Porter's Generic Strategies and Firm Performance

Literature review

We focused on Porter's generic strategies' framework for a couple of reasons. Firstly, Porter's framework of generic strategies is inherently tied to firm performance. Secondly, Porter's framework overlaps with other typologies. Porter's differentiation strategy resembles prospector strategy, and Porter's strategy of cost leadership is similar to Miles and Snow's defender cost leadership strategies. Porter's focus strategy is very much like Miller and Friesen's niche innovator strategy.

To make clearer the term "strategy" are presented several strategy definitions. Schendel and Hofer, defined strategy as: "strategy provides directional cues to the organization that permit it to achieve its objectives, while responding to the opportunities and threats in its environment." "Strategy is analyzing the present situation and changing it if necessary. Incorporated in this is finding out what one's resources are or what they should be". Cannon, "Strategies are the directional action decisions which are required competitively to achieve the company's purpose." Strategies are potential actions that require top management decisions and large amounts of the firm's resources. In addition, strategies affect organization's long-term prosperity, typically for at least 5 years, and thus are future oriented. Strategies have multifunctional or multidivisional consequences and require consideration of both the external and internal factors facing the firm.

Porter's model and generic strategies are considered as an important part of management theories, through which it is explained the firm behavior toward competitors in a certain industry. The term "generic strategy" refers to a wide area of usage and opportunity to create competing advantage despite the industry, the sort, and size of organization. Strategy is an essential part of any effective business plan. By using an effective competitive strategy, a company finds its industry niche and learns about its customers. According to Porter, strategies allow organizations to gain competitive advantage from three different bases: cost leadership, differentiation, and focus. Porter calls these bases generic strategies.

Meaning of low-cost strategy relationship with firm performance

Low-cost strategy emphasizes producing standardized products at a very low per-unit cost for consumers who are price sensitive. According to Griffin, low-cost strategy is a strategy in which an organization attempts to gain a competitive advantage by reducing its costs below the costs of competing firms.

It is worth mentioning that according to Thompson et al., a low-cost provider's foremost strategic objective is meaningfully lower costs than rivals - but not necessarily the absolutely lowest possible cost. In striving for a cost advantage over rivals, company managers must incorporate features and services that buyers consider essential.

Low-cost strategy puts importance in an increment in organizational performance. It includes the process by which the company is capable of producing or distributing goods and services with a lower cost than the competitors. Porter defines a low-cost strategy as trading of standard products 30 combined with aggressive prices. Pursuing low-cost strategy should be considered not as a product/service offered which is an inferior product, but as a product/service that has same comparative qualities with competitors and an appropriate price. It is worth mentioning that Porter has shown the relationship between low-cost strategy and firm performance, and he found that low-cost strategy is a successful way to realize stable competing advantage through reducing and controlling the cost and as a result raising organization performance.

Numerous authors explained that low-cost strategy can be defined by two alternative types. Type one is a low-cost strategy that offers products or services to a wide range of customers at the lowest price available on the market. Type two is a best-value strategy that offers products or services to a wide range of customers at the best price value available on the market.

The reason that why organizations continue to pursue low-cost strategy is that it helps firms to increase their performance; for the sake of low cost, the company is capable of selling the product and service with a lower price and still providing the same level of profitability with the competitors, and protecting the organization from powerful suppliers by ensuring necessary flexibility inside the area of profit to cope with an increment in input prices, it serves as a barrier for entrants in conditions of the economic scale, control, and cutting the expenses, as well as through experience of curve.

Strategists should be careful about decision making to pursue the low-cost strategy, and it does not provide a permanent competitive advantage for companies that use low cost or best value. Low-cost strategy must achieve their competitive advantage in the way that is very difficult to copy or match by competitors. If the low-cost method can be found relatively easy by rivals or is inexpensive to imitate that strategy, the low-cost advantage will not last long enough to yield a valuable edge in the marketplace, which claims that in a manner that low-cost strategy is successful in improving organization performance, it must fulfill two ways to accomplish this: (a) perform value chain activities more efficiently than rivals and control the factors that drive the costs of value chain activities and (b) revamp the firm's overall value chain to eliminate or bypass some cost-producing activities. But, both of these steps could be imitated by competitors, and therefore, strategists should analyze in detail the competitors and their ability to respond with the same strategy, before they decide to apply the low-cost strategy. By pursuing a low-cost strategy, firms must be careful to use no such aggressive price cut which leads their profits to be low or not existing. Using this strategy constantly is mindful of technological breakthrough cost-saving or any other value chain progress by rivals that could erode or destroy the firm's competitive advantage.

