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Strategy Development

What Is Strategy?

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The Five Competitive Forces That Shape Strategy

by Michael E. Porter

Building Your Company’s Vision

by James C. Collins and Jerry I. Porras

Reinventing Your Business Model

by Mark W. Johnson, Clayton M. Christensen, and Henning Kagermann

Blue Ocean Strategy

by W. Chan Kim and Renée Mauborgne

Strategy Execution

The Secrets to Successful Strategy Execution

by Gary L. Neilson, Karla L. Martin, and Elizabeth Powers

Using the Balanced Scorecard as a Strategic Management System

by Robert S. Kaplan and David P. Norton

Transforming Corner-Office Strategy into Frontline Action

by Orit Gadiesh and James L. Gilbert

Turning Great Strategy into Great Performance

by Michael C. Mankins and Richard Steele

Who Has the D?: How Clear Decision Roles Enhance Organizational Performance

by Paul Rogers and Marcia Blenko

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What Is Strategy?

by Michael E. Porter

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The Idea in Brief—the core idea The Idea in Practice—putting the idea to work

Article Summary

What Is Strategy?

A list of related materials, with annotations to guide further exploration of the article’s ideas and applications

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What Is Strategy?

The Idea in Brief The Idea in Practice

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The myriad activities that go into creating, producing, selling, and delivering a product or service are the basic units of competitive advantage.

Operational effectiveness

means performing these activities better— that is, faster, or with fewer inputs and defects—than rivals. Companies can reap enormous advantages from operational ef- fectiveness, as Japanese firms demon- strated in the 1970s and 1980s with such practices as total quality management and continuous improvement. But from a com- petitive standpoint, the problem with oper- ational effectiveness is that best practices are easily emulated. As all competitors in an industry adopt them, the

productivity frontier

—the maximum value a company can deliver at a given cost, given the best available technology, skills, and manage- ment techniques—shifts outward, lowering costs and improving value at the same time. Such competition produces absolute improvement in operational effectiveness, but relative improvement for no one. And the more benchmarking that companies do, the more

competitive convergence

you have—that is, the more indistinguish- able companies are from one another.

Strategic positioning

attempts to achieve sustainable competitive advantage by preserving what is distinctive about a com- pany. It means performing

different

activi- ties from rivals, or performing

similar

activi- ties in different ways.

Three key principles underlie strategic positioning.

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

Strategic position emerges from three distinct sources:

•

serving few needs of many customers (Jiffy Lube provides only auto lubricants)

•

serving broad needs of few customers (Bessemer Trust targets only very high- wealth clients)

•

serving broad needs of many customers in a narrow market (Carmike Cinemas op- erates only in cities with a population under 200,000)

2. Strategy requires you to make trade-offs in competing—to choose what

not

to do.

Some competitive activities are incompatible; thus, gains in one area can be achieved only at the expense of another area. For example, Neutrogena soap is positioned more as a me- dicinal product than as a cleansing agent. The company says “no” to sales based on deodor- izing, gives up large volume, and sacrifices manufacturing efficiencies. By contrast, Maytag’s decision to extend its product line and ac- quire other brands represented a failure to make difficult trade-offs: the boost in reve- nues came at the expense of return on sales.

3. Strategy involves creating “fit” among a company’s activities.

Fit has to do with the ways a company’s activities interact and rein- force one another. For example, Vanguard Group aligns all of its activities with a low-cost strategy; it distributes funds directly to con- sumers and minimizes portfolio turnover. Fit drives both competitive advantage and sus- tainability: when activities mutually reinforce each other, competitors can’t easily imitate them. When Continental Lite tried to match a few of Southwest Airlines’ activities, but not the whole interlocking system, the results were disastrous.

Employees need guidance about how to deepen a strategic position rather than broaden or compromise it. About how to ex- tend the company’s uniqueness while strengthening the fit among its activities. This work of deciding which target group of cus- tomers and needs to serve requires discipline, the ability to set limits, and forthright commu- nication. Clearly, strategy and leadership are inextricably linked.

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What Is Strategy?

by Michael E. Porter

harvard business review • november–december 1996

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I. Operational Effectiveness Is Not Strategy

For almost two decades, managers have been learning to play by a new set of rules. Compa- nies must be flexible to respond rapidly to competitive and market changes. They must benchmark continuously to achieve best prac- tice. They must outsource aggressively to gain efficiencies. And they must nurture a few core competencies in race to stay ahead of rivals.

Positioning—once the heart of strategy—is rejected as too static for today’s dynamic mar- kets and changing technologies. According to the new dogma, rivals can quickly copy any market position, and competitive advantage is, at best, temporary.

But those beliefs are dangerous half-truths, and they are leading more and more companies down the path of mutually destructive compe- tition. True, some barriers to competition are falling as regulation eases and markets become global. True, companies have properly invested energy in becoming leaner and more nimble. In many industries, however, what some call

hypercompetition

is a self-inflicted wound, not the inevitable outcome of a changing paradigm of competition.

The root of the problem is the failure to dis- tinguish between operational effectiveness and strategy. The quest for productivity, quality, and speed has spawned a remarkable number of management tools and techniques: total quality management, benchmarking, time-based com- petition, outsourcing, partnering, reengineering, change management. Although the resulting operational improvements have often been dramatic, many companies have been frustrated by their inability to translate those gains into sustainable profitability. And bit by bit, almost imperceptibly, management tools have taken the place of strategy. As managers push to im- prove on all fronts, they move farther away from viable competitive positions.

Operational Effectiveness: Necessary but Not Sufficient.

Operational effectiveness and strategy are both essential to superior performance, which, after all, is the primary goal of any en- terprise. But they work in very different ways.

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A company can outperform rivals only if it can establish a difference that it can preserve. It must deliver greater value to customers or create comparable value at a lower cost, or do both. The arithmetic of superior profitability then fol- lows: delivering greater value allows a company to charge higher average unit prices; greater efficiency results in lower average unit costs.

