now what is strategy

8/8/2019 Now What is Strategy

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Copyright 2006 Professor Michael E. Porter

What is Strategy?

Professor Michael E. PorterHarvard Business School

University of Iceland

October 2, 2006This presentation draws on ideas from Professor Porters books and articles, in particular, Competitive Strategy(The Free Press, 1980); Competitive

Advantage (The Free Press, 1985); What is Strategy? (Harvard Business Review, Nov/Dec 1996); Strategy and the Internet (Harvard BusinessReview, March 2001); and a forthcoming book. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form orby any meanselectronic, mechanical, photocopying, recording, or otherwisewithout the permission of Michael E. Porter. Additional information may

be found at the website of the Institute for Strategy and Competitiveness, www.isc.hbs.edu.


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3 Copyright 2006 Professor Michael E. Porter20061002 University of Iceland 20060925.ppt

How Managers Think About Competition

COMPETING TO BE THEBEST

COMPETING TO BE THECOMPETING TO BE THE

BESTBESTCOMPETING TO BE

UNIQUE

COMPETING TO BECOMPETING TO BE

UNIQUEUNIQUE

The worst error in strategy is to compete with rivals on the same dimensions


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Flawed Concepts of Strategy

Strategy as aspiration

Our strategy is to be #1 or #2

Our strategy is to grow

Our strategy is to be the world leader

Strategy as action

Our strategy is to merge

internationalize

consolidate the industry

outsource

Strategy as vision

Our strategy is to meet our customers needs

to advance technology for mankind


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Vision Statements

Autodesk

Transforming business by design

Avon

To be the company that best understands and satisfies the product, service andself-fulfillment needs of women globally.

Goodyear Tire and Rubber

Become a market-focused tire company providing superior products and

services to end-users and to our channel partners, leading to superiorreturns for our shareholders.

Lafarge

To be the undisputed world leader in building materials

Marriott International, Inc.

To be the number one lodging company in the world.


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Setting the Right Goals

The fundamental goal of a company is superior long-term returnon investment

Growth is good only if superiority in ROIC is achieved and

sustained

Prevalent accounting adjustments to reported profitability(e.g., writeoffs, writedowns, restructuring charges) can

obscure true economic performance and lead to badcompetitive choices

Profitability must be measured realistically, capturing the actualprofits on the full investment

Profitability metrics besides ROIC (e.g. return on sales;

ebitda margin; pro-forma earnings; cash flow margin) arerisky for strategy

Goodwill must be treated as part of investment

Setting unrealistic profitability or growth targets can underminestrategy


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Economic Performance versus Shareholder Value

EconomicPerformanceEconomicEconomicPerformancePerformance Shareholder ValueShareholder ValueShareholder Value

Economic Performance Measures Sustained ROIC

Sustained Revenue Growth

Shareholder-Derived MeasuresStock Price

EPS

EPS Growth

Shareholder value is the result of creating real economic value

Pleasing todays shareholders is not the goal


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$4

$9

$14

$19

$24

Stock Price and Economic Value Over TimeTaiwan Semiconductor, 2000 2005

Note: Moving averages are over the past 5 years. Return on Equity calculated as net income for the past 12 months divided by common stockholder equity (adjusted for stock splits). Returnon Capital calculated as EBIT / (capital employed plus short-term loans minus intangible assets). Sales converted from New Taiwan Dollars at average yearly rate.

Source: Compustat; Bloomberg; authors calculations.

StockPrice(US$)

200520042003200220012000

35.1%35.9%23.3%13.3%11.5%39.2%Net Inc. Margin

23.2%

25.8%

29.4%

32.2%

$5.3

14.1%15.0%13.4%13.5%16.7%ROC moving avg.

21.4%23.2%13.3%6.8%5.7%ROC

15.2%17.2%16.1%17.1%21.4%ROE moving avg.

