Snapshot : E-commerce is competitive. This week we explore how to use Porter’s 3 generic strategies of cost leadership, differentiation and focus to define your competitive strategy in e-Commerce. We’ll show how your competitive strategy shapes the way you run your online business. Learn from our examples of different online businesses applying each strategy.
Porter’s generic strategies model is a simple strategic planning framework that helps you define your competitive approach. Online businesses can use the model to help find their e-Commerce competitive advantage. Deciding how you’ll compete shapes how you run your business.
The model itself is simple, but it has far-reaching consequences for e-Commerce businesses. For example, in this article we’ll show its impact on key areas like pricing and cost management, brand positioning and customer experience.
Porter’s generic strategies
In 1980, Professor Michael Porter identified three competitive strategies that businesses can follow :- cost leadership, differentiation and focus.
These generic strategies can apply to any size or form of business. Your start to define your competitive strategy by answering a key strategic question – do you compete by aiming for low cost or by building a unique position in the minds of customers?
The low cost position
The low cost position focuses on financial levers to drive demand and manage profitability. It follows classic economic theory that price is the main influence on demand and lower prices drive more volume sales.
To keep prices competitive, you focus on economies of scale. You aim for a broad target audience and to maximise volume sales. This spreads production and fixed costs over more units which obviously gives your profitability a boost.
The unique position
The unique position on the other hand focuses on differentiating the brand from competitors in the minds of customers.
Being different on its own is not enough though. The target audience has to value the point of difference. They need to value it enough for it to matter more than price in their purchase decision.
A unique position competitive strategy in e-Commerce could include faster delivery times, access to expert advice, or unique products and services not available elsewhere, for example. These would be things some customers will value more than a cheap price.
Broad or narrow target audience
If you follow the unique position approach, you have a second strategic choice to make.
You need to decide whether to aim at a broad target audience – a pure differentiation approach – or a narrow target audience – the focus or niche approach.
The choice of broad vs narrow shapes how you activate your unique position competitive strategy in e-Commerce. It affects the range you offer and your order to delivery system for example.
But let’s start with the simplest strategy which is to look for cost leadership.
Competitive Strategy in e-Commerce 1 - Cost leadership
Cost leadership starts with a focus on price. Classic economic theory states simply that cheaper products sell more and expensive items sell less.
(we’ll come on to exceptions to this theory – called Veblen pricing – when we talk about focussed competitive strategies).
You sell more products because you’re cheaper than competitors, and selling more products drives economies of scale that help you keep costs down so you can keep your prices low.
However, a lot depends on your category and how important price is to customers in the market. A key way to measure this price importance is price elasticity.
Price elasticity is a quantifiable measure of the relationship between price and sales volume. It’s expressed as a ratio or index based on the predicted percentage volume change for a 1% price change.
For example, a price elasticity of 5 would mean a volume changes 5% for every 1% price change. This applies both to price rises (a 1% price increase means a 5% volume decrease) and price cuts (a 1% price decrease means a 5% volume increase).
You normally need econometric modelling to calculate price elasticity.
This modelling is a specialised statistical analysis which gathers large amounts of activity data to calculate the relationship between activities and sales in your market. This analysis typically covers a 2 to 3 year period and includes :-
- historic sales and prices (regular and promotional)
- media spends
- advertising campaign details
- new product launches
- levels of distribution and availability.
A multivariate analysis calculates the relative statistical impact of the different marketing activities on sales. Analysis of the price specific effect (with the impact of other marketing activities stripped out) gives you your price elasticity.
It predicts the sales impact of price changes, so you can forecast what will happen when you (and your competitors) change price. You use this price “model” to find the price point that’ll create the best sales – profit mix for your brand.
Cost leadership and price elasticity
High price elasticity (say over 3 for example) means sales change significantly when price changes. It suggests customers value price over other marketing benefits. Brands are seen as generic rather than different, and customers choose mainly on price, with low levels of brand loyalty.
Cost leadership works well when there’s high price elasticity. You find this mix in categories which are primarily commodity based, and where brands and benefits are relatively similar.
As per our article on price discounting, there’s pros and cons to using price as a marketing lever.
The advantages of price as a lever
On the pro side, it’s simple. Customers find price easy to understand. Online customers can also easily compare prices between sellers.
