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Cost Leadership and Differentiation; An Investigation of the Fundamental Trade-Off

between Low Cost Leadership and Differentiation Strategies

CHAPTER ONE

1.1 Abstract

Strategy as applied in business organizations is a rather complex and broad concept. In his

definition, Porter (1996) defines strategy as the ‘creation of a unique and valuable position

involving different sets of activities.’ Basically, strategic positioning aims at choosing activities

that have the potential to yield superior profitability because they happen to be quite different

from those of the rivals and thereby create a sustainable competitive advantage. However, no

competitive advantage can be completely enduring and that is why strategy should be

distinguished from the other closely related concept, operational efficiency.

In order to investigate the issue of trade-off between differentiation and cost leadership, an

incisive literature review has been conducted. This is correspondingly accompanied by a cross-

check evaluation of the contemporary business position in respect of the matter. In particular,

this research study examines whether cost leadership and differentiation strategies are mutually

exclusive. When one considers the impact of Porter’s model and in specific on managers, it is of

paramount importance that one takes a critical look.

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The traditional believe that differentiation and low cost leadership are mutually exclusive has

been strongly embraced by some modern practitioners and yet others are of the view that it does

not hold any relevance in the face of modern business practices. Several researchers into the

topic have actually questioned the existence and if the relevance of the inevitable trade-off

between the two strategies. If the traditional view of the inevitable trade-off between the two

concepts proves inconsistent with the current state of affairs but a mixed strategy combining the

two proves appropriate, then business executives need to reconsider their strategic choices.

1.2 Research Objectives

To investigate the fundamental trade-off between low cost leadership and differentiation

strategies

1.3 Purpose of research

This dissertation explores the existing literature on the fundamental trade-off between

differentiation and low cost leadership business strategies. Practical applications and concepts

about the compatibility of the two strategies will be reviewed thoroughly as a complement to the

theoretical literature so as to shed some light on the inherent relationship between theory and

practice. The research is not necessarily intended to be used by any government or institution in

implementation of policies but will generally add more knowledge to the existing literature by

producing new insight on generic strategies and specifically the incompatibility between

differentiation and cost leadership strategies.

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CHAPTER TWO: LITERATURE REVIEW

2.1 Low Cost Leadership and Differentiation as Strategies for Achieving Competitive

advantages

Competitive advantages in organizations can be achieved through cost leadership. This has the

implication to the fact that, for the organization to successfully gain a competitive edge, it must

consider a production process that is of the lowest cost as compared to other players in the

industry (Oskarsson & Sjöberg, 1994). To be a cost leader, the organization likewise should be

achieving parity of the least proximity with regard to differentiation even if it may be dependent

on the cost leadership associated with the competitive advantage of the firm. It becomes a

disastrous situation whereby several companies operating in the same industry strive for the

achievement of cost leadership. This type of a competitive advantage is better achieved as a

result of a practice of economies of scale (Miller & Friesen, 1986).

Any improvement in quality cost strategies results in corresponding increase in the cost of

production. Consequently, increased cost may result in reduced demand and as such

differentiation limits market share. However, the negative relationship between market share and

differentiation does not impact much on the profitability margin since premium prices are

justified by increased cost (Roth, 1992). While the two concepts can generate significant

competitive advantage which in turn improves business performance, operational efficiency is

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easy to imitate and as such, the competitiveness stands a risk of erosion. Actually researchers

claim that the main threat to sustaining a competitive advantage can always diagnose and make

exact duplication or in some cases render obsolete a firm’s competitive advantage.

A competitive advantage in an organization may also be achieved through differentiation. The

achievement of differentiation has the implication of the fact that, the organization strives

towards uniqueness in relation to other players in the industry in consideration of specific

dimension which most of the consumers appreciate to a great degree. The use of differentiation

requires that the cost position is not ignored (Miller & Friesen, 1986). All the segments that have

a significant impact on the differentiation should not tend towards the decrease in cost. With

regard to the area of differentiation, the cost should be kept at a lower stage relative to the

premium price that the customers are ready to offer. Differentiation can be based on areas such

as the product, the image, service rendered, sales, marketing or distribution.

The type of strategy that a business employs and performance it achieves are positively

correlated (Oskarsson & Sjöberg, 1994). The positive effects of increased differentiation on

market share depends on two factors; the uniqueness of the differentiation strategy and the

perceived effect of the strategy. Increased differentiation should be correspondingly translated

into product improvement so that the cost reduction effect can take place. The reason for this is

that increased product quality results in beneficial effects on the relative product demand. So if

increased demand is governed by increase in sales volume, then there might be certain beneficial

effects on cost positioning through positive and direct influence on market position (Roth, 1992).
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According to what Porter states, with the onset of imitation of successful firms by the

competitors, there is a high possibility that they will be under pressure of choosing between the

lower cost and the issue of differentiation. There is a possibility for the improvement of

technology by the firms coupled the approaches that lead to the reduction in cost in a

simultaneous manner with the improvement of differentiation. At the end of it all, the

competitors will be compelled towards the imitation and a tendency of making a choice which

will result in emphasizing advantage (Miller & Friesen, 1986).

Businesses that use differentiation strategy also use low cost leadership strategy to a certain

extent. The cost leadership strategies also demonstrate certain traits associated with

differentiation. According to Roth, (1992), there are no businesses that employ pure strategies

and as such both low cost leadership and differentiation strategies are usually used

simultaneously. Roth, (1992) argues that the underlying dimension is not low cost versus

differentiation but low cost versus high cost. This researcher claims that it is low cost and high

costs that lie on opposite ends of a continuum. Therefore, if a business chooses to pursue a cost

strategy, it should consider the low cost approach but if it chooses to pursue a differentiation

strategy then the business has to consider adopting high cost approach (Miller & Friesen, 1986).

