Accounting: The Language of Business (Part 2)

Capital isn't this pile of money sitting somewhere; it's an accounting construct.

Bethany McLean

Introduction to Accounting and Business

(Part B)

by

Charles Lamson

Business Strategy

How does a business decide which products or services to offer to consumers? For example, should Best Buy offer warranty and repair services to its customers? Many factors influence this decision, but ultimately the decision is made on the basis of whether it is consistent with the overall business strategy of the company.

A business strategy is an integrated set of plans and actions designed to enable the business to gain an advantage over its competitors, and in doing so, to maximize its profits. The two basic strategies a business may use are a low-cost strategy or a differentiation strategy.

Under a low-cost strategy, a business designs and produces products or services of acceptable quality at a cost lower than that of its competition. Walmart and Southwest Airlines are examples of businesses with a low-cost strategy. Such businesses often sell no frills, standardized products to the most typical customer in the industry. Following this strategy, businesses must continually focus on lowering costs.

Businesses may try to achieve lower costs in a variety of ways. For example, a business may employ strict budgetary controls, use sophisticated training programs, implement simple manufacturing technologies, or enter into cost-saving supplier relationships. Such supplier relationships may involve linking the supplier's production process directly to the client's production processes to minimize inventory costs, variations in raw materials, and record-keeping costs.

A primary concern of a business using a low-cost strategy is that a competitor may achieve even lower costs by replicating the low-costs or developing technological advances. Another concern is that the competitors may differentiate their products in such a way that customers no longer desire a standardized, no-frills product. For example, local pharmacies most often try to compete with Walmart on the basis of personalized service rather than cost.

Under a differentiation strategy, a business designs and produces products or services that possess unique attributes or characteristics for which customers are willing to pay a premium price. For the differentiation strategy to be successful, a product or service must be truly unique or perceived as unique in quality, reliability, image, or design. To illustrate, Maytag attempts to differentiate its appliances on the basis of reliability, while Tommy Hilfiger differentiates its clothing on the basis of image.

Businesses using a differentiation strategy often use information systems to capture and analyze customer buying habits and preferences. For example, many grocery stores such as Kroger and Safeway issue magnetic cards to preferred customers that allow the consumer to receive special discounts on purchases. In addition to establishing brand loyalty, the cards allow the stores to track consumer preferences and buying habits for use in purchasing and advertising campaigns.

Companies may enhance differentiation by investing in manufacturing and service technologies, such as flexible manufacturing methods that allow timely product design and delivery. Some companies use marketing and sales efforts to promote product differences. Other companies use unique credit granting arrangements, emphasize personal relationships with customers, or offer extensive training and after-sales service programs for customers.

A business using a differentiation strategy wants customers to pay a premium price for the differentiated features of its products. However, a business may provide features that exceed the customers needs. In this case, competitors may be able to offer customers less differentiated products at lower costs. Also, customers' perceptions of the differentiated features may change. As a result, customers may not be willing to continue to pay a premium price for the products. For example, as Tommy Hilfiger clothing becomes more commonplace, customers may be unwilling to pay a premium price for Hilfiger clothing. Over time, customers may also become better educated about the products and the value of the differentiated features. For example, IBM personal computers were once viewed as being differentiated on quality. However, as consumers have become better educated and more experienced with personal computers, Dell computers have also become perceived as being of high-quality.

A business may attempt to implement a combination strategy that includes elements of both the low cost and differentiation strategies. That is, a business may attempt to develop a differentiated product at competitive, low-cost prices. For example Andersen Windows allows customers to design their own windows through the use of its proprietary manufacturing software. By using flexible manufacturing, Andersen Windows can produce a variety of Windows in small quantities with a low or moderate cost. Thus, Andersen Windows sell at a higher price than standard low-cost windows but at a lower price than fully customized windows built on site.

As you might expect, a danger of a business using a combination strategy is that its products might not adequately satisfy either end of the market. That is, because its products are differentiated, it cannot establish itself as the low-cost leader, and at the same time, its products may not be differentiated enough that customers are willing to pay a premium price. In other words, the business may become "stuck in the middle."

A business may also attempt to implement different strategies for different markets. For example, Toyota segments the market for automobiles by offering the Lexus to image- and quality-conscious buyers. To reinforce this image, Toyota developed a separate dealer network. At the same time, Toyota offers a low-cost automobile, the Echo, to price-sensitive buyers. 

*WARREN, REEVE, AND FESS, 2005, ACCOUNTING, 21ST ED., PP. 4-6*

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