the central
strategic challenge. Change, the story goes, is the striking feature of
contemporary business, and successful firms will be the ones that deal most
effectively with change, not simply those that are good at planning ahead. When
the direction of change is too uncertain, managers simply cannot plan effectively.
When industries are rapidly and unpredictably changing, strategy based on
industry analysis, core capabilities, and planning may be inadequate by
themselves, and would be well complemented by an orientation towards dealing
with change effectively and continuously.
Evolutionary Change
Theories that draw analogies between biological evolution and economics or
business can very satisfying: they explain the way things work in the real world,
where analysis and planning is often a rarity. Moreover, they suggest that
29
strategies based on flexibility, experimentation and continuous change and
learning can be even more important than rigorous analysis and planning.
Indeed, overplanning is a danger to be avoided.
In Competing on the Edge, Eisenhardt (1998) advocates a strategy based on

what she calls "competing on the edge," combining elements of complexity
theory with evolutionary theory. In such a framework, firms develop a "semi-
coherent strategic direction" of where they want to go. They do this by having
the right balance between order and chaos - firms can then successfully evolve
and adapt to their unpredictable environment. By competing at the "edge of
chaos," a firm creates an organization that can change and produce a continuous
flow of competitive advantages that form the "semi-coherent" direction. Firms
are not hindered by too much planning or centralized control, but they have
enough structure so that change can be organized to happen. They successfully
evolve, because they pursue a variety of moves, and in doing so make some
mistakes but also relentlessly reinvent the business by discovering new growth
opportunities. This strategy is characterized by being unpredictable,
uncontrolled, and inefficient, but it works. It's important to note that firms should
not just react well to change, but must also do a good job of anticipating and
leading change. In successful businesses, change is time-paced, or triggered by
the passage of time rather than events.
In Built to Last, Collins and Porras (1994) outline habits of long-successful,

visionary companies. Underlying the habits is an orientation towards
evolutionary change: try a lot of stuff and keep what works. Evolutionary
processes can be a powerful way to stimulate progress. Importantly, though,
Collins and Porras also find that successful companies each have a core
ideology that must be preserved throughout the progress. There is no one
formula for the "right" set of core values, but it is important to have them. In
strategy-speak, it is this core ideology that most fundamentally differentiates the
firm from competitors, regardless of which market segments they get into. They
are deeply held values that go beyond "vision statements" - they are
mechanisms and systems that are built into the system over time. Attention to
the core beliefs may sometimes defy short-term profit incentives or conventional
business wisdom, but it is important to maintain them. Examples of core
ideologies are: HP's commitment to making an "original technical contribution" in
every market they enter, Wal-mart's "exceed customer expectations," Boeing's
"being on the leading edge of aviation," and 3M's "respect for individual initiative."
Notice the "maximize shareholder wealth" is not an adequate core ideology - it
does not inspire people at all levels and provides little guidance.
In the context of strategy and planning, this book offers a couple of important
lessons:
• Unplanned, evolutionary change can be an important component to success.
Strategy and planning should foster and complement such change, not
suffocate it.
30
• Certain core beliefs are fundamental to organizations, and should be
preserved at all costs. Not everything about an organization is a candidate
for change in considering alternative strategies.
Hypercompetition
Traditional approaches to strategy stress the creation of advantage, but the
concept of hypercompetition teaches that strategy is also the creative destruction
of an opponent advantage. This is because in today's environment, traditional
sources of competitive advantage erode rapidly, and sustaining advantages can
be a distraction from developing new ones. Competition has intensified to make
each of the traditional sources of advantage more vulnerable; the traditional
sources are: price & quality, timing and know-how, creation of strongholds (entry
barriers have fallen), and deep pockets. The primary goal of this new approach
to strategy is disruption of the status quo, to seize the initiative through creating a
series of temporary advantages. It is the speed and intensity of movement that
characterizes hypercompetition. There is no equilibrium as in perfect
competition, and only temporary profits are possible in such markets.
Successful strategy in hypercompetitive markets is based on three elements:

• Vision for how to disrupt a market (setting goals, building core competencies
necessary to create specific disruptions)
• Key capabilities enabling speed and surprise in a wide range of actions
• Disruptive tactics illuminated by game theory (shifting the rules of the game,
signaling, simultaneous and strategic thrusts)
31
Additional Tools for Strategic
Thinking and Analysis
Game Theory
Game Theory in Strategy
Game theory helps analyze dynamic and sequential decisions at the tactical
level. The main value of game theory in strategy is to emphasize the importance
of thinking ahead, thinking of the alternatives, and anticipating the reactions of
other players in your "game." Key concepts relevant to strategy are the payoff
matrix, extensive form games, and the core of a game. Application areas in
strategy are:
• new product introduction
• licensing versus production
• pricing
• R&D
• advertising
• regulation
The Importance of Understanding "The Game"

