Executive Summary. 3
Generic Strategies: Appraisal and Critiques. 5
Strategy; how to look? 5
Strategy; what are we looking at? 5
Companies Background. 6
Industry Analysis. 6
Service Differentiation; the advantages. 7
Service Differentiation; the risks. 8
Cost Leadership; the advantages. 9
Cost Leadership; the risks. 10
Is That All? 11
Generic Strategies; are they still valid? 11
Porter’s Five Forces; are they enough? 12
Final Thoughts. 12
Critical Analysis. 13
Are Porter’s generic strategies still valid? Is studying the Five Forces’ enough to analyze rivalry in an industry? Many critiques have been attacking the soundness and the feasibility of Porter’s ideas proving their weaknesses in analyzing the industry. Researches showed that Porter’s generic strategies are not as independent and opposite as they were described. They are interdependent and they can be used simultaneously by a single rival, a process known as “Hybrid Strategy”. Though combining these two strategies was claimed to be a failing strategic approach by their father, they are simultaneously used today as the only recipe to boost performance and achieve higher profitability rather then rivals using a pure generic strategy. An example was given to illustrate these ideas: Starbucks and Dr. Cafe. By analyzing the advantages and risks facing these two companies, it was proved that these companies are not able to sustain using one single generic strategy rather a combination of them.
This paper will examine the generic strategies suggested by Porter, the advantages and the risks however by using the local regional information. It starts by a theoretical background, discussing strategy, concept and shedding the light on different approaches of what is strategy and how to analyze it. Then a brief discussion of the generic strategies is presented. Afterwards, two companies have been selected as basis for comparison: Starbucks implementing a service differentiation strategy, and Dr. Cafe implementing a cost-leadership strategy. The companies’ background is discussed along with an industry analysis. To asses the competitive strategies of both companies, a study of the advantages and risks of each strategy is presented using theoretical and practical aspects supported by various modern research and articles. Then the discussion steers at the end to attack the validity of Porter’s generic strategies and Five Forces model in order to assess the soundness of these models and theories in modern business. The paper is bound to few limitations shown towards the end before the conclusion section.
Generic Strategies: Appraisal and Critiques
Firms exist because they create and sustain a certain value as they are able to organize the activities in the value chain. As rivalry grows, firms need to develop their own competitive strategies, i.e. the set of actions needed to achieve a competitive edge over rivals to better attract consumers and build a loyal consumer base. Research proved that retaining a customer is less expensive then steeling a new one from a competitor. “Satisfied loyal customers advocate a company’s products and services which is a much more cost effective way of creating new customers then engaging in expensive advertising campaigns” (Anon, 2002, p.2.4). Obviously this creates a battle for market share among rivals in a manner that highlights the original military meaning of the word “strategy” to describe a defense and counter defense moves in wars.
Strategy; how to look?
A company achieves a competitive advantage whenever it adapts an edge over its competitors on how to attract consumers. However, the question is: how to design the basis for a competitive strategy? De Wit and Meyer (2004) revealed two opposite perspectives on business level strategy. The first perspective relies on the market opportunities and changes as the basis for organization design. This perspective known as the “outside-in” takes into account changes in customer demands, challenges from rivals, entry barriers impeding, supplier power resistance. The “inside-out” perspective focuses on internal resources and physical assets to build distinctive competences difficult for rivals to imitate. Market opportunities are then mapped with these resources in order to boost profitability and promote a specific market positioning. The choice of which perspective to use depends on many aspects related to market structure, consumer needs, etc… This paper will shed the light on strategies based on the “outside-in” perspective.
Strategy; what are we looking at?
There are many variations of the competitive strategies that a company can adapt. Porter’s approach (1998, cited in De Wit & Meyer, 2004; Anon, 2002) was based on three different generic strategies: cost leadership, service differentiation and focus strategies. Later Thompson, Strickland and Gamble (2005) proposed an updated approach based on five different generic strategies: low cost provider, differentiation strategy, best cost provider, lower cost focused strategy and differentiation focused strategy.
The cost leadership strategy is of a cost leader competing in a range of segments and it can only be achieved by one vendor in a market without the need to have low prices and without any degradation in performance. “[The] aim is to secure a cost advantage over [the] rivals, price competitively by customer and achieve a high profit margin … while [delivering] acceptable quality … at the lowest possible cost … to open up a significant and sustainable cost gap over competitors” (Anon, 2002, p. 3.33). To achieve a cost leadership, the firm should have a “clear understanding of the drivers of costs in the organization’s value chain… [it] must invest in the assets of the company that will secure this long-run position” (Anon, 2002, p.4.13).