Ultimately, all differences between companies in cost or price derive from the hundreds of ac- tivities required to create, produce, sell, and de- liver their products or services, such as calling on customers, assembling final products, and training employees. Cost is generated by per- forming activities, and cost advantage arises from performing particular activities more effi- ciently than competitors. Similarly, differentia- tion arises from both the choice of activities and how they are performed. Activities, then are the basic units of competitive advantage. Overall ad- vantage or disadvantage results from all a com- pany’s activities, not only a few.

1

Operational effectiveness (OE) means per- forming similar activities

better

than rivals per- form them. Operational effectiveness includes but is not limited to efficiency. It refers to any number of practices that allow a company to bet- ter utilize its inputs by, for example, reducing de- fects in products or developing better products faster. In contrast, strategic positioning means performing

different

activities from rivals’ or per- forming similar activities in

different

ways. Differences in operational effectiveness among

companies are pervasive. Some companies are able to get more out of their inputs than others because they eliminate wasted effort, employ more advanced technology, motivate employees better, or have greater insight into managing particular activities or sets of activ- ities. Such differences in operational effective- ness are an important source of differences in profitability among competitors because they directly affect relative cost positions and levels of differentiation.

Differences in operational effectiveness were at the heart of the Japanese challenge to Western companies in the 1980s. The Japa- nese were so far ahead of rivals in operational effectiveness that they could offer lower cost and superior quality at the same time. It is worth dwelling on this point, because so much recent thinking about competition depends on it. Imagine for a moment a

productivity frontier

that constitutes the sum of all existing

best practices at any given time. Think of it as the maximum value that a company deliver- ing a particular product or service can create at a given cost, using the best available tech- nologies, skills, management techniques, and purchased inputs. The productivity frontier can apply to individual activities, to groups of linked activities such as order processing and manufacturing, and to an entire com- pany’s activities. When a company improves its operational effectiveness, it moves toward the frontier. Doing so may require capital in- vestment, different personnel, or simply new ways of managing.

The productivity frontier is constantly shift- ing outward as new technologies and man- agement approaches are developed and as new inputs become available. Laptop com- puters, mobile communications, the Internet, and software such as Lotus Notes, for exam- ple, have redefined the productivity frontier for sales-force operations and created rich possibilities for linking sales with such activi- ties as order processing and after-sales sup- port. Similarly, lean production, which involves a family of activities, has allowed substantial improvements in manufacturing productivity and asset utilization.

For at least the past decade, managers have been preoccupied with improving operational effectiveness. Through programs such as TQM, time-based competition, and benchmarking, they have changed how they perform activities in order to eliminate inefficiencies, improve customer satisfaction, and achieve best practice. Hoping to keep up with shifts in the produc- tivity frontier, managers have embraced con- tinuous improvement, empowerment, change management, and the so-called learning orga- nization. The popularity of outsourcing and the virtual corporation reflect the growing recognition that it is difficult to perform all activities as productively as specialists.

As companies move to the frontier, they can often improve on multiple dimensions of per- formance at the same time. For example, manu- facturers that adopted the Japanese practice of rapid changeovers in the 1980s were able to lower cost and improve differentiation simul- taneously. What were once believed to be real trade-offs—between defects and costs, for example—turned out to be illusions created by poor operational effectiveness. Managers have learned to reject such false trade-offs.

Michael E. Porter

is the C. Roland Christensen Professor of Business Administration at the Harvard Business School in Boston, Massachusetts.

This article has benefited greatly from the assistance of many individuals and companies. The author gives spe- cial thanks to Jan Rivkin, the coauthor of a related paper. Substantial research contributions have been made by Nicolaj Siggelkow, Dawn Sylvester, and Lucia Marshall. Tarun Khanna, Roger Martin, and Anita McGahan have pro- vided especially extensive comments.

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harvard business review • november–december 1996

Constant improvement in operational ef- fectiveness is necessary to achieve superior profitability. However, it is not usually suffi- cient. Few companies have competed success- fully on the basis of operational effectiveness over an extended period, and staying ahead of rivals gets harder every day. The most obvious reason for that is the rapid diffusion of best practices. Competitors can quickly imitate management techniques, new technologies, input improvements, and superior ways of meeting customers’ needs. The most generic solutions—those that can be used in multiple settings—diffuse the fastest. Witness the pro- liferation of OE techniques accelerated by support from consultants.

OE competition shifts the productivity fron- tier outward, effectively raising the bar for everyone. But although such competition pro- duces absolute improvement in operational ef- fectiveness, it leads to relative improvement for no one. Consider the $5 billion-plus U.S. commercial-printing industry. The major players— R.R. Donnelley & Sons Company, Quebecor, World Color Press, and Big Flower Press—are competing head to head, serving all types of customers, offering the same array of printing technologies (gravure and web offset), in- vesting heavily in the same new equipment, running their presses faster, and reducing crew sizes. But the resulting major productivity

gains are being captured by customers and equipment suppliers, not retained in superior profitability. Even industry-leader Donnelley’s profit margin, consistently higher than 7% in the 1980s, fell to less than 4.6% in 1995. This pattern is playing itself out in industry after industry. Even the Japanese, pioneers of the new competition, suffer from persistently low profits. (See the insert “Japanese Companies Rarely Have Strategies.”)

The second reason that improved opera- tional effectiveness is insufficient—competitive convergence—is more subtle and insidious. The more benchmarking companies do, the more they look alike. The more that rivals out- source activities to efficient third parties, often the same ones, the more generic those activities become. As rivals imitate one an- other’s improvements in quality, cycle times, or supplier partnerships, strategies converge and competition becomes a series of races down identical paths that no one can win. Competition based on operational effective- ness alone is mutually destructive, leading to wars of attrition that can be arrested only by limiting competition.

