By combining two types of competitive advantage with the firm's choice of scope - broad market v.s. narrow segment. Porter defined three generic strategies: cost leadership, differentiation and focus. According to Porter cost leadership and differentiation are mutually exclusive strategies and firms that are 'stuck in the middle' are most guaranteed low profitability.
A firm must make decisions as to which customer requirements to focus on, where to position their product or service in the market. Cost leadership typically implies narrow-line, limited-feature, standardised offering. In case of IKEA or Southwest Airlines, a low-price, no-frills offering is associated with clear market positioning and unique brand image.
Cost leadership - objective is to become the lowest cost producer in the whole industry. Typically involves production of large scale which enable firm to exploit economies of scale.
Differentiation leadership - the business targets much larger markets and aims to achieve competitive advantage across whole industry.
In most industries, market leadership is held by firms that maximise customer appeal by effective differentiation with low cost - Toyota, Nike. Cost leaders are frequently not market leaders but smaller competitors with minimal overhead, cheaply acquired assets.
Cost focus - business seeks a lower cost advantage in only one or small number of market segment. The product will be basic, perhaps similar product to the higher priced and featured market leader, but acceptable to sufficient customers.
Differentiation focus is classic niche marketing strategy. A business aims to differentiate within just one or a small number of target market segments. Clearly identifiable customer needs and wants and a valid basis for differentiation.
Simultaneously pursuing differentiation, cost efficiency and innovation. The most successful firms are often those who have managed to differentiated themselves in a highly cost-effective manner.