Successful strategy cannot depend just on one firm's position in industry,
capabilities, activities, or what have you. It depends on how others react to your
moves, and how others think you will react to theirs. By fully understanding the
dynamic with others, you can recognize win-win strategies that make you better
off in the long term, and signaling tactics that avoid lose-lose outcomes.
Moreover, if you understand the game, you can take actions to change the rules
or players of the game in your favor. Brandenburger and Nalebuff (1995) give
some good examples of this. One way a company can change the game and
capture more value is by changing the value other players can bring to it, as the
Nintendo example illustrated. In summary, companies can change their game of
business in their favor by changing:
• players ("Value Net") - customers, suppliers, substitutors, and complementors
(not just the competitors)
• added values - the value that each player brings to the collective game
• rules - laws, customs, contracts, etc. that give a game its structure
• tactics - moves used to shape the way players perceive the game and hence
how they play
• scope - boundaries of the game.
Game theory has been a burgeoning branch of economics in recent years. It is a

complex subject that spans games of static (one-time) and dynamic (repeated)
nature under perfect or imperfect information. The references below will be
helpful for those wishing to explore the theory and modeling of game theory in
32
more detail. For strategy, though, it can often be a major step just to recognize
certain situations as games, and thinking about how a player can set out to
change the game.
References:
Introduction to game theory in corporate strategy
• Oster, S.M., Modern Competitive Analysis, Chapter, 13, Oxford Press, 1994,
pp.237-250.
• Brandenburger, Adam M.; Nalebuff, Barry J. "The right game: use game
theory to shape strategy" Harvard Business Review v73, n4 (July-August,
1995):57.
Basic introduction to game theory concepts

• A.K. Dixit and B. J. Nalebuff, Thinking Strategically: The Competitive Edge in
Business, Politics, and Everyday Life, W.W. Norton & Company, pp. 347-367
• Gibbons, R., Game Theory for Applied Economists, Princeton: Princeton
University Press, 1992.
• Binmore, K., Fun and Games: A Text on Game Theory, Lexington: D.C.
Heath & Co., 1992.
More advanced economics texts on game theory

• Fudenberg, D. and J. Tirole, Game Theory, Cambridge: MIT Press, 1991.
• Myerson, R., Game Theory: An Analysis of Conflict, Cambridge: Harvard
University Press, 1991.
Options
Options theory has influenced corporate strategy unlike any other paradigm
coming from Wall Street. The “real option” is analogous to the financial option in
that a company with an investment opportunity holds the right but not the
obligation to purchase an asset at some time in the future. Business schools
have taught managers to analyze/evaluate investment decisions using net
present value (NPV), which assumes one of two things: 1) the investment is
reversible or 2) if not, it is a now-or-never proposition. In fact, most investment
decisions are irrevocable allocations of resources and capable of being delayed.
Dixit and Pindyck (1995) discuss how the options approach to capital investment
provides a richer framework that allows managers to address the issues of
irreversibility, uncertainty, and timing more directly.
The options framework places value on flexibility (keeping the investment option
alive) and modularity (creating options):
Flexibility examples: 1) Investments in R&D can create options that allow the
company to undertake other investments in the future should market conditions
33
be favorable. 2) A mining facility operating at a loss given current prices may be
deliberately kept open because closure would incur the opportunity cost of giving
up the option to wait for higher future prices.
Modularity examples: 1) A land purchase could lead to development of mineral

reserves. 2) An electric utility could invest in small additions to capacity as
needed to meet uncertain demand instead of building expensive, large-scale
plants.
The option is structured such that the company can exercise it when profitable
and let it expire when it is not, depending on how uncertainty is resolved. As
long as there are some contingencies under which the company would choose
not to invest, the option has value. Thus, options theory captures the fact that
the greater the uncertainty, the greater the value of the opportunity and the
greater the incentive to wait and keep the option alive rather than exercise it.

• The options approach is particularly appropriate for companies in very volatile
and unpredictable industries, such as electronics, telecommunications,
biotech, and pharmaceutical industries.
• When raising capital, greater value should be placed on investments that
create options, compared to those that exercise options.
• Options are especially appropriate for analyzing a series of phased
investments.
• Options theory helps us understand how traditional discounted cash flow
analysis systematically underestimates the benefits of waiting.
• Real options also provide a means for evaluating disinvestment, an often
overlooked opportunity to avoid future losses (e.g., closing a facility in
response to a market downturn).
• Consider whether the client would be in a better position after some
uncertainty is resolved. In framing alternatives, consider strategies that
include downstream decisions. Options might be the ideal way to model such
decision opportunities.
Introductory Books on Real Options
Amram, M. and N. Kulatilaka, Real Options : Managing Strategic Investment in

an Uncertain World, Harvard Business School Press, 1998.
- takes the finance approach to real options, much like the Luenberger text.
Focus is on problems in which risks are priced by exchange traded securities
(market risks).
Real Options in Capital Investment, Trigeorgis, L, editor, 1995.

- A collection of articles intended for both academic and professional audience.
34
Trigeorgis, L., Real Options : Managerial Flexibility and Strategy in Resource
Allocation, MIT Press, 1996.
- Perhaps the best overall general introduction to real options, without taking a strictly finance or
strictly decision analytic approach. Features a good comparison of various approaches to
valuing risky investments. A practical approach that is not as academic as Dixit and Pindyck.
Academic References
Dixit, Avinash K. and Robert S. Pindyck, Investment Under Uncertainty,

Princeton, 1994.
The book to read if you are interested in mathematical formulations of real
options problems (i.e. dynamic programming and stochastic differential
equations)
Luenberger, D., Investment Science, Oxford Univ. Press, 1997