22.2%25.4%15.4%7.7%5.5%ROE

$8.2$7.6$5.9$4.7$3.9Revenue ($B)

2000 20052004200320022001

$24


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Setting the Right GoalsFood Retailing

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

0% 5% 10% 15% 20% 25%

MarketValue to

Sales Ratio2004 Data

Source: CompustatNote: ROIC calculated as EBIT divided by Average Invested Capital (Total Assets less Excess Cash less Current Operating Liabilities)

ROIC Average

(1999-2004)

Winn-Dixie

Food Lion

Kroger

Albertsons

Safeway

Supervalu

Whole Foods

Publix

Average FoodRetailing Market Value

to Sales Ratio

AverageFood Retailing

ROIC


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Economics of StrategyDisaggregating Economic Performance

0%

5%

10%

15%

20%

25%

30%

Pharmacia & Upjohn* Southwest Airlines

Return onInvestedCapital

1985-2002

19.55%

12.75%

Source: CompustatNote: ROIC calculated as EBIT divided by Average Invested Capital (Total Assets less Excess Cash less Current Operating Liabilities)

* Prior to 1995, reflects Pharmacia only. Company was acquired in 2000 by Monsanto, which then changed its name to Pharmacia

28.14%

Industry Average

5.05%


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Threat of SubstituteProducts or Services

Threat of NewEntrants

Rivalry Among

ExistingCompetitors

Bargaining Power

of Suppliers

Bargaining Power

of Buyers

Determinants of Long-Term Industry Profitability


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Reshaping Industry Structure

Foodservice Distribution

Offering value-added services

Offering private-label products

Moving to national procurement contracts

Increasing the use of sophisticated information technology


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Determinants of Relative Performance

Differentiation(Higher Price)

Lower Cost

CompetitiveAdvantage

Competitive

Advantage


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Economics of StrategySouthwest Airlines

0

2

4

6

8

10

12

Southwest Airline Industry Average

Centsper ASM

Note: ASM (Available Seat Miles) defined as total seats available multiplied by miles flownSource: Airline annual reports and authors calculations

Operating Profit per

Available Seat Mile

Operating Cost perAvailable Seat Mile

CostAdvantage:2.44

Pricing

Differential:1.72

Revenue and Cost per Available Seat Mile, Average of 1998 - 2000


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Competing in a business involves performing a set of discrete

activities, in which competitive advantage resides

Sources of Competitive AdvantageActivities and the Value Chain

SupportActivities

Marketing& Sales

(e.g. SalesForce,

Promotion,Advertising,

ProposalWriting, Web

site)

InboundLogistics

(e.g. IncomingMaterial

Storage, DataCollection,

Service,CustomerAccess)

Operations

(e.g. Assembly,ComponentFabrication,

BranchOperations)

OutboundLogistics

(e.g. OrderProcessing,

Warehousing,Report

Preparation)

After-SalesService

(e.g. Installation,CustomerSupport,

ComplaintResolution,

Repair)

M

a

r

g

i

n

Primary Activities

Firm Infrastructure(e.g. Financing, Planning, Investor Relations)

Procurement(e.g. Components, Machinery, Advertising, Services)

Technology Development(e.g. Product Design, Testing, Process Design, Material Research, Market Research)

Human Resource Management(e.g. Recruiting, Training, Compensation System)

Value

Whatbuyers arewilling topay


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Marketing& Sales

(Lead generation,Model home

display, Salesforce, Customer

selection of

personalizedoptions)

Land Acquisition& Development

(Identify attractivemarkets, Secure

land, Procureentitlements and

permits, Preparesite)

Construction

(Design,Engineering,Schedule and

manageconstruction

process)

Closing

(e.g. CustomerFinancing,

Contract, Title,Closing)

After-SalesService

(e.g. Warranties,Customer

Complaints)

M

a

r

gi

n

Primary Activities

SupportActivities


Procurement(e.g. Materials, Subcontracted Labor, Advertising, Services)

Technology Development(e.g. Product Design, Testing, Process Design, Materials Research, Market Research)


Defining the Value ChainHomebuilding

Value



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Creating a unique andsustainable competitiveposition

Assimilating, attaining, andextending best practices

OperationalOperational

EffectivenessEffectiveness

StrategicStrategic

PositioningPositioning

Run the same races faster Choose to run a different race

Achieving Superior PerformanceOperational Effectiveness is Not Strategy


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Five Tests of a Good Strategy