Porter’s model in effect implies that if all firms are placed on the continuum, firms with above

average profit would be found at the ends of the continuum. Any other point on the continuum

which does lie on the ends implies an unclear strategy. This is what is commonly called ‘stuck in

the middle’. This means a trade-off can be inevitable if a business cannot move away from one

end without its strategies becoming unclear which may eventually cause it to lose profits. Thus,
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while the proponents of porters argue that cost leadership and product differentiation are

irreconcilable, the opponents hold that a trade-off between the two strategies does not necessarily

have to be (Oskarsson & Sjöberg, 1994).

It is however to the acknowledgement of Porter that, an organization may achieve high strides of

success as they tend to pursue the lower cost along with differentiation at the same time in their

endeavor to the achievement of a competitive advantage (Roth, 1992). The reduction of cost is

not an automatic implication of sacrificing on differentiation. Appreciable results may be

achieved though the use of practices that result in a higher degree of efficiency as well as

effective through the employment of a diversity of technology. According to the suggestions of

Porter, there arises some rare occasions in which some organizations achieve success as a result

of combining both the approaches intended at achieving a competitive edge Porter, M.E. (1988).

2.2 Examining the divergence point

High differentiation and low cost position are just but two unique ways of gaining competitive

advantages (Miller & Friesen, 1986). Essentially, both strategies are governed by certain

relationships which hint to an interaction effect between them. Thus an effective business firm

cannot in any way afford to put special emphasis on only one business strategy at the expense of

the other. Recent studies on cost leadership and differentiation cut-off reveal clear differences in

the conception of differentiation and cost leadership strategies but all point to the fact that there

is no any one single strategy that can be utilized for effective performance. Differentiation

strategy comprises of a large number of interrelated elements such as quality guarantee but
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superiority quality is the only one that is mostly associated with the strategy. In effect,

superiority in quality is perceived to be a major determinant of differentiation not only in studies

but also in tests and researches (Parker & Helms, 1992).

At such instances, the firms were in apposition of reaping high profiles of benefits as compared

to other organizations that opted for one approach to competitive advantage. The potential ability

of an organization towards the achievement of cost leadership together with differentiation at the

same time leads to higher rewards coupled with additive form of benefits with differentiation

resulting to the achievement of premium prices while cost leadership brings about lower costs

Porter, M.E. (1988). Porter’s conceptualization models have been heavily criticized by even

some of the proponents of Porter’s school of thought. For instance, Hambrick, (1983) argues that

it might be true that differentiation and efficiency are incompatible but they cannot be opposite

ends of a single continuum as Porter presents them. Dess and Davis, (1984) claim that

competitive strategies can be represented as broad types of strategic groups. This means that cost

leadership makes out one group and this includes all strategies that are similar and have certain

aspects in common.

High cost differentiation can limit a business’ potentiality to reap economies of scale and hence

the market share. Nurturing a good relationship between market share and differentiation is

fundamental for the success of a business. Thus, no single business no matter its size or nature of

business can maintain its competitive edge in the market without embracing certain aspects of

the differentiation strategy (Roth, 1992). The model of generic strategies as originally postulated

by Porter in 1980 addresses business practitioners with an evaluative technique for gaining
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understanding of industry trends and competitors. By practitioners, Porter means all business

managers interested in improving the performance of their businesses or security analysis

strategies attempting to understand or forecast business failure or success. The reason for

strategic planning being an issue of primary concern for business managers is that it can easily

lead to immense benefits for the firm (Phillips et al, 1983).

For the firm that takes the option of achieving a competitive advantage through lower cost, their

focus is usually on improving the profitability arising due to lower costs as compared to others in

the same industry. Putting, the value of the product at a lower cost but near that one of the

competitors is tantamount to translating to superior returns. This therefore implies that lowering

the cost of the products results to advantage since this encourages the consumers to buy more

due to the reason that they access products of a higher value at a reasonably low cost (Parker &

Helms, 1992). Strategies can be well reconciled (i.e. without trade-off) since firms can introduce

skills to suit both strategies at the same time. As a matter of fact, strategies that are combined are

less likely to run into risks related with pure strategies i.e specialization (e.g. mller,1988; wright

et al,1991). Quoting Miller (1988), strategic specialization may result in ”major gaps or

weaknesses in product offerings, fail to consider important customer needs, be simple for

competitors to counter, and ,after some time, bring inflexibility and lessen an organizations

vision . “Miller (1998) states that caterpillar originally tried to be the highest-quality producer of

earth-movers world wide by paying attention only to durability and precision but failed to

consider efficiency and economy.

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Considering the disparities that exist between the two models however indicates that they both

have some features in common (Parker & Helms, 1992). One of the most notable features is the

management of the value chain which is an avenue towards competitive advantage, and with a

continuous improvement of the value chain. This also facilitates that the product acquires an

extremely higher value relative to the competitors. The common feature are important in that

they facilitate that the models are applicable simultaneously towards the creation of a

competitive advantage on the basis of a higher order, which is in essence next to impossible to

create an imitation of a competitive advantage (Porter, 1988).