Luenberger’s binomial lattice approach is a useful simplification of dynamic programming
approaches to real options. The book also includes some powerful finance tools for pricing
market risk.
• Smith, James E., “Options in the real world: Lessons learned in evaluating oil
and gas investments,” Operations Research, Jan/Feb 1999.
• Smith, James E. and Robert Nau, “Valuing Risky Projects: Option Pricing
Theory and Decision Analysis,” Management Science, Vol. 41, No. 5, May
1995.
• Smith, James E., “Valuing Oil Properties: Integrating Option Pricing and
Decision Analysis Approaches,” Operations Research, Mar/Apr 1998.
- Jim Smith’s work has been instrumental in integrating the decision analysis and
finance approaches to risky investments. Focuses mainly on problems that are
at least partly influenced by market-spanning risks (i.e. risks that are priced by
exchange traded derivatives, such as oil and gas futures)
Popular Business References

A number of recent articles have promoted real options to the general
management audience:
Amram, M., N. Kulatilaka, “Disciplined decisions: Aligning strategy with the

financial markets,” Harvard Business Review, Jan/Feb 1999.
- a concise summary of the concepts in their book (see above).
Dixit, Avinash K. and Robert S. Pindyck, “The Options Approach to Capital

Investment,” Harvard Business Review, May 1995.
- a good overview of why flexibility in decision making is important. Written by
the authors who are also experts in the academic real options literaure. A good
starting point for those who are already familiar with decision analysis.
35
Leslie, K. and Michaels, M. “The Real Power of Real Options,” McKinsey
Quarterly, 1997 No 3.
- promotes the intuition from analysis of real options as a framework for strategic
thinking.
Copeland, T. and P. Keenan, “How much is flexibility worth,” McKinsey Quarterly,

1998 No 2
- general introduction to real options as a means to price market risk, focusing
more on the finance tradition of real options (no arbitrage pricing) than the
decision analysis tradition. Useful if you are dealing with uncertainties that are
tracked well by the market (i.e. oil and gas prices, etc.)
• Luehrman, T., “Investment Opportunities as Real Options: Getting Started on

the Numbers,” Harvard Business Review, July 1998.
• Luehrman, T., “Strategy as a Portfolio of Real Options,” Harvard Business
Review, September 1998.
- try to generalize the Black-Scholes basis for real options thinking to a general
audience. A bit hoky and simplistic.
36
Strategic Scenarios
Scenarios are powerful vehicles for challenging our mental models of the world.
The value is not in predicting the future, but in making better decisions today.
The decision makers could be individuals, businesses, or policy makers.
Scenarios are a nice complement to the principles of decision analysis: the DA
cycle ends in decisions and insights, while the scenario process ends in a
scenario.
Why Develop Scenarios? - Uncovering the Decision

Besides predicting the future, scenarios aid in strategic decision making:
• Make the decision conscious. The first step in the scenario process is
making the decision conscious. People's decision agenda is often
unconscious, and people should not avoid a decision just because they feel
powerless.
• Articulate current mindsets. Scenarios are like stories we can tell
ourselves - they are a powerful way of suspending disbelief and avoiding the
dangers of denial. Often, people may refuse to think about possibilities that
are unappealing to them. The process of scenario building, considering both
optimistic and pessimistic and just plain different futures, overly exposes
"mental models" and assumptions that may be inbred in the organization.
• Develop insights and solid instincts. Insights come from asking the right
questions - from having to consider more than one scenario. Also, scenario
building helps develop a gut feeling for a situation, and assures us that we've
been comprehensive in covering the bases relevant to our decision.
How to Develop Scenarios?

Developing scenarios is similar to developing and pruning influence diagrams in
DA, but the scope of consideration is a little broader with scenarios. Still,
scenario builders should consider both narrow (situation specific) and broad
questions. Typically, the scenario building exercise will result in no more than
four scenarios - any more is too complex to draw insights. The set of scenarios
should span a range of outcomes; typically something like "same but better,"
"worse," and "different but better."
Steps to developing scenarios are as follows:

1. Identify the focal issue or decision. (DA analogue: frame the decision)
2. Identify the basic driving forces influencing the outcome: social, technological,
economic, political, environmental. (DA analogue?)
3. Identify the key forces in the local environment: determining the
predetermined elements and critical uncertainties. (DA analogue: identify the
uncertainties)
4. Rank the uncertainties in order of importance. (DA analogue: tornado
diagram)
37
5. Selecting scenario plots (logics). Scenario plots typically run according to
certain logics, like:
winners & losers, challenge & response, evolution, revolution, cycles, etc.
6. Flesh out scenarios. Each plot will lead to a different decision today. From
the different plots, narrow and combine them to form two or three coherent
scenarios.
7. Assess implications of scenarios on decision.
8. Identify leading indicators and signposts. Learn to notice symptoms, cues,
and warning signals of certain plots unraveling before you.
References:
• Schwarz, Peter, The Art of the Long View: Planning for the Future in an
Uncertain World, Doubleday, New York, 1991.
• Schwartz, Peter, "Composing a Plot for Your Scenario," Plannning Review
20, no. 3 (1992):41-46.
• Mason, David H. "Scenario-based Planning: Decison Model for the Learning
Organization," Planning Review 22, no. 2 (1994):6-11. (This also introduces
the idea of organizational learning).
• Simpson, Daniel G., "Key Lessons for Adopting Scenario Planning in
Diversified Companies," Planning Review 20, no. 3 (1992): 10-17, 47-48.
Other Particularly Relevant EES&OR Core

