The Two Key Approaches to Strategic Management (VCE SSCE Business Management): Revision Notes
The Two Key Approaches to Strategic Management
Introduction to Porter's Generic Strategies
Porter's Generic Strategies is a strategic management framework that helps businesses achieve sustainable competitive advantage. Developed by Michael Porter in his 1985 book Competitive Advantage: Creating and Sustaining Superior Performance, this framework can be applied to businesses of all sizes across all industries.
This framework is universally applicable—it works for small startups, multinational corporations, manufacturing businesses, service providers, and non-profit organizations. The principles remain consistent regardless of industry or size.
The framework identifies two primary strategic approaches that businesses can adopt:
- Lower cost (cost leadership)
- Differentiation
These approaches help businesses review and plan changes as part of their transformation process. For example, when choosing accommodation, a budget caravan park and a luxury resort represent different strategic approaches—the caravan park pursues lower cost, while the luxury resort focuses on differentiation. Both target different market segments and appeal to different customer needs.
Key concepts in strategic decision-making
Competitive advantage
Competitive advantage refers to the unique position a business holds in its market. It establishes:
- Whether products are differentiated in any meaningful way from competitors
- Whether the business operates as the lowest cost producer in its industry
A sustainable competitive advantage is one that can be maintained over time, allowing the business to outperform competitors consistently.
Competitive scope
Competitive scope determines the breadth of a business's target market. Businesses must decide whether to:
- Target a wide market (serving many different customer segments)
- Focus on a narrow niche market (serving a specific, well-defined segment)
The choice of competitive scope is not about being big or small—it's about how broadly you define your target customers. A small business can target a wide market, and a large business can focus on a narrow niche.
This decision significantly influences which generic strategy will be most effective.
Understanding the two approaches
Cost leadership (lower cost)
The cost leadership approach focuses on becoming the lowest cost producer in an industry. This strategy requires:
- Internal focus: Emphasis on improving processes, systems and procedures
- Efficiency in operations to reduce costs
- Ability to pass savings on to customers while maintaining profitability
- Strong control over operational expenses
Businesses pursuing cost leadership must continuously work to streamline operations and eliminate waste, allowing them to offer competitive prices that attract price-sensitive customers.
Worked Example: Cost Leadership in Practice
Consider a discount airline:
- Step 1: Standardizes fleet to one aircraft type (reduces maintenance costs)
- Step 2: Eliminates free meals and luggage allowances (reduces service costs)
- Step 3: Uses secondary airports with lower fees (reduces operating costs)
- Step 4: Maximizes aircraft utilization with quick turnarounds (increases efficiency)
Result: Passes cost savings to customers through lower fares while maintaining profitability
Differentiation
The differentiation approach aims to make products or services distinct from competitors. This strategy requires:
- External focus: Understanding customer needs and market segments
- Creating unique features, quality, or brand image
- Targeting specific market segments that value these differences
- Building customer loyalty through perceived uniqueness
Differentiation allows businesses to charge premium prices because customers perceive added value in their distinctive offerings.
Strategic focus: internal versus external
The choice between cost leadership and differentiation fundamentally affects where a business directs its attention:
Cost leadership = Internal focus on processes and procedures Differentiation = External focus on market segments and customer needs
Porter emphasizes that businesses must make a deliberate, considered choice between these approaches. Attempting to pursue both simultaneously often results in becoming "stuck in the middle"—achieving neither cost leadership nor effective differentiation. This middle position typically leads to below-average performance as the business fails to excel in either dimension.
The decision-making process
Selecting the appropriate generic strategy requires systematic analysis. Porter recommends that businesses should not rush this decision, as different approaches appeal to different market segments and require different organizational capabilities.
Step 1: Conduct Five Forces analysis
Porter's Five Forces analysis examines the competitive environment by assessing five key factors:
- Supplier power: How much control do suppliers have over prices and terms?
- Buyer power: How much influence do customers have in negotiating prices?
- Competitive rivalry: How intense is competition among existing firms?
- Threat of substitution: How easily can customers switch to alternative products?
- Threat of new entry: How easy is it for new competitors to enter the market?
This analysis reveals the structural forces shaping industry competition and profitability. Understanding these forces helps businesses identify where they can gain competitive advantage.
The Five Forces model is not just about identifying threats—it also reveals opportunities. High barriers to entry might protect your position, while low supplier power might enable cost leadership through better negotiation.
Step 2: Conduct SWOT analysis
A SWOT analysis examines both internal and external factors:
Internal factors:
- Strengths: What does the business do well? What resources and capabilities provide advantage?
- Weaknesses: Where does the business face limitations? What needs improvement?
External factors:
- Opportunities: What favorable external conditions could the business exploit?
- Threats: What external challenges or risks could harm performance?
The SWOT analysis provides insight into the business's current position and readiness to pursue different strategic approaches.
