SBA

Porter’s Generic Strategies

I had another topic in mind for this IT Matters, but I found myself in two separate conversations this week about the different considerations in the “Build or Buy?” decision for key business software depending upon the nature of the business.

Chances are that if you’ve had any formal business education you will know of “Porter’s Generic Strategies” - if not then type that phrase into Google or Bing or Wikipedia and read the top few explanations. Basically Porter’s model proposes that in order to pursue competitive advantage in its chosen line of business / market / industry there are only three (maybe four) basic strategies. These are Cost Leadership, Differentiation (generally via product, service or marketing), and Focus (concentrating on a small niche of the market). It is possible that either or both of Cost Leadership or Differentiation may be combined with Focus to create four strategy options instead of considering Focus as a single strategy. Once you have identified which of the generic strategies your business employs in order to seek competitive advantage you can make reasonable generic assumptions about your best approach to buying technology to meet your business needs.

Starting with Cost Leadership (cost not price). Cost Leadership is about becoming the lowest cost producer or supplier in your market. If a consumer pays ten pounds for the product - whether you supply it or one of your competitors supplies an equivalent, then the supplier who achieves the lowest costs in supplying the product will likely make the highest profit margin - he can bank more money for business resilience, future expansion, promotion etc., or he can sacrifice margin to undercut competitors who cannot afford to drop their prices as much. 

Technology acquisition and operating costs (IT staff, software maintenance and support etc.) are a major cost in most businesses, but the percentage of IT costs as a proportion of total operating costs for businesses of similar scale and complexity can vary immensely - for most businesses it’s between five percent and thirty percent, but I have seen some commercial businesses where the IT cost is below three percent, and others where it is above thirty percent, for comparable business benefit. 

Clearly some business might massively reduce their overall operating costs by taking a different approach to IT. Typically this huge variance is due to risk perception and risk appetite when making IT buying decisions. There used to be an adage amongst IT leaders that “nobody ever got fired for buying IBM”. IBM was at the time the premier IT brand in the world, and charged correspondingly high prices - but if the IT went disastrously wrong, damaging the business, the executive leadership could point out to the board and shareholders that it wasn’t the fault of the IT department - they had mitigated the technology risk by using the best technology supplier available irrespective of the price. That might be a reasonable approach if the business strategy is not cost leadership, but any business wishing to pursue a cost leadership strategy would be well advised to consider whether a lowest cost approach to technology could make a significant difference. If you’re not going to get extra business benefit vs your competitors by buying higher-priced systems to solve similar problems then why take on the extra cost?

If you are, as most businesses are, pursuing a Differentiation strategy then you may wish to look at IT systems differently.  Your business systems functions will likely fall into two categories - generic and differentiating.  Your generic business functions, ones which you do in much the same way as your competitors, are unlikely to merit the expensive investment of premium-brand or bespoke systems, you might as well use cheap off the shelf solutions. Your method of differentiating your product or service in the market may however imply using different technology to your competitors - which often means that it needs to be bespoke to you, or has been built with the capability to be extensively customised so that you can implement your differentiation. 

Your differentiation may lie within the nature of the product or service, or the way it is produced, or the way you enable the customer to access or buy the product - each of these would imply that you are doing something which requires you to have some business processes that are different to your competitors, possibly even unique within the market - and therefore unlikely to have been included within the functionality of an off-the-shelf business system. Why would a technology supplier invest money in developing features that he did not know customers would use? There is a strong possibility that if your competitive strategy is based upon offering the customer a different experience or service to that offered by your competitors then you will benefit from bespoke or customised systems to support those processes which enable you to deliver differentiation. Obviously your method of differentiation would be weak and easy to replicate if it was included as standard in the systems which your competitors could buy off the shelf, so paying the higher cost of bespoke or customised systems to support a differentiation strategy could make good business sense.

That leaves us with the two Focus strategies to consider. The nature of Focus strategies is that they tend to be niche, they target narrow sections of the market and are best served by smaller, more specialist businesses aiming for fewer customers but with higher profit margins. Even though Focus businesses are by their nature specialist, they compete with other businesses in the same market aiming for the same niche so both Cost Focus and Differentiated Focus models can be found. Typically the smaller market segment of Focus businesses means that they have fewer customers and less money to invest in IT, and can’t benefit from economies of scale as much as their bigger more generalist competitors so they have simpler and more manual business processes. These factors again affect the approach to IT systems. 

With a Cost (Price) Focus competitive strategy the business will still want to minimise its operating cost, and that means that the selection of IT systems should again be significantly influenced by cost. Whilst IT should provide the business process functionality needed for operational efficiency, the acquisition and operating costs need to be considered carefully against the efficiency payback - most business IT systems give the best return when they are applied to simple highly repetitive business processes, and businesses which are focused on a small segment of a market will generally have fewer transactions and amortise the cost of their IT against fewer repetitions of their processes, so processes which in larger businesses can be made more cost effective by automating them with IT are commonly still cheaper performed manually in businesses operating a Cost Focus strategy. 

A business operating a Differentiated Focus strategy is similarly likely to be smaller with fewer repetitions of its business processes, and so needs to consider whether the payback of having sophisticated or expensive business systems capabilities is really merited, however if the system is going to be the tool which enables the differentiation aspect of competitive strategy then it is highly likely that an off the shelf solution will not do the job, and that the cost of bespoke systems development will be merited because it is commonly the case that where differentiation is enabled through technology the design and cost of the technology is one of the major barriers preventing other market players from eroding the Differentiated Focus model. The only caveat is that the cost of the technology will often be very high as both an investment and as a proportion of overall operating costs, so the business pursuing a Differentiated Focus strategy enabled by the exploitation of bespoke IT capabilities needs to have developed a very complete financial model prior to making such a significant investment.

In summary, when making any substantial investment in IT or business systems it is a worthwhile process to position the perceived costs and benefits against Porter’s Generic Strategies model to help you in bringing the decision factors back into the context of the business. Buying sophisticated technology usually means considering many complex factors, and it is easy to lose objectivity when faced with a wall of competing features and the FUD (fear, uncertainty and doubt) based marketing employed by the high-end technology suppliers. You can buy a basic four drawer metal filing cabinet for £150, or a high-end four drawer metal filing cabinet for over £1,500. Similarly you can buy a business system for CRM or ERP or Financials etc. for £40,000 or £400,000 and the suppliers of each will claim that they are functionally equivalent. It’s easy to understand the features of a filing cabinet and see where the money goes, it’s much more complex with business systems. Aligning your decision making with Porter’s Generic Strategies is a useful method in helping you to understand whether the cheap or expensive option is more likely to support your business, or whether you would be better off by carrying on the “old-fashioned” way and keeping IT out of it.