Determinants of a Successful Differentiation Strategy
Stanislav Tripes, Lenka Komarkova, Petr Pirozek and Jiri Dvorak
The University of Economics, Prague, the Faculty of Management, J. Hradec, The Czech
Republic
[email protected]
[email protected]
[email protected]
[email protected]
Abstract: The discussion about the business level of strategy represented by Porter’s generic strategies has been debated
in the academic and scholarly community for a long time. Differentiation is based on the specific competitive advantage, its
formulation and presentation for customers. Ways of differentiating an enterprise’s product or service is through its
quality, innovations, unique resources or improving customers’ responsiveness (Jones and George, 2012). Uniqueness and
differentiation do not mean unequivocal success, as customers can also be sensitive to other factors and circumstances,
which are connected to the dynamics of the environment or the customers’ perception of entrepreneurial behaviour etc.
The purpose of our study is to investigate whether the success of the differentiation strategy depends on the level of the
definition of competitive advantage, the level of strategy formulation (if managers are focused rather on functional,
business or corporate levels), corporate identity, and corporate image and simultaneously the suitability of this strategy
with regards to the environmental dynamics. As a representation of performance, we have used Return on Assets (ROA),
which was calculated from the financial reports of the enterprises in 2012. These numbers were compared with the
average ROA in domestic industries (represented by NACE coding) and these enterprises were subsequently divided into
two groups: “Successful (above average ROA)” and “Unsuccessful (under average ROA)”. Our data set included 260
enterprises operating in the Czech Republic. Better generality of our dataset was assured due to the incorporation of
enterprises of all sizes, ownership types, different domestic industries and legal forms. Data were collected using semi‐
structured interviews including qualitative and quantitative questions. The whole interview was recorded, with the
answers subsequently evaluated by a group of experts. Only enterprises which defined their strategy as a “rather
differentiation” or “differentiation” were used in this paper. The final tally of incorporated enterprises in our research was
114 enterprises. We used a chi‐squared test (of independence) and logistic regression as the data analysis tools. The
preliminary results show that the successes of enterprises are significantly statistically dependent on the level of strategy
formulation. Thus, a manager should formulate their strategy from a global point of view (at the corporate level). The
second most dependent variable for success of the differentiation strategy was corporate identity. According to our data
set, the definition of competitive advantage and corporate image are not significant factors for the success of an
enterprise. Particular results will be presented in the paper.
Keywords: differentiation strategy, return on assets, enterprises, environment, identity, image
1. Introduction
Everyone wants to be different, have something more special than others. The desire to be different is
mirrored in the everyday lives of each of us and it influences not only people in the role of customers, but also
the strategy of enterprises. The way of thinking about differentiation is not only serving different product
characteristics, but also identifying and understanding relationships and influences between the enterprise
and its customers, and asking how these interactions can be used for increasing added value for customers.
Managers face lack of competitiveness caused by increasing customer requirements on higher added value.
Enterprises want to satisfy customer requirements and are really important due to the managers’ choice of
proper strategy. The manager can choose from several ways to satisfy the customer. There are three main
target customer groups that have different requirements: price sensitive customers; those who appreciate
high added value; and a third group are customers who want a low price and high added value at the same
time. These three customer groups have been identified by Porter (Porter, 2008) and mirrored into three basic
generic strategies: low‐cost, hybrid and differentiation. Our study is focused on the most demanding customer
group: those who want higher added value, the differentiation group. Differentiation can be perceived from
two perspectives: from the perspective of the customer and from the point of view of the manager.
Nowadays, there has appeared the formable task for managers using the differentiation strategy in satisfying
their customers’ desires and requirements. A satisfied customer returns often (or buys the product regularly),
leading to the success (financial performance) of the enterprise. The task for managers is hidden in identifying
the particular requirements of their customers and determining how the differentiation works with regard to
the enterprise environment. This was the field of this study.
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This study was carried out in the Czech Republic, which forms part of o Central and Eastern European
countries. The goal of this study was to analyse strategy formulation (especially generic strategies) with regard
to the economic transformation over the past 20 years. Enterprises in this area of Europe are still learning
managerial approaches and trying to formulate their strategy regarding their environment. Some enterprises
have used the knowledge of environment and their product portfolio to formulate proper strategy.
Nevertheless, the knowledge of management theory and its application seems to be quite poor. The managers
sometimes make decisions which aren’t cohesive, especially using inappropriate types of generic strategies,
leading to lower performance (Dvorak et al., 2013).
We understand an enterprise as a set of components which the manager should consider within the
performance evaluation. According to Morton (1991),these components are the strategy, structure, culture
and selected management tools which build the organization. We consider all components, its interaction and
dynamics of environment as influencing factors to performance. The most influential parameter to success or
failure (represented by average ROA in the industry) of enterprises seems to be the strategy (Pudil et al.,
2014).
Academic discussions in the field of strategy and performance have been mainly focused on evaluating the
performance with regard to the chosen type of strategy at the business level (Hill and Jones, 2012; Jones and
George, 2012). The main stream of research usually compares the success of generic strategies (low‐cost,
hybrid and differentiation) to each other (Hill, 1988; Leitner and Güldenberg, 2010; Pertusa‐Ortega et al.,
2009) or separately (Liu and Wu, 2011). Scholars are not able to decide whether one of them is the best
strategy at all. Everything depends on the particular circumstances around the enterprise (Nandakumar et al.,
2010). Parnell (2010) made an interesting point , where he pointed out that combination of generic strategies
increased the performance, but not in every instance. These discussions led us to consider the particular
determinants influencing the success of each strategy, as the particular determinants of success of each
strategy have not been deeply investigated.
We presume that when determining the success or failure of a particular differentiation strategy, it is
necessary to take into account the dynamics of the environment, the level competitive advantage definition,
corporate identity and image and the level of strategy formulation. The differentiation can be based on a
unique source of competitive advantage, its definition and sustainability in the dynamic environment. When
the environment is highly dynamic, then the sustainability of competitive advantage can be lower (Chang and
Wang, 2013). At the same time, the overall effort (corporate identity) for differentiation, the customers’
perception about the enterprise (corporate image) can serve as a potential source of success. Last but not
least, the level of strategy formulation is considered such as the perception of the managers and the
polarization of the effort towards functional, business or corporate level of strategy (Jones and George, 2012).
Determinants influencing performance of enterprises have been a hot topic in the academic and business
community for a long time. Managers are pushed to increase the performance but in the current dynamic
environment, it has become continuously more difficult. As previously mentioned, there are a lot of influences
and managers want to know how to be successful with respect to market circumstances and their strategy.
Managers can be interested in determinants dependent on success or failure of the differentiation strategy
because of knowledge about these determinants can help them focus their efforts for differentiation more
efficiently. The determinants of successful differentiation are interesting for the academic community as well,
due to a lack of research in this area. Future research in this field can be investigated using qualitative research
methods for developing the theory and subsequently its validation, thanks to quantitative methods. We have
chosen the quantitative approach using our huge data set.
The purpose of this paper is to indicate if there is a relationship between the success of differentiation strategy
and the above‐mentioned determinants. This study tests the theory of Determinants of Successful
Differentiation strategy that corporate image, corporate identity, dynamics of environment, definition of
competitive advantage and level of strategy formulation influence the performance of enterprises represented
by average Return On Assets (ROA). The survey participants were managers of enterprises operating in the
Czech business environment. The following research question was formulated for this purpose.
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RQ: Is the performance of enterprises represented by ROA positively influenced by the definition of competitive
advantage, level of strategy formulation, corporate identity, image and overall dynamics of the enterprises
environment?
2. Theoretical background
Success or failure depends on the overall strategy of the enterprise. There are lot of approaches focusing on
particular strategies and the strategic management is a very broad field. The whole strategic planning process
includes environmental analyses, strategy formulation, implementation and control. Our study is focused on
the environment and the formulation of strategy. Generally, the scholarly sources mention three levels of
strategy formulation: Functional, Business and Corporate level (Hill and Jones, 2012). The corporate level is
about defining the field and means of entrepreneurial activity. Most enterprises are focused on a single
industry where the managers decide to enhance their activities through three different ways: diversification,
vertical or horizontal integration and finally internationalization. The corporate level strategy considers the
whole organization and environment with opportunities to future development. On the other hand, the
business level of strategy serves possible ways in fulfilling the corporate goal. It is focused on the way of selling
product or services to the customer. These ways were described by M. Porter (2008) as generic strategies:
Cost‐leadersh ip, Hybrid (or “Stuck in the middle”), Differentiation strategy and focused strategies. The
functional level of strategy elaborates the chosen business strategy into improving Responsiveness to
Customers, Quality, Innovations and Efficiency (Jones and George, 2012). All three levels of strategy
formulation should be consistent and considered a functional unit. Some managers are more focused on some
particular level that means that they perceive some level as more important (MacKay and McKiernan, 2004;
Narayanan et al., 2011). Considering all levels together increases the added value and supports the
competitive advantage, which results in a higher performance.