Service differentiation strategy however is about adding “costs in order to add value for which customers are willing to pay premium prices” (Anon, 2002, p.3.33). The firm provides unmatched and unique product attributes or services that are respected by buyers to capture this market positioning and charge premium prices (De Witt & Mayor, 2004). It is about being unique in a conceivable way by the consumer. It is about understanding customer needs. For a differentiation strategy to succeed, it should be well communicated with a customer. An example of both strategies can further clarify those concepts.
Established in 1985 in Seattle, Starbucks offers a range of hot and cold coffee beverages and food items at premium prices. It introduced a unique service-differentiation for customers looking for unmatched, best-of-class experience in the store from the moment a customer walks in the store (venue layout, design, architecture and lighting, banned smoking), to ordering a coffee beverage and finally to the cool experience of relaxed seats and soft music. This attracting environment is copied in all the 7,000+ worldwide branches of Starbucks to reflect the billboard of the company, i.e. the brand image conceived in the minds of the customer. The marketing approach was to focus too little on advertising and too high on customers’ need and to rely on word-of-mouth (Thompson & Gamble, 1997; Habermann, Mattis, Medvedowsky & Nash, 2004).
Established in 1997 by a Saudi citizen with a banking background (Ali, 2004), Dr. Cafe started as a small entrepreneur coffee outlet to serve simple hot coffee beverages in the capital of Saudi Arabia. Due to the cheap availability of the local human and asset resources, Dr. Cafe’s mission was to compete with other rivals on the bases of cost leadership making good use of the domestic alliances with partners and suppliers. As Dr. Cafe expanded over the years, the mission was reloaded: the adoption of copycat strategy to Starbucks’ services to create a new image of the store reflecting almost the same products and services of Starbucks (store architecture, layout product offerings) but from a cost leadership point of view. As a result of achieving high profit margin, Dr. Cafe expanded to around 20+ stores in the past three years.
Note that it is almost impossible to find primary data from companies in this part of the world even if it is an international organization such as Starbucks. The only source of information was a consultancy firm for both companies who revealed that the current market share for each company is around 23% each
A market structure is a “means of characterizing a market by reference to the degree of rivalry … that exists between firms in it” (Anon, 2002). Again from an outside-in perspective, the market structure dictates the conduct of the organization which in turn affects the performance. This approach known as the SCP paradigm is used as a general framework in market analysis. Based on local market (considering other major rivals), and on the market share figures provided above, it can be concluded that the market structure might best be described as “Loose Oligopoly”. However this industry, like any other, is subject to competitive pressures and risks that should be highlighted. If a firm manages to control the pressures and avoid the risks, the value associated with this firm can be sustained. The industry analysis will be done using several tools and frameworks such as Porter’s Five Forces Model.
Service Differentiation; the advantages
There are a number of advantages gained when a differentiation strategy is used. Successful differentiation (Gillis, 2005):
Reduces rivalry when promoting a product or service that is hard to be copied or replicated by rivals.
Earns less price sensitive buyers
Promotes strong brand loyalty to justify high prices.
The key idea here is branding, i.e. the added value in the product to create a strong buyer brand loyalty, awareness, association and value (Anon, 2002). Starbucks has managed over the time to differentiate itself from all other rivals by building a strong brand image and awareness. Starbucks logo (shown above) is a reminder to any buyer for the store experience and the quality and the multitude of Starbucks drinks and beverages. Loyal buyers are ready to pay premium prices to enjoy the experience, the service or even the best-of-class products.
Entry Barriers: Any market entrants must invest in its value chain – access to technology, economies of scale and access to distribution channels – and on product branding in order to match Starbuck’s experience.
Supplier Power: Starbucks outsmarts the bargain power of suppliers using the high margins to overcome price increases, or propagate them to loyal buyers (Zahrowski, 2004).
Buyer Power: Note that in this industry, the buyer power is negligible for both companies. However, the low tempting prices of other rivals decrease the switching costs and could invite some customers to move away.
Substitute products: Starbucks has managed successfully to control and benefit from substitute products such as PepsiCo. In their research, Thompson and Gamble revealed “a joint venture arrangement to create new coffee-related products for mass distribution through Pepsi channels” (1997, p.5 of 9).
