Which of the following is a difference between a low-cost strategy and a differentiation strategy?

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journal article

The Academy of Management Review

Vol. 13, No. 3 (Jul., 1988)

, pp. 401-412 (12 pages)

Published By: Academy of Management

https://doi.org/10.2307/258088

https://www.jstor.org/stable/258088

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Abstract

In the policy literature there is an assumption that the generic business-level strategies of differentiation and overall cost leadership are generally inconsistent. Contrary to this view, this article presents a contingency framework in which differentiation can be a means for firms to establish an overall low-cost position and discusses that a combination of differentiation and low cost may be necessary for firms to establish a sustainable competitive advantage.

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The Academy of Management Review, now in its 26th year, is the most cited of management references. AMR ranks as one of the most influential business journals, publishing academically rigorous, conceptual papers that advance the science and practice of management. AMR is a theory development journal for management and organization scholars around the world. AMR publishes novel, insightful and carefully crafted conceptual articles that challenge conventional wisdom concerning all aspects of organizations and their role in society. The journal is open to a variety of perspectives, including those that seek to improve the effectiveness of, as well as those critical of, management and organizations. Each manuscript published in AMR must provide new theoretical insights that can advance our understanding of management and organizations. Most articles include a review of relevant literature as well. AMR is published four times a year with a circulation of 15,000.

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What kind of strategy have you adopted for your business? Before you decide whether you want a low-cost strategy, do you know what other options you have available to you? This is where the idea of a competitive strategy comes in.

What Is a Competitive Strategy?

A competitive strategy is simply anything a business does in order to gain a competitive advantage over its competitors. It is a good thing for the consumers in the market because it gives them added value. Sometimes, that added value comes in the form of lower prices and sometimes it comes in the form of increased services and benefits, which ultimately justifies the higher prices that they have to pay.

In a general sense, there are four possible competitive strategies that a business can implement: The main strategies are actually two, and the other two are simply variations on the main strategies.

The two main strategies you can adopt as a business are that you focus either on costs or on differentiation. When you focus on costs, then you try to become a low-cost provider. When you focus on differentiation, then you look to compete by adding extra value to your customers that they won’t find in your competitors. In other words, you are focusing on areas other than cost to set yourself apart from the competition.

The other two strategies are simply variations on the first two. For cost, you can either lower your costs in a broad sense or you can lower them only for a specific niche. The same goes for differentiation.

Low-Cost Strategies

With a low-cost strategy, you can only win if you are the company with the lowest cost in the market. If a bunch of companies are selling products in that area, which, for all intents and purposes, are identical, then the company that sells the products at the lowest prices will get the greatest number of customers.

If you can keep your costs low, then you will benefit from such a strategy. If a bunch of companies sell identical products at the same price, the company that can keep its costs low will have the highest profit margin, and will emerge the winner. This advantage is crucial because it allows the company that can keep its costs low to explore strategies to maintain that advantage and even increase it.

The company could try new marketing methods, for example, or increase its current marketing efforts. It could try to get better positions in retail stores so its products do better than those of competitors. It can invest in research and development to improve its products. However, the most powerful thing it can do to keep its competitors out of the market is to reduce its prices.

In fact, if you think about it, all companies in any given market that have higher costs only stay on in those markets because the lower cost companies let them. If the lower cost companies chose to, they could squeeze these higher cost companies out of the market by reducing their prices. The higher cost businesses would not be able to compete and would have to shut down. This is a strategy that has often been used to force competition out of the market.

This kind of strategy is a no-frills strategy. All you’ll be looking to do is to minimize your costs in order to give the lowest prices to your customers and allow them to save. You should have high technical capacity and plenty of capital and invest in the latest cost-saving technologies in order to be able to pull this off well.

In most cases, the very first companies that manage to significantly lower their costs end up being market leaders because they grow their market share and utilize their capacities well, which pushes their costs even lower due to economies of scale.

There is something to be said for this strategy, as far as the size of the business is concerned, and in fact, that is the basis upon which the strategy is divided into the broad and niche versions.

Low-Cost Provider Strategy

A low-cost provider seeks to sell its products at the lowest price it can, while still making a profit so that it can draw customers to the market. This is the broad version of the low-cost strategy because such companies try to appeal to a broad market. They will look boost their sales volumes as high as they can by attracting as many different types of customers to buy as many different types of their products as they can.

Obviously, such a company would have to be large in order to be able to pull the strategy off. It would need to have multiple product lines that appeal to a wide range of customer types and it would need to have very high production capacity in order to meet demand and generate high sales volumes. Small businesses might find it difficult to pull off this kind of strategy.

Focused Low-Cost Strategy

If a small business cannot appeal to the broader market, what is a small business to do? It focuses on a niche, of course. While a small business cannot feasibly achieve low prices on all of its products, it can try and focus on a small niche and try to be the lowest cost provider in the market for that specific niche. This is much easier to do and can help distinguish a small business for a specialty that could catapult it into massive growth. That is the essence of the difference between the two strategies. In the first you seek to lower costs everywhere, in the other you pick your battles and charge normal prices for everything else.

Differentiation Strategies

At the heart of differentiation is the belief that you need to position yourself in a unique, clear way in the market in order to attract customers. You want the market to perceive you as being a higher value provider than your competitors. Note the distinction between value and price. If you can convince the customer that you are providing them with more value than the next guy, then you can charge them a higher price.

Differentiation strategies work in market circumstances in which the customers aren’t just focused on price, but where they consider other aspects, as well, before they make a purchase. Consequently, this kind of competitive strategy tends to work better in certain markets than in others.

When you decide to adopt this strategy, you should understand the needs and preferences of your customers to a ‘t’. You should, therefore, be constantly innovating in order to keep up with those needs and preferences. Another thing you should work on building is your brand, including how visible it is and how well it is positioned.

General Differentiation vs. Focused Differentiation

Here again, just like with cost, you can either differentiate yourself in a broad sense or in a particular niche. If you tend to be a large company that focuses on a specific line or specific lines of products, then you can differentiate yourself in a broad sense so that customers recognize your brand in every product they buy from you. A good example here is Apple, which sells phones and computers while also offering various services. They have differentiated themselves in a broad sense so that every Apple product feels different, superior actually, from other products in its category.

You can also differentiate yourself in a particular niche. Have you ever loved going to a particular restaurant just for a specific item on their menu, such as their burger, or their milkshake and what have you? That is niche differentiation. The restaurant isn’t the best at every food it makes, but it’s certainly the best at one or two.

This kind of niche differentiation is particularly common with social media platforms. While Instagram, Facebook, and Instagram are all social media platforms that allow most of the same stuff (posting text, images, videos, live streaming, and engagements), they have all targeted specific niches in order to differentiate themselves. Instagram is for photos, Twitter for small shareworthy posts, and Facebook for longer posts and videos. That is part of what makes each of them so distinct in the world of social media.

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