Strategy: Creating and Sustaining – Michael Porter

Strategy: Creating and Sustaining

Competitive Advantage

Professor Michael E. Porter

Harvard Business School

Guayaquil, Ecuador

October 25, 2011

This presentation draws on ideas from Professor Porter"s books and articles, in particular, Competitive Strategy (The Free Press, 1980); Competitive Advantage (The Free Press, 1985); "What is Strategy?" (Harvard Business Review, Nov/Dec 1996); and On Competition (Harvard Business Review, 2008). No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Michael E. Porter. Additional information

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

20111024 – Ecuador Strategy Presentation – v3 – October 21, 2011 – Prepared by RA Jem Hudson

Thinking Strategically

COMPETING TO BE -> THE BEST COMPETING TO BE UNIQUE

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

Understanding the Concept of Strategy

• Strategy is different than aspirations

– "Our strategy is to be #1 or #2…"

– "Our strategy is to be the world leader…"

– "Our strategy is to grow…"

– "Our strategy is to provide superior returns to our shareholders…"

• Strategy is more than a particular action

– "Our strategy is to merge…"

– "… internationalize…"

– "… consolidate the industry…"

– "… outsource…"

– "…double our R&D budget…"

• Strategy is not the same as vision

– "Our strategy is to provide superior products and services…"

– "…to advance technology for mankind…"

Strategy defines the company"s distinctive approach to competing and the competitive advantages on which it will be based

Setting the Right Financial Goals

• Strategic thinking starts with setting proper financial goals for the Company

• The fundamental goal of a company is superior long-term return on investment

• Growth is good only if superiority in ROIC is achieved and sustained

– ROIC threshold

• Setting unrealistic profitability or growth targets can undermine

Strategy

Economic Performance versus Shareholder Value

Economic Performance ? Shareholder Value

Economic Performance

• Sustained ROIC

• Sustainable Revenue Growth

Shareholder Value

• Stock Price

• EPS Growth

• EPS Multiple

?

• Shareholder value is the result of creating real economic value

• Pleasing today"s shareholders is not the goal

Multiple Levels of Strategy Drive

Competitive Advantage

Competitive or Business Strategy

• How to compete in each distinct business or

Industry

?

Corporate or Portfolio Strategy

• The company"s mix of businesses

• The integration of business unit strategies

Economic Foundations of Competition

• Competition occurs at the level of each distinct business or industry

• Company economic performance results from two distinct causes

Industry Structure ? Positioning Within the Industry

– Industry Attractiveness – Sustainable Competitive Advantage

?

• Strategic thinking must encompass both areas

• Companies must focus on the health of the industry, not just their own position

Disaggregating Economic Performance:

Industry vs. Position

Note: "Invested capital less excess cash" is the average of the beginning period and the ending period values. Excess cash is calculated by subtracting cash in excess of 10% of annual revenue.

Source: Compustat (2007), author"s analysis

………….. Industry Average

9. Profitability of Selected U.S. Industries

1998 – 2008

Note: ROIC calculated as EBIT divided by Invested Capital

Source: Compustat , author"s calculations

10. Determinants of Industry Profitability

Industry Structure

• 1. Rivalry Among Existing Competitors

• 2. Threat of Substitute Products or Services

• 3. Bargaining Power of Buyers

• 4. Threat of New Entrants

• 5. Bargaining Power of Suppliers

?

• Part of the strategy agenda is to drive improvements in industry structure

11. Analyzing Industry Structure

Heavy Trucks

• 1. Rivalry Among Existing Competitors

• Heavy Price competition on standardized models

• 2. Threat of Substitute Products or Services

• Railroads

• Water transportation

• 3. Bargaining Power of Buyers

• Large fleets

• Leasing companies

• Small fleets and owner operators

• 4. Threat of New Entrants

• Many truck producers are assemblers

• 5. Bargaining Power of Suppliers

• Large independent suppliers of engines and drive train components

• Unionized labor

12. Industry Structure and Positioning

Paccar

• Focus on owner-operators

• Compete on differentiation

– Design trucks with special features and amenities

– Customization and build-to-order

– Design for low truck operating costs

– Offer extensive roadside assistance to truckers

• Command a premium price

?

