Shown below is a value chain, summarising the main activities that typifies a differentiation approach to gaining competitive advantage. The value chain is a linked set of distinct value creation activities within and around a firm, from the creation of basic raw materials to the use of the final product by the consumer. Each activity in the value chain can both add to the benefit that the consumers get from the product and the cost that is incurred in producing and selling the product.
Primary activities
Secondary activities
PM implemented strategies that correlate to the value chain, shown above. Firstly, PM attempted to focus on quality. This started right from the procurement process. All prospective suppliers were evaluated in terms of quality before price negotiations. PM also strived to maintain the highest quality of people.
Another differentiation strategy of PM was to build brand loyalty through advertising. Finally, PM wished to make total quality management a reality in every aspect of PM’s operations. Total quality management helps PM to coordinate activities tightly among its functions. PM initially used luxury-pricing techniques within the cheese division until 1992, when the increasing cost of milk combined with downward pressures on prices prompted a more price competitive approach.
The value chain below summarises the main strategies implemented by a firm that believes in low cost leadership.
The majority of strategies that PM used were low cost leader strategies, and therefore relate to those shown in the value chain above. PM intended to lead in productivity. Michael Miles, who was in charge of Kraft General Foods, believed in ruthlessly cutting costs and improving overall productivity. He was also known for his ability to make companies much ‘leaner’ and discovering ways of getting more from existing assets. Michael Miles helped Kraft General Foods to save more than $425 million by operating more efficiently, for example, using measures like improved capacity utilisation.
Following the merger of General Foods and Kraft, management moved to reduce raw material costs by combining the two purchasing functions and thereby gaining greater leverage with suppliers, which saved the company $36 million.
KGF achieved cost savings by grouping the Kraft and GF brands into product lines (such as refrigerated goods, frozen foods, and packaged dinners) and by combining its sales forces along product categories (such as cheese, coffees, and cereals).
PM had many sources of competition. Firstly, KGF was able to group the Kraft and GF brands into product lines. This is an example of a shared activity. A shared activity is where two or more businesses share a common activity, thereby eliminating unnecessary duplication and high activity costs. Sharing permits operation of value-adding activities on a larger, more efficient scale than would be possible for any single business acting on its own. Large diversified firms with established market positions in several different industries or market segments (such as PM) share activities in numerous ways to create competitive advantage.
Another prominent source of competition was the fact that PM inherited a wealth of skills from the takeovers. By overtaking Kraft Foods, PM were able to bring in capable managers and superior profit margins to the company. Also, the takeover created a much larger company than before, and therefore the new company was able to benefit form economies of scale.
PM was also able to benefit from economies of scope. This is where a firm producing n products can achieve lower average costs for each good, than if each of n goods is produced by a separate firm. PM exploited this by spreading its resources over many products.
KGF also advertised several products together, such as the “Great American Breakfasts” campaign, where ten different key brands were advertised simultaneously. KGF realised advertising savings with this scheme, since one large promotion catered for that of ten individual products. This is an example of spreading the cost of activities across a range of products, thus once again, economies of scope.
In conclusion, it can be seen that PM employs both low-cost leader strategies, and to a lesser extent, differentiation strategies. From a critical perspective, it can be seen that these strategies have limitations.
The biggest disadvantage of low cost leadership is the high level of asset commitment and capital-intensive activities that often accompanies this strategy. Other disadvantages include the ease at which competitors imitate cost reduction techniques and companies fixated on cost reduction may blind themselves to other changes evolving in the market. These may include better quality, growing customer demand for different types of products, higher levels of service, competitor offerings and even declining customer sensitivity to low prices.
In practice, a low-cost leadership strategy usually allows room for only one firm to pursue this strategy effectively. When numerous firms compete with one another to become the low-cost producer, the result is outright warfare.
Disadvantages of differentiation strategies are also plentiful. Other firms may attempt to ‘out differentiate’ firms that already have distinctive products by providing a similar or better product. Thus, differentiation strategies, while effective in generating customer loyalty and higher prices, do not completely seal off the market from other entrants.
Another disadvantage of differentiation is the difficulty in sustaining a price premium as a product become more familiar to the market. Price premiums become difficult to justify as customers gain more knowledge about the product.
Finally, differentiation often leaves a firm vulnerable to the eventual ‘commoditization’ of its product, service offering, or value concept when new competitors enter the market or when customers become more knowledgeable. Over time, firms that are unable to sustain their initial differentiation-based level with future product or service innovations will find themselves at a significant, if not dangerous, cost disadvantage when large numbers of customers eventually gravitate to those firms that can produce a similar product or service at a lower cost. This is similar to what happened with the cheese division of PM.
Increasingly, companies in every industry and from across the world need to find new ways to satisfy their customers’ wants for ever increased value and performance. Although each of the basic generic strategies provide the basis for building a source of competitive advantage, the longer-term viability of any single approach rests on the firm’s ability to provide new sources of value continuously.
As industry evolves and innovation flourishes, firms must provide more value to their customers while controlling costs and even perhaps lowering prices over the long term. Thus, I believe the way forward for PM is mass customisation. This is the capability to produce a growing variety or range of products at reduced unit costs. Mass customisation is a competitive weapon that helps firms to expand the range of their product offerings and modifications without incurring the high costs of variety.
David Godfrey Page of 5/8/2007