Product differentiation and cost leadership are interesting as well as popular research topics

within the wider area of strategy. The two topics have been widely discussed ever since Porter

advanced his model of generic business strategies in the 1980s. Modern day researchers into the

topic in fact refer to it as being among the most important contributors of literature on strategic

business management. However, the issue of whether cost leadership and differentiation are

mutually exclusive ahs not been adequately discussed and this as Phillips et al, (1983), claim can

be evidenced by elative scarcity of literature on the topic.

Differentiation on the other hand makes out the second group and this constitutes all strategies

that are similar and all contains certain elements that are generally associated with differentiation

though these do not have to be identical. Roth, (1992) supports this view and assets that choosing

a business strategy is akin to choosing strategic group membership. Each group will have its own

unique features which are not reconcilable and therefore a business can be a member in one

strategic group only. Several attempts have been made to combine cost leadership and
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differentiation but most of these have failed because the two groups are essentially incompatible.

This according to Miller, (1992), means that a trade-off between cost leadership and

differentiation is inevitable because the two strategies are mutually exclusive.

2.3 The concept of combined strategy

According to Porter, adopting a “single” strategy successfully requires total commitment;

thereby implementing two strategies needs an excessive effort. Chakraborty & PHILIP (1996),

states that some firms follow a mixed approach is due to difficulty in designing and

implementing an effective extensive strategy laid according to the two approaches. Since cost

leadership and differentiation strategies demand different resources, skills, organizational

arrangements and managerial styles that are hard and also incompatible to reconcile, efforts to

reconcile the two finally result to a trade-off. For example competition between cost leadership

and differentiation strategies require resources and technologies of functional support that stress

cost cutting throughout” the total functional areas of the organization.

Campbell-Hunt (2000) states that organizational constraints generally represent the main reason

why cost-and differentiation-strategies designs are known to be mutually exclusive. Strategies

are also exposed to various risks and hence require different guards, which on the other hand,

could be incompatible or even opposed to each other(Wright & Parsinia , 1988).Thus even if the

two strategies stress on profits and performance their approaches differ ( Chakraborty & Philip,

1996). Making a decision on which strategy to employ implies matching “strategic

requirements” with the firm’s resources, capabilities and short comings. Anyhow, since a firm
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has limited materials, it is an favorable to all strategies.( Porter,1980,Wright &

Parinsia,1988;Barney,2002).By being ‘all things to all customers’ a firm is in danger of

becoming too wide and finally answering to no particular customer or market segment (Porter ,

1980; Akan et al, 2006;Chakraborty & Philip,1996).

Grant (2005) for example names it as “one of the greatest strategic challenges of the 1990s”.in

relation to Murry (1988), the points that prefer cost leadership are free from conditions that

prefer differentiation and so there is no favored reason to rule out the likely hood of reconciling

cost and differentiation based on outside conditions .Contrary, outside conditions can very well

prefer mixed strategies, on condition that differentiation and market is positive, differentiation

may generate economies of scale ,equally meaning that higher differentiation and cost

reductions are arrived at the same time .As observed earlier differentiators demand a higher

price(originally justified by higher production cost strategies and product uniqueness).Hence

mixing strategies with success means that a firm may charge a higher price(than cost leaders)

while lowering cost strategies (compared to differentiators), leading to superior profits.

Excessive focus on a single point, strategy or strength risks lowering resilience and adaptability

in he long run. Combination strategies ,promote flexibility and makes it simple for firms to get

accustomed to changes, such as, advances in technology and changes in industry( Miller, 1992;

Parker &Helms,1992).Miller (1992), (Barney (2002) and Barney & Hesterly (2006) suggest that,

firms that are successful both in cost leadership and product differentiation ,can be expected to

have a sustained competitive advantage .As a matter of fact, combination of cost leadership and

differentiation can be expected to benefit from competitive cost advantage.

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A combination of cost leadership and differentiation strategies produces complex relations, e.g.

among employees, between employees, the technology in use, and the firm which they belong to.

The reason is because mixed strategies engage a lot of resources and organizational support.

Therefore, as long as the organizational strengths and weaknesses applied are rare, scarce and

expensive to imitate, the socially complex relations that materialize when reconciling strategies

constitute an origin of sustained competitive advantage (Miller, 1992; Berney, 2002; Berney &

Hesterley , 2006).

Phillips et al, (1983), advocates that a trade-off does not have to be mixed. Strategies can

generate superior performance as they have the capability to create socially complex relations

that market sham scarce, rare and costly to imitate, while Porter’s argues that mixed strategy is a

poor choice. Researches show that maximization of profit entails setting preferences foe

effective strategies that ultimately adopt low cost and premium prices if at all they have to result

in superior profits. If there were no trade-offs, all business practitioners should be adopting

combination rather than one single strategy. Evidently, this has never been the case, which in

turn suggests that a trade-off exist. In fact, most researchers concur that attempts to adopt

differentiation and cost leadership simultaneously tend to generate a trade-off. However, if a firm

successfully reconciles both strategies, efforts will be compensated by high performance.

2.4 Examining the relationship between combined strategy and market share
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Saloner et al, (2004) claim that differentiation leads to higher market share provided that the

product appeals to customers. This implies that a business firm has to identify and pursue its

customer preferences if it has to gain increased market shares by way of differentiation.

Specifically, customers will always want to get favorable products as characterized by such

aspects as firm’s resources, processes, skills and history. Differentiation as a strategy allows a

business firm to increase its market share through decreased price elasticity of demand.

