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CHAPTER 5

The Five Generic
Competitive
Strategies

Learning Objectives

THIS CHAPTER WILL HELP YOU UNDERSTAND:

LO 1 What distinguishes each of the five generic strategies and why some of these strategies
work better in certain kinds of competitive conditions than in others.

LO 2 The major avenues for achieving a competitive advantage based on lower costs.

LO 3 The major avenues to a competitive advantage based on differentiating a company’s
product or service offering from the offerings of rivals.

LO 4 The attributes of a best-cost provider strategy—a hybrid of low-cost provider and
differentiation strategies.

© Roy Scott/Ikon Images/SuperStock

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Strategy 101 is about choices: You can’t be all things to
all people.

Michael E. Porter—Professor, author, and cofounder of

Monitor Consulting

Strategy is all about combining choices of what to
do and what not to do into a system that creates the

requisite fit between what the environment needs and
what the company does.

Costas Markides—Professor and consultant

I learnt the hard way about positioning in business,
about catering to the right segments.

Shaffi Mather—Social entrepreneur

A company’s competitive strategy deals exclusively with the specifics of manage-
ment’s game plan for competing successfully—its specific efforts to position itself in
the marketplace, please customers, ward off competitive threats, and achieve a partic-
ular kind of competitive advantage. The chances are remote that any two companies—
even companies in the same industry—will employ competitive strategies that are
exactly alike in every detail. However, when one strips away the details to get at the
real substance, the two biggest factors that distinguish one competitive strategy from
another boil down to (1) whether a company’s market target is broad or narrow and
(2) whether the company is pursuing a competitive advantage linked to lower costs
or differentiation. These two factors give rise to five competitive strategy options, as
shown in Figure 5.1 and listed next.1

1. A low-cost provider strategy—striving to achieve lower overall costs than rivals
on comparable products that attract a broad spectrum of buyers, usually by under-
pricing rivals.

A company can employ any of several basic
approaches to competing successfully and gain-
ing a competitive advantage over rivals, but they
all involve delivering more value to customers
than rivals or delivering value more efficiently than
rivals (or both). More value for customers can mean
a good product at a lower price, a superior prod-
uct worth paying more for, or a best-value offering
that represents an attractive combination of price,
features, service, and other appealing attributes.
Greater efficiency means delivering a given level of

value to customers at a lower cost to the company.
But whatever approach to delivering value the
company takes, it nearly always requires perform-
ing value chain activities differently than rivals and
building competitively valuable resources and capa-
bilities that rivals cannot readily match or trump.

This chapter describes the five generic competi-
tive strategy options. Which of the five to employ
is a company’s first and foremost choice in craft-
ing an overall strategy and beginning its quest for
competitive advantage.

TYPES OF GENERIC COMPETITIVE STRATEGIES

LO 1

What distinguishes
each of the five
generic strategies
and why some of
these strategies
work better in certain
kinds of competitive
conditions than in
others.

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2. A broad differentiation strategy—seeking to differentiate the company’s product
offering from rivals’ with attributes that will appeal to a broad spectrum of buyers.

3. A focused low-cost strategy—concentrating on the needs and requirements of a
narrow buyer segment (or market niche) and striving to meet these needs at lower
costs than rivals (thereby being able to serve niche members at a lower price).

4. A focused differentiation strategy—concentrating on a narrow buyer segment (or
market niche) and outcompeting rivals by offering niche members customized
attributes that meet their tastes and requirements better than rivals’ products.

5. A best-cost provider strategy—striving to incorporate upscale product attributes
at a lower cost than rivals. Being the “best-cost” producer of an upscale, multifea-
tured product allows a company to give customers more value for their money by
underpricing rivals whose products have similar upscale, multifeatured attributes.
This competitive approach is a hybrid strategy that blends elements of the previous
four options in a unique and often effective way.

The remainder of this chapter explores the ins and outs of these five generic com-
petitive strategies and how they differ.

FIGURE 5.1 The Five Generic Competitive Strategies

Lower Cost

Type of Competitive
Advantage Being Pursued

M
a

rk
e

t
Ta

rg
e

t
Di?erentiation

Broad
Di?erentiation

Strategy

Overall
Low-Cost
Provider
Strategy

Best-Cost
Provider
Strategy

Focused
Low-Cost
Strategy

Focused
Di?erentiation

Strategy

A Broad
Cross-Section
of Buyers

A Narrow
Buyer
Segment
(or Market
Niche)

Source: This is an expanded version of a three-strategy classification discussed in Michael E. Porter, Competitive Strategy (New York: Free
Press, 1980).

