A critique of Porter’s cost leadership and differentiation strategies, Assignment, Sample, NKU, Singapore

Abstract:

Porter identifies high market share with cost leadership, citing GM as a successful practitioner of this 1. Introduction strategy. However, GM became a market share leader in the American automobile industry due to a strategy of market segmentation, differentiation and a broad scope shaped during the 1920s. Porter argues that cost leadership and differentiation offer an equally viable path to competitive success. Nevertheless, a differentiation strategy based on superior quality compared to competition is more profitable than cost leadership strategy. It can lead a business to become a market share leader, and consequently even a low-cost leader. Research indicates that differentiation and cost leadership can co-exist. However, Porter insists that each generic strategy requires a different culture and a totally different philosophy. The problem is that Porter’s generic strategies are too broad. It is not his logic that is flawed, but his basic premise that prescribes cost leadership strategy as the only route to market share leadership, and presents a narrow view of differentiation with a unique product—sold at a premium price—on the one hand, and a “standard, or no-frills” product on the other. Mintzburg (1988) says Porter’s cost leadership strategy should be called “price differentiation”: a strategy that is based on a lower price than that of the competition.

He suggests that business strategy has two dimensions: differentiation and scope. Thus, setting scope aside, competitive strategy has only one component: differentiation. So, the key question is not whether to differentiate, but how? First, make customer-perceived quality as the foundation of competitive strategy because it is far more critical to long-term success than any other factor. Second, serve the middle class by competing in the mid-price segment, offering better quality than the competition at a somewhat higher price. It is this path that can lead to market share leadership—a strategy that can be both profitable—and sustainable.

Key words: Michael Porter; cost leadership strategy; differentiation strategy; customer-perceived quality; market segmentation; price-quality segmentation; outpacing strategies

1. Introduction

A scholarly work that has received widespread recognition is Porter’s (1980, 1985) typology of generic strategies: cost leadership, differentiation and focus. These three fall into two basic categories. The focus strategy requires concentration on a niche or a narrow segment. But, Porter says that success in this strategy can be achieved either via cost leadership or differentiation. Thus, cost leadership and differentiation are the two basic strategies in Porter’s typology. These two then are the subject of discussion in this paper. Here our purpose is to offer a critique of Porter’s work, and a synthesis of the vast literature centered on it.

Thompson, Strickland, and Gamble (2008) have expanded Porter’s generic strategies from three to five.1 So, the author will also briefly examine their work.2

2. Cost Leadership Strategy

The cost leadership strategy focuses on selling a “standard, or no-frills” product (Porter, 1985, p.13) combined with “aggressive pricing” (Porter, 1980, p.36). It also involves serving multiple industry segments broadly to gain a low-cost advantage (Porter, 1985, p.12). According to Porter (1980, p.35), the core philosophy of this strategy entails:

“Cost leadership requires aggressive construction of efficient-scale facilities, vigorous pursuit of cost from experience, tight cost and overhead control, avoidance of marginal customer accounts, and cost minimization in areas like R&D, service, sales force, advertising, and so on. A great deal of managerial attention to cost control is necessary to achieve these aims. Low cost relative to competitors becomes the theme running through the entire strategy, though quality, service, and other areas cannot be ignored” (italics added).

Thus, the strategy involves making a “fairly standardized product and underpricing everybody else” (Kiechel, 1981b, p.181).

2.1 Major Reliance on Modern Capital Equipment

The cost leadership strategy requires “heavy up-front capital investment in state-of-the-art equipment” (Porter, 1980, p.36). Kiechel (1981a, p.140) emphasizes that to maintain cost leadership, a firm should “buy the largest, most modern plant in the industry.” In basic industrial commodities like pulp, paper, and steel, reducing production costs by a few percentage points has more strategic impact than marketing efforts (Bennett & Cooper, 1979, p.82). Porter (1980, p.43) also points out that in many bulk commodities, “it’s solely a cost game.” However, Levitt (1980) reminds us that even a so-called commodity can be differentiated.

In most markets, differentiation is critical. Investing heavily in state-of-the-art equipment without some market advantage can be risky.

2.2 Relying on Experience Curve to Underprice Competition is Risky

The theory suggests that the market-share leader can underprice competitors due to lower costs from cumulative experience, accelerating cost reduction (Kiechel, 1981a, p.140). This often results in price wars, which are typically brutal and end without winners, as price cuts are easily imitated (Wensley, 1981). Price competition assumes that most products are commodities (Giddens-Emig, 1983), but examples like Texas Instruments in the consumer watch market and DuPont in the nylon market highlight the pitfalls of this strategy.