Another school of thought rejects the argument forwarded by Porter and followers of his school

of thought. Cost leadership and differentiation are seriously taken to be reconcilable and even

hunted-for. A successful combined strategy produces superior profits according to some

researchers. But, this does not mean that a successful mixed strategy is simple to achieve; in fact,

from the opposite school of thought the challenge is noticeable. Great efforts are required in

adopting mixed strategy successfully (Reddy, 1980; Chakraborty & Philip,1996;Wright et al,

1986;Grant,2005).

Reitsperger, (1998) suggest a very similar explanation offering that differentiation strategy better

position a firm to offer a large product portfolio and thus appeals a broad market share. This

consequently leads to superior demand either through increased number of purchases per

customer or through increased number of customers. However, this is conditional upon industry

conditions and customer preferences. Moreover, there is general consensus that when

differentiation alone is translated to increased product quality, it is insufficient as a way of

achieving low cost position. Competition from well established firms often causes firms to

consider flexibility and adaptability to market and industry changes. This view is clearly
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comparable to Karan’s (1984) where he argues that low input have the ability to successfully

achieve both high differentiation and low cost production.

Traditional researches cost leadership and differentiation leadership have significantly

contributed to the field of business strategy. Most of these researches, started in the 1970s were

followed by a large number of pragmatic contributions most notably in the 1980s. Before the

formal documentation of the concept of strategic positioning, researches held the view that no

two identical strategic settings ever occur. Thus researches in the field of business level strategy

were complicated to study. In light of this, the introduction of the term strategic groups marked a

significant step in the process of facilitating research.

The basic principle here is that by assigning businesses which employ similar or closely related

strategies to one strategic group, the fast array of combinations is reduced. This means that if

researchers can be able to identify businesses with distinct and recurring patterns of strategic

behaviour, they can be able to limit their arduous researches to only observing a number of

different combinations that is equal to the number identified using strategic grouping. Strategy

types, according to Porter, (1980) have been identified in several industries in consumer and

industry products, insurance, chemical as well as brewing industries.

2.5 Examining the convergence point

According to Saloner, et al, (2001) reconciliation between cost leadership strategies and

differentiation is possible. A trade-off between the two strategies exist and occurs more often but
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is not necessarily inevitable, in spite the fact that reconciliation of the two strategies is a really

enormous challenge in respect of managing process requirements and conditions that are unique

to respective strategies. Successful combination of strategies entails creative selection and

identification of all possible parameters that are consequential as to the success of each strategy.

Normally, business firms that seek to reduce trade-offs are market oriented. But in Porter,

(1980) all firms have the potential to simultaneously combine cost leadership and differentiation

but then combining of the two strategies may require an extensive experience as well as thorough

knowledge of the working of all functionalities such as procuring inputs, stocking,

manufacturing, marketing, distribution or even recruitment and training of new employees. Most

important is the fact that business firms must at all times adapt to and successfully subscribe to

new management requirements that may emerge as result of reconciling cost leadership and

differentiation strategies.

Reitsperger, (1984) in his contrary view advocates for an inevitable trade-off and says that low

cost leadership and differentiation can be reconcilable; in essence, low cost leadership can be

employed to make a differentiation strategy. This view is supported by Dell who argues that cost

leadership and differentiation remain to be essentially different competitive strategic choices. To

meet the increased competition from rivals firms must consider employing certain aspects of

both strategies. Reducing costrategies has the impact of increasing profit margin. Integrating too

many elements of low cost leadership into the differentiation strategy may well damage the

initial strategy.
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The conditions that favor low cost leadership are independent of conditions which favor

differentiation strategy and for that matter there is no priori reason to rule out possibilities of

reconciling them based on external conditions (Saloner, et al, 2004). On the contrary, external

conditions do favor mixed strategies so long as the differentiation strategy serves as a means for

expanding market share. When there is a positive correlation between market share and

differentiation, differentiation can easily generate economies of scale which in turn means that

cost reductions higher cost reduction are achieved at the same time. For that reason, both

strategies if employed well can result into massive improvement of business performance as

determined by such indices as increased profit and demand.

Researches have shown that strategies can be reconciled successfully without need for trade-off

if firms develop skills for pursuing both strategies simultaneously. In essence, a business that

combines both strategies is less vulnerable to any risk that is associated with specialization or

pure strategies. (Saloner, et al, 2004) explains that strategic specialization can result in serious

weaknesses in product offering and this may make it easy for rivals to take over the competitive

advantage. For instance, Caterpillar Corporation attempted to become the world’s highest

producer of earth moving equipment by focusing on precision and durability but failed to take

into account economies of scale. In the long-run, the strategy failed.

Businesses do not have to focus exclusively on one strategy as these risks reducing adaptability

and resilience. Combining of low cost leadership and differentiation strategies has the effect of

enhancing flexibility and thus makes it easier for businesses to adapt to all sorts of changes like

advances in technology or industry based changes. While low cost leadership on its own can
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enhance profitability by enhancing demand, it may not enable the business to achieve its

strategic business objectives if the industry is dominated by stiff competition. Thus, a

fundamental trade-off between differentiation and cost leadership is necessary.

2.6 Low cost leadership strategy

The theme stipulating through the entire overall cost leadership strategy and the objective is the

low cost relative to competitors. This is clearly overall firm’s cost leadership. Aggressive design

and construction of efficient scale facilities and active pursuit of cost reductions through

experience, tight cost and overhead control, avoidance of marginal customer accounts, and

reduction in areas like research and development, service, sale force, advertising, etc, will attain

cost leadership. Low cost relative to competitors is the main agenda running through the whole

strategy when attempting to achieve an overall cost leadership position.