The definition of competitive advantage means how the manager is able to describe the enterprises’
competitive advantage from the source and maintainability point of view. A lot of different tangible or
intangible sources of competitive advantage exist including technology and innovation, organizational
structure, human resources, unique knowledge etc. (Cater and Cater, 2009; Chang and Wang, 2013; Ellis and
Calantone, 1994; Wang et al., 2011). The manager should be able to define what the sources of the
enterprises’ competitive advantage are, how the competitive advantage is used for strategy formulation and at
the same time its sustainability during the strategy period (Ehmke, 2008; Ellis and Calantone, 1994). The
generic value chain introduced by Porter (Porter, 2008; Stabell and Fjeldstad, 1998) usually helps in describing
competitive advantage, together with another tool, VRIO analysis. The sustainability of competitive advantage
is closely dependent on its dynamic capabilities and overall dynamics of the environment.
The dynamics of environment depicts the rate of changes in the micro‐ and macro‐environment of enterprises.
Usually these changes can be described and evaluated using strategic analysis tools like PEST analysis or
Porters’ 5F model (Hill and Jones, 2012). The dynamics can especially influence sources of competitive
advantage and differentiation. Differentiation strategy and its sustainability in the dynamic environment seem
to be lower and are dependent on particular sources of differentiation (Nandakumar et al., 2010). One of the
sources of differentiation can be the image perceived by customers.
Corporate identity and corporate image has been discussed for a long time and are closely connected. Both
terms have gone through longitudinal development (Furman, 2010; Melewar and Karaosmanoglu, 2006;
Otubanjo and Melewar, 2007). The strategy of enterprise should be mirrored in the corporate identity,
especially differentiation (Melewar and Karaosmanoglu, 2006). The overall identity and image of an enterprise
is visible for all stakeholders. The connection to the performance of an enterprise has two levels. The first level
is perceived by the current or potential employees who want to be a “proud part” of an organization which has
a positive image. This pride motivates them to a higher performance (Kim et al., 2011). The second level is
perceived by the customers who are more willingness to buy a product or service of an enterprise which has a
positive image (Pruzan, 2001). These above‐mentioned reasons are strong motives to managers why they
should improve the image of their enterprises to empower stakeholder opinion about the enterprise.
Stakeholder perceptions about enterprise dynamics, cooperativeness, business wisdom, character,
successfulness and withdrawnness can have a positive impact on the performance (Aaron J. Spector, 1961;
Furman, 2010).
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The performance of enterprises and strategy has been discussed by many authors from different points of
view (Leitner and Güldenberg, 2010; Nandakumar et al., 2010; Parnell, 2010). The most frequently discussed
topics are the influence of strategy, structure and environment on performance. The above‐mentioned
variables (level of strategy formulation, environmental dynamics, competitive advantage definition, corporate
image and identity) belong to variables influencing performance. Lively discussions exist about measuring
performance and its evaluation (Clarkson, 1995; Nandakumar et al., 2010). One of the possible ways to
measure the performance of an enterprise is Return on Assets (ROA). The ROA is used for performance
evaluation in the Czech Republic very often.
3. Methodology
We have collected a big data set covering nearly 100 variables including financial and information data (e.g.,
number of employees, legal form, industry operated), environment, strategy, structure, culture and factors
which represent relationships between these components. The whole data set consisted of 260 enterprises
operating in the Czech business environment. The data collection was from 2011 to 2013. The financial
indicator ROA is calculated for the year 2012. The data set was divided into two groups (above average ROA;
under average ROA) regarding to average ROA in the industry where the enterprise has operated. The
respondents were managers at the higher echelons or owners of enterprises from different industries, types of
ownership, legal forms and sizes of the organizations. The most frequently represented industries (according
to NACE coding) were Manufacturing; Wholesale and retail trade; and Information and Communication. For
this study we have selected only 114 enterprises that described their type of strategy on a business level as
differentiation or a “rather” differentiation strategy.
3.1 The survey design and data collection
The survey had two main parts: the financial and information data collection based on annual reports and
enterprises’ financial documents. The second part was the semi‐structured interview about the whole
enterprise from different points of view to gain sufficient knowledge (Creswell, 2014). The open‐ended
questions were used in order for the manager to be able to add some interesting piece of knowledge. The
interviewer took an audio recording and notes throughout the interview. The group of experts (excluding the
interviewer) analysed and evaluated all audio‐recordings and categorised the answers into categorical or
ordinal data and recorded into the matrix, using MS Excel. These values were consequently compared to the
notes of the interviewer for achieving higher accuracy.
The data analysis procedures are described in detail in the results.
4. Results
Our sample consisted of 114 enterprises: 78 with a “rather” differentiation strategy and 36 with a
differentiation strategy. An absolute majority of enterprises with a rather differentiation strategy were
unsuccessful while on the contrary, an absolute majority of enterprises with a differentiation strategy were
successful (Table 1). Data analysis was performed using the statistical software R version 3.0.1 (R Core Team,
2013).
