Evaluation of Competitive Strategy and Company Position

Understanding the competitive strategy and position of a company is crucial for analysts and investors because it provides insights into the company’s approach to gaining a competitive edge in the market and its ability to create value for its stakeholders.

Understanding Competitive Strategy

Every company, whether a multinational corporation like Apple or a local bakery, has a competitive strategy. This strategy can be either intentional or unintentional—an intentional strategy results from company-wide planning, performance measurement, and feedback loops to refine the strategy. For instance, Apple’s intentional strategy might involve continuous innovation and high-quality product design.

On the other hand, an unintentional strategy arises from different teams within a company pursuing their incentives, repeating past actions, or adhering to industry or professional norms. For example, a bakery might unintentionally develop a strategy of baking more bread on weekends due to higher demand without any formal planning.

Unintentional strategies often exacerbate communication and coordination issues within a company, although they might perform well in areas like discovery-oriented research. The effectiveness of a competitive strategy is demonstrated by a company’s history of value addition for its stakeholders, such as economic profits. The effectiveness of a strategy can only be judged retrospectively.

Evaluating Competitive Strategy

To evaluate a competitive strategy on a forward-looking basis, an analyst should assess the strategy along the following three dimensions:

• Does the strategy create a defense against the five industry forces? For example, does Apple’s strategy of continuous innovation and high-quality design protect it from competitive rivalry, threat of new entrants, threat of substitutes, bargaining power of suppliers, and bargaining power of customers?
• Does the strategy benefit from, or is at least not at odds with, the expected external industry influences identified in the PESTLE analysis? For instance, does a bakery’s strategy align with the political, economic, social, technological, legal, and environmental factors affecting the bakery industry?
• Does the company have the resources and capabilities to execute the strategy? For example, does Apple have the necessary technological expertise, financial resources, and human capital to execute its strategy of continuous innovation and high-quality design?

The analysis and answers to these questions are specific to each company and industry.

Three Well-Known Competitive Strategies

Three prominent competitive strategies that have been demonstrated to be successful across a myriad of industries are cost leadership, differentiation, and focus. These strategies, outlined in Michael Porter’s seminal research on business competition, offer distinct pathways to achieving a competitive edge.

Cost Leadership:

Cost leadership, as exemplified by companies like Walmart, hinges on minimizing costs and offering products at prices lower than competitors. It is executed through means such as achieving economies of scale, fostering a culture of strict cost control, and establishing low-cost distribution channels. This approach effectively shields against the threats of new entrants and intense industry rivalry, making it particularly suitable in industries where price is a major determinant of customer choice. However, it does carry risks, such as potential cost inflation and technological changes, that can erode the cost leadership position.

Differentiation:

Pursued by companies like Apple, differentiation strategy revolves around offering products with unique features and superior quality. It entails a substantial investment in advertising, brand building, and customer service. The goal is to create customer loyalty and reduce the bargaining power of buyers, thus defending against new entrants and substitutes. This strategy is often appropriate in industries characterized by innovation and where customers value distinctiveness. Yet, it is not without risks, including imitation by competitors and a potential increase in the pricing premium, which might deter customers.

Focus:

Focus strategy is often adopted by niche players, like a local bakery specializing in a specific type of bread, which focuses on serving a narrow target market exceptionally well. Leveraging a deep understanding of customer needs and preferences, companies adopting this strategy often incorporate elements from both cost leadership and differentiation strategies but with a more narrowed focus.

Focus strategy works effectively to defend against the threat of new entrants and substitutes, especially in sectors where customers are not primarily driven by price and have a preference for premium products. However, it risks being outcompeted in price and changing customer preferences. As outlined in the CFA curriculum, vol 3, page 520, the following is the analysis of the three strategies:

