Classic Innovation Strategy (Part 1 of 3)
Strategy is the overarching force behind successful innovation. It is crucial for a business to know what its purpose is before the organization can design products, services, or programs for sale. Each business has a unique purpose and reason for existing, a mission.
The most successful firms recognize a strategy that balances existing product lines while developing new products (NPD) that expand the market. Strategy is a key element of the New Product Development Professional (NPDP) certification exam and for engineering managers, but, more importantly, it is a fundamental characteristic of effective innovators.
Classical Strategy Framework
Approaches to strategy for business and innovation are quite numerous in the literature. There is often overlap in these many schools of thought, yet some theories have stood the test of time. For example, Michael Porter’s classic strategy framework characterizes a firm’s strategy by its competencies and market scope. The three resulting strategy archetypes are:
- Cost Leadership Strategy (cost competency, broad market scope);
- Differentiation (unique competency, broad market scope); and
- Segmentation (many competencies, narrow market scope).
Over the next couple of weeks at the Idea Incubator, we’ll review each of these strategy typologies and how they are useful in NPD work.
Cost Leadership Strategy
The classical cost leadership strategy is one in which the lowest cost manufacturer has the advantage. A cost leadership strategy is designed for a broad market scope, meaning that customers are not segmented. A firm with a cost leadership strategy is characterized by efficient, scalable facilities in which it invests to continually improve productivity.
Companies following a cost leadership strategy will maintain tight accounting controls on manufacturing costs and overhead expenses. They rely on their experience and maturity of operations to implement cost reduction projects in manufacturing. In addition, firms with cost leadership strategies will have efficient, cost-sensitive distribution channels.
An example of a company following a cost leadership strategy is Wal-Mart. Wal-Mart serves a broad customer base and keeps prices low through efficient distribution. Wal-Mart’s relationships with suppliers is both strong and heavy-handed so that the company can negotiate the best deals.
Benefits of Cost Leadership Strategy
There are several benefits of a cost leadership strategy. First, firms following a cost leadership strategy tend to have high returns on their investments in production facilities and distribution channels. Profit margins are high for a cost leader since markets tend to set prices well above the low cost of manufacturing and distribution at these firms. Obviously, another advantage then is to beat the competition with market share as these companies can offer lower prices to consumers while maintaining a good return.
As indicated, the cost leadership strategy will reduce the power of suppliers. Many vendors are anxious to access Wal-Mart’s broad customer base, for instance, so they will accept a trade-off of lower prices in exchange for larger sales volumes. This is a great advantage for the firm.
Disadvantages of Cost Leadership Strategy
Cost leaders generally are focused on improving existing products, services, and programs. Thus, a threat to this strategy is a technological advance in the industry that makes older technologies or products obsolete. New technology can also yield a cost benefit to new construction such that the firm finds itself with high sunk costs in facilities and process R&D.
Another risk in the cost leadership strategy is that competitors may be willing to live with even lower profit margins. This can lead to price wars between companies seeking cost leadership in the same industry. Results of such price wars reduce competition and innovation. Consumers lose diversity in the availability of products and services. Companies lose with the forced reduction in profit margins.
Attacking a Cost Leadership Strategy
If you find your firm attacking a competitor with a cost leadership strategy, approaches to win market share and profit include the following.
- Lower price entry with a product offering a competitive advantage (e.g. quality).
- R&D breakthroughs to advance technology for less expensive production or distribution.
- Products with differentiation that are perceived as significant by a broad set of customers.
Target, for example, is an effective competitor against Wal-Mart in the same industry but following similar cost leadership strategies. Customers view Target as more “upscale” than Wal-Mart and it is able to compete effectively within the retail space.
Cost Leadership Strategy Summary
A cost leadership strategy is one of three classical strategies. It focuses on a broad market segment, succeeding by providing the lowest cost production and distribution among competitors. Benefits of a cost leadership strategy include healthy profits and return on investment. A disadvantage of the cost leadership strategy is that technology can threaten the firm’s position with competitors offering new products or less expensive manufacturing processes. Competitors can also threaten a cost leader’s position by developing differentiated products and services. Differentiation is the second classical strategy that we’ll discuss next week!
You can read about the classical innovation strategy framework, including the cost leadership strategy, in NPDP Certification Exam Prep: A 24-Hour Study Guide.
To learn more about managing innovation strategy, please contact Global NP Solutions at firstname.lastname@example.org or by phone at 281-280-8717 for additional details. You may also enjoy learning more about managing projects in an NPDP workshop. Workshops address the strategies and best practices leading to successful NPD project implementation. NPDP workshops are held monthly through guided webinars or at your own pace in a cost-effective self-study format. We are also offering project management training through our partner, Leap University. Use code GNPS2015 to save $50 on your registration.
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