Table 1: Enterprises performance vs. strategy
Performance / Strategy
Rather Differentiation
Differentiation
Total
Success (Above average ROA)
35 (44.9%)
21 (58.3%)
56 (49.1%)
Failure (Under average ROA)
43 (55.1%)
15 (41.7%)
58 (50.9%)
Because the selected determinants (competitive advantage, strategy formulation, corporate identity,
corporate image and environmental dynamics) had only three levels (lower, middle, higher), and the
performance was in the form of binary variable (above the average ROA, under the average ROA) we used
statistical methods for categorical data.
First, for indicating paired association we used the Pearson chi‐squared test of independence (p‐values are
shown in Figure 1). We proved at the 5% significance level the dependency of financial performance on the
strategy formulation (p=0.024) and corporate identity (p=0.036). According the bar‐plots in Figure 1, we report
that:
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ƒ
ƒ
The higher level of strategy formulation, the higher the performance.
Performance represented by ROA is positively influenced by a strong corporate identity.
Second, to quantify the differences in success among the levels of two selected determinants, we chose
logistic regression, which is appropriate for a binary dependent variable. The explanatory ordinal variable
(strategy formulation or corporate identity, respectively) was expressed by two dummy variables (with a
reference category of “lower”).
Table 2: Point and interval estimates for odds ratio obtained through logistic regression
Strategy formulation
Corporate Identity
Levels
Odds ratio
95% Conf. Int.
Odds ratio
95% Conf. Int.
Middle vs. lower
1.500
(0.549; 4.212)
1.200
(0.207; 7.534)
Higher vs. lower
3.444
(1.351; 9.249)
3.769
(1.044; 17.855)
According to Table 2 we found determined that a higher (global) level of strategy formulation gives 3.44 times
higher odds of success than a lower (local) strategy formulation. Analogously, the higher level of the corporate
identity caused the average increase in odds of 277% (against the lower level). These both results are
statistically significant. This result means that if the manager considers all three levels of strategy together, the
enterprise is more successful. The overall effort to differentiation (based on corporate identity) led to better
results. Yet how the stakeholders perceive this effort, is not significantly important.
Figure 1: Distribution of financial performance conditionally on selected determinants
As Figure 1 shows, the distribution of the success and failure rate in particular variables (excluding strategy
formulation and corporate identity) between is without “rules”. That means that there is not some significant
trend which can help to managers in their job. The distribution can be influenced by other factors which
weren’t examined. These results are really interesting. The differentiation strategy should be based on a clear
definition of competitive advantage. Competitive advantage based on a unique source or products are the
main origins of differentiation. Nevertheless, enterprises whose competition advantage definition is at a higher
level are more successful than the others. Similarly, it is in the case of corporate image. The distribution also
depicts that higher performance brings a lower level than the “half way” (middle). On the contrary, it is in the
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case of environment dynamics. If the environment is rather static, the distribution is balanced. With increasing
dynamics are enterprises more successful, but there exist some limit and circumstances within the dynamic
environment which this trend changes. These results are hard to understand. For a better interpretation it is
necessary to analyse the audio‐recordings again within the explanatory sequential mixed methods research
design.
5. Discussion and conclusion
The results provide new insights into strategic formulation practises in the Czech Republic. Our previous
assumption that the ability to use management theory in the Czech Republic is poor was supported. According
to literature managers should formulate enterprises strategy based on knowledge of environment and its
dynamics. Especially the differentiation strategy should be based on clear definition of competitive advantage.
Our results support that Czech managers have weaker knowledge of management theory and decide rather on
their perception and cognition of enterprises situation. Recommendation which can be given from our results
is that managers should consider the whole organization and all levels of strategy within the strategy
formulation, rather than focusing just on business strategy (low‐cost, differentiation, and hybrid). At the same
time support corporate culture of purpose to improve corporate identity.
The results present some new information within the field of business strategy of enterprises in the Czech
environment. Despite the possible limitations of the research (the set of enterprises surveyed, the number of
respondents, etc.), some interesting things are obvious that will have to be further verified. In the following
stage of processing the results obtained, we can focus on causalities that bring new knowledge in the field of
the business strategy in the post transformation phase of the market system. The other results can be
investigated in Western European or North American countries. Managers in Western Europe and North
America can have different perception of strategy. Our result can be considered as a first step in the Czech
Republic. Nevertheless, it is necessary to collect more data including enterprises from other parts of Europe to
generalize our findings. Future research can be focused on the perception of differentiation strategy
determinants from the point of view of the manager and customer. The proper method for this field seems to
be mixed methods research design.
Acknowledgements
This work was supported by the Grant Agency of the Czech Republic ‐ project No. P403/12/1557 and by project
IG632094.
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