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152 PART 2 • STRATEGY FORMULATION

FIGURE 5-3
Porter’s Five Generic Strategies
Type 1: Cost Leadership—Low Cost
Type 2: Cost Leadership—Best Value
Type 3: Differentiation
Type 4: Focus—Low Cost
Type 5: Focus—Best Value
GENERIC STRATEGIES
Cost Leadership Differentiation Focus

Type 1
Large Type 2 Type 3 —
SIZE OF MARKET

Small — Type 3 Type 4
Type 5

Source: Based on Michael E. Porter, Competitive Strategy: Techniques for Analyzing Industries
and Competitors (New York: Free Press, 1980): 35–40.

Porter stresses the need for strategists to perform cost-benefit analyses to evaluate
“sharing opportunities” among a firm’s existing and potential business units. Sharing
activities and resources enhances competitive advantage by lowering costs or increasing
differentiation. In addition to prompting sharing, Porter stresses the need for firms to effec-
tively “transfer” skills and expertise among autonomous business units to gain competitive
advantage. Depending on factors such as type of industry, size of firm, and nature of
competition, various strategies could yield advantages in cost leadership, differentiation,
and focus.

Cost Leadership Strategies (Type 1 and Type 2)
A primary reason for pursuing forward, backward, and horizontal integration strategies
is to gain low-cost or best-value cost leadership benefits. But cost leadership generally
must be pursued in conjunction with differentiation. A number of cost elements affect
the relative attractiveness of generic strategies, including economies or diseconomies of
scale achieved, learning and experience curve effects, the percentage of capacity utiliza-
tion achieved, and linkages with suppliers and distributors. Other cost elements to
consider in choosing among alternative strategies include the potential for sharing costs
and knowledge within the organization, R&D costs associated with new product devel-
opment or modification of existing products, labor costs, tax rates, energy costs, and
shipping costs.
Striving to be the low-cost producer in an industry can be especially effective when the
market is composed of many price-sensitive buyers, when there are few ways to achieve
product differentiation, when buyers do not care much about differences from brand to
brand, or when there are a large number of buyers with significant bargaining power. The
basic idea is to underprice competitors and thereby gain market share and sales, entirely
driving some competitors out of the market. Companies employing a low-cost (Type 1) or
best-value (Type 2) cost leadership strategy must achieve their competitive advantage in
ways that are difficult for competitors to copy or match. If rivals find it relatively easy or
inexpensive to imitate the leader’s cost leadership methods, the leaders’ advantage will not
last long enough to yield a valuable edge in the marketplace. Recall that for a resource to be
valuable, it must be either rare, hard to imitate, or not easily substitutable. To employ a cost