Rivalry among players: It is reasonable to assume that competition in this field is strong coming from large number of rivals, slow demand, switching cost, exit barriers or diverse rivals’ strategies (Anon, 2002). For example, a number of national and international coffee shops have opened in the kingdom in the last few years (Costa Coffee, Coffee Time, Coffee House, Dunkin Donuts, etc…) offering various experiences for coffee lovers. Despite that, Starbucks still celebrates a good market share.
The discussion of rivalry and branding can not proceed without elaboration of the price elasticity concept. The less elastic the demand is, the more likely the product is differentiated in the eyes of buyers which lead to a successful differentiation strategy. Kotler believes that product demand is less elastic when “buyers think the higher prices are justified” (Kotler, 2003, p. 477). The following figures reflect the change in market demand when price change from P0 to P1.
Hence a successful differentiation strategy is one that is able to “rotate” the demand curve clockwise
Service Differentiation; the risks
However there are some risks associated with differentiation strategy: (Anon, 2002 & Gillis 2005):
Rivals can copy and provide the same service differentiation for customer eating up market share. No doubt, many rivals had copied Starbucks experience and increased their market share. Today, the look and feel of the store ambiance has become a standard for any coffee store replicating Starbuck’s differentiation strategy. However, as discussed earlier, Starbucks need to constantly work on the differentiation strategy to improve it and strengthen the brand image and to add more differentiated features.
Technological change will wipe off any previous investments. Any future technological advance represents threats to Starbucks’ long investment track in assets and resources. In this regard, Starbucks should continuously invest on research and development to grasp new technological change and steer it to its benefits.
The price gap between the service differentiator and a low-cost rival becomes too high. Consumers might then switch to a low-cost rival giving up brand loyalty. There is a number of remedies for this issue: Starbucks could offer free items or discounts promotions to random buyers (same concept used by hypermarkets). Second, prices could be revised and updated based on a market scanning. Finally, more differentiation, more services or more features could be added.
More risks were also suggested by Zahrowski (2004):
Over differentiation: Starbucks should continuously invest on improving the service differentiation and avoid over differentiation. If customers can not understand the importance of differentiation, and the basis for high prices, then they might switch to other rivals.
Experience effect on differentiation: Probably one of the major threats for Starbucks is the negative effect of customer’s experience on the importance of the service differentiation. With time, buyers will start losing interest in the value of the experience at Starbucks. One recommendation to solve this issue is by again continuously investing in research about customer needs to tweak the experience of the customers accordingly. For example some coffee shops are opening second hand library.
Finally, an important risk can be pulled from a PESTLE analysis affecting Starbucks:
Some politically sensitive buyers are affected negatively by the influence of the American politics on this part of world driving them to consider other rivals mainly Dr. Cafe as being the only Saudi based coffee network. Starbucks needs to carefully consider this threat as it is losing market share for it. A possible remedy and defense to political influence is probably a political reaction by contributing in the country economy or poverty.
Cost Leadership; the advantages
Cost leadership strategy is said to be the opposite strategy of service differentiation. There are many advantages: (Anon, 2002)
Protection against price wars: Dr. Cafe celebrates a high margin due to the cost leadership. If any rival (such as Starbucks, Dunkin Donuts …) attempts to lower prices, then there will be an advantage for the cost leader.
Flexibility in price wars: even if rivals drag the market to a price war, the cost leadership can defend aggressively any price wars. He can initiate a price war too.
Continuous profit: It so happened that industry recession (such as war, or political problems) causes troubles for normal players. However Dr. Cafe will continue to earn profit.
Not highly affected by prices fluctuation: when economy declines and affects selling prices negatively, or when suppliers’ prices increase, the cost leader would not be affected, specially. Dr. Cafe managed to have a long list of suppliers for raw materials, and enough buffer-margin to lower prices when overall market prices increase.
Barriers to Entry: at the heart of the advantages of a cost leader, Dr. Cafe represents a high entry barrier especially in Saudi Arabia. Owning a prestigious list of suppliers (local business-to-business), Dr. Cafe impedes entry barriers to this market imposing economy of scale and learning curve.
Industry profit: since Dr. Cafe priced its products at market price, a high above-average industry profit was gained. A high profit is contributing in the growth of Dr. Cafe inside and outside the country.
Gillis (2005) and Zahrowski (2004) examined more advantages:
Supplier Power: Perhaps Dr. Cafe is the only player putting high pressures on raw materials access. Having a cost leadership strategy requires revamping of the value chain where suppliers power should be faced aggressively. For example, Dr. Cafe makes a large amount of purchases from suppliers forcing their prices to be the lowest possible.