A unique value propositioncompared to other organizations

A different, tailored value chain

Clear tradeoffs, and choosing whatnot to do

Activities that fit together andreinforce each other

Continuity of strategy withcontinual improvement in realizingthe strategy

A unique value propositioncompared to other organizations


Clear tradeoffs, and choosing whatnot to do




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Strategic PositioningWhole Foods Markets

Natural, fresh, organic, and prepared foods andhealth items with excellent service at premium

prices

Educated, middle class, and affluent customerspassionate about food as a part of a healthylifestyle

Well-lit, inviting supermarket store formats withappealing displays and extensive prepared foods

sections Produce section as theater Caf-style seating areas with wireless internet for

meetings and meals

Each store carries local produce and has the authorityto contract with the local farmers

Information and education provided to shoppers along

with products High touch in-store customer service via

knowledgeable, non-unionized, highly motivatedpersonnel

Egalitarian compensation structure Own seafood procurement and processing facilities to

control quality (and price) from the boat to the counter

Donates 5% of profits to non-profits Each store has green projects, directed by

employees to improve environmental performance

Value PropositionValue PropositionValue PropositionDistinctiveActivities

DistinctiveDistinctive

ActivitiesActivities

Excellent strategies often include a social dimension of the value proposition


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Defining the Value Proposition

What RelativePrice?

What RelativeWhat Relative

Price?Price?

WhatCustomers?

WhatWhatCustomers?Customers?

WhichNeeds?

WhichWhichNeeds?Needs?

What end users?

What channels?

Which products?

Which features?

Which services?

A novel value proposition can also grow the pie/expand the industry


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Strategic PositioningEnterprise Rent-A-Car

Home-city replacement cars for drivers

whose cars are being repaired or who needan extra vehicle, at low rates (30% belowairport rates)

Numerous, small, inexpensive offices in each

metropolitan area, including on-premises offices atmajor accounts

Open during daylight hours

Deliver cars to customers homes or rental sites,or deliver customers to cars

Acquire new and older cars, favoring soon-to-bediscontinued older models

Keep cars six months longer than other majorrental companies

In-house reservations

Cultivate strong relationships with autodealerships, body shops, and insurance adjusters

Grassroots marketing with limited television

Hire extroverted college graduates to encouragecommunity interaction and customer service

Employ a highly sophisticated computer networkto track the fleet

Value PropositionValue PropositionValue PropositionDistinctiveActivities

DistinctiveDistinctive

ActivitiesActivities


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Making Strategic Tradeoffs

Tradeoffs occur when strategic positions are incompatible

the need for a choice

Sources of Tradeoffs

Incompatible product / service features or attributes

Differences in the best configuration of activities in the value chain to deliverthe chosen value proposition

Inconsistencies in image or reputation across positions

Limits on internal coordination, measurement, motivation, and control

Tradeoffs make a strategy sustainable against imitation by establishedrivals

An essential part of strategy is choosing what not to do


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Strategic TradeoffsNeutrogena Soap (1990)

Forgo cleaning, skin softening, and deodorizingfeatures

Choose higher costs through the configuration of:

packaging

manufacturing

detailing medical advertising

skin research

Give up the ability to reach customers via: promotions

television

some distribution channels


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Recent Thinking on the Sources of Competitive Advantage

Key Success Factors

Core Competencies

Critical Resources

Key Success Factors

Core Competencies

Critical Resources

Competitive advantage is seen as concentrated in a few parts of thevalue chain


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Mutually Reinforcing ActivitiesZara Apparel

Source: Draws on research by Jorge Lopez Ramon (IESE) at the Institute for Strategy and Competitiveness, HBS

VeryVery

flexibleflexibleproductionproduction

systemsystem

Tightcoordination

with 20wholly-owned

factories

Extensiveuse of

store salesdata

JIT delivery

VeryVeryfrequentfrequent

productproductchangeschanges

CuttingCutting--edge fashionedge fashion

at moderateat moderateprice andprice and

qualityquality

WordWord--ofof--mouthmouth

marketingmarketingand repeatand repeat

buyingbuying

Little mediaadvertising

Widelypopularstyles

Prime storePrime storelocations inlocations in

high traffichigh trafficareasareas

Customers

chic butcost-

conscious

Advanced

productionmachinery

Globalteam oftrend-

spotters

Productionin Europe

Fit is leveraging what is different to be more different


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Strategic Continuity

Continuity of strategy is fundamental to sustainable competitive advantage

e.g., allows the organization to understand the strategy

builds truly unique skills and assets related to the strategy

establishes a clearidentity with customers, channels, and other outside entities

strengthens the fit across the value chain

Reinvention and frequent shifts in direction are costly and confuse thecustomer, the industry, and the organization