Concepts
Students in EES&OR have a host of analytical tools available to add insight to
strategic thinking and analysis. Some of the more directly relevant topics
include:
• Decision Analysis
- decision hierarchy and framing
- strategy tables
- tornado diagrams
- analysis of decisions under uncertainty
- value of information
- options in decisions
• Finance
- investment analysis
- real options
• Economics
- demand-oriented pricing (dynamic, monopolistic pricing)
- game theory
38
Marketing Models for Product
Strategy
EES&OR 483 teaches two product planning methodologies that may be used
independently or as complements to each other. They add rigor to strategy at
the level of product planning and implementation. An excellent reference for
these and other marketing models is Lilien and Rangasaway (1998).
New Product Diffusion Models

The diffusion process is the spread of an idea or the penetration of a market by a
new product from its source of creation to its ultimate users or adopters. Note
that adoption refers to the decision to use an innovation regularly, whereas
diffusion is only concerned with initial trial of the product. (Source: Lilien, Kotler
and Moorthy, 1992, p. 461)
There are two types of diffusion effects:

• Innovation: trial of product caused by advertising and promotions
• Imitation: trial of product caused by word-of-mouth recommendations and
reputation
Prior to Bass (1969), diffusion models were either pure innovative (assume
diffusion only caused by external forces) or pure imitative (assume diffusion only
caused by imitation / word of mouth). The Bass model combines innovative and
imitative behavior into one model:
q
n(t ) =N (t ) =p (m −N (t )) + N (t )(m −N (t ))
m
innovation imitation
effect effect
or or
external internal
influence influence
where:
 (t )
n(t ) =N = Magnitude of trial demand (= the number of adopters at time t =
derivative of N with respect to t)
N (t ) = Cumulative number of adopters
m = Potential number of ultimate adopters
p = Influence parameter for innovation
q = Influence parameter for imitation
39
This expression can be rewritten for additional intuitive understanding using the
equivalent representation:
q
N (t ) =[m −N (t )][ p + X (t )]
m
unpenetrated adoptive pressure

market size p=innovative
q=imitative
Terms can be interpreted as representing one group of innovators and one group of imitators, or
as representing both the internal and external influences on all adopters.
Important Guidelines for Market Forecasting

• The model forecasts total market potential for a product, not sales for a particular company.
Company sales would depend on market share of the total, which depends on particular
product variables like quality, cost, and promotion, and distribution. Diffusion models only
help with the big picture; use conjoint analysis or other methods to forecast market share.
• In practice the actual coefficients are usually estimated by analogy to past products.
Coefficients for past products are generally available in tables, or may be estimated by
regression.
• Remember that diffusion models only represent demand associated with the trial of a product.
Additional terms need to be added to account for repeat purchase. A model that takes into
consideration both trial and repeat purchase demand would be a complete sales forecast.
• The Bass model is a predictive model that is most appropriate for forecasting sales of a
discontinuous new technology or durable product that has no competitors. In such situations,
the success of the product may be particularly uncertain, and the Bass model forecast may
only depict one possible outcome.
• Where you are in the product life cycle dictates the marketing and customer segmentation
strategy. With discontinuous innovations different marketing strategies are called for at
different stages of the technology life cycle to ensure that the product reaches a mass market
(see Section 5.5).
More recent research has focused on relaxing the assumptions of the Bass model:
• Allowing market potential to vary over time
• Not restricting that diffusion of an innovation be independent of all other innovations
• Allowing geographical boundaries of the system in which diffusion takes place to vary over
time
• Incorporating the effect of marketing actions such as pricing, advertising, etc. on the diffusion
process
• Considering supply restrictions
• Consideration of uncertainty
• Consider variations in diffusion rates in different countries
• Allow word of mouth effects to vary over time
The area of marketing planning modeling includes the incorporation of feedback

effects into diffusion models to turn advertising and pricing decisions over time
into optimal control problems.
References
40
• Lilien, Gary L., Philip Kotler, and K. Sridhar Moorthy, Marketing Models
(1992):457 (44 pages)
• Lilien, Gary, and A. Rangasaway, Marketing Engineering, Addison-Wesley,
1998, pp.195-204.
• Mahajan,Vijay, Eitan Muller, and Frank M. Bass, “New-Product Diffusion
Models,” Handbooks in OR & MS, v. 5 (1993): 349 (23 pages).
Conjoint Analysis
Conjoint analysis is market research methodology for modeling the market. A
quantitative, grass-roots approach, conjoint analysis is used to predict consumer
preferences for multiattribute alternatives. It is based on economic and
psychological research on consumer behavior, especially at the individual level,
which is considered key to making accurate predictions of the total market. The
subject of a conjoint study can be either a physical product or a service, and the
market can include both new and existing products/services.
What is conjoint analysis?

Think of the decision process that consumers go through when choosing
between complex alternatives. Products vary in terms of their features,
performance, and quality and thus are offered at various prices. Conjoint
analysis considers a product in terms of a bundle of attributes, or characteristics.
Through an interview, data are collected from respondents to capture the
tradeoffs they make between attributes. These data are processed to estimate a
utility function that expresses each respondent’s value for product attributes.
These utility values are then used in a market model or simulator to make
predictions about how consumers would choose among new, modified, and
existing products. Conjoint analysis allows us to analyze future market scenarios
based on primary market research. Other techniques, such as historical
analysis, would be insufficient to forecast the market for new products, whereas
conjoint analysis can model consumers’ reaction to hypothetical products that
may not yet exist.
Conjoint analysis is a decompositional model in that values are derived from

consumers’ responses to interview questions, as compared to asking consumers
to directly estimate model parameters. In direct assessment, respondents are
asked how likely they are to buy a certain product or how much they would be
willing to pay for a product with an attribute improvement. This technique is
limited in that products are not shown in a competitive context and these
questions do not generally represent realistic purchase decisions. Alternatively,
conjoint analysis uses inference, which provides a more accurate picture of
consumers’ buying behavior. In the analysis of responses to questions about
hypothetical product concepts, we can infer the value to each respondent of
having each attribute level. Rather than expecting respondents to provide direct
assessments, they are asked to make a number of decisions that are more
41
realistic and natural. In a typical pairwise comparison, two product concepts are
considered jointly. For instance:
Which drug treatment would you prefer?
Major side effects Minor side effects
High efficacy Moderate efficacy
A B

The scope of product planning issues addressed with conjoint analysis ranges
from the tactical level to the strategic level. The following is a list of some of the
product planning decisions for which conjoint analysis is currently used
worldwide:
• Pricing
• New product design
• Product positioning
• Competitive strategy
• Marketing strategies
• Market segmentation
• Investment decisions
• Sales forecasting
• Capacity planning
• Distribution planning
Conjoint analysis is a widespread, time-proven strategic tool. To ensure

success, practitioners must carefully set client expectations regarding what
conjoint can and cannot do. Conjoint simulators are directional indicators that
can provide significant insight into the relative importance of product features and
preferences for product configurations. These market simulators predict
preference share, that is market share potential. Many internal and external
influences such as awareness, marketing, sales force effectiveness, and
distribution drive market share in the real world. Unless these effects are
explicitly modeled in, care should be taken to regard the model results as
preference shares that assume perfect market penetration.
Conjoint analysis is implemented using commercially available software and

custom-programmed applications. Descriptions of packages available from one
of the leading developers, Sawtooth Software, are listed in the references below.
References (organized by needs/interest and ordered by usefulness):
42
A host of references and guides to choosing software are available at
http://www.sawtoothsoftware.com/
Getting Started with Conjoint on Your Project

• Curry, Joseph, “Conjoint Analysis: After the Basics”
• Orme, Bryan, “Which Conjoint Method Should I Use” (1997)
Client Interaction
• Curry, Joseph, “Understanding Conjoint Analysis in 15 Minutes”
• Orme, Bryan, “Helping Managers Understand the Value of Conjoint”
• Sawtooth Software, “Using Choice-Based Conjoint to Assess Brand Strength
and Price Sensitivity” (1996)
Choosing the Appropriate Software

• Sawtooth Software, “ACA System – Adaptive Conjoint Analysis, Version 4.0”
(1991-1996)
• Sawtooth Software, “CVA – A Full-Profile Conjoint System from Sawtooth
Software, Version 2.0”
• Sawtooth Software, “The CBC System for Choice-Based Conjoint Analysis”
(Jan 1995)
• Struhl, Steven, “Discrete Choice Modeling: Understanding a “Better Conjoint
than Conjoint”
Conjoint Methodology Design and Research
• Green, Paul E. and Abba M. Krieger, “Conjoint Analysis with Product-
Positioning Applications,” Handbooks in OR & MS, v. 5 (1993):467 (35 pages)
• Lilien, Gary, and A. Rangasaway, Marketing Engineering, Addison-Wesley,
1998, pp184-194.
• Huber, Joel, “What We Have Learned from 20 Years of Conjoint Research:
When to Use Self-Explicated, Graded Pairs, Full Profiles or Choice
Experiments”
• McFadden, Daniel F., “Conditional Logit Analysis of Qualitative Choice
Behavior,” Frontiers of Econometrics (1973)
• Green, Paul and Abba Krieger, “Individualized Hybrid Models for Conjoint
Analysis”, Management Science/Vol.42, No.6 (June 1996)
• Huber, Joel, Dan Ariely, and Gregory Fischer, “The Ability of People to
Express Values with Choices, Matching and Ratings” (1998)
• Orme, Bryan, Mark Alpert, and Ethan Christensen, “Assessing the Validity of
Conjoint Analysis-Continued”
• Huber, Joel, Dick Wittink, and Richard Johnson, “Learning Effects in
Preference Tasks: Choice-Based Versus Standard Conjoint” (1992)
• Wittink, Dick, and Joel Huber, John Fiedler, and Richard Miller, “The
Magnitude of and an Explanation/Solution for the Number of Levels Effect in
Conjoint Analysis” (1991)
43
Case Studies
• Page, Albert and Harold Rosenbaum, “Redesigning Product Lines with
Conjoint Analysis: How Sunbeam Does It” (1987)
• Wind, Jerry, Paul Green, Douglas Shifflet, and Marsha Scarbrough,
“Courtyard by Marriott: Designing a Hotel Facility with Consumer-Based
Marketing Models” (1989)
Conjoint History
• Green, Paul and V. Srinivasan , “Conjoint Analysis in Marketing: New
Developments with Implications for Research and Practice” (post-1978)
• Green, Paul and V. Srinivasan , “Conjoint Analysis in Consumer Research:
Issues and Outlook,” Journal of Consumer Research, Vol. 5 (1978)
• Lilien, Gary, Philip Kotler, and K. Sridhar Moorthy, “Decision Models for Product Design,”
Marketing Models (1992):238
Conceptual Marketing Frameworks

