Understanding Michael Porter

Summary

I though I understood Porter’s work, but never have I seen it presented so clearly and cleanly as in this book. Mandatory reading for anyone involved in strategy.

Highlights and notes

INTRODUCTION

If you are serious about strategy, Porter’s work is the foundation

My premise in writing this book is very simply that clear strategic thinking is essential for any manager in any setting, and Porter’s work lays out the basic principles and frameworks you need to master

The essence of strategy,” Porter often says, “is choosing what not to do.

No matter the industry or the company, for-profit or not, I have always found Porter’s work to be essential in making sense of what was going on

Two are especially relevant for this book: “What Is Strategy?” (1996), one of the most-cited and best-selling HBR articles of all time, and “The Five Competitive Forces That Shape Strategy” (2008), a major update of the classic that put Porter on the map

Porter’s work endures—and is so widely cited and used—because it works in both realms, theory and practice.

if there were no competition, there would be no need for strategy. Competitive rivalry is a relentless process working against a company’s ability to find and maintain an advantage

Only by competing to be unique can an organization achieve sustained, superior performance

Properly understood, competitive advantage allows you to follow the precise link between the value you create, how you create it (your value chain), and how you perform (your P&L).

Tradeoffs are the economic linchpins of strategy for two reasons. First, they are an important source of differences in prices and costs among rivals. Second, they make it difficult for rivals to copy what you do without compromising their own strategies

Part One: What is Competition?

STRATEGY EXPLAINS how an organization, faced with competition, will achieve superior performance.

The key to competitive success—for businesses and nonprofits alike —lies in an organization’s ability to create unique value. Porter’s prescription: aim to be unique, not best. Creating value, not beating rivals, is at the heart of competition

1. Competition: The Right Mind-Set

STRATEGY IS ONE OF the most dangerous concepts in business. Why dangerous? Because while most managers agree that it is terrifically important, once you start paying attention to how the word is used you will soon be wondering whether it means anything at all.

strategy,” which for Porter is shorthand for “a good competitive strategy that will result in sustainably superior performance

Strategy explains how an organization, faced with competition, will achieve superior performance

And yet, Porter tells us, one of the reasons so many companies fail to develop good strategies is that the people running them operate with fundamental misconceptions about what competition is and how it works

Michael Porter has a name for this syndrome. He calls it competition to be the best. It is, he will tell you, absolutely the wrong way to think about competition

Competition focuses more on meeting customer needs than on demolishing rivals

Because there are so many needs to serve, there are many ways to win

In the vast majority of businesses, there is simply no such thing as “the best.

Thus, the first flaw of competition to be the best is that if an organization sets out to be the best, it sets itself an impossible goal.

Every time one company makes a move, its rivals will jump to match it. With everyone chasing after the same customer, there will be a contest over every sale. This, says Porter, is competitive convergence. Over time, rivals begin to look alike as one difference after another erodes. Customers are left with nothing but price as the basis for their choices

when all rivals compete on the same dimension, no one gains a competitive advantage.

Companies only have to be “big enough,” which rarely means they have to dominate. Often “big enough” is just 10 percent of the market. Yet companies under the influence of winner-takes-all thinking tend to pursue illusory scale advantages. In doing so, they are likely to damage their own performance by cutting price to gain volume, by overextending themselves to serve all market segments, and by pursuing overpriced mergers and acquisitions.

The winner-takes-all model presupposes incorrectly that there is one scale curve in an industry and that all companies must move down that curve.* That is, it assumes that all rivals are competing to offer the universally best product or service. In practice, most industries exhibit multiple scale curves, each based on serving different needs.

When choice is limited, value is often destroyed. As a customer, you are either paying too much for extras you don’t want, or you are forced to make do with what’s offered, even if it’s not really what you need

Strategic competition means choosing a path different from that of others.