The recent wave of industry consolidation through mergers makes sense in the context of OE competition. Driven by performance pres- sures but lacking strategic vision, company after company has had no better idea than to buy up its rivals. The competitors left standing are often those that outlasted others, not com- panies with real advantage.

After a decade of impressive gains in opera- tional effectiveness, many companies are facing diminishing returns. Continuous improvement has been etched on managers’ brains. But its tools unwittingly draw companies toward imi- tation and homogeneity. Gradually, managers have let operational effectiveness supplant strat- egy. The result is zero-sum competition, static or declining prices, and pressures on costs that compromise companies’ ability to invest in the business for the long term.

II. Strategy Rests on Unique Activities

Competitive strategy is about being different. It means deliberately choosing a different set of activities to deliver a unique mix of value.

Southwest Airlines Company, for example, offers short-haul, low-cost, point-to-point service between midsize cities and secondary airports

Operational Effectiveness Versus Strategic Positioning

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Relative cost position

low lowhigh

high Productivity Frontier (state of best practice)

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What Is Strategy?

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in large cities. Southwest avoids large airports and does not fly great distances. Its customers include business travelers, families, and stu- dents. Southwest’s frequent departures and low fares attract price-sensitive customers who otherwise would travel by bus or car, and convenience-oriented travelers who would choose a full-service airline on other routes.

Most managers describe strategic position- ing in terms of their customers: “Southwest Airlines serves price- and convenience-sensitive travelers,” for example. But the essence of strat- egy is in the activities—choosing to perform activities differently or to perform different ac- tivities than rivals. Otherwise, a strategy is nothing more than a marketing slogan that will not withstand competition.

A full-service airline is configured to get passengers from almost any point A to any point B. To reach a large number of destinations and serve passengers with connecting flights, full-

service airlines employ a hub-and-spoke system centered on major airports. To attract passengers who desire more comfort, they offer first-class or business-class service. To accommodate passengers who must change planes, they co- ordinate schedules and check and transfer baggage. Because some passengers will be traveling for many hours, full-service airlines serve meals.

Southwest, in contrast, tailors all its activities to deliver low-cost, convenient service on its par- ticular type of route. Through fast turnarounds at the gate of only 15 minutes, Southwest is able to keep planes flying longer hours than rivals and provide frequent departures with fewer aircraft. Southwest does not offer meals, assigned seats, interline baggage checking, or premium classes of service. Automated ticketing at the gate encourages customers to bypass travel agents, al- lowing Southwest to avoid their commissions. A standardized fleet of 737 aircraft boosts the efficiency of maintenance.

Southwest has staked out a unique and valu- able strategic position based on a tailored set of activities. On the routes served by South- west, a full-service airline could never be as convenient or as low cost.

Ikea, the global furniture retailer based in Sweden, also has a clear strategic positioning. Ikea targets young furniture buyers who want style at low cost. What turns this marketing concept into a strategic positioning is the tai- lored set of activities that make it work. Like Southwest, Ikea has chosen to perform activi- ties differently from its rivals.

Consider the typical furniture store. Show- rooms display samples of the merchandise. One area might contain 25 sofas; another will display five dining tables. But those items rep- resent only a fraction of the choices available to customers. Dozens of books displaying fabric swatches or wood samples or alternate styles offer customers thousands of product varieties to choose from. Salespeople often escort cus- tomers through the store, answering questions and helping them navigate this maze of choices. Once a customer makes a selection, the order is relayed to a third-party manufacturer. With luck, the furniture will be delivered to the cus- tomer’s home within six to eight weeks. This is a value chain that maximizes customization and service but does so at high cost.

In contrast, Ikea serves customers who are happy to trade off service for cost. Instead of

Japanese Companies Rarely Have Strategies

The Japanese triggered a global revolu- tion in operational effectiveness in the 1970s and 1980s, pioneering practices such as total quality management and continuous improvement. As a result, Japanese manufacturers enjoyed sub- stantial cost and quality advantages for many years.

But Japanese companies rarely de- veloped distinct strategic positions of the kind discussed in this article. Those that did—Sony, Canon, and Sega, for example—were the exception rather than the rule. Most Japanese compa- nies imitate and emulate one another. All rivals offer most if not all product varieties, features, and services; they employ all channels and match one anothers’ plant configurations.

The dangers of Japanese-style compe- tition are now becoming easier to rec- ognize. In the 1980s, with rivals operat- ing far from the productivity frontier, it seemed possible to win on both cost and quality indefinitely. Japanese com- panies were all able to grow in an ex- panding domestic economy and by penetrating global markets. They ap-

peared unstoppable. But as the gap in operational effectiveness narrows, Jap- anese companies are increasingly caught in a trap of their own making. If they are to escape the mutually destruc- tive battles now ravaging their perfor- mance, Japanese companies will have to learn strategy.

To do so, they may have to overcome strong cultural barriers. Japan is noto- riously consensus oriented, and com- panies have a strong tendency to medi- ate differences among individuals rather than accentuate them. Strategy, on the other hand, requires hard choices. The Japanese also have a deeply ingrained service tradition that predisposes them to go to great lengths to satisfy any need a customer expresses. Companies that compete in that way end up blurring their distinct positioning, becoming all things to all customers.

This discussion of Japan is drawn from the author’s research with Hirotaka Takeuchi, with help from Mariko Sakakibara.

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having a sales associate trail customers around the store, Ikea uses a self-service model based on clear, in-store displays. Rather than rely solely on third-party manufacturers, Ikea designs its own low-cost, modular, ready-to-assemble furniture to fit its positioning. In huge stores, Ikea displays every product it sells in room-like settings, so customers don’t need a decorator to help them imagine how to put the pieces to- gether. Adjacent to the furnished showrooms is a warehouse section with the products in boxes on pallets. Customers are expected to do their own pickup and delivery, and Ikea will even sell you a roof rack for your car that you can return for a refund on your next visit.