Much of the MBA level marketing material is not concerned with just sales and
services, but rather with issues of strategic importance. While this material is
not taught in EES&OR483, it may be helpful to be aware of some key themes in
marketing. The following lists and descriptions provide an overview of important
marketing concepts. You'll notice that some of the concepts overlap with
strategy frameworks.
An excellent reference textbook for marketing frameworks:

Kotler, Philip. Marketing Management : Analysis, Planning, Implementation, and
Control , 9th ed. Upper Saddle River, NJ : Prentice Hall, 1997.
The Four P’s of the Marketing Mix

The phrase “the four p’s” is an easy way to remember and characterize the four
most important marketing decision variables. The four P’s are price, product,
promotion, and place:
“Price” variables:
• Allowances and deals
• Distribution and retailer markups
• Discount structure
“Product”variables:
• Quality
• Models and sizes
• Packaging
• Brands
• Service
44
“Promotion” variables:
• Advertising
• Sales promotion
• Personal selling
• Publicity
“Place” variables:
• Channels of distribution
• Outlet location
• Sales territories
• Warehousing system
Source: Kotler, 1997
Market-Oriented Strategic Planning

“Market-oriented strategic planning is the managerial process of developing and
maintaining a viable fit between the organization’s objectives, skills, and
resources and its changing market opportunities. The aim of strategic planning is
to shape and reshape the company’s businesses and products so that they yield
target profits and growth.” - Kotler, 1997
Three key ideas:

• Manage the company’s business as an investment portfolio.
• Assess the future profit potential of each business by consider the market
growth rate and the company’s fit.
• Develop a strategic game plan that makes sense in light of the company’s
industry position, objectives, skills, and resources.
The business strategic planning process:
External
environmental
analysis
Business Goal Strategy Program Feedback
mission formulation formulation formulation Implementation and control
Internal
environmental
analysis
Boston Consulting Group Growth-Share Matrix: “Invest in the stars, get rid of the
dogs!” The framework promotes the importance of market growth rate and
market share in determining the strategic importance of a product.
45
20%
Market Growth Rate
Question
Stars
Marks
10%
Cash Cows Dogs

0%
10x 1x .1x
Relative Market Share
Alternative Views Of The Value Creation Process:

One traditional business approach ignores the impact of marketing research on
product design. Under this framework, the first step is to make the product, and
then the second step is to figure out how and to whom it will be sold. This is still
a common problem in many companies today. A more sophisticated paradigm
recognizes that the consumer demand should drive product design. Marketing
research, segmentation, positioning, and conjoint analysis are all examples of
this more sophisticated approach. The diagrams below illustrate the two
paradigms.
Traditional physical process sequence:
Make the Product Sell the product
Design Advertise/
product Procure Make Price Sell Promote Distribute Service
The value creation and delivery sequence (McKinsey):
Choose the value Provide the value Communicate the value
Customer Market Value Product Service Sourcing Distributing Sales Advertising

segmentation selection/ Positioning devel devel Pricing Salesforce promotion
focus Making Servicing
46
Market Segmentation, Targeting, and
Positioning
“STP Marketing” is one way to characterize the modern strategic marketing
approach. STP stands for Segmenting, Targeting, and Positioning. The idea is to
use a more direct “rifle” approach instead of an undirected “shotgun” approach:
Market Segmentation Market Targeting Market Positioning
1. Identify segmentation 1. Evaluate the 1. Identify possible

variables and segment the attractiveness of positioning concepts
market. each segment. for each target segment.
2. Develop profiles of 2. Select the target 2. Select, develop, and communicate

resulting segments. segment(s). the chosen positioning concept.
Additional Notes On Segmentation, Targeting And Positioning:

The following set of notes provides a brief outline some of the key ideas in this
area.
Alternative approaches to marketing strategy:

• Mass marketing: one product for all customers
• Product-variety marketing: a variety of products for customers to choose from
• Target marketing: targeted products for specific customer groups
Patterns of market segmentation:

• Homogeneous preferences
• Diffused preferences
• Clustered preferences
Market segmentation procedure (one common approach) (Kotler, 1997):

1) Survey Stage: Exploratory interviews and focus groups, followed by
questionnaires to assess:
• Attributes and their importance ratings
• Brand awareness
• Product-usage patterns
• Attitudes toward the product category
• Demographics, etc.
2) Analysis Stage:
• Factor analysis applied to remove highly correlated variables.
• Cluster analysis applied to “create a specific number of maximally
different segments”.
47
3) Profiling Stage: Each cluster is profiled in terms of its distinguishing
attitudes, behavior, … Each cluster is a market segment.
Market targeting: 3 criteria for evaluating market segments:

• Segment size and growth
• Segment structural attractiveness (Porter’s 5 forces)
• Company objectives and resources
Five patterns of target market selection (Abell) (p. 284):

M1 M2 M3 M1 M2 M3 M1 M2 M3 M1 M2 M3 M1 M2 M3
P1 P1 P1 P1 P1
P2 P2 P2 P2 P2
P3 P3 P3 P3 P3
Single-segment Single-segment Market Product Full coverage

concentration concentration specialization specialization
P = Product M = Market
Developing a positioning strategy:

• “Positioning is the act of designing the company’s offer and image so that it
occupies a distinct and valued place in the target customers’ minds.” (Kotler)
• USP: Unique Selling Position. Promotion of a single benefit to the
marketplace. Effective strategy (as opposed to touting multiple benefits).
Positioning strategies:
• Attribute positioning
• Benefit positioning
• Use/application positioning
• User positioning
• Competitor positioning
• Product category positioning
• Quality/price positioning
Three steps:
1. Identify differences
2. Choose most important differences
3. Effectively signal differences to the target market
Economics: Differentiation  premium pricing
Treacy and Wiersema: 3 strategies that lead to successful differentiation and

market leadership:
• Operational excellence
48
• Customer intimacy
• Product leadership
Differentiation:
• Product differentiation:
• Service differentiation:
• Personnel differentiation:
• Image differentiation:
Analyzing Industries and Competitors

Industries and competition play a central role in strategic analysis. The following
notes reiterate these ideas from a marketing perspective.
Industry concept of competition - factors affecting industry structure and

competition:
• Number of sellers and degree of differentiation
• Entry and mobility barriers
• Exit and shrinkage barriers
• Cost structures
• Vertical integration
• Global reach
Industry structure types:

• Pure monopoly
• Pure oligopoly
• Differentiated oligopoly
• Monopolistic competition
• Pure competition
Market concept of competition: It may be important to consider competitors

which make different products but which meet similar needs. This is different
from an industry perspective when the view of competition is limited to those
firms offering the same or very similar products.
Product segmentation
Market segmentation
Competitive intelligence: gathering data about competitors. Benchmarking.
True market orientation balances consumer and competitor considerations.

Changing consumer needs and latent competitors are key factors and can be
more devastating than existing competitor actions.
49
50
The Technology Adoption Life Cycle:
Discontinuous Innovations
Some basic marketing concepts should be considered when thinking about
market forecasts and new product strategies. For instance, thinking of the new
product diffusion cycle (Bass model) as an inevitable cycle of sales can be very
misleading. First of all, the diffusion model forecasts total market potential, and
says nothing about the market share at a particular company. Second, the
decisions of the firm can influence the sales. This is fairly obvious when it comes
to the influence of product quality and cost, but marketing strategy is also
critically important when introducing new products that are discontinuous
innovations. In these cases, the market is not yet aware of the need for the new
product, and an understanding of how a product moves through the technology
life cycle will help a product reach its full potential faster and with higher
likelihood of success.
Geoff Moore, in his books Crossing the Chasm (1991) and Inside the Tornado
(1995), draws on marketing theory and high-tech experience to describe the
elements of the product life cycle for technology innovations. His work examines
how communities respond to discontinuous innovations - or any new products or
services that require the end user in the marketplace to dramatically change their
past behavior. He describes how companies must position their products
differently through the cycle to reach their full sales potential and become an
industry standard instead of a novelty. Many new hi-tech products start along a
classic new product diffusion curve, but fail soon thereafter. Anyone developing
strategy for discontinuous innovations should be familiar with the ideas Moore
writes about. Through the various phases of the technology adoption life cycle,
very different strategies for product and service offering and positioning are
called for.
The basis of the technology adoption life cycle is similar to the basis for diffusion
models: different groups of potential customers react differently to innovations,
and adoption proceeds from most enthusiastic to most conservative.
Communities respond to discontinuous innovation - when confronted with the
opportunity to switch to a new infrastructure paradigm, customers self-segregate
along an axis of risk-aversion. Moore separates customers into five categories,
along which the cycle of new technology adoption proceeds:
1. Innovators - technology enthusiasts who are fundamentally committed to new
technology on the grounds that sooner or later it will improve their lives.
2. Early Adopters - visionaries and entrepreneurs in business and government
who want to use the innovation to make a break with the past and start an
entirely new future
3. Early Majority - pragmatists who make up the bulk of all technology
infrastructure purchases; their purchasing behavior is based on evolution
51
rather than revolution, and they buy only when there is a proven track record
of useful productivity improvement.
4. Later Majority - conservatives who are very price sensitive and pessimistic
about the added value of the product; they buy only when technology has
been simplified and commoditized.
5. Laggards - skeptics who are not really potential customers; goal is not to sell
to them, but sell around their constant criticism.
The customer segments correspond to zones in the "landscape" figure below. In

addition, there is a sixth zone that Moore calls the "chasm," separating adoption
by the early market customers (1,2) from adoption by the early majority (3).
Moore describes the chasm as follows:
Whenever truly innovative high-tech products are first brought to market, they
will initially enjoy a warm welcome in an early market made up of technology
enthusiasts and visionaries but then will fall into a chasm, during which sales
will falter and often plummet. If the products can successfully cross this
chasm, they will gain acceptance within a mainstream market dominated by
pragmatists and conservatives. Since for product-oriented enterprises
virtually all high-tech wealth comes from this third phase of market
development, crossing the chasm becomes an organizational imperative.
(1995, p.19)
52
The Landscape of the Technology Adoption Lifecycle (source: Moore, 1995,
p.25)
Main Street
The
Tornado
Early Market The End of Life