• Paccar"s positioning limits the negative aspects of industry structure.

13. Industry Structure in Emerging Economies

• 1. Rivalry Among Existing Competitors

• Monopoly concessions

• SOEs with non-economic goals

• Distortion of competition due to price controls or regulations

• Protection against imports

• 2. Threat of Substitute Products or Services

• 3. Bargaining Power of Buyers

• Weak consumer protection laws

• Fragmented/small local buyers

• 4. Threat of New Entrants

• High barriers to entry due to local regulations and access to channels

• Protection limits foreign entry

• 5. Bargaining Power of Suppliers

• Protection of local suppliers

• Powerful foreign suppliers of know-how, licenses and equipment

– Industry competition in emerging economies is often limited or distorted by government policy or by the presence of entrenched monopolies

* Any industry can potentially achieve high returns on investment

– Removal of government distortions can lead to radical shifts in industry structure and profitability

14. Strategic Positioning

Achieving Superior Relative Performance

Differentiation (Higher Price) Lower Cost

?

Competitive Advantage

?

Lower Cost

15. Competitive Advantage and the Value Chain

Margin

Primary Activities

• 1. Inbound Logistics – (e.g. Incoming Material Storage, Data Collection, Service, Customer Access)

• 2. Operations – (e.g. Assembly, Component Fabrication, Branch Operations)

• 3. Outbound Logistics – (e.g. Order Processing, Warehousing, Report Preparation)

• 4. Marketing & Sales – (e.g. Sales Force, Promotion, Advertising, Proposal Writing, Web site)

• 5. After-Sales Service – (e.g. Installation, Customer Support, Complaint Resolution, Repair)

Support Activities

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

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

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

• 4. Procurement – (e.g. Components, Machinery, Advertising, Services)

* Value: What buyers are willing to pay

• All competitive advantage resides in the value chain. Strategy is manifested in how activities in the value chain are configured and linked together

16. Defining the Value Chain

Homebuilding

Margin

Primary Activities

• 1. Land Acquisition & Development – (Identify attractive markets, Secure land, Procure entitlements and permits, Prepare site

• 2. Construction – (Design, Engineering, Schedule and manage construction process)

• 3. Marketing & Sales – (Lead generation, Model home display, Sales force, Customer selection of personalized options)

• 4. Closing – (e.g. Customer Financing, Contract, Title, Closing)

• 5. After-Sales Service – (e.g. Warranties, Customer Complaints)

Support Activities

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

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

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

• 8. Procurement – (e.g. Components, Machinery, Advertising, Services)

• There are different ways of configuring the value chain in the same industry

17. Achieving Superior Performance

Operational Effectiveness is Not Strategy

OperationalEffectiveness ? Strategic Positioning

OperationalEffectiveness

• Assimilating, attaining, and extending best practices

?

Do the same thing better

Strategic Positioning

• Creating a unique and sustainable competitive position

?

Do things differently to achieve a different purpose

18. Reshaping Industry Competition

Zero Sum Competition ? Positive Sum Competition

Zero Sum Competition

• Compete head to head

• One company"s gain requires another company"s loss

• Competition often undermines industry profitability

Positive Sum Competition

• Compete on strategy

• More than one company can be successful

• Competition expands the value pool

19. What Is a Successful Strategy?

• A unique value proposition compared to other organizations

• A distinctive value chain tailored to the value proposition

• Making clear tradeoffs, and choosing what not to do

• Choices across the value chain that fit together and reinforce each other

• Strategic continuity, with continual improvement in realizing the strategy

Strategic Positioning

IKEA, Sweden

Value Proposition

• Young, first time, or price-sensitive buyers with design sophistication

• Stylish, space efficient and compatible furniture lines and accessories at very low price points.