Although much of its low-cost position comes from having customers “do it themselves,” Ikea offers a number of extra services that its com- petitors do not. In-store child care is one. Ex- tended hours are another. Those services are uniquely aligned with the needs of its custom- ers, who are young, not wealthy, likely to have children (but no nanny), and, because they work for a living, have a need to shop at odd hours.

The Origins of Strategic Positions.

Strategic positions emerge from three distinct sources, which are not mutually exclusive and often overlap. First, positioning can be based on pro- ducing a subset of an industry’s products or services. I call this

variety-based positioning

because it is based on the choice of product

or service varieties rather than customer segments. Variety-based positioning makes economic sense when a company can best produce particular products or services using distinctive sets of activities.

Jiffy Lube International, for instance, spe- cializes in automotive lubricants and does not offer other car repair or maintenance services. Its value chain produces faster service at a lower cost than broader line repair shops, a combination so attractive that many customers subdivide their purchases, buying oil changes from the focused competitor, Jiffy Lube, and going to rivals for other services.

The Vanguard Group, a leader in the mutual fund industry, is another example of variety- based positioning. Vanguard provides an array of common stock, bond, and money market funds that offer predictable perfor- mance and rock-bottom expenses. The com- pany’s investment approach deliberately sacrifices the possibility of extraordinary per- formance in any one year for good relative performance in every year. Vanguard is known, for example, for its index funds. It avoids mak- ing bets on interest rates and steers clear of narrow stock groups. Fund managers keep trading levels low, which holds expenses down; in addition, the company discourages customers from rapid buying and selling be- cause doing so drives up costs and can force a fund manager to trade in order to deploy new

Finding New Positions: The Entrepreneurial Edge

Strategic competition can be thought of as the process of perceiving new positions that woo customers from established positions or draw new customers into the market. For ex- ample, superstores offering depth of mer- chandise in a single product category take market share from broad-line department stores offering a more limited selection in many categories. Mail-order catalogs pick off customers who crave convenience. In princi- ple, incumbents and entrepreneurs face the same challenges in finding new strategic po- sitions. In practice, new entrants often have the edge.

Strategic positionings are often not obvi- ous, and finding them requires creativity and insight. New entrants often discover unique

positions that have been available but simply overlooked by established competitors. Ikea, for example, recognized a customer group that had been ignored or served poorly. Cir- cuit City Stores’ entry into used cars, CarMax, is based on a new way of performing activities— extensive refurbishing of cars, product guaran- tees, no-haggle pricing, sophisticated use of in- house customer financing—that has long been open to incumbents.

New entrants can prosper by occupying a position that a competitor once held but has ceded through years of imitation and strad- dling. And entrants coming from other indus- tries can create new positions because of dis- tinctive activities drawn from their other businesses. CarMax borrows heavily from

Circuit City’s expertise in inventory manage- ment, credit, and other activities in consumer electronics retailing.

Most commonly, however, new positions open up because of change. New customer groups or purchase occasions arise; new needs emerge as societies evolve; new distri- bution channels appear; new technologies are developed; new machinery or informa- tion systems become available. When such changes happen, new entrants, unencum- bered by a long history in the industry, can often more easily perceive the potential for a new way of competing. Unlike incum- bents, newcomers can be more flexible be- cause they face no trade-offs with their existing activities.

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capital and raise cash for redemptions. Vanguard also takes a consistent low-cost ap- proach to managing distribution, customer service, and marketing. Many investors in- clude one or more Vanguard funds in their portfolio, while buying aggressively managed or specialized funds from competitors.

The people who use Vanguard or Jiffy Lube are responding to a superior value chain for a particular type of service. A variety-based positioning can serve a wide array of custom- ers, but for most it will meet only a subset of their needs.

A second basis for positioning is that of serv- ing most or all the needs of a particular group of customers. I call this

needs-based positioning,

which comes closer to traditional thinking about targeting a segment of customers. It arises when there are groups of customers with dif- fering needs, and when a tailored set of activi- ties can serve those needs best. Some groups of customers are more price sensitive than others, demand different product features, and need varying amounts of information, support, and services. Ikea’s customers are a good example of such a group. Ikea seeks to meet all the home furnishing needs of its target customers, not just a subset of them.

A variant of needs-based positioning arises when the same customer has different needs on different occasions or for different types of transactions. The same person, for example, may have different needs when traveling on business than when traveling for pleasure with the family. Buyers of cans—beverage compa- nies, for example—will likely have different needs from their primary supplier than from their secondary source.

It is intuitive for most managers to conceive of their business in terms of the customers’ needs they are meeting. But a critical element of needs-based positioning is not at all intuitive and is often overlooked. Differences in needs will not translate into meaningful positions unless the best set of activities to satisfy them

also

differs. If that were not the case, every competitor could meet those same needs, and there would be nothing unique or valuable about the positioning.

In private banking, for example, Bessemer Trust Company targets families with a mini- mum of $5 million in investable assets who want capital preservation combined with wealth accumulation. By assigning one sophis-

ticated account officer for every 14 families, Bessemer has configured its activities for per- sonalized service. Meetings, for example, are more likely to be held at a client’s ranch or yacht than in the office. Bessemer offers a wide array of customized services, including invest- ment management and estate administration, oversight of oil and gas investments, and ac- counting for racehorses and aircraft. Loans, a staple of most private banks, are rarely needed by Bessemer’s clients and make up a tiny frac- tion of its client balances and income. Despite the most generous compensation of account officers and the highest personnel cost as a per- centage of operating expenses, Bessemer’s dif- ferentiation with its target families produces a return on equity estimated to be the highest of any private banking competitor.

