When starting any new business, but particularly when starting a new business in a competitive category, you need a clear notion of what your business strategy is.
You need to start in this way because one of the very first decisions—and perhaps the key decision you’ll make—concerns your core strategy.
Fortunately, perhaps surprisingly, this step ends up being easier than most people think.
In truth, you must choose one of three traditional business strategies. These three strategies go by different names, but you can think of them as the cost strategy, the differentiation strategy and the customer strategy.
Using a Cost-based Strategy
In a nutshell, if you pick a cost strategy, you work to reduce your costs. Then you price your products or services at a low price. And you hope to, well, steal customers or clients from your competitors because your prices are lower.
An important point in all this—one that’s sometimes missed by new entrepreneurs—is this: You only pass a portion of cost-savings onto customers.
In other words, in business that uses a cost strategy, you might find some way to save, for example, $10,000 in costs. You pass, perhaps, half of these cost savings onto your customers or clients in the form of lower prices. This is how you steal customers. You keep the other half as profit. This is how you make money.
And now let me make a point about cost strategies and small businesses: To make a cost strategy work in any business, you typically need scale. In other words, you need enough size to compete with other large businesses.
I don’t want to rain on anybody’s parade, but frankly I would be immediately suspicious of someone today starting an owner-operated, owner-financed business based on a cost-strategy. If someone were to choose this strategy, my gut tells me the business would need to have some really significant, built-in cost advantages.
Using a Differentiation-based Strategy
There’s a second strategy a business, including a small business, can use. The strategy relies on differentiation of the product or service. In other words, the business makes its products or services different from those of its competitors.
If you select a differentiation strategy, you work to differentiate your product or service.
You incur costs to differentiate of course. But the fact that your product or service is different from what other competitors provide—better, unique, more specialized, or whatever—makes your products or services more attractive to certain customers or clients than the products or services of your competitors.
Here’s a key point: You must be able to charge your customers or clients more for your differentiation. In fact, you need to charge customers more for the differentiation than the differentiation costs. But again, the strategy can be very successful. In retailing, for example, Nordstrom uses a differentiation strategy.
Small businesses, in general, find differentiation an easier strategy to succeed with than the cost-strategy discussed earlier. Therefore, differentiation is definitely a strategy you need to consider.
Using a Customer Strategy
If you’re very clever, you can sometimes combine the cost strategy and the differentiation strategy to create a hybrid, customer strategy.
A customer strategy gives you a competitive advantage when targeting certain groups of customers who want a combination of cost savings and product differentiation.
You see hybrid strategies work well in industries like retailing and service businesses. If a particular group of customers wants some inexpensive items and some differentiated items, you can win some customers from a cost-strategy competitor and some customers from a differentiation-strategy competitor by cleverly combining these strategies. I would say that the large retailer, Target, does this. Target may not, for example, offer you prices as good as Wal-Mart. And Target may not offer you merchandise that’s as differentiated as, say, Nordstrom. But Target probably offers certain suburban middle-class shoppers a better collection of cost savings and differentiated products.
The trick with a hybrid strategy, obviously, is customer knowledge. In a sense, you can tell whether you’re able to execute a hybrid customer strategy. A customer strategy, in essence, means you compete on the basis of knowledge about your customers.
Caution: I will make the perhaps obvious observation that because Internet businesses tend to have very limited customer contact, a hybrid strategy may be challenging for an Internet business or largely web-based small business.
A warning, here, too: You should be aware that there’s a non-strategy that usually kills businesses in competitive industries and that sort of resembles the customer strategy.
The non-strategy? Trying to be all things to all people. When you try that, you lose customers who shop on the basis of price to competitors who use a cost strategy. (This is particularly easy with Internet businesses because competitors are just a click away.)
Similarly, you lose customers who shop for differentiated products to your competitors who use the differentiation strategy. The hybrid customer strategy, therefore, is not simply trying to be all things to all people.
Tips for Picking the Right Strategy for Your Small Business
Several points should be made about business strategic planning:
- You pick the strategy most likely to make your venture successful. Picking a strategy, then, needs to rest on an analysis of your venture’s strengths and weaknesses and on an analysis of your competitors’ strengths and weaknesses and their strategies. This analysis leads to a decision to choose one of the traditional strategies—the one that will clearly make your products or services more attractive to certain customers.
- You will want to identify the specific tactics that your small business will use to execute its strategy. For example, if your market analysis shows that you’re a low-cost provider, you might choose the cost strategy. And then to follow up, you would also identify the tactics you can use to grind down your costs so you can win new customers away from your competitors on the basis of cost.
- Your unique talents, skills and interests often suggest an appropriate strategy. People who successfully execute a cost strategy are experts at managing costs. People who successfully execute a differentiation strategy are product or service experts. Finally, people who successfully execute a customer strategy are customer experts. Another way to explain their success in a market is that they’re simply being rewarded for their expertise.
- Some research indicates that new businesses are more likely to succeed with a high-end product or service rather than with a low-end, low cost product or service. This makes sense if you think about. It’s often easier to differentiate yourself if you’re new or small simply because you are new or small. Furthermore, in many industries, entrepreneurs find it relatively difficult to run a super-low-cost operation simply because you won’t enjoy any economies of scale.
- And a final point: If you’re interested in the details of how the business strategic planning process works, you might want to read Michael Porter’s book, Competitive Advantage. Porter, a Harvard Business School professor, is the father of business strategic planning. And his book, while rather dry, supplies a goldmine of business strategic planning information.
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Here’s something that I’ve noticed again and again about small businesses. They usually don’t do a very good job about maximizing their tax deductions.
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