Fundamentally, the risks in pursuing the Porters generic competitive strategies are two: first, failing to attain or sustain the strategy; second, for the value of the strategic advantage provided by the strategy to erode with industry evolution. More narrowly, the three strategies are predicated on erecting differing kinds of defenses against the competitive forces, and not surprisingly they involve differing types of risks. It is important to make these risks explicit in order to improve the firm’s choice among the three alternatives.
Risks of Overall Cost Leadership Strategy
Cost leadership imposes severe burdens on the firm to keep up its position, which means reinvesting in modern equipment, ruthlessly scrapping obsolete assets, avoiding product line proliferation and being alert for technological improvements. Cost declines with cumulative volume are by no means automatic, nor is reaping all available economies of scale achievable without significant attention.
Cost leadership strategy is vulnerable to the risks, such as relying on scale or experience as entry barriers. Some of these risks are
- Technological change that nullifies past investments or learning;
- Low-cost learning by industry newcomers or followers, through imitation or through their ability to invest in state-of-the-art facilities;
- Inability to see required product or marketing change because of the attention placed on cost;
- Inflation in costs that narrow the firm’s ability to maintain enough of a price differential to offset competitors’ brand images or other approaches to differentiation.
The classic example of the risks of cost leadership is the Ford Motor Company of the 1920s. Ford had achieved unchallenged cost leadership through limitation of models and varieties, aggressive backward integration, highly automated facilities, and aggressive pursuit of lower costs through learning. Learning was facilitated by the lack of model changes. Yet as incomes rose and many buyers had already purchased a car and were considering their second, the market began to place more of a premium on styling, model changes, comfort, and closed rather than open cars. Customers were willing to pay a price premium to get such features. General Motors stood ready to capitalize on this development with a full line of models. Ford faced enormous costs of strategic readjustment given the rigidities created by heavy investments in cost minimization of an obsolete model.
Another example of the risks of cost leadership as a sole focus is provided by Sharp in consumer electronics. Sharp, which has long followed a cost leadership strategy, has been forced to begin an aggressive campaign to develop brand recognition. Its ability to sufficiently undercut Sony’s and Panasonic’s prices was eroded by cost increases and U.S. anti-dumping legislation, and its strategic position was deteriorating through sole concentration on cost leadership.
Risks of Differentiation Strategy
Differentiation strategy also involves a series of risks:
- The cost differential between low-cost competitors and the differentiated firm becomes too great for differentiation to hold brand loyalty. Buyers thus sacrifice some of the features, services, or image possessed by the differentiated firm for large cost savings;
- Buyers need for the differentiating factor falls. This can occur as buyers become more sophisticated;
- Imitation narrows perceived differentiation, a common occurrence as industries mature.
The first risk is so important as to be worthy of further comment. A firm may achieve differentiation, yet this differentiation will usually sustain only so much of a price differential. Thus if a differentiated firm gets too far behind in cost due to technological change or simply inattention, the low cost firm may be in a position to make major inroads. For example, Kawasaki and other Japanese motorcycle producers have been able to successfully attack differentiated producers such as Harley-Davidson and Triumph in large motorcycles by offering major cost savings to buyers.
Risks of Focus Strategy
- The cost differential between broad-range competitors and the focused firm widens to eliminate the cost advantages of serving a narrow target or to offset the differentiation achieved by focus;
- The differences in desired products or services between the strategic target and the market as a whole narrows; competitors find sub-markets within the state.