LOW-COST PROVIDER STRATEGIES
Striving to achieve lower overall costs than rivals is an especially potent competitive
approach in markets with many price-sensitive buyers. A company achieves low-cost
leadership when it becomes the industry’s lowest-cost provider rather than just being
one of perhaps several competitors with comparatively low costs. A low-cost pro-
vider’s foremost strategic objective is meaningfully lower costs than rivals—but not

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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. A product offering that is too frills-free can be viewed by consumers as
offering little value regardless of its pricing.

A company has two options for translating a low-cost advantage over rivals into
attractive profit performance. Option 1 is to use the lower-cost edge to underprice
competitors and attract price-sensitive buyers in great enough numbers to increase
total profits. Option 2 is to maintain the present price, be content with the present
market share, and use the lower-cost edge to earn a higher profit margin on each
unit sold, thereby raising the firm’s total profits and overall return on investment.

While many companies are inclined to exploit a low-cost advantage by using
option 1 (attacking rivals with lower prices), this strategy can backfire if rivals
respond with retaliatory price cuts (in order to protect their customer base and
defend against a loss of sales). A rush to cut prices can often trigger a price war
that lowers the profits of all price discounters. The bigger the risk that rivals will
respond with matching price cuts, the more appealing it becomes to employ the
second option for using a low-cost advantage to achieve higher profitability.

The Two Major Avenues for Achieving
a Cost Advantage
To achieve a low-cost edge over rivals, a firm’s cumulative costs across its overall
value chain must be lower than competitors’ cumulative costs. There are two major
avenues for accomplishing this:2

1. Perform value chain activities more cost-effectively than rivals.
2. Revamp the firm’s overall value chain to eliminate or bypass some cost-

producing activities.

Cost-Efficient Management of Value Chain Activities For a
company to do a more cost-efficient job of managing its value chain than rivals,
managers must diligently search out cost-saving opportunities in every part of the
value chain. No activity can escape cost-saving scrutiny, and all company personnel
must be expected to use their talents and ingenuity to come up with innovative and
effective ways to keep down costs. Particular attention must be paid to a set of factors
known as cost drivers that have a strong effect on a company’s costs and can be used
as levers to lower costs. Figure 5.2 shows the most important cost drivers. Cost-cutting
approaches that demonstrate an effective use of the cost drivers include:

1. Capturing all available economies of scale. Economies of scale stem from an
ability to lower unit costs by increasing the scale of operation. Economies of
scale may be available at different points along the value chain. Often a large
plant is more economical to operate than a small one, particularly if it can be
operated round the clock robotically. Economies of scale may be available due
to a large warehouse operation on the input side or a large distribution center on
the output side. In global industries, selling a mostly standard product world-
wide tends to lower unit costs as opposed to making separate products for each
country market, an approach in which costs are typically higher due to an inabil-
ity to reach the most economic scale of production for each country. There are
economies of scale in advertising as well. For example, Anheuser-Busch could

CORE CONCEPT

A low-cost provider’s basis
for competitive advantage
is lower overall costs than
competitors. Successful
low-cost leaders, who have
the lowest industry costs,
are exceptionally good at
finding ways to drive costs
out of their businesses and
still provide a product or
service that buyers find
acceptable.

CORE CONCEPT

A cost driver is a factor
that has a strong influence
on a company’s costs.

A low-cost advantage over
rivals can translate into
better profitability than
rivals attain.

LO 2

The major avenues
for achieving
a competitive
advantage based on
lower costs.

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afford to pay the $5 million cost of a 30-second Super Bowl ad in 2016 because
the cost could be spread out over the hundreds of millions of units of Budweiser
that the company sells.

2. Taking full advantage of experience and learning-curve effects. The cost of
performing an activity can decline over time as the learning and experience of
company personnel build. Learning and experience economies can stem from
debugging and mastering newly introduced technologies, using the experiences
and suggestions of workers to install more efficient plant layouts and assembly
procedures, and the added speed and effectiveness that accrues from repeatedly
picking sites for and building new plants, distribution centers, or retail outlets.

3. Operating facilities at full capacity. Whether a company is able to operate at or
near full capacity has a big impact on unit costs when its value chain contains
activities associated with substantial fixed costs. Higher rates of capacity utili-
zation allow depreciation and other fixed costs to be spread over a larger unit
volume, thereby lowering fixed costs per unit. The more capital-intensive the
business and the higher the fixed costs as a percentage of total costs, the greater
the unit-cost penalty for operating at less than full capacity.

