Competitive Advantage: Porter's Generic Strategies for Small Firms

Every small business owner has heard that they need a competitive advantage. Fewer have a clear answer to the follow-up question: an advantage based on what, exactly, and for whom?

Michael Porter of Harvard Business School gave strategy one of its most durable answers. In his book Competitive Strategy, first published in 1980, he described three generic strategies a business can use to outperform rivals: cost leadership, differentiation and focus. Decades later, the framework is still a practical way to check whether your business is built around a real advantage or just hoping for one.

This guide explains the three strategies in plain terms, how they apply to small firms, and a trap Porter warned about.

Where advantage comes from

Porter's 1996 Harvard Business Review article "What Is Strategy?" states the basic logic: "A company can outperform rivals only if it can establish a difference that it can preserve. It must deliver greater value to customers or create comparable value at a lower cost, or do both."

Harvard's Institute for Strategy and Competitiveness puts it even more simply. Strategic positioning, it says, "should translate into one of two things: a premium price or lower costs for the company." Customers either pay you more because you are worth more to them, or you earn more on each sale because it costs you less to deliver.

The three generic strategies

Porter's 1996 article names the three generic strategies as cost leadership, differentiation and focus.

• Cost leadership: competing by having lower costs than rivals. The Institute notes that to compete on cost, companies must balance price with acceptable quality.
• Differentiation: competing by being distinctive enough that customers will pay more. In the Institute's words, "To command a premium price, a company must deliver distinctive value to customers."
• Focus: targeting a particular group of customers or needs and tailoring the business to them. Porter describes a focused competitor as one that "targets the special needs of a subset of customers and designs its activities accordingly."

Cost and differentiation describe how you win. Focus describes how broad a market you try to win in. A focused business can pursue a cost advantage or a differentiation advantage within its chosen niche.

Why focus is the natural home for many small firms

For many small businesses, a broad low-cost strategy is the hardest one to sustain. The lowest costs in an industry often come from scale, such as buying power and long production runs, and larger rivals usually have more of it.

Focus is different. Porter writes that focused competitors "thrive on groups of customers who are overserved (and hence overpriced) by more broadly targeted competitors, or underserved (and hence underpriced)." That is an opening small firms can use:

• Overserved customers are paying for things they don't need. A business that strips those extras away can serve them at lower cost.
• Underserved customers need more than the broad players offer. A business that goes deeper for them can charge for it.

One example Porter gives of a focused competitor is Jiffy Lube, which specialized in automotive lubricants rather than offering other repair and maintenance services. He writes that this produced faster service at a lower cost than broader-line repair shops.

For example, imagine a hypothetical print shop that stops chasing every walk-in job and specializes in fast-turnaround materials for local real estate agents. It learns their formats, keeps templates on file and offers same-day delivery. That is focus with differentiation: narrower than a general print shop, but better for one group.

The trap: stuck in the middle

The Institute for Strategy and Competitiveness notes that companies that try to be all things to all customers "can wind up getting stuck in the middle, a strategic mistake that Michael Porter calls 'the kiss of death.'" It also notes that it is possible to compete on low cost and be differentiated at the same time, so the danger is not combining strengths. The danger is never choosing.

Porter's 1996 article gives a cautionary example. Continental Airlines set out to match Southwest on a number of point-to-point routes with a service it called Continental Lite, while remaining a full-service airline elsewhere. Porter writes that the airline lost hundreds of millions of dollars, and he concludes that "Continental tried to compete in two ways at once." Most small businesses won't fail that dramatically, but the pattern is common: adding discount offers that cheapen a premium brand, or adding premium services that a low-price business can't deliver profitably.

Making an advantage last: trade-offs and fit

Porter argues that two things protect a position from imitation.

The first is trade-offs. If serving your chosen customers well means doing things that would hurt you with other customers, rivals can't copy you without giving something up. "Trade-offs are essential to strategy," he writes. "They create the need for choice and purposefully limit what a company offers."

The second is fit among your activities. When your pricing, staffing, location, suppliers and marketing reinforce one another, a competitor has to copy the whole system, not one piece. Porter illustrates this with a simple calculation: if a rival has a 90 percent chance of matching any single activity, its chance of matching four of them falls to about 66 percent (.9 × .9 × .9 × .9), and it keeps falling as the system grows.

Harvard's Institute also lists the elements of a successful strategy, which include a unique value proposition compared to competitors, a different way of operating to deliver it, clear trade-offs including what not to do, activities that fit together and reinforce each other, and continuity of direction over time.

Choosing your strategy

Work through these questions with your team:

1. Who are your best customers today, and what do they value most that alternatives don't give them?
2. Are you mainly winning on price, on distinctiveness or on serving a specific group especially well? Be honest; "a bit of everything" is a warning sign.
3. Where are customers overserved or underserved by the larger players in your market?
4. What would you have to stop doing to sharpen your position?
5. Do your activities support the position, or do some of them pull against it?

If you want a structured way to look at the market first, our guide SWOT Analysis Done Well: From Four Lists to Real Choices pairs well with these questions.

Key takeaways

• Advantage comes down to earning a premium price or operating at lower cost, and preserving that difference.
• Porter's three generic strategies are cost leadership, differentiation and focus.
• Broad cost leadership is usually hard for small firms; focus on an overserved or underserved group is often a better fit.
• The biggest risk is being stuck in the middle: never choosing how or where to compete.
• Trade-offs and activities that fit together make an advantage harder to copy.

Sources

• Michael E. Porter, Harvard Business Review, What Is Strategy? (November–December 1996)
• Harvard Business School Institute for Strategy and Competitiveness, Strategic Positioning
• Harvard Business School Institute for Strategy and Competitiveness, Creating a Successful Strategy
• Harvard Business School, Faculty and Research: Competitive Strategy: Techniques for Analyzing Industries and Competitors (Free Press, 1980)