Competing on price can also lead to a “discount” image, which is hard to shake off. For instance, Sharp tried to compete on price despite offering quality products, resulting in a negative image (Rachman & Mescon, 1979, p.218; Porter, 1980, pp.45-46).

2.3 No Such Thing as a “Commodity”: Everything Can Be Differentiated

Levitt (1980) argues that everything can be differentiated, even commodities. Branding has transformed simple products like chicken, bananas, and potatoes (Levitt, 1980). Industrial markets, often seen as commodity-dominated, also exhibit differentiation based on factors like delivery reliability and service (Caves, 1987, p.22; Levitt, 1980, p.84). Porter (1985, p.121) concurs that competitive advantage can be achieved through service differentiation even in price-sensitive markets.

2.4 Porter Identifies High Market Share with Cost Leadership Strategy

Porter (1980, p.36) claims that achieving “a low overall cost position often requires a high relative market share or other advantages, such as favorable access to raw materials.” However, high market share is often achieved through differentiation rather than cost leadership (Hambrick, 1983; Gale, 1992).

2.4.1 Porter—GM Successful Follower of Cost Leadership Strategy

Porter (1980, p.43) cites General Motors (GM) as a successful cost leader. However, GM’s low-cost position resulted from high market share achieved through differentiation. GM’s CEO Sloan’s strategy of offering “a car for every purse and purpose” and rationalizing car prices and segments was crucial in this success (Cray, 1980, p.243; Sloan, 1972).

2.5 Differentiation: The Genesis of GM’s Past Success

GM’s broad scope in serving multiple auto industry segments allowed it to gain a low-cost position (Porter, 1985, p.12). The popularity of closed-body cars in the 1920s led GM to attack Ford’s low-cost Model T with a differentiated Chevrolet, which was a resounding success (Cray, 1980, pp.230-231).

The Japanese automakers’ entry into the U.S. market in the 1970s highlighted GM’s decline. GM’s focus on style over technology, “planned obsolescence,” and lack of innovation sowed the seeds of its downfall. Despite dominating the U.S. auto industry for decades, GM’s reliance on multiple brands and outdated strategies couldn’t withstand global competition.

2.6 Mintzberg: Cost Leadership is a “Price Differentiation” Strategy

Porter (1985, p.13) states that “a cost leader cannot ignore the bases of differentiation” and must achieve parity in differentiation relative to competitors. Mintzberg (1988, p.15) argues that “price differentiation” may follow cost leadership as a necessary aspect. A cost leader must command prices near the industry average to be an “above-average performer,” which requires effective differentiation.

The essence of cost leadership strategy, including producing a “standard, or no-frills” product (Porter, 1980, p.35; 1985, p.13), must be balanced with achieving differentiation to sustain competitive advantage.

2.7 Thompson, Strickland, and Gamble’s Low-Cost Provider Strategy

Thompson, Strickland, and Gamble (2008) cite Motel 6 as an example of a company following a “low-cost provider” strategy. However, it can be argued that Motel 6 is actually pursuing a low-price strategy by competing in the economy segment of the hotel/motel industry. Within this segment, Motel 6 has differentiated itself by positioning its brand with the claim of offering “the lowest price of any national chain” (Crowell, 2009).

3. Differentiation Strategy

Porter’s (1980, p.37; 1985, p.14; 1990, p.37) differentiation strategy emphasizes the creation of a product that is perceived industry-wide as unique and is rewarded with a premium price. He further suggests that differentiation often requires exclusivity, which generally prevents high market share (Porter, 1980, p.38). Porter also notes that differentiation is typically incompatible with cost leadership (Porter, 1985, pp.127-128; 1990, p.38).

3.1 Ambiguity in Porter’s Concept of “Premium Price”

Markets can be segmented into three basic price-quality segments: premium, mid-price, and economy (Datta, 1996). Porter’s use of the term “premium price” seems ambiguous. Generally, a business competing in the premium segment does not achieve high market share due to high prices. Thus, Porter’s claim that differentiation and high market share do not generally go together implies his reference to “premium price” means competing in the premium segment. Examples provided by Porter (1980, p.37) of differentiation mostly belong to the premium segment, except for Coleman and Crown Cork & Seal, which do not fit this categorization. Therefore, the distinction between “premium price” and “price premium” is crucial.

3.2 Distinction Between Segmentation and Differentiation

The term “premium price” needs clarification in relation to market segmentation. Porter (1985, p.127) states that differentiation is usually costly, but also inherently relative, requiring comparison to competitors’ value chains. For example, Mercedes E-class competes within the luxury segment against BMW 5-series, not mid-priced cars like Ford Taurus. Differentiation can occur both within and between segments, making the distinction between segmentation and differentiation more a matter of degree than kind.

