Toyota, Target and Togo's

This week in undergraduate strategy was our discussion of generic business-level strategies — one of the most fundamental lessons of the entire course. This reminded me of two paradoxes of generic strategies, one big and one small.

In his 1985 book, Michael Porter argued there are two generic strategies

• low cost, which is the basis of competition under cases of commodization
• differentiation, which requires firms create unique products that are valued by buyers.

Porter originally argued it was impossible to do both simultaneously: increasing perceived value will increase costs, while cutting costs will cut perceived value. Geoff Moore makes a more nuanced version of the same point in Dealing with Darwin. Marketing experts also cite the potential for brand confusion (premium features for commodity products, cost cutting on premium products.)

This leads to the big paradox. Since Porter, other strategy researchers have claimed there are exceptions. Examples include JetBlue until 2008, Toyota until 2009.

Explaining (or dismissing) these exceptions is one of the dilemmas of teaching this material, or applying it to the real world. Given it failed in the long run for Toyota — relentless cost cutting led to declining quality and led to a public relations nightmare — perhaps this “big paradox” is really just a rare and temporary exception to an unavoidable strategic contradiction.

The small paradox seems more permanent and puzzling. Exhibit A is Target, which has nearly the cost cutting of Wal-Mart but with a much better shopping experience. (Both my wife and sister swear by Targét, but rarely if ever would be found in Wal-Mart.)

So how does Target maintain its price premium over Wal-Mart? Would it be better off going straight at Wal-Mart, or is this just a chance to segment a really big nationwide market? I continue to wrestle with this exemplar of the small paradox.

After class, one of my students talked about his experience at the early Togo’s, a sandwich shop founded by Tom Neumann and Gordon Reed. If Neumann and Reed are the McDonald brothers, the SJSU student Michael Cobler is the Ray Kroc of Togo’s who grew the business (before it was sold to Dunkin’ Brands in 1997.)

Togo’s was a cult favorite here in the Bay Area for many years. Today they charge a marked premium over Subway, but for the life of me I can’t understand why people pay it.

My student recalled fondly working for Cobler, who gave Togo’s a clear differentiation strategy until it was lost under its new corporate owners.

Like rivals, Cobler relentlessly cut costs to remain competitive. Unlike rivals, he would not cut costs if it would diminish his perceived quality edge: flavorful ingredients trumped cardboard at every opportunity. I haven’t seen the numbers, but I was told extra ingredient costs of 5% or less could be used to support the Togo’s price premium (which today is 20-30%).

So maybe a slight premium of costs can be used to sustain a larger premium of prices. It probably requires a large market (like fast food and department stores) to allow both a low cost and a slight premium vendor to co-exist.

Are there other examples? Continental managed post-911 cuts to match its bigger rivals, but remained at or near the top of customer satisfaction — in part by not cutting costs as badly as its rivals. Even this advantage appears to be temporary, because next month Continental is being acquired by United (one of the worst carriers).