Citibank’s private bank, on the other hand, serves clients with minimum assets of about $250,000 who, in contrast to Bessemer’s clients, want convenient access to loans—from jumbo mortgages to deal financing. Citibank’s account managers are primarily lenders. When clients need other services, their account manager re- fers them to other Citibank specialists, each of whom handles prepackaged products. Citibank’s system is less customized than Bessemer’s and allows it to have a lower manager-to-client ratio of 1:125. Biannual office meetings are of- fered only for the largest clients. Both Bessemer and Citibank have tailored their activities to meet the needs of a different group of private banking customers. The same value chain can- not profitably meet the needs of both groups.

The third basis for positioning is that of seg- menting customers who are accessible in dif- ferent ways. Although their needs are similar to those of other customers, the best configu- ration of activities to reach them is different. I call this

access-based positioning

. Access can be a function of customer geography or cus- tomer scale—or of anything that requires a different set of activities to reach customers in the best way.

Segmenting by access is less common and less well understood than the other two bases. Carmike Cinemas, for example, operates movie theaters exclusively in cities and towns with populations under 200,000. How does Car- mike make money in markets that are not only small but also won’t support big-city ticket prices? It does so through a set of activities that result in a lean cost structure. Carmike’s

A company can outperform rivals only if it can establish a difference that it can preserve.

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small-town customers can be served through standardized, low-cost theater complexes re- quiring fewer screens and less sophisticated projection technology than big-city theaters. The company’s proprietary information system and management process eliminate the need for local administrative staff beyond a single theater manager. Carmike also reaps advan- tages from centralized purchasing, lower rent and payroll costs (because of its locations), and rock-bottom corporate overhead of 2% (the in- dustry average is 5%). Operating in small com- munities also allows Carmike to practice a highly personal form of marketing in which the theater manager knows patrons and pro- motes attendance through personal contacts. By being the dominant if not the only theater in its markets—the main competition is often the high school football team—Carmike is also able to get its pick of films and negotiate better terms with distributors.

Rural versus urban-based customers are one example of access driving differences in activities. Serving small rather than large cus- tomers or densely rather than sparsely situ- ated customers are other examples in which the best way to configure marketing, order processing, logistics, and after-sale service ac- tivities to meet the similar needs of distinct groups will often differ.

Positioning is not only about carving out a niche. A position emerging from any of the sources can be broad or narrow. A focused

competitor, such as Ikea, targets the special needs of a subset of customers and designs its activities accordingly. Focused competitors thrive on groups of customers who are over- served (and hence overpriced) by more broadly targeted competitors, or underserved (and hence underpriced). A broadly targeted com- petitor—for example, Vanguard or Delta Air Lines—serves a wide array of customers, per- forming a set of activities designed to meet their common needs. It ignores or meets only partially the more idiosyncratic needs of par- ticular customer customer groups.

Whatever the basis—variety, needs, access, or some combination of the three—positioning requires a tailored set of activities because it is always a function of differences on the supply side; that is, of differences in activities. How- ever, positioning is not always a function of differences on the demand, or customer, side. Variety and access positionings, in partic- ular, do not rely on

any

customer differences. In practice, however, variety or access differ- ences often accompany needs differences. The tastes—that is, the needs—of Carmike’s small- town customers, for instance, run more toward comedies, Westerns, action films, and family entertainment. Carmike does not run any films rated NC-17.

Having defined positioning, we can now begin to answer the question, “What is strategy?” Strategy is the creation of a unique and valu- able position, involving a different set of activi- ties. If there were only one ideal position, there would be no need for strategy. Compa- nies would face a simple imperative—win the race to discover and preempt it. The essence of strategic positioning is to choose activities that are different from rivals’. If the same set of ac- tivities were best to produce all varieties, meet all needs, and access all customers, companies could easily shift among them and operational effectiveness would determine performance.

III. A Sustainable Strategic Position Requires Trade-offs

Choosing a unique position, however, is not enough to guarantee a sustainable advantage. A valuable position will attract imitation by in- cumbents, who are likely to copy it in one of two ways.

First, a competitor can reposition itself to match the superior performer. J.C. Penney, for instance, has been repositioning itself

The Connection with Generic Strategies

In

Competitive Strategy

(The Free Press, 1985), I introduced the concept of ge- neric strategies—cost leadership, differ- entiation, and focus—to represent the alternative strategic positions in an in- dustry. The generic strategies remain useful to characterize strategic positions at the simplest and broadest level. Van- guard, for instance, is an example of a cost leadership strategy, whereas Ikea, with its narrow customer group, is an ex- ample of cost-based focus. Neutrogena is a focused differentiator. The bases for positioning—varieties, needs, and access— carry the understanding of those generic strategies to a greater level of specificity.

Ikea and Southwest are both cost-based focusers, for example, but Ikea’s focus is based on the needs of a customer group, and Southwest’s is based on offering a particular service variety.

The generic strategies framework in- troduced the need to choose in order to avoid becoming caught between what I then described as the inherent contradictions of different strategies. Trade-offs between the activities of in- compatible positions explain those contradictions. Witness Continental Lite, which tried and failed to compete in two ways at once.

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from a Sears clone to a more upscale, fashion- oriented, soft-goods retailer. A second and far more common type of imitation is strad- dling. The straddler seeks to match the benefits of a successful position while maintaining its existing position. It grafts new features, ser- vices, or technologies onto the activities it already performs.

For those who argue that competitors can copy any market position, the airline industry is a perfect test case. It would seem that nearly any competitor could imitate any other air- line’s activities. Any airline can buy the same planes, lease the gates, and match the menus and ticketing and baggage handling services offered by other airlines.

Continental Airlines saw how well South- west was doing and decided to straddle. While maintaining its position as a full-service air- line, Continental also set out to match South- west on a number of point-to-point routes. The airline dubbed the new service Conti- nental Lite. It eliminated meals and first- class service, increased departure frequency, lowered fares, and shortened turnaround time at the gate. Because Continental remained a full-service airline on other routes, it contin- ued to use travel agents and its mixed fleet of planes and to provide baggage checking and seat assignments.