Comparing Mercedes E-class with Lincoln Continental within the luxury segment shows a price premium for Mercedes. Hence, instead of saying Mercedes follows a differentiation strategy, it is more accurate to state that it competes in the premium segment.

3.3 Differentiation and Uniqueness

Porter (1980, p.37) describes differentiation as synonymous with uniqueness. However, as competitors like BMW and Cadillac also offer high-performance cars, Mercedes cannot be considered unique. In today’s hypercompetitive environment, uniqueness is less sustainable than offering superior quality compared to principal competitors (Buzzell, 2010, p.480).

3.4 Customer-Perceived Quality

Differentiation strategies are generally more profitable than cost leadership strategies. High-performing companies focus on customer value rather than cost (Peters & Waterman, 1982, p.186). Research from the PIMS database shows that customer-perceived quality is fundamental to competitive position and profitability (Gale, 1992; Buzzell & Gale, 1987, p.7).

3.5 Compatibility of Differentiation with High Market Share and Cost Leadership

Contrary to Porter’s view, differentiation and high market share can coexist, and differentiation can lead to a low-cost position due to increased sales volume, learning curve effects, and economies of scale and scope (Hill, 1988; Murray, 1988). Empirical research supports the feasibility and profitability of hybrid strategies that combine differentiation and low cost (Miller & Dess, 1993).

Toyota Camry exemplifies a successful mid-price car that leads in sales while Toyota remains the leading low-cost producer globally (Thomson, Strickland & Gamble, 2008, p.152). Even Porter acknowledges that a low overall cost position may not be incompatible with differentiation (Porter, 1980, p.44).

3.6 Superior Quality Leading to Lower Cost

Innovative product design and process technology can simultaneously improve quality and reduce costs (Porter, 1985, p.105). For instance, the 1997 Toyota Camry achieved higher quality with fewer parts compared to its 1996 model (Krebs, 1996).

3.7 Thompson, Strickland, and Gamble’s Broad Differentiation Strategy

Thompson, Strickland, and Gamble’s (2008) “broad differentiation” strategy is more inclusive than Porter’s, as it does not distinguish between premium and mid-price segments. They also propose a “best-cost provider strategy,” exemplified by Lexus, which combines low cost and differentiation by leveraging Toyota’s lean production system. This holistic approach allowed Toyota to offer luxury at a competitive price (Hamel & Prahalad, 1994, p.89; Stalk & Webber, 1993, pp.97-98).

Toyota’s success came from its lean production system, not merely cost reduction, highlighting the importance of innovation and holistic business strategies.

4 Two Conflicting Views of Cost Leadership

The concept of cost leadership has sparked a longstanding debate within strategic management, primarily between Michael Porter’s perspective and that of his critics. Porter contends that cost leadership and differentiation are inherently incompatible strategies. According to him, a firm must choose one over the other to achieve sustainable competitive advantage (Porter, 1980).

4.1 Critics: Cost leadership compatible with differentiation strategy

Critics of Porter’s framework argue against the dichotomy between cost leadership and differentiation. They propose that these strategies are not mutually exclusive but rather exist on a continuum, where firms can integrate elements of both to enhance their competitive position (Miller, 1992b; Miller & Dess, 1993). This perspective suggests that by combining cost efficiency with unique value propositions, firms can effectively differentiate themselves while maintaining cost leadership.

4.2 Porter: Cost Leadership and Differentiation Embody Different Philosophies

Michael Porter has staunchly defended his view that cost leadership and differentiation represent fundamentally distinct paths to competitive advantage. He asserts that each strategy requires a unique set of organizational resources, structures, and management styles (Porter, 1985). Porter’s framework emphasizes that pursuing both strategies simultaneously risks diluting strategic focus and leaving the firm “stuck in the middle,” unable to achieve competitive advantage in either cost or differentiation.

4.3 Cost Leadership vs. Differentiation: A False Choice

While Porter argues for the distinctiveness of cost leadership and differentiation strategies, critics suggest that his typology oversimplifies strategic possibilities. They propose that firms can achieve market leadership through differentiation strategies that also incorporate elements of cost efficiency. This approach challenges Porter’s assertion that firms must rigidly adhere to either a low-cost or differentiation strategy (Buzzell & Gale, 1987).

