Competitive strategies – cost strategy vs. differentiation strategy

Competitive strategy refers to a way of creating competitive advantage over competitors. It represents a greater value for the customer, created either by lower prices or by providing greater benefits and services that justify higher prices.

Generally speaking, there are four possible ways to differentiate a business – to become a cost leader (meaning that you become the lowest-cost producer in the industry) and to become a differentiation leader (meaning that you compete in areas other than price valued by customers), both in a narrow or broad scope of business’ activities.

Choosing the right competitive strategy is crucial to corporate as well as business unit and products and/or services strategy development.

Cost strategy

Cost strategy is built on no-frills. Cost leadership strives towards cutting costs to a minimum possible levels in order to provide customers with lower prices and thus boost their savings. Cost strategy prerequisites normally relate to high technical capabilities and access to capital for the company to invest in technology and assure economies of scale.

In most of the cases cost strategy for first-movers lead to significant increase in market share and capacity utilization, that further drives down costs.

Building a strategy on minimizing costs requires a company to achieve:

  • High productivity
  • High capacity utilization
  • Use of bargaining power to negotiate the lowest prices for production inputs
  • Lean production methods (e.g. JIT)
  • Effective production process
  • Effective distribution channels

Leading cost leadership brands have obtained a major success by introducing revolutionary business models built on a single base – the lowest possible prices for a given perceived value.

Differentiation strategy

Differentiation strategy is built on a belief that one needs a clear and unique positioning. Differentiation leadership focuses in providing perks that add value for consumers, while higher prices are a sort of “make up” for their higher costs.

Building a strategy on a differentiation requires a company to continuously invest in and develop:

  • Superior product quality (features, benefits, durability, reliability)
  • Branding (strong brand recognition, desire and loyalty)
  • Industry-wide distribution across all major channels (i.e. the product or brand is an essential item to be stocked by retailers)
  • Marketing capabilities (advertising, sponsorship etc.)

Differentiation strategy could be further divided into:

  • Purification (decrease in price; decrease in perceived value) – examples: EasyJet, Tata, Logan etc.
  • Hybrid (decrease in price; increase in perceived value) – examples: IKEA (SCM optimisation), Loreal (new brands as a response to crisis) etc.
  • Sophistication (increase in price; increase in perceived value) – examples: Mercedes (status), VW (reliability); Toyota (TQM)

Despite the fact that these brands pointed out above achieve significant economies of scale, they do not rely on a cost leadership strategy to compete. Strong marketing capabilities enable them to sell products for a premium and at the same time persuade customers to become brand loyal.

Focus strategy (the scope of business’ activities)

Cost strategy as well as differentiation strategy could be narrow or broad. Small and medium sized companies are often forced to become focused, namely a niche player, since they are unable to compete against better-resourced broad market companies’ offerings. Only true understanding of the market dynamics and customers’ unique needs in combination with unique low cost or well-specified products and/or services eventually result in strong brand loyalty.

How to differentiate your products and/or services in the market?

Are your products and/or services uniquely positioned in the market? If not – following the steps written below:

Step 1: Examine  existing positioning of the company and its products and/or services in customers’ minds

Step 2: Choose the competitive strategy (cost strategy vs. differentiation strategy) you think you should be following

Step 3: Analyze the competition and determine the industry standard

Step 4: Study market dynamics and search for market gaps

Step 5: Choose your most appropriate competitive strategy and look for potential practical solutions

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