Distinctive Activities

• Modular, ready-to-assemble, easy to ship furniture designs

• In-house design of all products

• Wide range of styles which are all displayed in huge warehouse stores with large on-site inventories

• Self-selection by the customer

• Extensive customer information in the form of catalogs, explanatory ticketing, do-it-yourself videos, and assembly instructions

• IKEA designer names attached to related products to inform coordinated purchases

• Suburban locations with large parking lots

• Long hours of operation

• On-site, low-cost, restaurants

• Child care provided in the store

• Self-delivery by most customers

21. Defining the Value Proposition

?

• A novel value proposition often expands the market

• 1. What Customers?

• What end users?

• What channels?

• 2. Which Needs?

• Which products?

• Which features?

• Which services?

• 3. What Relative Price?

• Premium? Parity? Discount?

Strategic Positioning

PACCAR

Value Proposition

• Highly customized trucks targeted at owneroperators with superior amenities but low cost of use and extensive customer support

• Command a 10% premium price

Distinctive Activities

• Customized features and amenities geared toward owner-operators (e.g., luxurious sleeper cabins, plush leather seats, noise-insulated cabins, sleek exterior styling, etc.)

• Products designed for durability and resale value

• Industry leader in fuel efficiency and emissions reduction, including medium duty hybrids

• Offer truck financing, leasing and insurance services

• Provide diagnostic services for customers (e.g., fuel efficiency, remote service analysis)

• Flexible manufacturing system configured for customization

• Built to order, not to stock

• Extensive dealer network (1,800 locations) to provide extensive customer contact and aftermarket support

• Extensive roadside assistance network

• 24-hour parts distribution system providing rapid

Service

23. Making Strategic Tradeoffs

• Tradeoffs occur when strategic positions are incompatible

Sources of Tradeoffs

– Incompatible product or service features / attributes

– Differences in the value chain required to best deliver the chosen value proposition

– Inconsistencies in image or reputation across value propositions

– Organizational complexity of delivering different value propositions

?

• Tradeoffs create the need for choice

• Tradeoffs make a strategy sustainable against imitation by established rivals

• An essential part of strategy is choosing what not to do

24. Strategic Tradeoffs

IKEA, Sweden

IKEA

Product

• Low-priced, modular, ready-to-assemble

designs

• No custom options

• Furniture design driven by cost,

manufacturing simplicity, and style

Value Chain

• Centralized, in-house design of all products

• All styles on display in huge warehouse stores

• Large on-site inventories

• Limited sales help, but extensive customer

information

• Long hours of operation

Typical Furniture Retailer

Product

• Higher priced, fully assembled products

• Customization of fabrics, colors, finishes,

and sizes

• Design driven by image, materials, varieties

Value Chain

• Source some or all lines from outside

suppliers

• Medium sized showrooms with limited

portion of available models on display

• Limited inventories / order with lead time

• Extensive sales assistance

• Traditional retail hours

25. Typical Thinking About the Sources of Competitive Advantage

• "Key" Success Factors

• "Core" Competencies

• "Critical" Resources

?

• Competitive advantage is usually seen as concentrated in a few parts

of the value chain

26. Mutually Reinforcing Activity Choices

IKEA

• 1. Complete line of furniture and accessories to furnish home (MAIN)

Designer identification of compatible lines

All items on display and instock

Year-round stocking to even out production

• 2. Customer self delivery and assembly

All items on display and instock

Instructions and support for customer assembly

Suburban locations with ample parking

Ease of transport and assembly

"Knock-down" kit packaging

Suburban locations with ample parking

Very large stores

• 3. Modular, scalable furniture designs

Designer identification of compatible lines

Ease of transport and assembly

"Knock-down" kit packaging

In-house design focused on cost of manufacturing

High variety, but ease of manufacturing

• 4. Low manufacturing and logistical costs

In-house design focused on cost of manufacturing

High variety, but ease of manufacturing

100 percent sourcing from long-term suppliers

Year-round stocking to even out production

• 5. Self-selection by customer

All items on display and instock

Explanatory catalogs, informative displays and labels

High traffic store layout

27. Strategic Continuity

• Continuity of strategy is essential to creating and sustaining competitive advantage

– e.g., understanding the strategy

– building truly unique skills and assets related to the strategy

– establishing a clear identity with customers, channels, and other outside entities

– strengthening fit across the value chain

• "Reinvention" and frequent shifts in direction are costly and confuse the customer, the industry, and the organization

?

