A model approach Generating strategic options by Adrian Sims

Michael Porter’s Three Generic Strategy model is one of the best known in strategic management. However in the Management Accounting – Business Strategy exam, few marks are awarded just for explaining such a model. Candidates must also be able to assess the quality of the model, suggest how it may be used and apply it to relevant cases. Strategic option generation forms an important part of the rational planning process. This process involves: * deciding the general direction of the organisation and the level of performance it must reach to satisfy stakeholders; * identifying the main threats and opportunities in its operating environment, in particular the factors affecting financial performance, and forecasts or scenarios for how these may develop; * an assessment of its strengths and weaknesses in relation to threats and opportunities; * an understanding of the contribution to earnings from its products and customer groups and how these may change. Porter’s three strategic approaches to gaining competitive advantage are: * overall cost leadership – low cost relative to competitors; * differentiation – creating something that is perceived in the industry as unique; * focus – serving a narrow strategic target more effectively than rivals who are competing more broadly. This can be split into “cost focus” and “differentiation focus”. Executing each strategy successfully involves different resources, strengths, organisational arrangements and managerial style. It is rare for all three to suit any one firm so managers should focus on just one strategy or risk dilution of their competitive advantage. This is, according to Porter, the only way that firms can outperform rivals and deliver satisfactory shareholder returns. Porter’s strategic prescriptions stem from analysis of the impact of five competitive forces on a firm’s profits. The forces Porter refers to include: * the threat of new entrants into an industry or market served by a specific company; * the bargaining power of suppliers; * the bargaining power of the consumer; * the threat of substitute products/services; *the intensity of rivalry among existing firms. He argues that a firm must adopt a strategy that combats these forces better than the strategy developed by its rivals if it is to deliver superior shareholder value. If the firm is successful in this, its improved profitability will come from a combination of two things – each year it will enjoy a higher margin than its rivals operating in the same market and, as the product lifecycle unfolds and prices start to fall during the mature stage, it will survive longer than its rivals. Combining the two means better long-term profitability and this, in turn, equates to superior shareholder value – in other words, higher present value of future financial returns than rival firms. Let’s look at Porter’s three strategies. Achieving the industry’s lowest delivered cost to customer provides several competitive advantages. It reduces the impact of competition by allowing the firm to increase profit margins at the prevailing level of industry prices – it can also become the price leader because no other firm can undercut it. It also reduces the impact of buyer and supplier power by giving the firm a “cushion” of profits against cost increases and price cuts – buyer and supplier power could instead drive rivals from the industry. Differentiation is a perceived value for the buyer with several competitive advantages: