The Only Two Strategies That Lead to Strategic Advantages in Business

Although Michael Porter famously outlined three generic strategies for sustainable growth–cost leadership, differentiation, and focus–the first two strategies are really the only viable strategies for creating a durable competitive advantage.

Cost leadership means having a low-price position in a market by reducing your company’s costs and minimizing investment in areas like R&D and marketing, all in an effort to become the lowest-priced player in an industry.

A low-price position leads to increased market share. With that comes economies of scale, enabling even higher margins and sustainable growth.

Differentiation means creating a product or service with unique value. This often involves investing more heavily in R&D, high-quality materials, unique features, or superior customer service.

Customers of differentiated brands are more loyal and willing to pay a premium. This results in higher, more defensible margins and greater leverage in cost negotiations with suppliers for the brand.

The gold standard is to have low costs but also high differentiation.

Companies that achieve this combination are exceptional. For example, Apple’s hardware and software integration allows them to manufacture at scale, cheaply, while simultaneously, charging a premium price for their perceived differentiation in the market.

One important side note here: Contrary to what many believe, low-cost and differentiated positions are not mutually exclusive.

You can hold both positions simultaneously. When possible, it is actually preferable to hold both positions.

That said, given the definitions of cost leadership and differentiation, and that relatively few companies have achieved both positions, you can see how it’s not often the case that a brand can hold both positions, successfully.

Porter’s third generic strategy, focus, involves narrowing your market to a small but lucrative audience that you can serve so well that you have a near monopoly. 

Focus, as a strategy, is more of a complement to cost leadership or differentiation. It’s not a standalone strategy because it overlaps both differentiation and cost leadership. (See above: Even Porter’s diagram of the three generic strategies has focus cutting across both cost leadership and differentiation and not as a standalone)

In Playing to Win, A.G. Lafley and Roger L. Martin, both disciples of Michael Porter, articulate the microeconomic reasons why there are only two winning strategies for businesses.

Lafley and Martin explain that, to keep higher profit margins, the laws of supply and demand cannot be ignored.

When a product or service is considered a commodity buyers can go anywhere to buy it for effectively the same price. 

And, if as an owner of a commodity business, you try to price your commodity product higher, you lose customers.

If one gas station is too expensive, people just go to the next one. There’s no reason, as a consumer, you’d be willing to pay a higher price.

On the flip side, if you price your commodity product too low, you can’t cover your costs, and thus can’t stay in business for too long. 

Eventually, per the laws of supply and demand, the market dictates an equilibrium price and all of the sellers in a commodity market become price takers–charging effectively the same price. And when you’re a price taker, you don’t control your costs so you can’t control your fate. 

The only way to win given this dynamic is to become the lowest cost player, which is not easy to do.

When you’re the lowest cost player you become a price maker and ultimately have more control over your destiny.

On the other hand, when a company is differentiated, the customer believes in the unique value of its product or service and is thus willing to pay a premium for it.

Here customers essentially believe that supply is limited and dictated by the seller and because of that, the seller is, by definition, the price maker, which invariably leads them to capturing higher profit margins.

Critics of Porter’s three generic strategies, mostly proponents of Blue Ocean strategy or the Resource-based view of competitive strategy, would point out that these strategies assume that businesses are static and that competition usually leads to worse outcomes for everyone, but the customer.

And while I have understand this perspective, I think having a plan, albeit it a generic one, is better than none at all, and that Blue Ocean strategy is really just the most extreme version of differentiation, and thus fits neatly within Porter’s generic strategies framework.

So based on basic economic theory, as Lafley and Martin point out, there are only two ways to grow a business sustainably. You can be the lowest cost player, reducing your costs and increasing your margin to build a moat. Or you can take a differentiation approach and build unique customer value to charge a higher margin.