Implications

• Maintain continuity in the value proposition

• Continuously improve ways to realize the value proposition

– Strategic continuity and continuous change should occur simultaneously

• Continuity of strategy allows faster improvement.

28. Finding a Unique Strategic Position

• Finding a novel value proposition

– Creative segmentation

– Understanding tradeoffs

29. Reinventing the Value Chain

Enterprise Rent-A-Car

Value Proposition

• Home-city replacement cars to drivers whose cars

are being repaired or who need an extra vehicle, at

low rates (30% below airport rates)

Distinctive Activities

• Numerous, small, inexpensive offices, including

on-premises offices at major accounts

• Open during daylight hours

• Delivers cars to customers" homes or rental sites,

or customers to cars

• Acquire new and older cars, favoring soon-to-be

discontinued older models

• Keep cars six months longer than other major

rental companies

• In-house reservations

• Grassroots marketing with limited television

• Cultivate strong relationships with auto

dealerships, body shops, and insurance adjusters

• Hire extroverted college graduates to encourage

community interaction and customer service

• Employ a highly sophisticated computer network to

track its fleet

30. Finding a Unique Strategic Position

• Finding a novel value proposition

– Creative segmentation

– Understanding tradeoffs

• Reinventing the value chain

31. Strategic Positioning

Nespresso

Value Proposition

• Uniquely high quality, easy to prepare single-serve

espresso coffee at a premium price

• Demanding, convenience-sensitive, affluent

consumers, and offices

Distinctive Activities

• Extra-high quality ground coffee in 16+ varieties

• Individually proportioned capsules for freshness

and ease of use

• Tailored espresso machines manufactured by

high-end machine vendors

• Capsules sold only online or through about 200

coffee boutique shops in major cities, not in mass

market food channels

• Nespresso Club to achieve high levels of

communication with customers

• Focused image-oriented media advertising

32. Finding a Unique Strategic Position

• Finding a novel value proposition

– Creative segmentation

– Understanding tradeoffs

• Reinventing the value chain

• Anticipating industry dynamics

• Successful strategies involve a core strategic insight that is

improved and expanded over time

33. Growing Strategically

1. Make the strategy even more distinctive

– Introduce new technologies, features, products or services that leverage other

distinctive activities within the value chain

– Create a social dimension to the value proposition and value chain

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

– Raise the penetration of chosen customers / needs

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

– Aggressively reposition foreign acquisitions around the company"s strategy

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

– Find other customers and segments that value the strategy

?

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

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

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

• In many cases, shareholders are actually best served by earning a high return and returning capital, especially via dividends

Competing Regionally and Globally

• Selling in many nations

?

• Locating activities in different nations

?

• Coordinating a regional or global network

• Margin

Firm Infrastructure

Human Resource Management

Technology Development

Procurement

??

• Inbound Logistics

• Operations

• Outbound Logistics

• Marketing And Sales

• After Sales Service

35. Internationalization

Strategic Principles

• Internationalize in ways that reinforce the company"s strategy

• Internationalize first in product lines or customer segments where the company has the most unique advantages

• Prioritize markets to enter

– Similar needs and segments

– Expatriates

• Gain direct access to foreign markets as soon as practical rather than relying solely on intermediaries

• Use alliances selectively as transitional strategies

– Ensure that alliances do not block the company"s ability to gain competitive advantage and build its own capabilities

• Locate and integrate manufacturing and other activities from a regional perspective

36. Why Do Good Managers Choose Bad Strategies?

Flawed Management Concepts

• Misunderstanding of strategy principles

• Poor industry definition obscures the arena in which competitive advantage is actually determined

Pressures for Industry Convergence

• Industry conventional wisdom leads all companies to follow common practices

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

• Labor agreements or regulations constrain price, product, service or process alternatives

37. Why Do Good Managers Choose Bad Strategies?

Management Practices

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

• Over-outsourcing makes products and activities homogenous and less distinctive

Organizational Incentives

• Inappropriate goals and performance metrics bias strategy choices

– Size over profitability

– Short time horizon

• A desire for consensus blurs strategic tradeoffs

• Rapid turnover of leadership undermines strategy in favor of short-term performance