Immunization against buyers bargain power: However as discussed earlier the buyer power is almost negligible in this case.
Reducing substitute attractiveness: being a cost leader does not mean low quality. Dr. Cafe can at any time lower prices while still maintaining good quality reducing the threat of substitute products. Dr. Cafe can also act offensively against substitute products by investing to be the first to create substitute products (as in the case of Starbucks and bottled cold coffee sold via PepsiCo stands), or invest in potential substitute copyrights.
Rivalry among players: It is a very risky move to fight on prices bases with a cost leader because it is always a lost case. Any rival lowering its prices to compete with Dr. Cafe might find himself losing market share as buyers start switching to a cost leader suspecting a drop in quality for rivals. This boosts profitability more and more. Also offensive moves can be taken against rivalry. Dr. Cafe was the first to introduce the concept of drive-thru ordering. Moreover, Dr. Cafe employees will go outside the store to the parking areas on the street to take orders directly from cars. This move is highly welcomed by customers. By excelling in a cost leadership position, some rivals might even consider exiting the business, which ultimately reduces rivalry.
Cost Leadership; the risks
Despite those advantages, there are numerous threats and risks when implementing a cost leadership strategy as follows (Anon, 2002):
Risks of losing valuable assets: it so happens that cost-leader strategies revamp the value chain to minimize cost. This includes restructuring the organization to blindly reduce the stuff at the cost of losing key workers.
Focus drifting away from strategy: the focus drifts away from studying customer requirements to only cost cutting which will hinder the progress. A simple recommendation is to conduct constantly market analysis to follow change in customer needs and reflect it on its strategy.
Rivalry copying cost-leader strategy: with the growth of internet, gathering information is easy. Rivalry can swiftly copy the cost-leader strategy which will threaten its position and its profitability.
Excessive focus on resources downsizes can lead to a weak hollowed structure vulnerable to any disturbances in the market.
When fighting against a service differentiation such as Starbucks, Dr. Cafe will always push for his image as a cost leader. If costs actually rise, then margins will fall, and Dr. Cafe can no longer fight with Starbucks on its brand image and its strategy advantage.
Technological change will wipe off any previous investments (the same type of threat to a service differentiation). Any future technological advances represent threats to Dr. Cafe’s long investment track in assets and resources.
Gillis (2005) added a couple more risks:
Gradual decline of cost differences between rivals.
Cost leadership becomes a target for cost focusers impeding any development for the cost-leader as it constantly reacts to rivals.
Is That All?
It goes without a doubt that Porter’s generic strategies and Five Forces model are subject to criticism. The rise of the internet, the change in economy and politics, and the move from a steady to a turbulent rivalry environment pushed many companies to re-invent the wheel by pursuing a new line of competitive strategies as more forces acting on them appeared.
Generic Strategies; are they still valid?
In today’s fast changing world with a massive advance in technology and globalization, some firms are trying to adopt more then one generic strategy in order to defend against any risk associated by using one pure strategy and to be able to shift immediately from one strategy to the other as a defensive or even offensive move. This approach was described by Porter (1998) as “stuck in the middle”. Porter believes that “[this] strategic position is usually a recipe for below-average performance… [it] is often a manifestation of a firm’s unwillingness to make choices about how to compete” (1998, cited in De Witt & Meyer, 2004, p. 264-265). This concept has been heavily criticized by many researches.
Kay (1996) argues that Porter’s stuck in the middle approach is completely wrong and in reality it is exactly the other way around. He believes that the “stuck in the middle position – medium cost, medium quality – in fact does slightly better than the clearly focused choices of high cost/high quality or low cost/low quality” (p. 2 of 3). These critiques could to a certain extent question the validity of Porter’s concepts. Porter’s classical example of Toyota as the world famous car manufactory deploying a cost-leadership strategy (Anon, 2002) is also a subject of criticism. In the eyes of consumers, Toyota is known (at least in the local market) for the spare parts availability, after sales support, superior engine performance and elegant car design. These attributes may qualify for a service differentiation which proves that mixing of strategies can be an excellent mix for higher profitability.
Kim (2004) conducted a research on Korean cyber malls challenges the soundness of Porter’s generic strategies and found that “stuck in the middle” approach might have been a mistake in the 1980 due to the stability of the environment. However, Kim proved in his research that “a combination of generic strategies in e-business competitive environments is not only possible but also required” (p. 8 of 30). Kim concluded that deploying a hybrid strategy of mixture of more then one generic strategies is more successful and delivers higher performance then pure cost leadership or service differentiation.