It is necessary to identify the gains of low-cost position in order to understand how overall cost

leadership strategy may produce superior profitability. As suggested by Porter [a low- cost

position] offers an industry a defense against rivalry from competitors, since its lower cost

suggest strategies that it can still gain returns after its competitors have fully exhausted their

profits through rivalry. A low-cost position protects the firm from influential buyers because they

can exert influence, only to push down prices to the level of next efficient competitor.

Low cost, by providing more flexibility to cope with input cost increases, acts as a defense

against powerful suppliers. In terms of scale economies or cost advantages the factors that lead to
 19

low-cost position also provide necessary entry barriers. A low cost position often places the firm

in a suitable position vis-à-vis substitutes relative to its competitors in the industry Achieving a

low overall cost position frequently requires a high relative market share because scale

economies and cost advantages tend to guard a firm from powerful buyers and suppliers and

provide substantial entry handles. Put in a different manner, by reducing the five threats of

entry, that is; rivalry, substitutes, suppliers and buyers, cost advantages can create value for a

firm.

Business competitors cannot easily copy the strategy when a firm creates a sustainable cost

advantage .Sources of cost superiority that tend to be difficult to imitate include: differential

access to cost productive inputs and technological software .If, learning economics and

technological hardware is proprietary, duplication may be difficult. Particular consideration to

the organizing structure, management controls, compensation policies, and leadership strategies

must be put in place while organizing a cost leadership strategy. The arrangement of the

organization and implementation tools should comply and reinforce the strategy. Porter (1980)

has divided necessities of overall cost leadership strategy into; commonly required skills and

resources; and common organizational requirements.

Commonly necessary skills and resources when executing cost overall leadership are available

capital investments and availability of capital, process engineering skills, intense supervision of

labour, ease designed products for manufacture , and low-cost distribution systems .Common

organizational necessities constitute of serious cost control, frequent detailed control reports

structured organization and responsibilities, and incentives structured to meet strict quantitative
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objectives. According to Berney & Hesterly (2006), limited layers in the reporting structure,

easy reporting relationships minimal corporate staff, and focus on thin range of business

functions are properties of organizational structure that authorize firms to achieve the full

portencial of cost leadership strategies. Management control systems that reinforce the

implantation of cost leadership are, strict cost control systems, quantitative cost goals, direct

supervision of labour, raw materials, inventory a cost leadership philosophy. Rewards for cost

reduction and incentives for employees to be involved in cost reductions are good examples of

good compensation policies.

2.7 Product Differentiation and how it can be a source of strategic advantage

Differentiation entails differentiating the product or service provided by the firm. In other words,

it’s the creation of a product that is perceived industrial-wise to be unique .Differentiation can be

attained in various ways, for example, through design, name of the brand, brand image,

technological features, customer delivery, and dealer network. Structures of differentiation can

be sorted into three categories .To induce differentiation, affirm may target directly on product

[or service] attributes, e.g., features of a product, complexity of the product, launching of the

product,or location .A firm may emphasis on the relationship between itself and its customers

,e.g., by customizing the product ,consumer marketing and product reputation (Saloner, et al,

2004).

Lastly, differentiation can be applied by focusing on the linkage within or between firms, which

considers linkage within functions of a firm, linkage within other firms product composition,
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distribution channels and service support .To be ideal the firm must differentiate itself along

several dimensions. As a matter of fact, Barney & Hesterly (2006) argue that, product

differentiation is entirely an expression of creativity and innovations of individuals and groups

within the firm .It is only hindered by the opportunities at hand, or that can be generated, in a

particular industry, and by the willingness and capability of the firm to creatively explore ways

and means to take advantage of the opportunities.

Porter (1980), argues differentiation can produce super profits for the reason that, [it] provides

cover against competitive rivalry because of loyalty to the brand by customers and the resultant

price sensitivity. It also enhances the margin which helps in avoidance of low-cost position .The

expected customer loyalty and the need for a competitor to overcome uniqueness produce entry

barriers. Differentiation provides higher margins with which to counter with supplier power, and

it clearly adjust strategies to buyer power because buyers lack comparable alternatives and are

therefore price sensitive .Finally, differentiated firms in order to achieve customer loyalty must

be better positioned vis-à-vis substitutes than its competitors.

Apart from reducing the threat of the five such as entry, rivalry, substitutes, suppliers and buyers,

differentiation adds value by facilitating a firm charge a premium price that is greater than the

marginal cost incurred by differentiation. Successful differentiation requires that the strategy be

rare, scarce and costly to duplicate. And scarce , rare and costly structures for differentiation are

sources of sustainable competitive advantage .As stated earlier, Barney & Hesterly (2006) mean”

the rarity of a differentiation move depends on the ability of individual firms to be innovative

and creative in finding new ways to differentiate their products”. In other words, innovative and
 22

creative firms will always manage to differentiate themselves from competitors .As rivals move

in to imitate these firms’ last differentiation move, innovative and creative firms will already be

working on new moves thus they will be one step ahead of competition.

In general, bases and structures for differentiation that are costly to imitate and duplicate include,

between functions timing location reputation distribution channels and services, and support

.Depending on the circumstances, product contents, with other firms ,product customerisation

and complexity, and consumer marketing could be costly to imitate or duplicate. Preparations to

launch a differentiation strategy need particular consideration to the organizational structure,

management controls, compensation policies, and implementing cost leadership strategies.

Mentioned earlier, organization and implementation tools must fit and also reinforce the strategy.

