The Four Strategies

There’s really only four competitive strategies:

1. Broad + differentiated
2. Broad + low cost
3. Niche + differentiated 
4. Niche + low cost

Of course, this might strike you as a wild oversimplification. But I want to convince you that it’s not.

In fact, I believe this lens is one of the most powerful tools that any founder, operator, or investor can have. Because it cuts to the core of the two most important challenges every business has to overcome in order to succeed: why would anyone buy your product, and how can you make money selling it?

Understand that, and everything else a business needs to do clicks into place. Overlook them, you’re in grave danger of losing your way.

It’s important to know that this “four strategies” framework wasn’t just something I made up. It was created by the most cited author in the fields of business and economics, Michael Porter. He introduced it in his book, Competitive Advantage, and it’s been a staple in business schools and in practice ever since.

Navigating the market without this framework is like trying to navigate the world with no concept of north, south, east, and west. It’s possible — our ancestors certainly did it! — but those equipped with a compass can go much further and faster without getting lost.

This essay is split into five major sections. The first four sections cover each of the four strategies. These all contain one main example, three shorter examples, and some additional commentary on how to make the strategy in question work. The final section covers a special case: strategy for monopolies.

Companies examined include:

• Dollar General
• Blue Nile
• Southwest Airlines
• Costco
• Slack
• Pfizer
• Blue Bottle
• Eight Sleep
• Smile Direct Club
• Bird, Lime, etc
• Planet Fitness
• Redbox
• Superhuman
• The Financial Times
• Mizzen+Main
• Canon
• Facebook
• Google
• Amazon

Let’s get started :)

Broad + Low Cost

All strategies require obsessive focus. But “focus” doesn’t always mean a narrower segment of customers. Sometimes it can take the form of obsessing over delivering acceptable value to a wide range of customers at a lower price than anyone else.

Here, the goal isn’t to charge the lowest price possible, but instead to have the lowest cost possible without sacrificing too much in product performance. Then, you’re in position to charge a bit less than anyone else and still maximize profits.

Dollar General. Despite all the talk about the death of retail, Dollar General is thriving. Over the past five years the Dollar General stock (NYSE: $DG) has earned a 129% return and shows no signs of stopping. This is all a result of their focused execution of the “cost leadership” strategy.

It starts with how they choose retail store locations. Dollar General stores are built in places that Walmart (their biggest competitor) often won’t go—inner city neighborhoods and tiny rural towns. Since these neighborhoods aren’t attractive to most retailers, Dollar General pays rock-bottom prices for rent, yet still remain in close proximity to their target customer. 

Once they find a location, Dollar General stores are cheap to develop. They cost only $250k to open and each store is around 7,300 square feet - about one-tenth the average size of a Walmart.

Dollar General also doesn’t employ any excess staff members (such as greeters) which further keeps costs down.

Finally, Dollar General offers a no frills shopping experience with a limited product selection. Their stores have only 10-12 thousand unique items (compared to ~60,000 at a Walmart Supercenter) and they rarely carry any fresh produce. This helps to simplify inventory buying in addition to saving money on cold storage and product spoilage. 

These four factors—lower rent, cheaper build-out, fewer employees, and a limited product selection—all contribute towards what Porter would call low direct operating costs. It’s one of the main ways to pursue the cost leadership strategy.

Additional examples:

• Blue Nile. Unlike Tiffany’s or Zales, Blue Nile has no retail locations. Therefore, they have no retail staff, leases, or other associated costs. They don’t even have a warehouse where they store all their diamonds. Intead, they use a drop-shipping model. This is how they’re able to offer engagement rings and other diamonds at a lower price. Their drop-ship model not only allows Blue Nile to have a higher cash balance than retail stores (since it’s not tied up in inventory), but also allows them to offer a wider selection. Additionally, they trade the commitment of multi-year contracts with suppliers for favorable payables terms - often 30-120 days, freeing up more cash.
• Southwest Airlines. While airlines today have copied many of Southwest’s best practices, a big reason they gained market share in the 80s and 90s was due to innovative cost cutting strategies. For example, they were one of the first to offer short-haul, intra-state flights instead of the hub-and-spoke model that most airlines adopted. Additionally, they provided cheaper food ($0.20 per meal vs $5.00 per meal industry average), didn’t use travel agents, and flew into uncongested airports of small cities. This last part - flying into small airports where the runway wait times are shorter - is what Porter calls achieving high asset utilization. Airlines can’t change their biggest fixed costs (owning the planes), but they can get more flights out of them. 
• Costco. Costco is a discount retailer using a cost leadership strategy - similar to Dollar General - but executes it in a different way. Costco buys in bulk to get discounts on supply and only charges a small markup in their stores. In fact, after accounting for store costs (rent, employees, etc.) they usually break even. How does Costco make money then? If you want to shop at Costco, you have to buy their $60 / year membership. Since the membership doesn’t have any incremental costs, it goes straight to the bottom line. This model allows Costco to undercut competitors - thus attracting a price-conscious customers - while still turning a profit through the memberships. 

Summary: The key thing to remember here is that a cost leadership strategy starts with a unique advantage in unlocking lower operating costs. Don’t make it fancy, make it cheap. 

Broad + Differentiated

Sometimes new technologies come along that are just better. The iPhone, for example, wasn’t created to serve any particular niche or segment (e.g. business users, teenagers, etc). Instead, it’s for anyone willing to pay for quality.

Here, the key is to understand what your customers care about, and give it to them in a superior way. In order to do this, you’ll often (but not always) have to spend a bit more money. But that’s ok, so long as your customers are willing to pay a premium.