You can change price fairly quickly and regularly online. The easiness of updating prices on a website makes it attractive as a competitive strategy in e-Commerce.
Sales promotions grab attention and pull in more visitors to online stores, attracted by the opportunity of a bargain.
They can also be compelling to customers when you time limit the offer e.g. “50% off this week only”.
This creates the idea of scarcity (see our article on behavioural science for more on this). This creates an urgency to buy so you don’t miss out. This urgency will clearly boost short-term sales.
The disadvantages of price as a lever
Price changes impact your Profit and Loss sheet. Rely too much on price cuts and promotions to drive sales, and you reduce profitability.
Sometimes you’ve no choice on price promotions. Some retailers demand it in return for space on the shelf or on their website. For them, price promotions drive sales. But for you, price promotions drain profits.
In categories with a history of low prices and frequent sales promotions, customers often expect to not pay full price. This reduces profitability on all brands.
This isn’t the only problem price discounting sets up.
As everyone who buys gets the discount, you lose money from customers who would’ve paid full price. Customers might also pantry fill. They buy extra and stock up, but then don’t repurchase until they run low (impacting your future sales).
The lower the price, the lower the profitability.
Even when price discounts bring in new customers, these customers may well be brand switchers. These are the opposite of loyal customers who always buy whichever brand is on promotion.
Along with price which brings money in to your business, you also need to look closely at cost management which takes money out of your business.
To follow a cost leadership competitive strategy in e-Commerce successfully, you need to look for ways to keep costs down. You do this either though economies of scale, or looking for ways to be more efficient.
Cost management covers two types of cost – variable and fixed.
Managing variable costs
Variable costs relate directly to how much you produce. Cost goes up for every item produced.
Your business content determines what specifically counts as variable costs.
For example, in manufacturing, variable costs cover raw materials, packaging and supply chain costs like storage and transport. Other production costs like utility bills can also be variable – the more you produce, the higher your electricity costs for heating, lighting and running machinery for example.
For service led businesses, variable costs apply to the staff and technology you need to provide the service. If sales go up, you’ll need more people and more systems capacity to meet demand.
For e-Commerce businesses, the main variable costs are storage and transport. Every item you sell has to be stored and shipped. These costs clearly vary by how much you sell.
To reduce the cost per unit sold, you’d look for economies of scale and efficiencies.
For example, you could negotiate better deals from warehouse supplies and shipping companies based on increased sales. You negotiate an economy of scale based volume discount for putting more overall business their way.
You can look for efficiencies in how you store, ship and deliver products when your sales go up such a using full pallet loads and full truck containers.
(See also our article on selling with Amazon to learn how Amazon negotiate better deals with suppliers).
Managing fixed costs
Fixed costs are all other costs that come with running a business. You incur these no matter how many products you sell.
These can include :-
- rent or mortgages on operating offices, premises and warehouses
- management and admin salaries
- insurance and interest payments
- advertising and promotion costs
Fixed cost management tries to eliminate unnecessary costs and minimise necessary costs. For example, it looks at what the company pays for expenses when staff travel, and where to locate operations to keep costs low.
In the e-Commerce world, Amazon is well known for its relentless focus on managing fixed costs.
For example, when they started, they famously made their office desks out of recycled doors rather than buy new desks.
They’re also well known for making staff travel in economy rather than business or first class.
(Fairly ironic given the cost of their leader’s recent space flight was put at over $5bn).
For online stores who aim for cost leadership, what this all means is a focus on large ranges of products (to drive economies of scale), and a lot of focus on keeping fixed and variables costs down through their order to delivery systems.
E-Commerce competitive strategy in action - Cost leadership
One well-known Australian example of cost leadership is Bunnings and their low price guarantee.
Though price isn’t the first message on their website home page, it’s a big part of their cost leadership competitive strategy in e-Commerce.
Low price guarantee
Check out their price guarantee for example, which is set up as a specific selling policy.
If you find a lower competitor price for an in-stock item, they’ll beat it by 10%.
Even with lots of exclusions (trade quotes, stock liquidations, commercial quantities and marketplace products), this is still clearly cost leadership behaviour.
