According to Michael E. Porter's description of the five forces of competition, companies can raise their profitability by placing their activities in markets or industries with a low degree of competition. By doing so, the company will potentially develop a large market-share and great profits.
However, companies also have a second opportunity to generate profitability. Companies can optimize their position within a certain industry, and thereby obtain great profits - even if the industry in general may have below-average profitability. Therefore, it is claimed that companies, if they position their products or services effectively, may be able to generate great profits, even if the industry is generally crowded with players all wanting a piece of the pie.
Michael E. Porter proposes that companies have the opportunity to position their products or services by either costs or differentiation, and that this positioning can be applied to either a narrow or a broad scope of buyers.
This results in three generic strategies, which are called Cost Leadership Strategy, Differentiation Strategy and Focus Strategy. These strategies can be applied at the business unit level, and are as such generic, because they are not firm or industry dependent. Therefore, each company may adopt one of these strategies to obtain greater profits, even though other players in the industry pursue completely other strategies.
The three generic strategies are presented below:
Cost Leadership Strategy
When following a cost leadership strategy, a firm sets out to become the low cost producer in its industry. The company must pursue all sources of cost advantage, which can be varied according to the structure of the industry. Companies may seek to gain economies of scale, optimize manufacturing practices, secure raw materials at competitive prices, develop highly efficient technologies etc. The essence of this strategy is, of course, to reduce prizes, and thereby achieve an above-average market share.
Companies following a differentiation strategy seeks to deliver unique products to the market, which shows characteristics that are highly valued by the customers. This differentiation and uniqueness is then potentially rewarded by a higher price.
This generic strategy focuses its attention on small segments and niches within the industry. Companies following this strategy will tailor their strategies to serve these segments, and will potentially be able to exclude other players from selling products to this segment or niche. The focus strategy has two variants.
1) Cost Focus Strategy:
Firms following this strategy seek to provide the best prizes and prize-advantages to their target segments.
2) Differentiation Focus Strategy
Firms following this strategy seek to differentiate their products and services to niche customers and narrow target segments. Thereby, these firms may be able to charge a primium for their products, and may be able to become an innovative and valuable supplier for their niche customers.
It may be wise for companies not to pursue, or combine, the strategies above on a business unit level. A combination of strategies may cause the company to get stuck in the middle, meaning that the company does not pursue one of the strategies satisfactorily. It might e.g. be very difficult to focus on low-cost and differentiation simultaneously.
Therefore is seems wise for managers to choose only one of the above strategies - and to stick with it.