4. Improving supply chain efficiency. Partnering with suppliers to streamline the
ordering and purchasing process, to reduce inventory carrying costs via just-in-
time inventory practices, to economize on shipping and materials handling, and to

FIGURE 5.2 Cost Drivers: The Keys to Driving Down Company Costs

Learning and
experience

Capacity
utilization

Supply chain
e?ciencies

Bargaining
power

Outsourcing or
vertical

integration

Incentive
systems and

culture 

Economies of
scale

Input costs

Communication
systems and
information
technology

Production
technology
and design

COST
DRIVERS

Source: Adapted from Michael E. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York: Free Press, 1985).

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ferret out other cost-saving opportunities is a much-used approach to cost reduc-
tion. A company with a distinctive competence in cost-efficient supply chain man-
agement, such as BASF (the world’s leading chemical company), can sometimes
achieve a sizable cost advantage over less adept rivals.

5. Substituting lower-cost inputs wherever there is little or no sacrifice in product
quality or performance. If the costs of certain raw materials and parts are “too
high,” a company can switch to using lower-cost items or maybe even design the
high-cost components out of the product altogether.

6. Using the company’s bargaining power vis-à-vis suppliers or others in the value
chain system to gain concessions. Home Depot, for example, has sufficient bar-
gaining clout with suppliers to win price discounts on large-volume purchases.

7. Using online systems and sophisticated software to achieve operating efficien-
cies. For example, sharing data and production schedules with suppliers, coupled
with the use of enterprise resource planning (ERP) and manufacturing execution
system (MES) software, can reduce parts inventories, trim production times, and
lower labor requirements.

8. Improving process design and employing advanced production technology. Often
production costs can be cut by (1) using design for manufacture (DFM) proce-
dures and computer-assisted design (CAD) techniques that enable more integrated
and efficient production methods, (2) investing in highly automated robotic pro-
duction technology, and (3) shifting to a mass-customization production process.
Dell’s highly automated PC assembly plant in Austin, Texas, is a prime exam-
ple of the use of advanced product and process technologies. Many companies
are ardent users of total quality management (TQM) systems, business process
reengineering, Six Sigma methodology, and other business process management
techniques that aim at boosting efficiency and reducing costs.

9. Being alert to the cost advantages of outsourcing or vertical integration. Out-
sourcing the performance of certain value chain activities can be more economical
than performing them in-house if outside specialists, by virtue of their expertise
and volume, can perform the activities at lower cost. On the other hand, there can
be times when integrating into the activities of either suppliers or distribution-
channel allies can lower costs through greater production efficiencies, reduced
transaction costs, or a better bargaining position.

10. Motivating employees through incentives and company culture. A company’s
incentive system can encourage not only greater worker productivity but also
cost-saving innovations that come from worker suggestions. The culture of a com-
pany can also spur worker pride in productivity and continuous improvement.
Companies that are well known for their cost-reducing incentive systems and
culture include Nucor Steel, which characterizes itself as a company of “20,000
teammates,” Southwest Airlines, and Walmart.

Revamping of the Value Chain System to Lower Costs Dramatic
cost advantages can often emerge from redesigning the company’s value chain system
in ways that eliminate costly work steps and entirely bypass certain cost-producing
value chain activities. Such value chain revamping can include:

· Selling direct to consumers and bypassing the activities and costs of distribu-
tors and dealers. To circumvent the need for distributors and dealers, a company
can (1) create its own direct sales force (which adds the costs of maintaining and

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supporting a sales force but which may well be cheaper than using independent
distributors and dealers to access buyers) and/or (2) conduct sales operations at
the company’s website (incurring costs for website operations and shipping may
be a substantially cheaper way to make sales than going through distributor–dealer
channels). Costs in the wholesale and retail portions of the value chain frequently
represent 35 to 50 percent of the final price consumers pay, so establishing a direct
sales force or selling online may offer big cost savings.

· Streamlining operations by eliminating low-value-added or unnecessary work
steps and activities. At Walmart, some items supplied by manufacturers are deliv-
ered directly to retail stores rather than being routed through Walmart’s distribu-
tion centers and delivered by Walmart trucks. In other instances, Walmart unloads
incoming shipments from manufacturers’ trucks arriving at its distribution cen-
ters and loads them directly onto outgoing Walmart trucks headed to particular
stores without ever moving the goods into the distribution center. Many super-
market chains have greatly reduced in-store meat butchering and cutting activities
by shifting to meats that are cut and packaged at the meatpacking plant and then
delivered to their stores in ready-to-sell form.