Continuity is required in the value proposition

Successful companies continuously improve in how they realize their strategy

Strategic continuity and continuous change should occursimultaneously. They are notinconsistent

Continuity of strategy allows learning and change to be faster and more effective


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Barriers to Strategy

Flawed Management Concepts

Misunderstanding of strategy itself

Poor industry definition

Industry Pressures

Industry conventional wisdom leads all companies to follow

common practices

Customers ask for incompatible features or request new products orservices that do not fit the strategy

Labor agreements limit ways of configuring activities

Regulation constrains price, product, service or process alternatives


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Internal Practices

Inappropriate goals and performance metrics bias strategy choices

Short time horizon

A desire forconsensus undermines strategic tradeoffs

Rapid turnover of leadership undermines strategic direction toachieve short-term performance benefits

Inappropriate cost allocation leads to too many products, services,or customers

Outsourcing makes activities homogenous and less distinctive


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Barriers to StrategyNeutrogena Soap (2005)

Prior to the 1990s Neutrogena was thenumber one brand recommended bydermatologists

Neutrogena had a relatively narrow targetmarket but deep penetration and highcustomer loyalty

Beginning in the early- to mid-1990s, new

growth-oriented management shiftedNeutrogena from a dermatologist-focusedmarketing concept to mass market televisionadvertisements and celebrity endorsements

Neutrogena lost market share whileGalldermas Cetaphil captured the loyalty ofdermatologists, and prospered

Source: Draws on research conducted at the Institute for Strategy and Competitiveness and interviews conducted with a former Neutrogena executive.


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Capital Market Biases

Strong pressures to emulate currently successful peers

Strong pressure to grow fasterthan the industry

A strong bias for doing deals (M&A)

Industry-wide analyst metrics are misaligned with true value and

drive strategic convergence that undermines performance

Over-weighting ofequity-based management compensationamplifies these unhealthy pressures


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Strategy

What Is a Strategy? What is Not a Strategy?

Best practice improvement

Execution

Aspirations A vision

Learning

Agility

Flexibility Innovation

The Internet (or any technology)

Downsizing

Restructuring Mergers / Consolidation

Alliances / Partnering

Outsourcing

Best practice improvement

Execution

Aspirations A vision

Learning

Agility

Flexibility Innovation

The Internet (or any technology)

Downsizing

Restructuring Mergers / Consolidation

Alliances / Partnering

Outsourcing

A unique value propositionversus competitors


Clear tradeoffs, and choosing

what not to do



A unique value propositionversus competitors


Clear tradeoffs, and choosing

what not to do




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Customers are independent restaurantsand institutions

The product line consists ofwell over10,000 SKUs

Sales and service activities are carriedout by local sales reps

Value-added services, credit terms, and

distributors private-label products arevalued and allow support product/servicedifferentiation

Logistical activities are heavily local innature (local warehouses and trucks)

Defining the Right Business: Products and ServicesFoodservice Distribution

Broadline DistributionBroadline Distribution Systems Distribution

Customers are national chains

The product line consists ofseveralhundred SKUs

Customer relationships and servicesare specified by national contracts

Price is the key basis for selection;

customers do not purchase value-added services or private-labelproducts

A national distribution andwarehousing network is required


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Defining the Right Business: Geography

GlobalGlobalGlobalNationalNationalNationalLocalLocalLocal RegionalRegionalRegional

SupportActivities

Marketing& Sales

(e.g. SalesForce,

Promotion,Advertising,

ProposalWriting, Web

site)

InboundLogistics

(e.g. IncomingMaterial

Storage, DataCollection,


Operations

(e.g. Assembly,Component

Fabrication,Branch

Operations)

OutboundLogistics


Warehousing,Report

Preparation)

