What is Strategy? - Michael Porter

I. Operational Effectiveness (OE)

• Definition: OE means performing similar activities better than rivals.

  • This includes, but is not limited to, efficiency, such as reducing defects, developing better products faster, eliminating wasted effort, employing advanced technology, or motivating employees better.

• Necessity but Insufficiency: While OE is essential to superior performance and companies can reap enormous advantages from it, it is not sufficient for sustainable profitability.

• Management Tools: The quest for productivity, quality, and speed has led to numerous management tools like total quality management (TQM), benchmarking, time-based competition, outsourcing, partnering, and reengineering.

• The Productivity Frontier: This concept represents the sum of all existing best practices at any given time, or the maximum value a company can deliver at a given cost using the best available technology, skills, and management techniques.

  • When a company improves its OE, it moves toward this frontier.

  • The frontier is constantly shifting outward as new technologies and management approaches develop.

• Why OE is not Sustainable:

  • Rapid Diffusion of Best Practices: Best practices are easily emulated and diffuse quickly across competitors, especially generic solutions.

  • Competitive Convergence: As companies benchmark and imitate one another's improvements, their strategies converge, leading to them becoming "indistinguishable from one another".

    • This results in "mutually destructive competition" and "wars of attrition" where no one truly wins.

  • Zero-Sum Competition: The pursuit of OE alone often leads to static or declining prices and pressures on costs, compromising long-term investment.

• Examples:

  • Japanese Companies: Pioneers of OE in the 1970s and 1980s through practices like TQM and continuous improvement, achieving cost and quality advantages.

    • However, they rarely developed distinct strategic positions, leading to imitation and persistently low profits as the gap in OE narrowed.

  • U.S. Commercial-Printing Industry: Major players competing head-to-head, investing in the same equipment and practices, resulting in productivity gains captured by customers and suppliers, not retained as superior profitability.

II. Strategy

• Definition: Strategy is the creation of a unique and valuable position, involving a different set of activities.

  • It means performing different activities from rivals' or performing similar activities in different ways. Competitive strategy is about "being different".

• Essence of Strategy: The essence lies in the activities chosen and how they are performed, rather than just marketing slogans or customer descriptions.

• Three Key Principles of Strategic Positioning:

  1. Creation of a Unique and Valuable Position: Involves a different set of activities.

     • Sources of Strategic Positions:

       • Variety-based positioning: Producing a subset of an industry’s products or services. It makes sense when a company can best produce particular products using distinctive activities.

         • Examples: Jiffy Lube (automotive lubricants only), The Vanguard Group (array of low-cost, predictable mutual funds like index funds).

       • Needs-based positioning: Serving most or all the needs of a particular group of customers. This arises when customer groups have differing needs that a tailored set of activities can best serve.

         • Examples: Ikea (targets young furniture buyers who want style at low cost, happy to trade service for cost), Bessemer Trust Company (targets very high-wealth clients wanting capital preservation, offering highly customized services) vs. Citibank’s private bank (targets clients needing convenient access to loans, with a less customized system).

       • Access-based positioning: Segmenting customers who are accessible in different ways, even if their needs are similar. Access can be a function of geography, customer scale, or anything requiring a different set of activities to reach customers.

         • Example: Carmike Cinemas (operates exclusively in small cities and towns under 200,000 population, using a lean cost structure tailored to these markets).

  2. Strategy Requires Trade-offs: To choose what not to do. Trade-offs occur when competitive activities are incompatible, meaning gains in one area are achieved at the expense of another.

     • Purpose of Trade-offs: They create the need for choice and protect against imitation by repositioners and straddlers.

     • Reasons for Trade-offs:

       • Inconsistencies in image or reputation: Delivering inconsistent value can confuse customers or undermine reputation.

       • Incompatibilities in activities: Different positions require different product configurations, equipment, employee behavior, skills, and management systems.

       • Limits on internal coordination and control: Clear choices clarify organizational priorities and prevent confusion.

     • Examples: Neutrogena soap (chose a "kind to the skin" medicinal positioning, saying "no" to deodorizing and large supermarket volumes, sacrificing manufacturing efficiencies for product attributes).

       • Continental Lite's failure (tried to straddle full-service and low-cost models, leading to compromises like cutting travel agent commissions and frequent-flier benefits, resulting in huge losses).

  3. Strategy Involves Creating "Fit" Among a Company's Activities: Fit refers to the ways a company’s activities interact and reinforce one another. It goes beyond achieving excellence in individual activities to combining them effectively.

     • Importance of Fit: Drives both competitive advantage and sustainability. It locks out imitators by creating an interlocking system that is hard to replicate, as rivals get little benefit from imitating only parts.

     • Types of Fit:

       • First-order fit: Simple consistency between each activity and the overall strategy.

         • Example: Vanguard aligns all activities with its low-cost strategy (minimal portfolio turnover, direct distribution, limited advertising, employee bonuses tied to cost savings).

       • Second-order fit: Activities are reinforcing. One activity enhances the value of another.

         • Example: Neutrogena's medical and hotel marketing activities reinforce each other, lowering total marketing costs.

       • Third-order fit: Optimization of effort, where coordination and information exchange across activities eliminate redundancy and minimize wasted effort.

         • Example: The Gap optimizes inventory management by restocking basic clothing almost daily from warehouses, minimizing the need for large in-store inventories and speeding up product cycles.

     • Activity-System Maps: Useful tools to visualize how a company's strategic position is embedded in a tailored set of activities, showing how higher-order strategic themes are implemented through clusters of linked activities.

     • Example: Southwest Airlines (low-cost, short-haul, point-to-point service between midsize cities and secondary airports).

       • Its strategy is a "whole system of activities" where elements like rapid gate turnarounds, no meals/assigned seats/baggage transfers, standardized 737 fleet, and motivated ground crews all reinforce each other to deliver low cost and high convenience.

III. Challenges to Strategy and the Role of Leadership

• Why Companies Fail to Have Strategy:

  • Misguided view of competition: Confusing OE with strategy, believing trade-offs are unnecessary, and imitating competitors.

  • Organizational failures: Reluctance to make difficult choices, herd behavior, and employees lacking a holistic vision due to empowerment without strategic context.

  • The Growth Trap: The desire to grow often leads managers to broaden their position by adding product lines, features, or acquiring brands, which blurs uniqueness and compromises the strategic position.

    • Examples: Maytag expanded beyond reliable washers/dryers into full-line appliances and acquired other brands, leading to a decline in return on sales.

    • Neutrogena broadened distribution and product lines, diluting its image and uniqueness.

• Profitable Growth: Instead of broadening, companies should concentrate on deepening a strategic position, leveraging existing activity systems and reinforcing uniqueness.

  • This can involve globalization consistent with strategy or creating stand-alone units for different strategic positions.

• The Role of Leadership: Crucial for developing and maintaining a clear strategy. Leaders must:

  • Define and communicate the company's unique position.

  • Make trade-offs and forge fit among activities.

  • Provide discipline and say "no" to distractions or compromises that blur the strategy.

  • Ensure strategic continuity, allowing for improvements in individual activities and fit, rather than frequent, costly shifts in positioning.