38. Why Do Good Managers Choose Bad Strategies?

Capital Markets

• Search for short-term "surprises" in earnings or revenue

• Use of industry-wide metrics are misaligned with true economic value and drive strategic convergence

• Encourage companies to emulate currently "successful" peers

• Strong pressure to grow faster than the industry

• Bias in favor of "doing deals" (M&A)

39. Multiple Levels of Strategy Drive Competitive Advantage

Competitive or Business Strategy

• How to compete in each distinct business or

Industry

?

Corporate Strategy

• Advantaged positions in attractive industries

• Capturing synergies across business units

40. Premises of Corporate Diversification

• Overall corporate size per se does not create economic value

• Competition occurs at the level of individual businesses

• Being part of a diversified company involves inevitable costs for business units

• Shareholders can diversify directly at lower cost

• Successful corporate strategy must produce a clear and offsetting benefit to the competitive advantage of business units

– That are not possible with alternative governance structures (e.g. alliances)

?

• The central issue in corporate strategy is how the corporation adds competitive value to its businesses.

41. Diversification in Emerging Economies

Typical Business Groups

• Financial Services

• Sugar

• Airline

• Hotel

• Real Estate

• Services

• Computer

• Wholesaler

• Grocery

• Stores

• Fast Food

• Franchises

• Industrial

• Parts

• Imports/

• Distribution

• Food

• Processing

• TobaccoTextiles

• Car Dealership

42. Corporate Strategy

• Shared characters

• Shared brand

• Shared family values

• Cross-promotions

MAIN DISNEY COMPANYS

• 1. Theme Parks

• 2. Family Motion Pictures

• 3. Consumer Products

• 4. Television Programming

• 5. Disney Records

• 6. Youth Books and Educational Materials

• 7. Traveling Shows

43. Creating Corporate Value Added

• Harnessing fit across the value chains of business units

– Sharing activities across business units

– Leveraging proprietary knowledge and skills across units

• Sharing corporate overhead is not enough

44. The Process of Developing a Strategy

• Strategy should be developed and periodically reviewed in a formal process rather than being left to occur spontaneously

– The process need not be highly structured

• Business unit strategy development is best done in a multifunctional team including the general manager and heads of important functions

– The strategic planning department serves as staff

– The strategy team is relatively small

– The team needs to work together not separately

• Strategy development is not a fully democratic process. The leader must ultimately

decide

• The strategy must be communicated widely, both externally and internally

• Enhancements to the strategy should be discussed and implemented continuously

• A strategy review, which examines the assumptions on which the strategy is based, should take place formally at least once per year

45. Communicating Strategy

• Strategy involves everyone in an organization, not just top management

• The benefits of strategy are greatest when it is communicated widely in the organization

• Communicating strategy requires a simple and vivid way of describing the essence of the company"s unique position

– Symbols of the strategy are invaluable tools

– Repetition

• The basic strategy and value proposition must also be communicated to customers, channels, suppliers, and financial markets

– What about confidentiality?

• Leaders should not assume that subordinates understand the strategy, or that they agree with it

– Help each organizational unit translate the strategy into implications for its own mandate

• Individuals who do not ultimately accept the strategy cannot have an

ongoing role in the company

46. The Role of Leaders in Strategy

Commitment to strategy is tested every day

• Drive operational improvement, but clearly distinguish it from strategy

• Lead the process of choosing the company"s unique position

– The CEO is the chief strategist

– The choice of strategy cannot be entirely democratic

• Communicate the strategy relentlessly to all constituencies

– Harness the moral purpose of strategy

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

• Decide which industry changes, technologies, and customer needs to respond to, and how

the response can be tailored to the company"s strategy

• Measure progress against the strategy using metrics that capture the implications of the

strategy for serving customers and performing particular activities

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

?

"Commitment to strategy is tested every day"

The Role of Business in Society: Creating Shared Value

Professor Michael E. Porter

Harvard Business School

Guayaquil, Ecuador

October 25, 2011