After-SalesService

(e.g. Installation,Customer

Support,ComplaintResolution,

Repair)

M

a

r

g

i

n

Primary Activities





Value


Separate localvalue chains

Integrated globalvalue chain

Ability to Leverage Key Activities Across Geography

Cross-National

CrossCross--

NationalNational

A distinct strategy is needed for each relevant geographic market


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Finding a Strategic Position

Leveraging Unique Activities Building off activities with true

uniqueness

Looking fornew activityconfigurations and combinations

Migrate toward the chosen strategic position

Focus incremental investments on reinforcing the chosen position

Segmenting the Industry Strategically

Creatively segmenting productvarieties, customer groups, andpurchase occasions

Harnessing Tradeoffs

Identifying tradeoffs in the valueproposition or in the value chain

Capitalizing on Industry Dynamics Identifying strategic positions opened

up by industry changes

Segmentation and Strategic Positioning


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Customer Group

Preferred, lowest risk drivers

Set of Activities

Direct customer interaction through direct mail,telephone, and the Internet

Sophisticated direct mail targeting low riskhouseholds

35+ year database and modeling utilities onpreferred drivers

Complex rating and pricing system

Heavy advertising to drive requests for ratequotes (Ive got good news.)

Quote rates to only 50% of customers whoinquire about coverage

15-20% lower prices than competition Network of insurance adjusters with cell phones

working out of own vehicles for immediateresponse

24-hour customer service to handle sales, policyinquires, and claims

Conservative, liquid investment portfolio

Customer Group

High-risk drivers shunned by standardautomobile insurers

Set of Activities Distribution primarily through independent

agents

Sales force that educates independent agents incomplex information gathering techniques

30-year database on high-risk drivers

Complex rating scheme 14,000 different prices

50-300% premium pricing over standardsegment

Adjusters work from offices on wheels to provideimmediate response. Adjusters trained and

empowered to write out check at scene ofaccident

Steep incentives to make a 4% underwritingprofit

Conservative, liquid investment portfolio

Segmentation and Strategic PositioningAutomobile Insurance

ProgressiveProgressiveProgressive GeicoGeicoGeico

Growing Strategically


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Growing Strategically1. Make the strategy even more distinctive

Introduce new technologies, features, products or services that are tailored tothe strategy and which leverage other distinctive activities within the valuechain

2. Deepen the strategic position (rather than broaden it)

Raise the penetration of chosen customers / needs

3. Expand geographically to tap new regions or countries using the samepositioning

Aggressively reposition foreign acquisitions around the companys strategy

4. Expand the market for what the company can uniquely deliver

Find other customers and segments that value the strategy

It is an illusion that growth (and especially profitability) areeasier to achieve in untapped or growth segments

It is difficult, and often dangerous, to try to grow faster than theunderlying market for an extended period.

Industry leaders should concentrate as much, or more, ongrowing the category as on growing share

In many cases, shareholders are best served by earning a high

return and returning capital, especially via dividends


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How can activities be shared across geography to gain competitiveadvantage?

Where should each activity be located to gain competitiveadvantage?

InboundLogistics

(e.g. IncomingMaterial Storage,Data Collection,


Operations

(e.g. Assembly,ComponentFabrication,

BranchOperations)

M

a

rg

i

n

Primary Activities

SupportActivities



Competing InternationallyLeveraging the Value Chain Across Geography



OutboundLogistics


Warehousing,Report Preparation)

Marketing& Sales

(e.g. Sales Force,Promotion,Advertising,

Trade Shows,Proposal Writing)

After-Sales Service

(e.g. Installation,Customer Support,

ComplaintResolution, Repair)


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The Role of Leaders in Strategy

Lead the process of choosing the companys unique position The CEO is the chief strategist The choice of strategy cannot be entirely democratic

Clearly distinguish operational effectiveness improvement and strategy

Communicate the strategy relentlessly to all constituencies Harness the moral purpose of strategy

Maintain discipline around the strategy, in the face of many distractions.