Ismail (2003) made research on Malaysian giant firms such as Nestle, Ajinomoto, and F&N. He examined the value chain activities, and strategies implemented and concluded that not a single firm is deploying a single pure generic strategy. He described as “interchange” the process of switching from one generic strategy to another in order to boost performance.
Back to Cr. Cafe, it is actually a live example of a successful combination of a cost-leader and service differentiator that is achieving the same market share of Starbucks. As seen before, the strategy was to imitate Starbucks’ experience by offering comfortable chairs, wireless internet access, background music and different types of drinks and beverages. Starbucks is also not far from this discussion. Using locally made products and supplies and human resource proved eagerness to squeeze their costs in a cost-leader’s eye. Whether it is called stuck in the middle, interchange or hybrid, combining more then one strategy proved to be “a recipe for above-average performance”.
Porter’s Five Forces; are they enough?
A recent study (Recklies, 2001a & Anon, 2005b) showed that there are three new additional forces that are heavily affecting the market and are not seen in the classical Five Forces model:
Digitalization: The rise of information technology and advance in technology gave the users wider access to information and gave the organizations the power to operate online serving more customers than those in their local markets. In its website, Starbucks grasped the importance of digitalization and started selling coffee online in an easy-to-use website that displays marketing information about the company. Dr. Cafe has also penetrated the “.com” world with a website showing marketing information only.
Globalization: As the world is acting as a global network attracting all businesses to operate online. This new force is certainly not seen from the Five Forces model is pushing organizations to operate on global scale and be available all over the world. It’s obvious that the growth of Starbucks all over the world to operate on over 7,000+ stores is something of an importance. Dr. Cafe is following the same path with an estimate number of stores around 150 worldwide.
Deregulation: As government influence is fading and with the rise of European Union, the new world of open markets is emerging, and the idea of outsourcing and organization restructuring is now a hot subject. This new force on the market is another pressure acting on these organizations.
As discussed earlier, the subject of elasticity is by far the most important concern of a service differentiator. Simply put, a service differentiator strategist must focus on “rotating the demand curve clockwise”. The more inelastic the demand for a product or service is, the more likely it represents more value in the eyes of the buyers which will justify charging high prices.
Whether it is a service differentiation, cost leadership or any strategy, every strategist should monitor constantly the value chain in order to minimize the cost specially when the market is unpredictable and prices are fluctuating. Facing increasing power of suppliers, buyers, substitutes and new entrants coupled with growing rivalry battles on market share and new evolving forces (globalization, digitalization and deregulation), it is highly important to focus on the value chain optimization as well as the customer satisfaction.
As discussed earlier, it is very difficult to acquire primary data from companies in the local region. Therefore it is really hard to proof the validity of Dr. Cafe’s cost-leadership strategy. When asked for an interview, a Starbucks sales manager refused to give any information and to answer any question at all. Dr-Cafe regional manager refused to even meet the interviewer. The only source of information is a consultancy company that provides internet solutions for both these firms. A phone interview was held with the business development manager of this consultancy on December 10, 2005. He disclosed some information about competition analysis for these firms as well as their market share as seen earlier.
The paper has considered only the political element in the PESTLE framework. Further study on the market from different aspects could reveal more advantages or disadvantages for the strategies. However, due to word limit, only political aspect has been reviewed.
The information provided about both companies is related to the local regional strategy which is probably different from the internationally adopted strategies. For example, due to local government rules, Starbucks was not allowed to play music in the store nor use their original logo. Also, Starbucks avoid doing any campaigns, publicity and any type of appearances in the market as it is rejected and boycotted by some religious segments of the society. Perhaps, Starbucks would have earned a higher market share if they were to adopt their normal strategic moves, the same way they do it around the world.
In this paper, the subject of elasticity has been revisited as mechanism to analyze the success of a service differentiation strategy. Then the advantages and risks of generic strategies have been examined in accordance with old and modern theories taking an example of two companies: Starbucks and Dr Cafe. It has been proven that firms can not survive by adopting one single generic strategy but rather by mixing more then one strategy to reach optimum performance. In today’s fast changing world, it is obvious that implementing a single pure strategy can not promote a competitive edge to beat rivalry and increase the market share. Porter’s generic strategies, which were claimed to be separate and opposite, have acquired a new meaning today as recipes of combined ingredients for a “Hybrid strategy”. They are now interdependent.