A successful low-cost strategy usually infiltrates the entire firm, as evidenced by high efficiency, low overhead, limited perks, intolerance of waste, intensive screening of budget requests, wide spans of control, rewards linked to cost containment, and broad employee participation in cost control efforts.

Can the differentiation strategy serve as a tool for increasing firm performance? Yes

Differentiation strategy is one of Porter's key business strategies. Differentiation refers to the development of a unique product or service. Differentiation strategy is a strategy in which an organization seeks to distinguish itself from competitors through the quality of its products or services.

According to Porter, if product or service is unique, this strategy provides high customer loyalty. Therefore, if customers perceive the product or service as unique, they are loyal to the company and willing to pay the higher price for its products. According to Hesterley and Barney, differentiation of product or service is an expression of individual and group creativity inside firms, which means that the risk of imitating differentiation is depended on firms' capacity to be creative in finding methods that make the product unique. And for this strategy, Porter 30 showed the relationship with firm performance and the advantages that firms earn from pursuing differentiation strategy referring to realizing higher incomes compared with competitors because of mark trust, quality, and perception that clients have for the company product.

It is worth mentioning that even differentiation strategy does not defend the firm strategy from imitation by competitors forever, and David wrote that differentiation does not guarantee competitive advantage, especially if standard products sufficiently meet customer needs or if rapid imitation by competitors is possible. According to him, successful differentiation can mean greater product flexibility, greater compatibility, lower costs, improved service, less maintenance, greater convenience, or more features.

A successful differentiation strategy allows a firm to charge a higher price for its product and to gain customer loyalty because consumers may become strongly attached to the differentiation features declares that to the extent that differentiating attributes are tough for rivals to copy, a differentiation strategy will be especially effective, but the sources of uniqueness must be time-consuming, cost-prohibitive, and simply too burdensome for rivals to match. Therefore, the firm should pay attention when it decides to pursue the differentiation strategy. In their research, Guisado-González et al. have found that implementation of a differentiation strategy in the manufacturing innovative companies influences positively the probability of establishing agreements of R&D cooperation and innovation with other organizations.

The ways that managers can enhance differentiation based on value drivers according to Thompson et al. include the following: create product features and performance attributes that appeal to a wide range of buyers; improve customer service or add extra services; invest in production-related R&D activities; strive for innovation and technological advances; pursue continuous quality improvement; increase marketing and brand-building activities; seek out high-quality inputs; and emphasize human resource management activities that improve the skills, expertise, and knowledge of company personnel.

Is it possible that firms implement differentiation strategy and low-cost strategy simultaneously?

Given the beneficial impact of both strategies on the firm competitive position, it logically will raise the question: Can a firm simultaneously implement both strategies? After all, if each strategy separately can improve firm performance, wouldn't be better for the firm to implement both of them? The answers to these questions are not compatible between authors.

According to Hesterly and Barney, the answer is No: These strategies cannot be implemented simultaneously. In their view, the organizational requirements of these strategies are essentially contradictory. Low-cost strategy requires simple reporting relationships, whereas product differentiation requires cross-divisional/cross-functional linkages. According to them, firms that do not make this choice of strategies (medium price, medium market share) or that attempt to implement both strategies will fail. These firms are said to be "stuck in the middle".

In the Porter strategy trade-off paradigm, opposed strategic dimensions could not be pursued at the same time without creating some sort of inefficiency in the firm's value chain. This is because strategic positioning, such as differentiation and low cost, involves contradictory activities and resource allocation that are mutually exclusive. Another approach of strategy which is called "blue ocean strategy" argues the opposite; even more, they go beyond that firms can apply all these activities simultaneously: elimination, reduction, growing, and creating.

Strategic authors have analyzed the "blue ocean strategy" by conducted a study of business launches in 108 companies. They found that 86% of these launches were line extensions, i.e., incremental improvements to existing industry offerings within red oceans, while a mere 14% were aimed at creating new markets or blue oceans. While line extensions in red oceans did account for 62% of the total revenues, they only delivered 39% of the total profits. By contrast, the 14% invested in creating blue oceans delivered 38% of total revenues and a startling 61% of total profits. Given that business launches included the total investments made for creating red and blue oceans (regardless of their subsequent revenue and profit consequences, including failures), the performance benefits of creating blue oceans are evident. In this explanation, blue ocean strategy looks a bit like differentiation strategy, because it creates something different from existing products. So, what is the relationship between blue ocean strategy and differentiation strategy?