It’s competing on price to make sure competitors don’t undercut them. They can do this because they have large economies of scale from being the market leader.
Price approach on product pages
You can also see their price approach by looking at how they set up product pages.
Take the first first category on their site for example. – Automotive tools.
On this page you can see prices prominently displayed with a large font. When you want to highlight a good price, use a large font. (similarly, if you want to downplay price, use a small font).
They also use charm pricing. This is when you set a price at $x.99 or similar, rather than rounding up to the next dollar. This common approach makes price point appear more attractive.
Studies have shown customers tend to scan prices quickly and focus on the first part of the price, not the full price. So, even though logically a $9.99 price is only $0.01 saving versus $10 for example, many customers perceive the difference as higher as they give disproportionate value to the $9 part of the price.
Bunnings also drive economies of scale with a large range. You can choose from 14 separate categories, each with many sub-categories and thousands of products.
Competitive Strategy in e-Commerce 2 – Differentiation
For business who don’t want to compete on price and cost, there is another choice.
In many categories, there will be buyers who base their decisions on other factors. When you understand these factors, and organise your brand to meet them better than anyone else, that’s a differentiation competitive strategy. Customers choose you because they value your point of difference.
Brand identity differentiation
For example, you can create a point of difference though your brand identity. Here, you focus on a mental association that’s particularly relevant to your target audience. This association becomes more important than price. The price elasticity is low. Customers will pay little attention to the price, because they value the association, the point of difference more.
Look at cars for example. Many brands associate themselves with a specific buying factor to take the focus away from just price.
Volvo and safety. Volkswagen and reliability. BMW and performance.
These Points of Difference usually come from the Reason Why and the Reason to Believe in the brand’s positioning statement.
For e-Commerce brands, the positioning Point of Difference often focusses on the level of service.
Service offer differentiation
A service based Point of Difference in e-Commerce would help customers buy the product, or make the order to delivery system work better for them.
Other e-Commerce service options include better delivery options. Guaranteed delivery by a certain time. Evening or weekend delivery options.
Customers value these extra options, so that they’re willing to pay more for them. This makes price elasticity lower – price is less of a factor in the buying decision.
But their size means they can’t move as quickly as smaller players in the market. That’s where competitors like Jimmy Brings come in with a differentiated approach to their competitive strategy in e-Commerce.
Instead of price, they focus on speed of delivery.
On their home page for example, their lead message is that they can deliver wine, beer and spirits in 30 minutes to most places in Sydney.
Speed of delivery
To some customers in the alcohol market, speed of delivery is important. If you’re throwing a party for example (to celebrate the end of a lockdown) or unexpected guests turn up (unlikely in lockdown).
Their Point of Difference is they don’t have centralised warehouses or stores. Instead, they use their vans as mobile mini-warehouses and position them around the city to be able to deliver anywhere within 30 minutes. This set-up supports their competitive strategy in e-Commerce of fast, local deliveries.
They don’t compete on price with Dan Murphy’s. For the same bottle of Nature’s Harvest Organic Shiraz for example, they charge $16.99 compared to $12.99 at Dan Murphy’s.
But, they promise to deliver all products within up to 2 hours for a flat $6.50 delivery charge. More often, it’s within 30 minutes.
Compare that to Dan Murphy’s delivery service. Their 2 hour delivery option costs $15. Their standard delivery charge is $6.90 (still more than Jimmy Brings) for a 2-4 business day delivery. Dan Murphy’s might have the price and the range, but Jimmy Brings differentiates itself on speed of delivery.
Jimmy Brings can’t compete on range for example. Its vans can only hold so much product.
They stock 35 different red wines, where Dan Murphy’s offers thousands of red wines. That’s the trade-off between distributing from mobile vans and from a warehouse.
But for customers who want fast delivery, range is less important. Speed matters to those customers and that’s what Jimmy Brings focus on.
A different approach to cost management
Cost management has a different focus with a differentiation strategy. Its focussed more on what’s best for the customer (irrespective of cost) rather than what’s best for the company’s bottom line.
To differentiate, brands need to invest in the systems and processes that support the point of difference.
Great customer experience matters more than saving cost. Jimmy Brings costs per delivery will be higher than Dan Murphy’s for example. They need to pay for those vans and drivers.