4.4 Internal Orientation of Cost Leadership Strategy

Porter’s cost leadership strategy primarily focuses on internal operational efficiencies rather than customer perceptions. Critics argue that this internal orientation may overlook the importance of customer-driven strategies in shaping competitive advantage (Mathur, 1986). They advocate for strategies that prioritize customer needs and perceptions as a starting point for developing competitive advantage.

4.5 Porter’s Shift in Thinking: Recognition of Innovation and Differentiation

Over time, Porter has acknowledged the evolving nature of competitive advantage and the role of innovation in strategic management. He suggests that differentiation strategies, which emphasize product uniqueness and superior customer value, may offer more sustainable advantages than cost leadership alone (Porter, 1990). This subtle shift in Porter’s perspective reflects broader recognition within strategic management of the dynamic interplay between innovation, differentiation, and cost efficiency.

5: A Proposed Framework of Competition

Based on the critiques and evolving perspectives on cost leadership and differentiation, a revised framework of competition can be proposed that integrates these insights.

5.1 Differentiation: The Cornerstone of Competitive Strategy

Building on Mintzberg’s dimensions of business strategy, differentiation emerges as a fundamental driver of competitive advantage (Mintzberg, 1988). This framework suggests that differentiation, through unique product features and superior customer value perceptions, should form the core of a firm’s strategic approach.

5.2 Customer-Perceived Quality: The Centerpiece of Competition

The framework advocates for placing customer-perceived quality at the forefront of competitive strategy. Research consistently shows a strong positive correlation between product quality and profitability, emphasizing the critical role of quality in sustaining competitive advantage (Buzzell, 2004)

5.3 Road to Market Share Leadership: Differentiation at Moderate Prices

Contrary to Porter’s emphasis on cost leadership or premium pricing, this framework suggests capturing market share leadership through differentiation at moderate price points. By appealing to the middle-class segment and offering superior quality at competitive prices, firms can achieve sustainable market leadership (Datta, 2010).

5.4 The Role of “Outpacing” Strategies

Acknowledging the dynamic nature of markets, the framework proposes “outpacing” strategies that combine innovation with efficiency. Rather than adhering strictly to cost leadership or differentiation, firms should focus on continuously adapting their strategies to outpace competitors through timely innovations and operational efficiencies (Gilbert & Strebel, 1989).

5.5 A Subtle Shift in Strategic Thinking

Reflecting on Porter’s evolving views, the framework underscores the importance of adapting strategies to changing market dynamics. Porter’s recognition of differentiation as a sustainable competitive advantage highlights a departure from earlier static frameworks, aligning with modern strategic management principles (Porter, 1990).

6. Conclusion

An extensive review of Porter’s cost leadership and differentiation strategies has revealed four major themes. First, he identifies high market share with cost leadership, citing GM as a successful practitioner of this strategy. But GM became a market share leader in the U.S. auto industry mainly because of a strategy of market segmentation, differentiation and a broad scope devised during the 1920s.

Second, he suggests that cost leadership and differentiation strategies are an equally viable path to outperform the competition. However, a differentiation strategy based on superior quality relative to competition is more profitable than cost leadership strategy. It can lead a business to become a market share leader and therefore even a low-cost leader.

Third, Porter’s generic strategies are overly broad and present a narrow view of differentiation with a unique product—sold at a premium price—on the one hand, and a “standard, or no-frills” product on the other. Fourth, Porter affirms that cost leadership and differentiation strategies—as he has defined them—are not just dimensions that could be mixed or matched to formulate a strategy. Rather, each strategy requires a different culture and a different philosophy. Nonetheless, research indicates that differentiation and cost leadership can actually go together.

Mintzburg (1988) suggests that Porter’s cost leadership should be called “price differentiation” strategy because it relies on a price that is lower than that of the competition. He also says that business strategy has two dimensions: differentiation and scope. So, setting scope aside competitive strategy has only one component: differentiation. The important question is not whether to differentiate, but how?

First, customer-perceived quality should be the cornerstone of competition, because it is far more critical to long-term success than any other factor. Second, in consumer markets the best road to market share leadership is serving the middle class by competing in the mid-price segment, and offering superior quality compared to the competition, at a somewhat higher price. This is essential for two reasons: (1) to maintain an image of quality; and (2) to ensure the strategy is both profitable and sustainable.

Finally, cost leadership strategy is internally rather than customer oriented. However, this deficiency represents a more general problem. The “word customer rarely appears in management journal article titles, management textbook indexes, or session titles at the Academy of Management meetings” (Dean & Bowen, 1994, p.408; italics added). No wonder “customer” represents a big gap in management theory (Datta, 1997).

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