The explanation of the relationship between the blue ocean strategy and differentiation strategy is given in the following: Blue oceans are defined by untapped market space, demand creation, and the opportunity for highly profitable growth. Although some blue oceans are created well beyond existing industry boundaries, most are created from within red oceans by expanding existing industry boundaries. In blue oceans, competition is irrelevant because the rules of the game are waiting to be set. The term "blue ocean" is an analogy to describe the wider potential of market space that is vast, deep, and not yet explored. It will always be important to navigate successfully in the red ocean by outcompeting rivals. So the main direction which is promoted by blue ocean strategy is to create something (product or service) different from the products or services that exist in the market.

Another question is regarding the relationship between blue ocean strategy and low-cost strategy. Is blue ocean strategy basically a low-cost strategy, i.e., is it about capturing the low end of a market with a low enough price? (www.blueoceanstrategy.com). The answer is No; blue ocean strategy pursues differentiation and low cost simultaneously by reconstructing market boundaries. A blue ocean strategic move captures the mass of target buyers not through low-cost pricing, but through strategic pricing. The key here is not to pursue pricing against the competition within an industry but to pursue pricing against substitutes and alternatives that are currently capturing the non-customers of your industry.

Focus strategy in the function of improving firm performance

Focus strategy is proposed from Porter 30 as a generic strategy, which has shown that if the firm implements the focus strategy in an appropriate way, its performance will be increased. Focus strategy is a strategy in which an organization concentrates on a specific regional market, product line, or group of buyers.

Through focus strategy, the company has as a purpose to serve a segment in the close market. Pursuing this strategy provides firm the integration of wide range activities that are connected with differentiation and low cost in a particular segment from which company generates higher profits, and Pulaj states that firms advantage during implementation of focus strategy are higher. One of the advantages is firm's capacity to act with high speed in order to adjust the changes in the environment, taste, and preferences of consumers. Focusing on a specific market with different needs from the others, it creates an advantage compared to rivals based on the knowledge and experience in fields related to competencies such as low cost or differentiation. According to David, a successful focus strategy depends on an industry segment that is of sufficient size, has good growth potential, and is not crucial to the success of other major competitors. Strategies such as market penetration and market development offer substantial focusing advantages.

Focus strategy has two alternative types. Type one is a low-cost focus strategy that offers products or services to a small range (niche group) of customers at the lowest price available on the market. Type two is a best-value focus strategy that offers products or services to a small range of customers at the best price value available on the market. Sometimes called "focused differentiation," the best-value focus strategy aims to offer a niche group of customers the products or services that meet their tastes and requirements better than rivals' products do.

Midsize and large firms can effectively pursue focus-based strategies only in conjunction with differentiation or cost leadership-based strategies. All firms in essence follow a differentiated strategy. Because only one firm can differentiate itself with the lowest cost, the remaining firms in the industry must find other ways to differentiate their products. Focus strategies are most effective when consumers have distinctive preferences or requirements and when rival firms are not attempting to specialize in the same target segment.

The conceptual model derived from the relationship between Porter's generic strategies and firm performance

The literature for strategies provides numerous theories, research methodologies, and ideas on the strategy–performance relationship. Researchers have found the link between generic strategies and performance lessened by situational variables including a focus on manufacturing and profitability. To investigate the generic strategies and performance link, many researchers began utilizing approaches found to be generalizable across industries, specifically those proposed by Porter.

Several researchers have treated this relationship and later on were supported by other researchers. Some of the research supported singular generic strategies also produces results which sow seeds of doubt about the relationship between singular generic strategy and superior performance, and it appears some businesses succeed only when they combine differentiation and low-cost generic strategies. Allen and Helms seek further research on the relationship between strategy and firm performance, including potential moderators of this relationship, which is clearly needed in order to advance strategic theory.

Therefore starting from the existing literature for strategy, it will be presented the relation between Porter's generic strategy and firm performance. Figure 1 shows the conceptual model of this study. Authors were agreeing on the importance of generic strategies, but researchers have not determined yet, which of the three generic strategy frameworks helps more the firm to increase its performance. It seems that some combination of practices is more effective, but propositions on strategic practices have remained largely untested and there is a recognized need for empirical works in this area. This exploratory research begins to fill this gap in the literature and find out which of the three generic strategies is better to pursue by firms.

Fig. 1 Conceptual model.

Figure 1 presents the research conceptual model, which figuratively summarizes hypotheses that will be explored below.