Competing to be unique is unlike warfare in that one company’s success does not require its rivals to fail. It is unlike competition in sports because every company can chose to invent its own game. A better analogy than war or sports might be the performing arts. There can be many good singers or actors—each outstanding and successful in a distinctive way. Each finds and creates an audience. The more good performers there are, the more audiences grow and the arts flourish. This kind of value creation is the essence of positive-sum competition.

One popular management book, Blue Ocean Strategy, uses the metaphor of red oceans versus blue to distinguish bloody head-to-head competition from the clear blue seas where, its authors say, competition is irrelevant. This is a double misconception worth highlighting. First, it mistakenly portrays Porter as a champion of bloody “red ocean strategy,” when, in fact, his work stresses the opposite. Second, competition, properly understood, is never irrelevant.

2. The Five Forces: Competing for Profits?

Why are some companies more profitable than others? That’s the big question we’ll be working on. The answer has two parts. First, companies benefit from (or are hurt by) the structure of their industry. Second, a company’s relative position within its industry can account for even more of the difference

The real point of competition is not to beat your rivals. It’s to earn profits.

industry structure determines profitability—not, as many people think, whether the industry is high growth or low, high tech or low, regulated or not, manufacturing or service

For any organization trying to assess or formulate strategy, the five forces framework is the place to start

At its heart, business competition is about the struggle for profits, the tug-of-war over who gets to capture the value an industry creates. As complex and multidimensional as competition typically is, the math of profitability is simple. Porter reminds us to stay focused on the ultimate goal—profit— and on its two components, price and cost: Unit Profit Margin = Price – Cost

Powerful buyers will force prices down or demand more value in the product, thus capturing more of the value for themselves.

Buyers are more likely to exercise their negotiating leverage if they are price sensitive. Both industrial customers and consumers tend to be more price sensitive when what they’re buying is Undifferentiated Expensive relative to their other costs or income Inconsequential to their own performance

Powerful suppliers will charge higher prices or insist on more favorable terms, lowering industry profitability.

Both suppliers and buyers tend to be powerful if:

They are large and concentrated relative to a fragmented industry (think Goliath versus many Davids).

The industry needs them more than they need the industry

Switching costs work in their favor.

Switching costs work in the buyer’s favor when the buyer can easily drop one vendor for another.

Differentiation works in their favor. When buyers see little differentiation in the industry’s products, they have the power to pit one vendor against another.

They can credibly threaten to vertically integrate into producing the industry’s product itself.

Substitutes—products or services that meet the same basic need as the industry’s product in a different way—put a cap on industry profitability.

How do you assess the threat of a substitute? Look to the economics, specifically to whether the substitute offers an attractive price–performance tradeoff relative to the industry’s product.

Switching costs play a significant role in substitution. Substitutes gain ground when buyers face low switching costs

Entry barriers protect an industry from newcomers who would add new capacity.

How do you size up the threat of new entry? If you are a current player, what can you do to raise those barriers? If you are thinking of entering a new industry, can you overcome the barriers that stand in your way? There are a number of different kinds of entry barriers. Start with the following questions to help you identify and assess them.

are economies of scale, at what volumes do they kick in? The numbers matter. Where do these economies come from: From spreading fixed costs over a larger volume? From using more efficient technologies that are scale dependent? From increased bargaining power over suppliers?

Will customers incur any switching costs in moving from one supplier to another

Does the value to customers increase as more customers use a company’s product? (This is called a network effect.)

What is the price of admission for a company to enter the business? How large are the capital investments, and who might be willing and able to make them?

Do incumbents have advantages independent of size that new entrants can’t access? Examples include proprietary technology, well-established brands, prime locations, and access to distribution channels.

What kind of retaliation should a potential entrant expect should it choose to enter the industry? Is this industry known for making it tough for newcomers? Does the industry have the resources to compete aggressively?

Does government policy restrict or prevent new entrants?

If rivalry is intense, companies compete away the value they create, passing it on to buyers in lower prices or dissipating it in higher costs of competing

How do you assess the intensity of rivalry? Porter notes that it is likely to be greatest if

The industry is composed of many competitors or if competitors are roughly equal in size and power

Slow growth provokes battles over market share.