But a strategic position is not sustainable unless there are trade-offs with other positions. Trade-offs occur when activities are incom- patible. Simply put, a trade-off means that more of one thing necessitates less of another. An airline can choose to serve meals—adding cost and slowing turnaround time at the gate— or it can choose not to, but it cannot do both without bearing major inefficiencies.

Trade-offs create the need for choice and protect against repositioners and straddlers. Consider Neutrogena soap. Neutrogena Cor- poration’s variety-based positioning is built on a “kind to the skin,” residue-free soap formu- lated for pH balance. With a large detail force calling on dermatologists, Neutrogena’s mar- keting strategy looks more like a drug com- pany’s than a soap maker’s. It advertises in medical journals, sends direct mail to doctors, attends medical conferences, and performs re- search at its own Skincare Institute. To rein- force its positioning, Neutrogena originally focused its distribution on drugstores and avoided price promotions. Neutrogena uses a

slow, more expensive manufacturing process to mold its fragile soap.

In choosing this position, Neutrogena said no to the deodorants and skin softeners that many customers desire in their soap. It gave up the large-volume potential of selling through supermarkets and using price promotions. It sacrificed manufacturing efficiencies to achieve the soap’s desired attributes. In its original po- sitioning, Neutrogena made a whole raft of trade-offs like those, trade-offs that protected the company from imitators.

Trade-offs arise for three reasons. The first is inconsistencies in image or reputation. A com- pany known for delivering one kind of value may lack credibility and confuse customers—or even undermine its reputation—if it delivers an- other kind of value or attempts to deliver two inconsistent things at the same time. For exam- ple, Ivory soap, with its position as a basic, inex- pensive everyday soap, would have a hard time reshaping its image to match Neutrogena’s pre- mium “medical” reputation. Efforts to create a new image typically cost tens or even hundreds of millions of dollars in a major industry—a powerful barrier to imitation.

Second, and more important, trade-offs arise from activities themselves. Different positions (with their tailored activities) require different product configurations, different equipment, different employee behavior, different skills, and different management systems. Many trade-offs reflect inflexibilities in machinery, people, or systems. The more Ikea has config- ured its activities to lower costs by having its customers do their own assembly and delivery, the less able it is to satisfy customers who re- quire higher levels of service.

However, trade-offs can be even more basic. In general, value is destroyed if an activity is overdesigned or underdesigned for its use. For example, even if a given salesperson were capa- ble of providing a high level of assistance to one customer and none to another, the sales- person’s talent (and some of his or her cost) would be wasted on the second customer. Moreover, productivity can improve when vari- ation of an activity is limited. By providing a high level of assistance all the time, the sales- person and the entire sales activity can often achieve efficiencies of learning and scale.

Finally, trade-offs arise from limits on inter- nal coordination and control. By clearly choos- ing to compete in one way and not another,

The essence of strategy is choosing to perform activities differently than rivals do.

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senior management makes organizational priorities clear. Companies that try to be all things to all customers, in contrast, risk confu- sion in the trenches as employees attempt to make day-to-day operating decisions without a clear framework.

Positioning trade-offs are pervasive in competition and essential to strategy. They create the need for choice and purposefully limit what a company offers. They deter straddling or repositioning, because competi- tors that engage in those approaches under- mine their strategies and degrade the value of their existing activities.

Trade-offs ultimately grounded Continental Lite. The airline lost hundreds of millions of dollars, and the CEO lost his job. Its planes were delayed leaving congested hub cities or slowed at the gate by baggage transfers. Late flights and cancellations generated a thousand complaints a day. Continental Lite could not afford to compete on price and still pay stan- dard travel-agent commissions, but neither could it do without agents for its full-service business. The airline compromised by cutting commissions for all Continental flights across the board. Similarly, it could not afford to offer the same frequent-flier benefits to travelers paying the much lower ticket prices for Lite service. It compromised again by lowering the rewards of Continental’s entire frequent-flier program. The results: angry travel agents and full-service customers.

Continental tried to compete in two ways at once. In trying to be low cost on some routes and full service on others, Continental paid an enormous straddling penalty. If there were no trade-offs between the two positions, Conti- nental could have succeeded. But the absence of trade-offs is a dangerous half-truth that managers must unlearn. Quality is not always free. Southwest’s convenience, one kind of high quality, happens to be consistent with low costs because its frequent departures are facili- tated by a number of low-cost practices—fast gate turnarounds and automated ticketing, for example. However, other dimensions of air- line quality—an assigned seat, a meal, or bag- gage transfer—require costs to provide.

In general, false trade-offs between cost and quality occur primarily when there is redun- dant or wasted effort, poor control or accuracy, or weak coordination. Simultaneous improve- ment of cost and differentiation is possible

only when a company begins far behind the productivity frontier or when the frontier shifts outward. At the frontier, where compa- nies have achieved current best practice, the trade-off between cost and differentiation is very real indeed.

After a decade of enjoying productivity ad- vantages, Honda Motor Company and Toyota Motor Corporation recently bumped up against the frontier. In 1995, faced with in- creasing customer resistance to higher auto- mobile prices, Honda found that the only way to produce a less-expensive car was to skimp on features. In the United States, it replaced the rear disk brakes on the Civic with lower- cost drum brakes and used cheaper fabric for the back seat, hoping customers would not notice. Toyota tried to sell a version of its best- selling Corolla in Japan with unpainted bumpers and cheaper seats. In Toyota’s case, customers rebelled, and the company quickly dropped the new model.

For the past decade, as managers have im- proved operational effectiveness greatly, they have internalized the idea that eliminating trade-offs is a good thing. But if there are no trade-offs companies will never achieve a sus- tainable advantage. They will have to run faster and faster just to stay in place.

As we return to the question, What is strategy? we see that trade-offs add a new di- mension to the answer. Strategy is making trade-offs in competing. The essence of strat- egy is choosing what

not

to do. Without trade- offs, there would be no need for choice and thus no need for strategy. Any good idea could and would be quickly imitated. Again, performance would once again depend wholly on operational effectiveness.

