Building on the confusion of yesterday’s post, today’s entry focuses on the academic justification for a firm’s participation in the luxury segment. Though what appears below is very intellectual, it is very similar to the thoughts I had on the matter long before I ever knew I wanted to work in the luxury segment.

In his work covering business strategy, Michael Porter explains that there are two main categories, in which a firm’s competitive strengths fall: cost leadership and differentiation. Depending on the firm’s market focus (broad or niche), and the uniqueness of its products (custom or commodity) and services, Porter posits four generic strategies a firm can use to develop a competitive advantage.

Cost leadership is all about reducing the firm’s internal cost of delivering its products and services to its customers. Some of the most commonly used examples of cost leaders are Zara and H&M. One thing to note is that the cost leadership strategy requires a firm to be THE absolute low cost provider.

Firms using this strategy require a couple of things:

• Access to capital for investments that will lower costs (i.e. technology)
• Effective and efficient logistics (i.e. supply chain); and
• A low and spreadable cost base that gives the firm the opportunity to realize some economies of scale

Since cost leadership strategies are typically realized via operational and internal efficiencies, they are prone to imitation by other firms seeking to make higher profits. So, even though cost leaders have products that appeal to a wider market, their strategies are inevitably at risk of not staying unique to them alone. Thus, firms in this space compete largely by producing at the lowest cost to sell to the consumer at the lowest price.

On the other hand, Differentiation, relies on the firm’s ability to deliver unique products and services to consumers. Irrespective of the industry, brand perception is a huge differentiator. Examples of companies in this space are benchmarks like LVMH (a conglomerate of luxury brands) and Mandarin Oriental (hospitality).

Firms with a differentiation strategy require a couple of things:

• Continuous product development and innovation through R&D
• A commitment to delivering high-quality products/services
• Effective sales and marketing strategies that communicate the value of the firms differentiated products/services

Though differentiation seems to be a very advantageous strategy, it is not immune to risks. Like cost leadership, imitation is a big issue for firms in this area. Take the fashion industry as an example. Though they are highly sought and appreciated for their uniqueness, the high-end couture gowns and dresses you see in fashion shows are ubiquitously copied by other designers who try to follow “the next hot thing” in fashion. This happens especially because fashion consumers are fickle and disloyal by nature. Differentiators can also be usurped by firms with focus strategies.

Focus strategies are a hybrid between cost leadership and differentiation strategies. Focus strategies are implementations of either cost leadership or differentiation in narrow market segments. Firms using focus strategies leverage their strengths to either provide low cost or unique products and services to consumers. The trick here is that firms in this space have an advantage because they understand the specific dynamics of their niche target markets.

Examples of firms with focus strategies can include hospitality or retail mall groups that operate in multiple market tiers (luxury, mid-market, and low market). Companies like Zara could also be cited as examples because they offer limited quantities of differentiated garments, at low costs. However companies offering a composite of low-cost and unique offerings rarely succeed with focus strategies because they try “to be everything to everyone”

Michael Porter says that companies with focus strategies become “stuck in the middle” when they try to implement both cost leadership and differentiation within their core business segments. A solution to avoiding the “stuck in the middle” syndrome is to operate low-cost and differentiated segments as totally separate businesses. This gives managers more autonomy to pursue specific strategies based on their exact positioning within the competitive grid.

In my next post, I will bring my argument to a close with a take on how luxury firms might want to go about pursuing successful (and sustainable) business strategies.