Chasm
The strategy for "crossing the chasm," as well as the strategy for each of the
other "zones", are very particular to where the product is in the life cycle.
The figure below emphasizes the different value disciplines required at different
stages. Note that the source of competitive advantage changes through the
cycle - in Porter terms, it draws on various combinations of competing on cost
(operational excellence), differentiation (product leadership), and focus (customer
intimacy).
Value Disciplines and the Life Cycle (source: Moore, 1995, p.176)
Operational Excellence
Product Leadership &
& Customer Intimacy
Operational Excellence
Product
Leadership
only
Product Leadership
&
Customer Intimacy
Moore (1995, p.25) characterizes the zones as follows:

• The Early Market
A time of great excitement when customers are technology enthusiasts and
visionaries looking to be first to get on board with the new paradigm.
53
Visionaries are willing to work through bugs and put in effort themselves to
make the solution work. The product sells itself.
• The Chasm
A time of great despair, when the early market's interest wanes but the
mainstream market is still not comfortable with the immaturity of the solutions
available. The only safe way to cross the chasm is to put all your eggs in one
basket - target a single beachhead of pragmatist customers in a mainstream
market segment and accelerate the formation of 100 percent of their whole
product.
• The Bowling Alley
A period of niche-based adoption in advance of the general marketplace,
driven by compelling customer needs and the willingness of vendors to craft
niche-specific whole products. A whole product is the minimum set of
products and services necessary to ensure that the target customer will
achieve his or her compelling reason to buy. Pragmatists want a whole
product, with the necessary user infrastructure and customer support. At this
stage, companies should resist the temptation to try to provide a general
purpose whole product and simplify the whole product challenge. To get
customers on board, service content is high, ROI to end user must be high,
and partnerships with other companies may be called for. Success in the
niche can then be leveraged elsewhere. The two keys to targeting the right
niche customers here are (1) the segment has a compelling reason to buy,
and (2) the segment is not currently well served by any competitor.
• The Tornado
An ugly and frenzied period of mass-market adoption, when the general
marketplace (early majority customers) switches over to the new
infrastructure paradigm. It's a herd mentality. Keys to success in this period
are to ignore customer needs and product modifications and just ship, riding
the wave. Market share is critical at this stage to lock out competitors, and
partners should be eliminated. Companies entering the tornado should
expand distribution channels, attack the competition, and price to maximize
market share.
• Main Street
A period of aftermarket development, when the base infrastructure has been
deployed and the goal is now to flesh out the potential. Another reversal of
strategy is needed back to niche-based marketing. Before the product
becomes obsolete, there is an opportunity to settle into a profitable period of
differentiating the commoditized whole product with extensions focusing on
the end user.
• End of Life
Which comes too soon in high-tech. Companies should find caretakers that
can take over a fully commoditized product with low profit margin.
54
55

Generic Strategy

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Generic Strategy

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Porter's Generic Strategies

If the primary determinant of a firm's profitability is the attractiveness of the

Porter's Generic Strategies

Low Cost Product Uniqueness

Broad Cost Leadership Differentiation

Cost Leadership Strategy

• Access to the capital required to make a significant investment in

A differentiation strategy calls for the development of a product or service that

• Access to leading scientific research.

The risks associated with a differentiation strategy include imitation by

A Combination of Generic Strategies

Generic Strategies and Industry Forces

Generic Strategies and Industry Forces

Industry Generic Strategies

Porter's Generic Strategies

In his 1980 classic Competitive Strategy: Techniques for Analysing Industries

Combining multiple strategies is successful in only one case. Combining a

Cost Leadership Strategy

To be successful, this strategy usually requires a considerable market share

• process engineering skills

Examples include retailers such as Wal-Mart and KwikSave as well as IT firms

A firm attempts to maintain a low cost base by controlling production costs,

Further in consideration of factors mentioned above that facilitate a firm in

However, low cost leadership is attached to a disadvantage which is less

Variants on the Differentiation Strategy

Criticisms of generic strategies

A popular post-Porter model was presented by W. Chan Kim and Renée

An up-to-date critique of generic strategies and their limitations, including Porter,

However, contrarily to the rationalisation of Porter, contemporary research has

Though Porter had a fundamental rationalisation in his concept about the

The Cost Leadership Strategy

• Increasing profits by reducing costs, while charging industry-average

Remember that Cost Leadership is about minimizing the cost

The Differentiation Strategy

To make a success of a generic Differentiation strategy, organizations need:

• Good research, development and innovation.

Large organizations pursuing a differentiation strategy need to stay agile with

The Focus Strategy

Generic strategies apply to not-for-profit organizations too. A

Choosing the Right Generic Strategy

Use the following steps to help you choose.

• Reduce or manage supplier power.

Porter's Generic Strategies offer a great starting point for

Companies that pursue a Differentiation strategy win market share by offering

• Ask yourself what your organization's generic strategy

• If you're in an organization omitted to achieving Cost

• If your organization is pursuing to Differentiation, can

• And if you're working for a company that has a chosen a

PORTER GENERIC STRATEGIES...........................................................................................................5

Porter's Generic Strategies (source: Porter, 1985, p.12)

Broad 1. Cost Leadership 2. Differentiation

Some Perspective on Strategy Frameworks: Internal and External Framing for

Porter's focus on industry structure is a powerful means of analyzing competitive

Entry Barriers Rivalry Determinants

How is competitive advantage created?

How is competitive advantage implemented?

A firm gains competitive advantage by performing these strategically important

Porter describes three choices of strategic position that influence the

Porter defines three types of fit:

How is competitive advantage sustained?

What are core competencies and capabilities?

Implications for strategy?

Resource-Based View of the Firm (RBV)