IV. Fit Drives Both Competitive Advantage and Sustainability

Positioning choices determine not only which activities a company will perform and how it will configure individual activities but also how activities relate to one another. While op- erational effectiveness is about achieving ex- cellence in individual activities, or functions, strategy is about

combining

activities. Southwest’s rapid gate turnaround, which

allows frequent departures and greater use of aircraft, is essential to its high-convenience, low-cost positioning. But how does Southwest achieve it? Part of the answer lies in the com-

Strategic positions can be based on customers’ needs, customers’ accessibility, or the variety of a company’s products or services.

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pany’s well-paid gate and ground crews, whose productivity in turnarounds is enhanced by flexible union rules. But the bigger part of the answer lies in how Southwest performs other activities. With no meals, no seat assignment, and no interline baggage transfers, Southwest avoids having to perform activities that slow down other airlines. It selects airports and routes to avoid congestion that introduces de- lays. Southwest’s strict limits on the type and length of routes make standardized aircraft possible: every aircraft Southwest turns is a Boeing 737.

What is Southwest’s core competence? Its key success factors? The correct answer is that everything matters. Southwest’s strategy in- volves a whole system of activities, not a col- lection of parts. Its competitive advantage comes from the way its activities fit and rein- force one another.

Fit locks out imitators by creating a chain that is as strong as its

strongest

link. As in most companies with good strategies, Southwest’s activities complement one another in ways that create real economic value. One activity’s cost, for example, is lowered because of the way other activities are performed. Similarly, one activity’s value to customers can be en- hanced by a company’s other activities. That is the way strategic fit creates competitive advan- tage and superior profitability.

Types of Fit.

The importance of fit among functional policies is one of the oldest ideas in strategy. Gradually, however, it has been sup- planted on the management agenda. Rather than seeing the company as a whole, manag- ers have turned to “core” competencies, “criti- cal” resources, and “key” success factors. In fact, fit is a far more central component of competitive advantage than most realize.

Fit is important because discrete activities often affect one another. A sophisticated sales force, for example, confers a greater advan- tage when the company’s product embodies premium technology and its marketing ap- proach emphasizes customer assistance and support. A production line with high levels of model variety is more valuable when com- bined with an inventory and order processing system that minimizes the need for stocking finished goods, a sales process equipped to ex- plain and encourage customization, and an advertising theme that stresses the benefits of product variations that meet a customer’s

special needs. Such complementarities are pervasive in strategy. Although some fit among activities is generic and applies to many companies, the most valuable fit is strategy-specific because it enhances a posi- tion’s uniqueness and amplifies trade-offs.

2

There are three types of fit, although they are not mutually exclusive. First-order fit is

simple consistency

between each activity (func- tion) and the overall strategy. Vanguard, for example, aligns all activities with its low-cost strategy. It minimizes portfolio turnover and does not need highly compensated money managers. The company distributes its funds directly, avoiding commissions to brokers. It also limits advertising, relying instead on pub- lic relations and word-of-mouth recommenda- tions. Vanguard ties its employees’ bonuses to cost savings.

Consistency ensures that the competitive ad- vantages of activities cumulate and do not erode or cancel themselves out. It makes the strategy easier to communicate to customers, employees, and shareholders, and improves implementation through single-mindedness in the corporation.

Second-order fit occurs when

activities are reinforcing

. Neutrogena, for example, mar- kets to upscale hotels eager to offer their guests a soap recommended by dermatolo- gists. Hotels grant Neutrogena the privilege of using its customary packaging while requir- ing other soaps to feature the hotel’s name. Once guests have tried Neutrogena in a lux- ury hotel, they are more likely to purchase it at the drugstore or ask their doctor about it. Thus Neutrogena’s medical and hotel market- ing activities reinforce one another, lowering total marketing costs.

In another example, Bic Corporation sells a narrow line of standard, low-priced pens to vir- tually all major customer markets (retail, com- mercial, promotional, and giveaway) through virtually all available channels. As with any variety-based positioning serving a broad group of customers, Bic emphasizes a common need (low price for an acceptable pen) and uses marketing approaches with a broad reach (a large sales force and heavy television adver- tising). Bic gains the benefits of consistency across nearly all activities, including product design that emphasizes ease of manufacturing, plants configured for low cost, aggressive purchasing to minimize material costs, and

Trade-offs are essential to strategy. They create the need for choice and purposefully limit what a company offers.

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in-house parts production whenever the economics dictate.

Yet Bic goes beyond simple consistency be- cause its activities are reinforcing. For example, the company uses point-of-sale displays and frequent packaging changes to stimulate im- pulse buying. To handle point-of-sale tasks, a company needs a large sales force. Bic’s is the largest in its industry, and it handles point-of- sale activities better than its rivals do. More- over, the combination of point-of-sale activity, heavy television advertising, and packaging changes yields far more impulse buying than any activity in isolation could.

Third-order fit goes beyond activity rein- forcement to what I call

optimization of effort

. The Gap, a retailer of casual clothes, considers product availability in its stores a critical ele- ment of its strategy. The Gap could keep prod-

ucts either by holding store inventory or by re- stocking from warehouses. The Gap has optimized its effort across these activities by restocking its selection of basic clothing almost daily out of three warehouses, thereby mini- mizing the need to carry large in-store invento- ries. The emphasis is on restocking because the Gap’s merchandising strategy sticks to basic items in relatively few colors. While compara- ble retailers achieve turns of three to four times per year, the Gap turns its inventory seven and a half times per year. Rapid restock- ing, moreover, reduces the cost of implement- ing the Gap’s short model cycle, which is six to eight weeks long.

