What do you do when a tough competitor enters your space? Many businesses cut their prices, starting a ‘race to the bottom’ as their previously unassailed niche becomes just another commodity product or service.
This strategy carries the seeds of its own destruction.
In his classic book, The Competitive Advantage of Nations, Harvard Business School professor Michael Porter outlines five forces that shape competition:
- New competitors enter the market
- Rivalry among existing competitors intensifies
- Substitute products arrive
- Buyers use their buying power to squeeze margins
- Suppliers assert greater bargaining power
The classic case of a business re-inventing itself is Nokia, which switched from being a forest products producer to a mobile phone manufacturer as competition from cheaper timber producers eroded its margins. Australian examples of substitute products abound – from generic pharmaceuticals to ‘home brand’ items on supermarket shelves.
Porter’s book studies the reasons that some industries are destined to be more profitable than others. This is useful for businesses that can easily exit their original industry and dive into another, more profitable sector – but it doesn’t give much hope to those of us who are locked into a niche from which there is no possible re-invention. After all, a telco is always going to be a telco.
But how do you optimise profit for your own firm?
Some approaches adopted by businesses going through disruptive change include surveying their customers or their competitors, and changing their method of operation. These are legitimate approaches, but it is unclear why one approach would work and another fail.
According to Porter, there are two major strategies used by businesses to make more profit than their competition:
- Spend less than your competitor on production costs – without losing quality.
- Charge more for your product or service – without increasing costs significantly.
Marketers misuse two of Porter’s key terms
The term ‘differentiation’ is used by Porter to describe products for which buyers will readily pay a premium.
Marketers often use the word ‘differentiation’ to describe the reason they believe customers should buy their product. Wrong! It’s not about a few differences in features and benefits. Your strategy needs to go deeper than that.
Marketers also use the term ‘lowest-cost producer’ to refer to the cheapest price of an item or service. Wrong again!
The two key strategies for making your business more profitable than your competitors are very specifically about maximising profit.
Spending less, or ‘cost leadership’ in Porter’s words, means bending your unique resources or capabilities until you can sustainably make the same product as your competitor for less than it costs them to make it.
Charging more, or ‘differentiation’, means harnessing your abilities to build a product for which buyers will willingly pay more – and without increasing your costs significantly to do so. If you can command a 10 percent premium, your costs must rise by less than 10 percent.
But what if neither of these strategies is exactly right for you?
Whatever you do, don’t try to do a bit of each. That answer is not to mess with your differentiator and then trim your costs, but to work with an expert to bring into play a strategy that Porter calls ‘focus’.
This will involve applying either of these powerful techniques narrowly. If you can’t be a cost leader or offer differentiated product to the whole market, then focus only on the market segment for which you can.