Step 3: Compare SWOT with Five Forces results
After completing both analyses, businesses should:
- Identify patterns and connections between internal capabilities and external forces
- Determine whether to increase or reduce exposure to each of the five forces
- Assess which forces present the greatest opportunities or threats
This comparison step is critical—it's where strategic insight emerges. The goal is to find alignment between what the business does well (strengths) and what the market environment demands (forces). This alignment reveals the most viable strategic path forward.
This comparison helps reveal which strategic approach aligns best with the business's situation. For example, if supplier power is high but the business has strong operational efficiency (a strength), cost leadership might be viable despite supplier challenges.
Worked Example: Combining Five Forces and SWOT
A coffee shop chain conducts its analysis:
Five Forces insight: High competitive rivalry, moderate buyer power, low supplier power SWOT insight: Strength in premium brand image and loyal customer base, weakness in operational efficiency
Strategic conclusion: The business should pursue differentiation rather than cost leadership because:
- Its strength lies in brand and customer loyalty (supports differentiation)
- Its weakness in efficiency makes cost leadership difficult
- High rivalry means differentiation can help it stand out
- Customers show moderate willingness to pay for quality (supports premium pricing)
Step 4: Select the generic strategy
Based on the combined analysis, businesses should select the strategy that:
- Provides the strongest set of strategic options
- Aligns with organizational strengths
- Addresses market opportunities effectively
- Minimizes exposure to weaknesses and threats
The selected strategy should become the business's primary strategic focus. Consistency and commitment to the chosen approach are essential for building sustainable competitive advantage.
Important strategic considerations
Focus on one strategy
Porter strongly advises that once a business determines its strategic approach, it should remain committed to that strategy.
Attempting to pursue both cost leadership and differentiation simultaneously typically results in:
- Diluted focus and resources
- Confusion in the market about the business's value proposition
- Failure to achieve excellence in either approach
- Loss of competitive advantage
This doesn't mean a business can never change strategy—but any change should be deliberate, well-planned, and fully committed to the new direction.
Avoid single-segment over-concentration
While focusing on one generic strategy is important, businesses should avoid concentrating exclusively on only one market segment. This creates vulnerability if that segment:
- Declines in size or profitability
- Becomes saturated with competitors
- Experiences changing preferences
Think of this as strategic diversification within your chosen approach. If you've chosen differentiation, target multiple segments that value your unique offerings. If you've chosen cost leadership, serve multiple price-sensitive segments. This provides stability without losing strategic focus.
Maintaining some market diversity within the chosen strategic approach provides stability and reduces risk.
Exam guidance
Key command word: Analyse
When asked to analyse Porter's Generic Strategies, you should:
- Identify and explain the two key approaches
- Examine the relationship between competitive advantage and competitive scope
- Break down the decision-making process into its component steps
- Consider the implications of choosing one approach over another
- Use specific business examples to illustrate your points
"Analyse" requires you to break something down into its component parts and examine relationships. Don't just describe—explore how different elements connect and influence each other. Always support your analysis with evidence or examples.
Key command word: Evaluate
When asked to evaluate a strategic choice, you should:
- Assess the strengths and limitations of each approach
- Consider the context of the specific business and industry
- Weigh up the benefits of cost leadership against differentiation
- Make a justified judgement about which approach is most suitable
- Support your conclusion with evidence from the case study or business context
"Evaluate" requires you to make a judgement. This means weighing evidence, considering both sides, and reaching a supported conclusion. Your evaluation should demonstrate balanced thinking before arriving at your final judgement.
Application to case studies
When applying Porter's Generic Strategies to case studies:
- Identify which approach the business currently uses
- Assess whether this approach is successful given the Five Forces
- Consider whether internal strengths (SWOT) support the strategy
- Evaluate whether a change in approach would improve competitive position
- Justify recommendations with specific evidence from the case
Remember!
Key Points to Remember:
- Porter's Generic Strategies identifies two main approaches: lower cost (cost leadership) and differentiation
- Cost leadership requires an internal focus on processes and efficiency, while differentiation demands an external focus on market segments and customer needs
- Businesses must choose one primary strategic approach and commit to it—trying to do both typically fails
- The decision-making process involves four key steps: Five Forces analysis, SWOT analysis, comparing results, and selecting the strategy
- Sustainable competitive advantage comes from consistently executing the chosen strategy better than competitors
Highlighted Key Terms:
- Porter's Generic Strategies: Framework for achieving sustainable competitive advantage through lower cost or differentiation
- Cost leadership: Strategy of becoming the lowest cost producer in the industry
- Differentiation: Strategy of making products/services distinctly different from competitors
- Competitive advantage: The unique position that allows a business to outperform rivals
- Five Forces: Supplier power, buyer power, rivalry, threat of substitutes, threat of new entrants
- SWOT: Analysis of Strengths, Weaknesses, Opportunities, and Threats
Critical Frameworks:
- Porter's Five Forces Model: A tool for analyzing competitive environment and industry profitability
- SWOT Analysis: Systematic examination of internal capabilities and external conditions
- Strategic Selection Process: Four-step approach combining Five Forces, SWOT, comparison, and strategy selection