High exit barriers prevent companies from leaving the industry.

Rivals are irrationally committed to the business; that is, financial performance is not the overriding goal.

Price competition, Porter warns, is the most damaging form of rivalry. The more rivalry is based on price, the more you are engaged in competing to be the best. This is most likely when

It is hard to tell one rival’s offerings from another (the problem of competitor convergence we saw in chapter 1) and buyers have low switching costs. This typically drives rivals to lower their prices to attract customers

Rivals have high fixed costs and low marginal costs, creating the pressure to drop prices because any new customer will “contribute to covering overhead.”

Capacity must be added in large increments, disrupting the industry’s supply–demand balance and leading to price cutting to fill capacity.

The product is perishable, an attribute that applies not only to fruit and fashion but also to a wide range of products and services that quickly become obsolete or lose their value. A hotel room, an airline seat, or a restaurant table that goes unfilled is “perishable.”

The five forces framework applies in all industries for the simple reason that it encompasses relationships fundamental to all commerce.

It matters that you grasp the deeper point: there are a limited number of structural forces at work in every industry that systematically impact profitability in a predictable direction.

The collective strength of the five forces matters because it affects prices, costs, and the investment required to compete. Industry structure determines how the economic value created by an industry is divided—how much is captured by companies in the industry versus customers, suppliers, distributors, substitutes, and potential new entrants.

Typical Steps in Industry Analysis

1. Define the relevant industry by both its product scope and geographic scope.
   Porter offers this rule of thumb: where there are differences in more than one force, or where differences in any one force are large, you are likely dealing with distinct industries. Each will need its own strategy
2. Identify the players constituting each of the five forces and, where appropriate, segment them into groups
3. Assess the underlying drivers of each force. Which are strong? Which are weak? Why?
4. Step back and assess the overall industry structure. Which forces control profitability? Not all are equally important. Dig deeper into the most important forces in your industry. Are your results consistent with the industry’s level of profitability today and over the long term? Are the more profitable companies better positioned in relation to the five forces?
5. Analyze recent and likely future changes for each force. How are they trending? Looking ahead, how might competitors or new entrants influence industry structure?
6. How can you position yourself in relation to the five forces? Can you find a position where the forces are weakest? Can you exploit industry change? Can you reshape structure in your favor?

Strategy,” Porter writes, “can be viewed as building defenses against the competitive forces or finding a position in the industry where the forces are weakest.”

industry structure is dynamic, not static. When you do industry analysis, you are taking a snapshot of the industry at a point in time, but you are also assessing trends in the five forces.

The Five Forces: Competing for Profits The real point of competition is earning profits, not taking business away from your rivals. Business competition is about the struggle for profits, the tug-of-war over who gets to capture the value an industry creates. Companies compete for profits with their direct rivals, but also with their customers, their suppliers, potential new entrants, and substitutes. The collective strength of the five forces determines the average profitability of the industry through their impact on prices, costs, and the investment required to compete. A good strategy produces a P&L better than this industry average baseline. Using five forces analysis simply to declare that an industry is attractive or unattractive misses its full power as a tool. Because industry structure can “explain” the income statements and balance sheets of every company in the industry, insights gained from it should lead directly to decisions about where and how to compete. Industry structure is dynamic, not static. Five forces analysis can help anticipate and exploit structural change.

3. Competitive Advantage: The Value Chain and Your P&L

For Porter, competitive advantage is not about trouncing rivals, it’s about creating superior value. Moreover, the term is both concrete and specific. If you have a real competitive advantage, it means that compared with rivals, you operate at a lower cost, command a premium price, or both. These are the only ways that one company can outperform another. If strategy is to have any real meaning at all, Porter argues, it must link directly to your company’s financial performance. Anything short of that is just talk.

organizations are supposed to use resources effectively. The financial measure that best captures this idea is return on invested capital (ROIC). ROIC weighs the profits a company generates versus all the funds invested in it, operating expenses and capital. Long-term ROIC tells you how well a company is using its resources

the only way to know if you are achieving the ultimate goal of creating economic value is to be brutally honest about the true profits you’ve earned and all the capital you’ve committed to the business. Strategy, then, must start not only with the right goal, but also with a commitment to measure performance accurately and honestly.