Decide which industry changes, technologies, and customer needs torespond to, and how the response can be tailored to the companys strategy

Measure progress against the strategy using metrics that capture theimplications of the strategy for serving customers and performing particularactivities

Sell the strategy and how to evaluate progress to the financial markets

Commitment to strategy is tested every day


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Corporate Social ResponsibilityA Growing Agenda

External pressures for CSR continue to grow There are a widening range of issues for which companies are being held

responsible

Community expectations continue to rise

There are new government regulations and reporting requirements Activists are more sophisticated at using the media to advance their agendas

Numerous organizations monitor, rank, and report social performance

These rankings can have a meaningful impact on customers, investors

and potential partners

The legal and business costs are great for those engaging in practicesdeemed unacceptable

CSR is increasingly important to business leaders, yet the concept and itsjustifications remain unclear

Four Prevailing Justifications for CSR


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Four Prevailing Justifications for CSR

Moral Obligation

Achieving commercial success in ways that honor ethical values Inadequate guidance to balance complex competing social and economic interests Wide variability of personal values among managers and stakeholders

Sustainability"Meeting the needs of the present without compromising future needs

Most effective on environmental issues where improvements can yield immediate economic benefits In other areas, intangible long term consequences provide a weak justification for short term costs

License to OperateBuilding goodwill to secure the acquiescence of governments and stakeholders

Licenses and approvals are necessary But this approach cedes control of CSR agenda to external players that do not fully understand

corporate strategy and operations Encourages short term and disjointed responses to the squeakiest wheel of the moment

ReputationEnhancing reputation and brand with customers, investors, and employees

Little evidence of sustained competitive advantage Emphasizes the visible and popular rather than the social and business impact of corporate activities

The prevailing justifications are based on broad aspirations that provide little

specific guidance or priorities for company actions


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Outside-In Social Impact


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Context for

Firm Strategyand Rivalry

Related andSupportingIndustries

Factor(Input)

Conditions

Demand

Conditions

Sophistication of local demand

(Appeal of social value propositions, e.g.,

Whole Foods customers)

Demanding regulatory standards

(e.g., California auto emissions & mileage

standards)

Unusual local demand in specialized

segments that can be served nationally

and globally

(e.g., Urbi housing financing; Unilevers

bottom of the pyramid strategy)

Presence of high quality, specialized inputs

available to firms

Human resources

(e.g., Marriotts job training)

Physical infrastructure

(e.g., Nestl's milk collection dairies)

Administrative infrastructure

Information infrastructure

(e.g., Nestl's knowledge transfer to milk

farmers)

Scientific and technological infrastructure

(e.g., Intels investment in global wireless

access) Natural resources

(e.g., Grupo Nuevos water conservation)

Local suppliers

(e.g., Syscos locally grown produce)

Research institutions and universities

(e.g., Microsofts Working Connections)

Access to firms in related fields

Presence of clusters instead of isolated

industries

Access to capital

(open markets, government regulation)

Vigorous local competition(absence of trade barriers, fair regulations)

Intellectual property protection

Transparency

(financial reporting, corruption--e.g., Extractive

Industries Transparency Initiative)

Rule of law

(Security, protection of property, legal system)

Meritocratic incentive system

(Opportunities for educational advancement)

Outside-In Social Impact

Source: Michael Porter, The Competitive Advantage of Nations, 1990 Many of these elements are influenced by or inextricably linked with social conditions

Defining the Corporate Social Agenda


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Defining the Corporate Social Agenda

GenericSocial Issues

Value ChainImpacts

CompetitiveContext

Social issuesthat are notsignificantlyimpacted bythe companysoperations,nor materiallyaffect itslong termcompetitiveness

Social issues thatare significantlyimpacted by thecompanysactivities in theordinary course ofbusiness

Social issues in thecompanys externalenvironment thataffect theunderlying driversof competitivenessin the locationswhere the companyoperates

Which issues fall into each category will differby industry, cluster, companyand location

Corporate Involvement in Society: A Strategic Approach


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Corporate Involvement in Society: A Strategic Approach

Generic

Social Issues

Value Chain

Impacts

Competitive

Context

Good citizenship Mitigate harm

Defensive/Reactive Affirmative

Unique value chainactivities that benefitsociety whilereinforcing strategy

Strategic philanthropythat leveragesactivities andcapabilities to improve

salient areas ofcontext

now what is strategy

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