Both cost leadership and differentiation are two of the four Generic Strategies introduced by Michael E. Porter in his 1985 book “Competitive Advantage: Creating and Sustaining Superior Performance,” alongside cost focus and differentiation focus.
Porter emphasized the need to pursue a single strategy because pursuing two or more could result in a so-called “stuck-in-the-middle” situation in which a firm loses its entire focus and renders it without a clear direction of its future trajectory.
The difference between cost leadership and differentiation strategies can prove this point. A firm cannot readily pursue one while also attempting to pursue the other because these two have competing goals and objectives. The two are fundamentally poles apart.
Understanding the Difference Between Cost Leadership and Differentiation
General Definitions
Remember that both strategies are part of the Generic Strategies. Furthermore, it is important to reiterate that Porter warned firms against using these two altogether. To understand the difference between the two, nevertheless, take note of the following definitions:
Cost Leadership: A position in which a firm attains cost-efficient, thereby allowing it to claim that it is the cheapest manufacturer of goods or provider of services. A specific cost leadership centers on driving down all of the costs associated with the operation of a firm.
These costs include manufacturing or service delivery costs, expenses associated with supply chain management, marketing budget, talent acquisition and retention expenditures, and all other costs related to running the business.
Differentiation: A business-level approach to compete in an industry or market aimed at positioning a firm or product as inherently unique without compromising its utility. A differentiated firm or its products have qualities or unique selling propositions that set them apart from equivalent products or substitutes from competitors.
Furthermore, a differentiated firm or product stands out from the competition because of its uniqueness, thereby making it possibly more attractive to the target consumers.
Specific Characteristics
Aside from the definitions above, another way to understand better the difference between these two strategies is to look at their purpose, their status as a source of competitive advantage, and the specific tactics under each. Take note of the following:
• Goals and Objectives: Both strategies are intended to increase the profitability of an organization by outcompeting the competitors. However, a cost leadership strategy intends to produce at high volumes while possibly offering a more competitive price point for its goods and services.
A differentiation strategy aims for a firm or its product to stand out from the rest and become as unique and as attractive as possible to the point that the price of a particular product would be negligible to the consumers.
• As A Source of Competitive Advantage: The advantage of a cost leader is that it can essentially offer lower prices because the costs it has incurred are lower than those incurred by its competitors. Furthermore, apart from having the authority to dictate market price trends, it can use excess funds from cost savings to increase its production volume or invest in business expansion initiatives.
Meanwhile, a highly differentiated firm or a firm with a highly differentiated product has the advantage of setting prices higher than the existing market price trend or industry benchmark, thereby maximizing its earning potential.
• Tactics: The tactics used by a cost leader center primarily on budget and resource management. These include high asset utilization, low direct and indirect costs through product and process standardization, and value chain control.
Other tactics include achieving and maximizing economies of scale, building and maintaining brand equity and brand loyalty, and banking on leadership and management capabilities by utilizing cumulative experience.
Differentiation, on the other hand, can be achieved through market research, product research and development, marketing and promotion strategies, and value addition. A firm can also differentiate itself by focusing on product, service, distribution, relationship, price, or brand differentiation.
Supposed Incompatibility Between Cost Leadership and Differentiation
The point raised by Porter regarding the need to focus on only one of the four Generic Strategies also highlights the difference between cost leadership and differentiation. For him, adopting two or more of the four leaves an organization unfocused.
He explained further that differentiation is inherently costly, thereby rendering it fundamentally unaligned with the purpose of a cost leadership strategy. It is also important to note that product standardization is one of the tactics used by cost leaders.
But several critics argued that a single strategy can be limiting and makes a firm inflexible. Several firms have jumped from one strategy to another depending on their needs. Others have used a hybrid strategy to maximize the advantage of several strategies.
A firm producing a standardized product can also produce related but differentiated sub-products under the same product category. Coca-Cola is a prime example. The company has been producing regular Coke, as well as low-sugar and zero sugar Coke variants.
It remains obvious that Coca-Cola still uses some elements of a cost leadership strategy such as standardization, value chain control, and high assets utilization while also using some elements of a differentiation strategy such as market research and product development.