· Reducing materials handling and shipping costs by having suppliers locate their
plants or warehouses close to the company’s own facilities. Having suppliers
locate their plants or warehouses close to a company’s own plant facilitates just-
in-time deliveries of parts and components to the exact workstation where they
will be used in assembling the company’s product. This not only lowers incoming
shipping costs but also curbs or eliminates the company’s need to build and oper-
ate storerooms for incoming parts and components and to have plant personnel
move the inventories to the workstations as needed for assembly.

Illustration Capsule 5.1 describes the path that Amazon.com, Inc. has followed on
the way to becoming not only the largest online retailer (as measured by revenues) but
also the lowest-cost provider in the industry.

Examples of Companies That Revamped Their Value Chains
to Reduce Costs Nucor Corporation, the most profitable steel producer in the
United States and one of the largest steel producers worldwide, drastically revamped
the value chain process for manufacturing steel products by using relatively inexpen-
sive electric arc furnaces and continuous casting processes. Using electric arc furnaces
to melt recycled scrap steel eliminated many of the steps used by traditional steel mills
that made their steel products from iron ore, coke, limestone, and other ingredients
using costly coke ovens, basic oxygen blast furnaces, ingot casters, and multiple types
of finishing facilities—plus Nucor’s value chain system required far fewer employees.
As a consequence, Nucor produces steel with a far lower capital investment, a far
smaller workforce, and far lower operating costs than traditional steel mills. Nucor’s
strategy to replace the traditional steelmaking value chain with its simpler, quicker
value chain approach has made it one of the world’s lowest-cost producers of steel,
allowing it to take a huge amount of market share away from traditional steel com-
panies and earn attractive profits. (Nucor reported a profit in 188 out of 192 quarters
during 1966–2014—a remarkable feat in a mature and cyclical industry notorious for
roller-coaster bottom-line performance.)

Southwest Airlines has achieved considerable cost savings by reconfiguring the
traditional value chain of commercial airlines, thereby permitting it to offer travelers
dramatically lower fares. Its mastery of fast turnarounds at the gates (about 25 minutes

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ILLUSTRATION
CAPSULE 5.1

In 1996, shortly after founding Amazon.com, CEO Jeff
Bezos told his employees,  “When you are small, some-
one else that is bigger can always come along and
take away what you have.” Since then, the company
has relentlessly pursued growth, aiming to become the
global cost leader in “customer-centric E-commerce”
across nearly all consumer merchandise lines. Amazon.
com now offers over 230 million items for sale in
America— approximately 30 times more than Walmart—
and its annual sales are greater than the next five larg-
est e-retailers combined.

In scaling up, Amazon has achieved lower costs not
only through economies of scale, but also by increasing
its bargaining power over its supplies and distribution
partners. With thousands of suppliers, Amazon.com is
not reliant on any one relationship. Suppliers, however,
have few other alternative e-retailers that can match
Amazon’s reach and popularity. This gives Amazon bar-
gaining power when negotiating revenue sharing and
payment schedules. Amazon has even been able to
negotiate for space inside suppliers’ warehouses, reduc-
ing their own inventory costs.

On the distribution side, Amazon has been develop-
ing its own capabilities to reduce reliance on third-party
delivery services. Unlike most mega retailers, Amazon’s
distribution operation was designed to send small orders
to residential customers. Amazon.com attained proxim-
ity to its customers by building a substantial network of
warehousing facilities and processing capability—249
fulfillment and delivery stations globally. This wide foot-
print decreases the marginal cost of quick delivery, as
well as Amazon’s reliance on cross-country delivery
services. In addition, Amazon has adopted innovative
delivery services to further lower costs and extend its
reach. In India and the UK, for example, through Easy

Ship Amazon’s crew picks up orders directly from sell-
ers, eliminating the time and cost of sending goods to a
warehouse and the need for more space.

Amazon’s size has also enabled it to spread the
fixed costs of its massive up-front investment in auto-
mation across many units. Amazon.com was a pioneer
of algorithms generating customized recommenda-
tions for customers. While developing these algo-
rithms was resource-intensive, the costs of employing
them are low. The more Amazon uses its automated
sales tools to drive revenue, the more the up-front
development cost is spread thin across total revenue.
As a result, the company has lower capital inten-
sity for each dollar of sales than other large retailers
(like Walmart and Target). Other proprietary tools
that increase the volume and speed of sales—without
increasing variable costs—include Amazon.com’s pat-
ented One Click Buy feature. All in all, these moves
have been helping secure Amazon’s position as the
low-cost provider in this industry.