According to Porter (1980) the commonly required skills and resources for initiating

differentiation are; strong marketing abilities, product engineering, creative and innovative flair,

basic research strong capability, corporate reputation for quality or technological leadership, long

industrial tradition or unique and rare combination of skills taken from other businesses, and

strong cooperation from reliable channels.

Strong coordination among functions in the functions of product development and marketing,

subjective measurement and incentives (instead of quantitative measures), and amenities to pull

professional and highly skilled labor, scientist strategies or innovative and creative people, are

the common organizational requirements. In addition Barney & Hesterley (2006) suggested that,

an organizational structure in support of differentiation may be characterized by cross-divisional

and cross-functional development teams, complex matrix structures and scattered pockets of
 23

intense creative efforts (skunk works) Typical management control systems that support

differentiation are broad management - making guidelines, managerial freedom within

guidelines and policy of experimentation. An example of compensation policy that supports

differentiation is rewarding risk-taking (as opposed to failure), creativity and multi dimensional

performance. Contrary to overall cost leadership, differentiation can become a hindrance to high

market share. This is because differentiation typically demands a perception of exclusivity with

high market shares.

CHAPTER THREE: RESEARCH METHODOLOGY

3.1 Introduction

This section spells out the procedures and the methods that the researcher employed in achieving

the objectives of the project as highlighted in the abstract of this paper. It defines the location of

the study, research procedures and analysis plan that were addressed in the course of the study

consideration when carrying out this particular research. The research was supposed to start with

the clear understanding of the research objectives as well as the hypothesis. Success of the

project was a factor of the provision of satisfying information in line with the objectives and

hypothesis relation to the fundamental trade-off between cost leadership and differentiation

strategies

3.2 Research Design

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The main objective of this research just as a recap is to identify the current state of the art trade-

off between low cost leadership and differentiation strategies in theory. The theoretical findings

of this research are complemented by several practical observations of the fundamental trade-off

drawn from several practitioners who have successfully reconciled the two strategies. In order to

fully satisfy the stated purpose of the research, the research has offered to conduct an analytical

and critical literature review of the subject. The reason for this is that the only way in which a

thorough analysis and understanding of the current state of the art of the topic can be understood

is by evaluating its current literature and examining its application in businesses.

A partial review of the literature can produce an erroneous image of the current state of the art of

the topic and as such, the researcher has undertaken a review of all major literature on the topic.

Having taken this important consideration into account, the researcher sees literature review

coming forth as a foreseeable as well as inevitable method. As Phillips et al, (1983) note,

when research on a topic is still nascent and knowledge relatively scarce, exploratory methods

like literature review become appropriate in conducting researches. The other decision underlies

the choice of data collection method. In any research study, there are two alternatives, namely

qualitative and quantitative data collection. The quantitative approach focuses on reasons and

facts. The primary objective of this approach is to identify and explain casual relationships

between phenomenons and as such the requirements on quantification of concepts and

objectivity of results are very high. The qualitative approach on the other hand is only applied

when one aims to uncover and understand phenomenon of which little or nothing is known

about. In contrast to the research method decision where the choice was quite evident, choice of

data collection is very complicated.

 25

Both qualitative and quantitative approaches can serve to collect data but the researcher adopted

the qualitative approach for the simple reason that this approach provides a complete image of

the topic under consideration besides offering a deeper insight into the issue of trade-off. By

disclosing all underlying arguments in respect of the trade-off issue, the evidences and examples

presented in the literature review makes a vivid reflection of the up to date debate on the topic.

This way, the readers will gain a better understanding and enhanced insight of the topic. In

addition, the approach will allow the reader to analyze and criticize all the arguments that have

been put forth. However, one main disadvantage of the qualitative approach is that it is not able

to provide a quantifiable answer at to which method or school of thought holds.

3.3 Data collection

The literature review section which makes the main contributor of this dissertation maps the

existing literature base so as to frame the problem in perspective and determine how the topic is

handled by current researchers. By reflecting on the nature the main debate, the topic has been

placed in an historical context which also reveals potential familiarity with current developments

in respect of the issue of trade-off.

Secondary data which mainly consists of strategies of various types of literature has been utilized

greatly in the development of the literature review and was in particular derived from journals,

strategic textbooks, online journals and reviews. The greatest advantage of secondary data is that

it is relatively easy and cheap to access and requires a very simple process to verify the
 26

information. The only inconvenience which is common in literature review is that all underlying

concepts as well as definitions, variable measurement and unit determination can at times differ

which if the case can have negative effects on the validity of results.

3.4 Research validity and reliability

The objective of this research is to establish accurate findings and yet the results and findings of

any report can only be accurate in light of the measure thus it is critical to evaluate the

effectiveness of the measure. In this section, particular attention is paid to validity and reliability.

These two values are critical to ensuring the scientific value of a research by asserting that

research findings are appropriate and useful. Validity determines how truthful findings are, that

is how well the research findings reflect the reality.

Three different types of validity can be distinguished namely, construct validity, external validity

and internal validity. Internal validity refers to the extent to which the research can permit

conclusions to be drawn that there is a casual relationship between two or more variables.

Construct validity and external validity on the other hand refer to how operationalization

measures the concept which it purports to measure. This is a very important aspect of research

quality that because it sets condition for interpretable and meaningful findings.

A debate about the findings of the preceding literatures on the fundamental trade-off between

low-cost leadership and differentiation includes the discussion of the ‘research’, more often than

not referring to the manner in which the statistics were collected”. This research being a

phenomenological, all questions are related to theoretical characteristics discussed in literature

 27

preview. The process would therefore be accurate in collecting, analyzing and sampling data;

hence the validity of result would be quite high. Considering that there are many different

aspects of validity, which influence the validity of the research in general.