3

Coordination and information exchange across activities to eliminate redundancy and minimize wasted effort are the most basic types of effort optimization. But there are

Explanatory catalogues, informative displays and

labels

Self-transport by customers

Limited customer service

Self-selection by customers

Modular furniture design

Low manufacturing

cost

Suburban locations

with ample parking

High-traffic store layout More

impulse buying

Ease of transport and

assembly Self-assembly by customers

“Knock-down” kit packaging

Wide variety with ease of

manufacturing

Limited sales staffing

Increased likelihood of

future purchase

In-house design focused

on cost of manufacturing

Ample inventory on site

Most items in

inventory

Year-round stocking

100% sourcing from

long-term suppliers

Mapping Activity Systems Activity-system maps, such as this one for Ikea, show how a company’s strategic position is contained in a set of tailored activities designed to deliver it. In companies with a clear

strategic position, a number of higher-order strategic themes (in dark grey) can be identified and implemented through clusters of tightly linked activities (in light grey).

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higher levels as well. Product design choices, for example, can eliminate the need for after- sale service or make it possible for customers to perform service activities themselves. Simi- larly, coordination with suppliers or distribu- tion channels can eliminate the need for some in-house activities, such as end-user training.

In all three types of fit, the whole matters more than any individual part. Competitive ad- vantage grows out of the

entire system

of activi- ties. The fit among activities substantially re- duces cost or increases differentiation. Beyond that, the competitive value of individual activi- ties—or the associated skills, competencies, or resources—cannot be decoupled from the sys- tem or the strategy. Thus in competitive com- panies it can be misleading to explain success by specifying individual strengths, core compe- tencies, or critical resources. The list of

strengths cuts across many functions, and one strength blends into others. It is more useful to think in terms of themes that pervade many activities, such as low cost, a particular notion of customer service, or a particular conception of the value delivered. These themes are em- bodied in nests of tightly linked activities.

Fit and sustainability.

Strategic fit among many activities is fundamental not only to competitive advantage but also to the sus- tainability of that advantage. It is harder for a rival to match an array of interlocked ac- tivities than it is merely to imitate a particu- lar sales-force approach, match a process technology, or replicate a set of product fea- tures. Positions built on systems of activities are far more sustainable than those built on individual activities.

Consider this simple exercise. The probabil-

Wary of small growth

funds

Very low expenses

passed on to client

A broad array of mutual funds excluding some fund categories

Strict cost control

Efficient investment management approach

offering good, consistent performance

Direct distribution

Straightforward client communication

and education

Limited international funds due to volatility and

high costs

Use of redemption

fees to discourage

trading

Employee bonuses tied to

cost savings

No marketing changes

No broker-dealer relationships

No-loads

No commissions to brokers or distributors

Only three retail

locations

In-house management for standard

funds

Limited advertising

budget

Very low rate of trading

No first-class travel for executives

Emphasis on bonds and equity index funds

On-line information

access

Shareholder education cautioning about risk

Long-term investment

encouraged

Vanguard actively

spreads its philosophy

Reliance on word of mouth

Vanguard’s Activity System Activity-system maps can be useful for examining and strengthening strategic fit. A set of basic questions should guide the process. First, is each activity consistent with the overall positioning – the varieties produced, the needs served, and the type of customers accessed? Ask those responsible for

each activity to identify how other activities within the company improve or detract from their performance. Second, are there ways to strengthen how activities and groups of activities reinforce one another? Finally, could changes in one activity eliminate the need to perform others?

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ity that competitors can match any activity is often less than one. The probabilities then quickly compound to make matching the en- tire system highly unlikely (.9

x

.9 = .81; .9

x

.9

x

.9

x

.9 = .66, and so on). Existing companies that try to reposition or straddle will be forced to reconfigure many activities. And even new entrants, though they do not confront the trade-offs facing established rivals, still face for- midable barriers to imitation.

The more a company’s positioning rests on activity systems with second- and third-order fit, the more sustainable its advantage will be. Such systems, by their very nature, are usually difficult to untangle from outside the com- pany and therefore hard to imitate. And even if rivals can identify the relevant interconnec- tions, they will have difficulty replicating them. Achieving fit is difficult because it re-

quires the integration of decisions and actions across many independent subunits.

A competitor seeking to match an activity system gains little by imitating only some activities and not matching the whole. Per- formance does not improve; it can decline. Recall Continental Lite’s disastrous attempt to imitate Southwest.

Finally, fit among a company’s activities cre- ates pressures and incentives to improve opera- tional effectiveness, which makes imitation even harder. Fit means that poor performance in one activity will degrade the performance in others, so that weaknesses are exposed and more prone to get attention. Conversely, im- provements in one activity will pay dividends in others. Companies with strong fit among their activities are rarely inviting targets. Their superiority in strategy and in execution only

No meals

No seat assignments

Limited passenger

service

Lean, highly productive ground and gate crews

Very low ticket prices

Short-haul, point-to-point

routes between midsize cities

and secondary airports

Frequent, reliable

departures

High aircraft

utilization

No baggage transfers

No connections with other airlines

15-minute gate

turnarounds

Flexible union

contracts

High compensation of employees

High level of employee

stock ownership

Limited use of travel agents

Automatic ticketing machines

Standardized fleet of 737

aircraft

”Southwest, the low-fare

airline”

Southwest Airlines’ Activity System

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compounds their advantages and raises the hurdle for imitators.

When activities complement one another, ri- vals will get little benefit from imitation unless they successfully match the whole system. Such situations tend to promote winner-take- all competition. The company that builds the best activity system—Toys R Us, for instance— wins, while rivals with similar strategies— Child World and Lionel Leisure—fall behind. Thus finding a new strategic position is often preferable to being the second or third imita- tor of an occupied position.

The most viable positions are those whose activity systems are incompatible because of tradeoffs. Strategic positioning sets the trade- off rules that define how individual activities will be configured and integrated. Seeing strat- egy in terms of activity systems only makes it clearer why organizational structure, systems, and processes need to be strategy-specific. Tailoring organization to strategy, in turn, makes complementarities more achievable and contributes to sustainability.