Strategy Implementation: Differentiation vs. Cost Leadership (Part 3)
While in parts 1 and 2 we dove into the definition of a strategy and how to collect data and conduct research to develop a thorough strategy, this essay focuses on how to define the strategy to follow. Collecting strategic data is a necessary but insufficient condition of strategic management. Data must be put to effective use in order to position your company clearly and decisively in the industry. Failing to precisely define your organization may get you "stuck in the middle." That is not a prosperous long-term position to have. When you are stuck in the middle, you do not push the gas pedal on lowering prices, nor do you focus your whole attention on superior product/service quality. Similar to how the saying goes in life, "have strong beliefs, loosely held." (supposedly from Stanford University professor Paul Saffo). So it goes in organizational strategy (to use loose parallelism): picking a clear positioning in the market is empowering. It can help you understand the true nature of your business. It can also allow your customers to identify your strategy and company vision. In this post, we will discover that there are two main strategies organizations can follow: differentiation, and cost leadership. Ultimately, the final objective of any business strategy is to generate (and sustain over time) a competitive advantage.
The Customer-Company Interaction
Competitive advantage can manifest itself in multiple ways. The customer-company interaction is a complex model heavily based on perception. Your company provides objective elements (e.g., products/services, clear processes, and pricing). The way consumers interact with your products and services is subjective. It is subject to cognitive bias and personal preferences/dispositions. Your customer's expectations drive satisfaction. The expectation gap makes the difference, not only in our happiness but also in customer satisfaction. Consumers' expectations also depend on the various inputs people get from the market, the competition, their past experiences with similar products, the intensity of their needs at any given time. This is all part of behavioral economics and psychology. Human beings are biased animals. So are the individuals and teams working at your business. So, it is not only businesses that are "complex" entities, but also the individuals powering those businesses.
Competitive advantage
Competitive advantage is the ability of a company to outperform its competitors. In a world/market with many players, it is only through a clear competitive advantage that your business can stand out. This is also valid for life, I would argue. What is your competitive advantage? Why should you be the most suitable person for that job? What makes you stand out as an individual?
There are two main ways an enterprise can develop a competitive advantage (Porter, 1980): cost leadership, or differentiation. These two strategies are mutually exclusive. You cannot implement them at the same time, unless you may want to risk getting "stuck in the middle," without a clear identity and positioning in the market. To be different from the competition, there are trade-offs to decide upon.
Cost leadership
A cost leadership strategy consists of offering a product that's similar to the competition, at a convenient/low price. Being an industry's cost leader requires efficiency maximization in terms of production and processes costs. If you can minimize your costs, you can transfer such an advantage to the final consumer, who can benefit from lower prices.
There are two main ways to adopt a cost leadership strategy:
Exploiting structural cost differences → If your business can especially leverage economies of scale and scope or the experience curve effects. The experience curve is an incredibly compelling concept in strategic management (and life in general). According to this concept, "the unit cost of a standard product declines significantly each time cumulative output doubles." I could notice the experience curve effect in my freelance Notion consulting journey. Every time I collaborated with a new client, I gained significant experience and decreased the time it would take me to develop Notion systems. But the prices charged were the same/higher. The main cost of consulting is time, we could argue. That's because consulting is a time-intensive activity, tailored to the client.
Cost Management → You can structure your processes and costs to be as efficient and minimized as possible. Hence, this would allow you to offer products at a low price. Managing costs attentively is a conscious and strategic decision. When combined with the experience curve effect, such a strategy can lead to significant cost decreases.
Differentiation
A differentiation strategy seeks a competitive advantage by offering a unique product, at a premium price. Apple is often the most cited brand in this context: the company implements a clear differentiation strategy due to the perceived uniqueness of its products. The key sources of competitive advantage stemming from differentiation are:
Quality → the quality of the product/service, and how much quality is perceived by consumers.
Time → the speed of execution/renewal of products/services. Netflix is an example of a speed-differentiated company: it provides new offerings very often, delighting customers and always providing novel stimuli.
Brand Image → the power of the brand is what differentiates such businesses. Brand image is ultimately a perception. When thinking about such a source of differentiation, numerous luxury fashion brands like Luis Vuitton and Gucci come to mind.
Customer relations → that is the direct relationships the business manages to establish with its customers. Reliability is also part of customer relations. Amazon is a solid example of such a competitive advantage. Their customer support is rather unique and their policies transparent.
How to achieve competitive advantage
Example of the smartphone market in early 21st century
Ultimately, the position to take in the market is a choice. Competitive advantage is a decision that needs to be carefully picked and fully embraced throughout your business processes. There are clear implications for wanting to be a cost leader: design to manufacture, minimize production costs, rely heavily on economies of scale, target the mass market, etc. So are there implications for wanting to be a differentiator. Being stuck in the middle is what you want to avoid. That can turn out to be a dangerous situation, lacking an identity and uniqueness. So, who would you like to be?
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