Thursday, February 28, 2008

Recessions and Differentiation Strategies

Eac day brings news of slowing economic growth. Moroever, we see many retailers reporting disappointing earnings and/or slicing their outlook for the year ahead. These reports raise an interesting question. How should retailers with a differentiation strategy react during a recession? By differentiation, I mean retailers who try to create better-than-average willingness to pay on the part of their customers, thus enabling them to charge premium prices. Limited Brands, for instance, employs a differentiation strategy in its businesses such as Victoria's Secret. Meanwhile, TJX tends to employ a low cost strategy in its businesses such as Marshall's.

The challenge during a recession is that many differentiated players may suffer larger declines in sales than low cost players, as budget-conscious shoppers flock to outlets that offer rock-bottom prices. My view is that differentiated retailers must be very careful during recessionary periods. The natural inclination might be to slash prices to retain customers during sluggish economic times. However, lower prices means lower margins, unless the retailer can also reduce costs. Herein lies the problem. If differentiated players are not careful in their cost reduction efforts, they may damage their brand, quality, and market reputation - thus compromising their position in the market and their ability to return to premium pricing in the future. Thus, the differentiated players in the retail sector have to be very careful, as efforts to shore up their financials during a recession can have long term detrimental effects that persist long after robust economic growth resumes.


BestDeals said...

1- Can any company/firm implement two strategies, cost leadership and product differentiation, at the same time?
2- Can you give an example of two firms one which is using cost leadership strategy and one which uses product differentiation strategy and both are able to maintain sustainable competitive advantage in the same industry and how?

it would be to great help to understand these concepts. Thanks

Michael Roberto said...

Strategist Michael Porter has argued that it's very difficult to implement a strategy that is trying to accomplish both cost leadership and differentiation at the same time. Great firms make tradeoffs. They don't try to be all things to all people. Put another way, it costs money to differentiate your product successfully, either through advertising, higher quality components, R&D, etc. Those investments require you to have higher costs, but you hope to make up for that by charging a price premium. Apple is a good example of this.

As for the question about an industry with two firms pursuing different paths... retail is an easy example. Wal-mart is a low cost player, while Target has clearly been a differentiated player. Similarly, in the express mail business in the 1990s, Fed Ex was clearly a differentiated player, while Airborne Express was a low cost player (Airborne was subsequently acquired by DHL).