3.5 Limitations

This dissertation does not seek to explore all existing literature on the topic. In stead, the research

has been conducted as a pre-work and is as such insufficient to fulfill the requirements of

literature review. The objective is to provide a critical and analytic evaluation of the problem

under study as identified in the previous section by reviewing the existing literature. Most

important is the fact that it is important to make a distinction between the various strategy levels.

Therefore, in the scope of this dissertation, the broad concept of strategy is limited only to

business level strategy. This limitation has been necessitated by the purpose of the research as

highlighted in the previous section and forms the guidance upon which the task is undertaken.

CHAPTER FOUR: DISCUSSION OF RESEARCH FINDINGS

4.1 The fundamental Trade-off between cost leadership and differentiation

Porter states that three conditions explain a firm’s success .One, a company must develop an

internally set of consistent set of objectives and functional policies that, that as a while define its

position in the market. To be more specific, strategy is perceived as a way of integrating the

activities of the diverse functional departments within a firm, marketing, production, research
 28

and procurement, finance and the like. An in-depth, explicit and mutually reinforcing set of goals

and functional policies are required to counter the centrifugal forces that lead functional

departments in various directions .Two, another condition for success is the internally consistent

set of goals and policies aligning the firm`s strengths and weaknesses with the (external) industry

opportunities and threats.

Strategy is the act of setting a company in line with its environment .Three, a firm’s strategy

must be in line with the creation and explosion of its so called ‘distinctive competences’. Choice

is essential, although there is no one way to position, on the contrary, there may be several

attractive positions .The challenges facing a firm in choosing a distinct position from its

competitors in order to avoid replication-a threat competitive advantage-while considering

logical inconsistencies in pursuit of several of several types of advantage or different aims

simultaneously .The general strategies advanced by Porter (1980) satisfy these conditions.

Even though Porter did not conjure the terms, cost leadership and differentiation, he was the first

to discuss the importance of selecting and focusing on one of the alternatives. Firms that do not

develop strategies in at least one of the three directions are called ”stuck in the middle”, a poor

strategic situation that yields low profits: “[the firm stuck in the middle]” either loses high

volume of customers who demand for low prices or must bid away its profits to get the business

away from low-cost firms. It also loses high-margin businesses-the cream to the firms that are

high-margin targets or have achieved differentiation overall (Saloner, et al, 2004).

 29

Market-leading firms inside overall cost leadership are the largest, while differentiation or focus

strategy are the smallest .Stuck in between are the least profitable firms or medium sized. In

effect Porter argues that strategies can be successfully reconciled under serious circumstances;

effectively laying down any of these generic strategies demands total commitment and

supporting organizational arrangements that are diluted if more than one primary target exist

strategies and hence it becomes necessary for a firm to select and adopt one of the three

suggested generic strategies.

4.2 Realization of the benefits of strategic business planning

Porter is considered by many as the most authoritative strategist in the in business strategy.

Phillips et al, (1983) for instance reckons that the arguments underlying the concepts advocated

in porter’s model of competitive strategy have shaped much f the present thinking in the

formulation of strategy. In essence, Porter’s model has been widely tested and in spite of several

efforts to modify or expand it, its original model has to date remained the most widely

commented, analyzed and tested. This model has been applauded for being easy to understand

appropriately without being vague.

Thus, an explicit method for formulating policies should be used to determine a business firm’s

long run competitive strength. This can help in generating a persistently higher rate of profit than

its competitors. In order to compete effectively in the long run, a first must start its operations by

choosing an appropriate positioning. Porter in his model proposed three different approaches for

gaining competitive advantage namely overall cost leadership, differentiation and focus.
 30

At around the end of the 1980s and the beginning of the following decade, there were debates

about whether the two strategies are mutually exclusive but these debates seem to have died

gradually with the introduction of the Japanese twin cost control methods, namely Total Quality

Management and Just In Time models, (Saloner, et al, 2001). These two models were widely

applied by major Japanese companies and were responsible for the success of such industries as

electronics, motorcycles, cars and musical instruments which have benefited massively from

their ability to combine low cost leadership with high quality and technological advancement.

The three strategies above have the capability of resulting in above- average profits; but all the

three may not be suitable for a firm. They may not be suitable because the three strategies are

different on several aspects and posses different requirements. This is identified in resources,

skills organizational arrangements, control procedures, incentive systems and management style.

Depending on how the selected strategy is applied, profitability may vary this is what will decide

on which strategy to adopt keeping in mind the benefits of strategic planning that dictate that the

selection be well founded.

The test and challenge comes in the selection of the best strategy that suits the firm’s strengths

and recourses and cannot be easily copied by competitors. This, on the other hand, demands for

good knowledge about the firm, its business surrounding and competitors. If the practitioner is in

possession of an explicit technique to analyze the firm’s structure and competition, there will be

gains in getting better knowledge and understanding of both elements. Porter’s (1980) model
 31

enables the decision making strategy and enhances the profits of a firm that selects a suitable

strategy.

4.3 Cost leadership-differentiation trade-off

The major reason why Porter and his followers of this theory advocate that a combination

strategy is a low strategic choice is that conflicting organizational requirements of cost

leadership and differentiation strategies create a trade-off that is necessary .The challenge is also

very costly and complicated, it is argued. Critics of Porter`s theory trust that a trade-off does not

have to be there .The main argument of the opposing school of thought is that differentiation

may be a product of cost reduction (scale and learning economies, innovation processes),which

means that factors that favor differentiation and coast leadership are not incompatible (Saloner,

et al, 2004).

