What is strategy by michael porter hbr nov dec 1996

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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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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

dereviled eulav reyub ecirpno N

Relative cost position

low lowhigh

high Productivity Frontier (state of best practice)

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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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harvard business review • november–december 1996

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-