$$\begin{array}{l|l|l|l}
\textbf{Strategy} & \textbf{Cost} & \textbf{Differentiation} & \textbf{Focus} \\
\textbf{Aspects} & \textbf{Leadership} & & \\
\hline
\text{Executing} & – \text{Economies of} & – \text{Investments in} & – \text{Proximity to} \\
\text{strategy} & \text{scale from} & \text{advertising, brand,} & \text{customers, strong} \\
\text{means} & \text{fixed costs} & \text{customer service} & \text{understanding of} \\
& – \text{Favorable access} & – \text{Superior quality,} & – \text{Protection using} \\
& \text{to raw materials} & \text{unique features} & \text{trademarks, copyrights,} \\
& – \text{Culture of} & – \text{Culture of} & \text{patents} \\
& \text{strict cost control} & \text{strong customer} & – \text{Incorporate elements} \\
& – \text{Aggressive pricing} & \text{experience} & \text{of both strategies,} \\
& \text{to gain high} & – \text{Premium pricing} & \text{focus on a} \\
& \text{volume} & – \text{Integration of} & \text{particular group} \\
& – \text{Low-cost distribution} & \text{services, software,} & \\
& – \text{Economies of scope} & \text{and hardware} & \\
\hline
\text{Which of} & – \text{Threat of new} & – \text{Threat of new} & – \text{Threat of new} \\
\text{the Five} & \text{entrants: Capital} & \text{entrants and of} & \text{entrants and of} \\
\text{Forces it} & \text{requirements, scale} & \text{substitutes: Customer} & \text{substitutes: Customer} \\
\text{defends} & \text{advantages} & \text{loyalty deters} & \text{loyalty deters} \\
\text{against} & – \text{Bargaining power} & \text{switching, protect} & \text{switching, protect} \\
& \text{of customers: Customers} & \text{market share} & \text{market share} \\
& \text{can only bring} & – \text{Bargaining power of} & – \text{Bargaining power of} \\
& \text{prices down leaving} & \text{customers: Customers} & \text{customers: Customers} \\
& \text{margin for cost} & \text{unwilling to} & \text{unwilling to} \\
& \text{leaders} & \text{comparison shop} & \text{comparison shop} \\
& – \text{Industry rivalry:} & – \text{Bargaining power of} & – \text{Difficult to serve} \\
& \text{Rivals may not} & \text{suppliers: Pass price} & \text{particular customer} \\
& \text{compete on price} & \text{increases to customers} & \text{group} \\
\hline
\text{Industry} & – \text{Price-conscious} & – \text{Customers value} & – \text{Price not foremost} \\
\text{appropriateness} & \text{customers} & \text{distinctiveness} & \text{concern} \\
& – \text{Minimal innovation} & – \text{Innovation varies} & – \text{Desire for} \\
& \text{in industry} & \text{in features} & \text{premiumization} \\
\hline
\text{Risks to} & – \text{Capital intensive} & – \text{Imitation by} & – \text{Larger competitors} \\
\text{the strategy} & – \text{Cost inflation,} & \text{competitors} & \text{outcompete on} \\
& \text{loss of discipline} & – \text{Pricing premium} & \text{price} \\
& – \text{Technological change} & \text{too high} & – \text{Differences in} \\
& \text{results in loss} & – \text{Buyers no longer} & \text{demand narrow} \\
& & \text{demand service} & – \text{May preclude high} \\
& & & \text{market share} \\
& & & – \text{Buyers no longer} \\
& & & \text{demand service} \\
\end{array}$$

Question

Which of the following statements about the competitive strategies outlined by Michael Porter is most accurate?

1. Cost leadership strategy is suitable for companies that prioritize creating products with unique features and superior quality.
2. Differentiation strategy aims to defend against the threat of new entrants and substitutes primarily by achieving economies of scale.
3. Focus strategy is often adopted by niche players targeting a narrow market segment and may incorporate elements from both cost leadership and differentiation strategies.

The correct answer is C.

The focus strategy is about serving a narrow or specific segment of the market exceptionally well, often by understanding their unique needs and preferences deeply. As described, this strategy can take elements from both cost leadership (e.g., serving this niche at a low cost) and differentiation (e.g., offering the niche a unique product).

A is incorrect. Cost leadership emphasizes minimizing costs to offer products at lower prices than competitors. It does not prioritize the creation of products with unique features and superior quality; that’s the essence of the differentiation strategy.

B is incorrect. While the differentiation strategy indeed defends against the threat of new entrants and substitutes, it does so by offering unique and high-quality products, fostering customer loyalty, and reducing the bargaining power of buyers. Achieving economies of scale is primarily an element of the cost leadership strategy, not differentiation.