Thus, as long as differentiation leads to cost reductions or enhanced price premium or both, cost

leadership and differentiation strategies can be mixed without a trade-off. The literature

references have shown several explanations as to why differentiation may reduce costs. Further

more, firms can develop management skills to relate with cost leadership and differentiation

strategy requirements, it is argued .There is prove by the empirical studies that have observed the

operation of firms with mixed strategies and the observations that have measured performance of

strategies and concluded that, firms having mixed strategies do equally good or better than cost

leaders and differentiators.

 32

Nearly two thirds of the empirical study within the located literature lay their support on the

argument in preference of reconcilable strategies .In other words, by measuring the identified

literature on the subject, a good number of the research follows the opposing school of thought

.In relation to interviewed practitioners, three for every four suggested that a trade-off need not

be and hence, results from the interviews look consistent with results from the literature review.

Also the literature review has shown that there are two major elements determining whether

researchers follow to Porter`s school of thought or the opposing school: the conceptualization of

cost leadership and differentiation, and the opinion on the nature of the correlation between

market share and performance (Saloner, et al, 2004).

To begin with, the conceptualization of cost leadership and differentiation as two dimensions of

strategic placing rather than two types of strategies permits researchers to discover the existence

of “combination” strategies. By looking at the two strategies as opposite ends of a single

continuum or two unrelated types of wide strategic groups, researchers overrule the possibility of

reconciling strategies for, closer to one end automatically means moving father away from

another. Selecting to position between the two ends is the same to choosing a stuck in the middle

strategic. The second supporters of a correct relationship between market share and performance

also state that cost leadership and differentiation strategies may move together as differentiation

is a source of cost reduction .Those who answered on the cross-check on the topic stated that

differentiation will serve to achieve cost reduction and that the relationship between

differentiation strategy and market share will be correct (although it is not necessarily the case).
 33

Anyway, not all respondents accept that this potentially responsive relationship means that

strategies will be reconciled. It’s true, a cost reduction need not require a serious change in

strategy as explained by Stefan Viotti and the case of SAS and snowflake.

In relation to method, cluster analysis techniques as a way to express strategic groups and the use

of the PIMS database for gathering samples dominates the sampled research studies. This was

also looked into by Campbell-Hunt (2000).

The literature review has tried to locate, present and summarize the available research of the

subject so as to make it clear what is being argued in and differentiation. Selected literature has

been classified in relation to school of thought, meaning whether strategies are trusted to be

mutually exclusive or can be potentially combined. Yet an important element to the discussion is

the meaning of the concept “combination strategy” (or “mixed” or “combined” strategy).

Although it is assumed that, a combined strategy has both elements usually associated with cost

leadership and with differentiation strategy, the definition remains unclear and allows a range of

interpretations. Often, It is emphasized that the two strategies must be applied simultaneously,

White (1986)alternatively advocates that firms can externally lay emphasis on opportunities to

differentiate while internally focused towards cost reduction; mixed strategies is arrived at

through the” sequential instead of simultaneous focus to the different organizational

requirements of these diverse business strategies.

As observed, the definition of “mixed strategy” or “combined strategy” can influence the

working together with either of the two schools of thought, and hence the lack of a stable, clear
 34

and definite definition renders research on the subject a tough affair. It’s difficult to compare

studies and the accumulated load of evidence is not available. The difficulty with a lacking

concrete definition can be seen in the literature. In some particular cases, a company is portrayed

as a successful cost leader of differentiator by a researcher, as others refer to the same as prove

that a trade-off may be avoided.

This is the issue with Wal-Mart:While Barney & Hesterley (2006) and Lumpkin, Droege & Dess

(2002) describe Wal-Mart successfully adopts a combined strategy and hence evidences the truth

that a trade-off may be done away with. The issue of Southwest brings out a another related

example as several researchers state that the airline is employing a cost leadership strategy, e.g

.Lumpkin, Droege & Dess (2002),with others arguing that the strategy employed is a mix of cost

and leadership differentiation, e.g. Grant (2006).Although Porter`s definitions and theories is

based on their studies, these researchers have advocated distinguishing observations and

discussions which explain that there is adequate space for (mis) interpretation.

Ghemawat refers to MacDonalds as facts that firms can realize ways to generate superior

products at lower costs, stating that ”McDonald`s brand recognition and product superiority at

lower cost explains that ”McDonald`s brand recognition and product consistency permit it to

charge a small premium over challenging fast-food vendor, even if it`s broad scale ,franchising

relationships and serious standardization permitted it to experience lower costs than it’s

competitors. After all, establishing ways to create a superior product at less cost is enough to

present a mixed strategy.

 35

Conclusion

As shown by the definitions of cost leadership and differentiation depicted in the Theory section

of this presentation, a firm must identify its strategy which is scarce, rare and costly to copy if it

wishes to produce competitive advantage and superior profitability. A leader in market cost

(Saloner, et al, 2004). For example, is not the firm that particularly sells at the extreme lowest

cost? As observed earlier a strategy is composed of many elements and especially; total elements

and specifically the way they relate is what brings out the strategy. By designing its brand

recognition and product consistency, McDonald was capable of charging a premium and in turn

to outwit its rivals, as Porter`s theory expects. Hence, due to a remarkably successful cost

leadership strategy, McDonald`s resulted as the cost leader per (Porter`s) definition.
 36

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