Amazon’s Path to Becoming the
Low-Cost Provider in E-commerce

© Sean Gallup/Getty Images

Note: Developed with Danielle G. Garver.

Sources: Company websites; seekingalpha.com/article/2247493-amazons-competitive-advantage-quantified; Brad Stone, The Everything Store (New York:
Back Bay Books, 2013); w w w.reuters.com/article/us-amazon- com-india-logistics-idUSKCN0T12 PL20151112 (accessed February 16, 2016).

versus 45 minutes for rivals) allows its planes to fly more hours per day. This
translates into being able to schedule more flights per day with fewer aircraft,
allowing Southwest to generate more revenue per plane on average than rivals.
Southwest does not offer assigned seating, baggage transfer to connecting air-
lines, or first-class seating and service, thereby eliminating all the cost-producing
activities associated with these features. The company’s fast and user-friendly
online reservation system facilitates e-ticketing and reduces staffing requirements

Success in achieving a low-
cost edge over rivals comes
from out-managing rivals
in finding ways to perform
value chain activities faster,
more accurately, and more
cost-effectively.

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at telephone reservation centers and airport counters. Its use of automated check-in
equipment reduces staffing requirements for terminal check-in. The company’s care-
fully designed point-to-point route system minimizes connections, delays, and total
trip time for passengers, allowing about 75 percent of Southwest passengers to fly
nonstop to their destinations and at the same time reducing Southwest’s costs for flight
operations.

The Keys to Being a Successful
Low-Cost Provider
While low-cost providers are champions of frugality, they seldom hesitate to spend
aggressively on resources and capabilities that promise to drive costs out of the busi-
ness. Indeed, having competitive assets of this type and ensuring that they remain
competitively superior is essential for achieving competitive advantage as a low-cost
provider. Walmart, for example, has been an early adopter of state-of-the-art technol-
ogy throughout its operations; however, the company carefully estimates the cost sav-
ings of new technologies before it rushes to invest in them. By continuously investing
in complex, cost-saving technologies that are hard for rivals to match, Walmart has
sustained its low-cost advantage for over 30 years.

Other companies noted for their successful use of low-cost provider strategies
include Vizio in big-screen TVs, EasyJet and Ryanair in airlines, Huawei in network-
ing and telecommunications equipment, Bic in ballpoint pens, Stride Rite in footwear,
and Poulan in chain saws.

When a Low-Cost Provider Strategy Works Best
A low-cost provider strategy becomes increasingly appealing and competitively
powerful when:

1. Price competition among rival sellers is vigorous. Low-cost providers are in the
best position to compete offensively on the basis of price, to gain market share
at the expense of rivals, to win the business of price-sensitive buyers, to remain
profitable despite strong price competition, and to survive price wars.

2. The products of rival sellers are essentially identical and readily available from
many eager sellers. Look-alike products and/or overabundant product supply
set the stage for lively price competition; in such markets, it is the less efficient,
higher-cost companies whose profits get squeezed the most.

3. It is difficult to achieve product differentiation in ways that have value to buyers.
When the differences between product attributes or brands do not matter much
to buyers, buyers are nearly always sensitive to price differences, and industry-
leading companies tend to be those with the lowest-priced brands.

4. Most buyers use the product in the same ways. With common user requirements, a
standardized product can satisfy the needs of buyers, in which case low price, not
features or quality, becomes the dominant factor in causing buyers to choose one
seller’s product over another’s.

5. Buyers incur low costs in switching their purchases from one seller to another.
Low switching costs give buyers the flexibility to shift purchases to lower-priced
sellers having equally good products or to attractively priced substitute products.
A low-cost leader is well positioned to use low price to induce potential customers
to switch to its brand.

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Pitfalls to Avoid in Pursuing a Low-Cost
Provider Strategy
Perhaps the biggest mistake a low-cost provider can make is getting carried away with
overly aggressive price cutting. Higher unit sales and market shares do not automati-
cally translate into higher profits. Reducing price results in earning a lower profit
margin on each unit sold. Thus reducing price improves profitability only if the lower
price increases unit sales enough to offset the loss in revenues due to the lower per
unit profit margin. A simple numerical example tells the story: Suppose a firm
selling 1,000 units at a price of $10, a cost of $9, and a profit margin of $1 opts to
cut price 5 percent to $9.50—which reduces the firm’s profit margin to $0.50 per
unit sold. If unit costs remain at $9, then it takes a 100 percent