But the result is faster deliveries, and better service for customers.
Differentiation led businesses use this better service to support higher prices which cover the extra costs required to support the better service.
Competitive Strategy in e-Commerce 3 – Focus
The final competitive strategy in e-Commerce – focus – is an extension of differentiation, but focusses on a much narrower target audience.
The focus with this strategy is to find unique target audiences who you can offer products and services which cannot be easily copied or replicated.
You find a unique niche positioning with a small but dedicated and loyal segment of the market. These customers willingly pay a price premium and are strong advocates for the brand.
Unique niche Point of Difference
The unique niche Point of Difference comes out of the Reason Why and Reason to Believe within the brand’s e-Commerce positioning.
For example it may relate to the quality of product or service, the sourcing or performance of ingredients and materials or some other relevant factor like the product’s sustainability or production values.
This unique position also leads to unusual phenomenon known as Velblen pricing. Named after economist Thorstein Veblen, it identifies some categories and brands where the traditional price – demand relationship works in reverse. Raising the price can make a product more desirable and increase sales.
It happens most often in categories where price implies both quality and scarcity. Customers are willing to pay a premium for such products to show off their status and stand out from others.
A good example of this from the performance car market would be the Bugatti Veyron. Only 450 were ever produced, but they sell for over $1m each and do not lose their value.
You also see it in other categories like fashion and jewellery. The more unique or exclusive a product, the more people are willing to pay for it.
E-Commerce competitive strategy in action - Niche
Our focussed competitive strategy in e-Commerce doesn’t use Veblen pricing though.
Prices for those sorts of goods are often not published. If you have to ask, you can’t afford them. So we’ll look at a more accessible but still focussed / niche online business instead.
UGG boots are a unisex style of sheepskin boot that originates from Australia. While there are many e-Commerce stores selling UGG boots online, most of these are made outside Australia.
One store – Uggs Australia – has decided to take a focussed niche position and only sells Uggs made in Australia. It claims to be the only 100% Australian made manufactured UGG boot seller with the last sheepskin footwear tannery in Australia.
Their șite focusses on the authenticity and origin of the product, and only sells UGG related products.
They sell 32 different types of women’s Ugg boots and 15 different types of men’s Uggs boots in a range of colours. But other than associated accessories such as cleaning materials, there’s no other products available on this site.
This is a good example of a focussed niche offer. They’ve picked a unique selling message (the only UGG boots 100% made in Australia) and focussed their efforts on reinforcing that message.
For customers, this keeps things nice and simple. This is the only choice for customers who want genuine 100% Australian UGG boots.
This means they’ll have a small but loyal segment of the market who value this authenticity. They won’t waste resources and effort chasing other customers who don’t value this in their decision.
A defendable position that’s hard to copy
This focussed competitive strategy in e-Commerce has many advantages. It creates a unique and defendable position that’s hard for competitors to copy. There’s less intense pressure to cut costs because you have loyal customers who value what you do and are willing to pay for it.
Of course, the size of your niche segment does also place a ceiling on how much you can sell. Your niche target audience has to be big enough to sustain your online business model.
Broaden the target audience and you potentially open up more sales. But you run the risk of diluting your unique offer and moving from a niche to a differentiation strategy.
Conclusion - competitive strategy in e-Commerce
Which competitive strategy to follow is an important decision in the e-Commerce planning process.
The cost leadership strategy focusses attention on price and cost. You aim to maximise volume sales to drive economies of scale and create efficiency.
Your online store will need to sell a wide range of products and be clear on the price offer – by offering a low price guarantee like Bunnings and Dan Murphy’s do, for example.
The differentiation strategy looks for other buying factors that customers value more than price. For example, your brand identity or specific services in the the e-Commerce offer. Speed of delivery is often a point of difference in e-Commerce for example. (as we showed with our example of Jimmy Brings).
The focus strategy extends the differentiation approach to focus on a specific small segment. This focus allows you to own a unique and defendable position in the market that’s hard to copy. However, there’ll be a ceiling on sales based on the number of customers in the segment.
Check out our guide to the e-Commerce planning process and our article on finding your e-Commerce competitive advantage to learn more. Or, contact us directly if you think you’d benefit from expert coaching on finding your competitive strategy in e-Commerce.