Performance is meaningfully measured only on a business-by-business basis because this is where competitive forces operate and competitive advantage is won or lost. Just to keep our terminology straight, for Porter strategy always means “competitive strategy” within a business. The business unit, and not the company overall, is the core level of strategy. Corporate strategy refers to the business logic of a multiple-business company. The distinction matters

Note that the time horizon for evaluating ROIC will vary depending on the investment cycle that characterizes the industry. In the aluminum industry, for example, where it can take eight years to bring a new smelter on-line, the appropriate time horizon is probably a decade. In contrast, three to five years is more appropriate for many service businesses. In a business with little capital, other measures of effective resource use may be required. For example, a consulting firm might measure returns per partner

The ability to command a higher price is the essence of differentiation, a

Marketers have their own definition of differentiation: it’s the process of establishing in customers’ minds how one product differs from others

For Porter, then, differentiation refers to the ability to charge a higher relative price. My advice here: Don’t get hung up on the language, as long as you don’t get sloppy about the underlying distinction. Remind yourself that the goal of strategy is superior profitability and that one of its two possible components is relative price—that is, you are able to charge more than your rivals charge.

Strategy choices aim to shift relative price or relative cost in a company’s favor

We now have a concise, concrete definition of competitive advantage: superior performance resulting from sustainably higher prices, lower costs, or both.

Since I’m going to be referring to activities and activity systems a lot, let’s be clear about the definition. Activities are discrete economic functions or processes, such as managing a supply chain, operating a sales force, developing products, or delivering them to the customer. An activity is usually a mix of people, technology, fixed assets, sometimes working capital, and various types of information.

Managers tend to think in terms of functional areas such as marketing or logistics because that is how their own expertise or organizational affiliation is defined. That’s too broad for strategy. To understand competitive advantage, it is critical to zoom in on activities, which are narrower than traditional functions. Alternatively, managers think in terms of skills, strengths, or competences (what the company is good at), but that’s too abstract and often too broad as well. To think clearly about actions you can take as a manager to impact prices and costs, you need to get down to the activity level where “what the company is good at” gets embodied in specific activities the company performs.

The sequence of activities your company performs to design, produce, sell, deliver, and support its products is called the value chain. In turn, your value chain is part of a larger value system: the larger set of activities involved in creating value for the end user, regardless of who performs those activities. An

In thinking about your value chain, then, it’s important to see how your activities have points of connection with those of your suppliers, channels, and customers. The way they perform activities affects your cost or your price, and vice versa.

Why does it matter? The answer: The value chain is a powerful tool for disaggregating a company into its strategically relevant activities in order to focus on the sources of competitive advantage, that is, the specific activities that result in higher prices or lower costs

1. Start by laying out the industry value chain

2. Next, compare your value chain to the industry’s.

If your value chain looks like everyone else’s, then you are engaged in competition to be the best.

3. Zero in on price drivers, those activities that have a high current or potential impact on differentiation

4. Zero in on cost drivers, paying special attention to activities that represent a large or growing percentage of costs

Are there actual or potential differences between your cost structure and those of your rivals? The challenge here is to get as accurate a picture as you can of the full costs associated with each activity, including not only direct operating and asset costs but also the overhead costs that are generated because you perform this activity

Until a company understands where its profit performance comes from, it will be ill equipped to deal with it strategically.

We now have a complete definition of competitive advantage: a difference in relative price or relative costs that arises because of differences in the activities being performed

Porter uses the phrase operational effectiveness (OE) to refer to a company’s ability to perform similar activities better than rivals. Most managers use the term “best practice” or “execution.

simply improving operational effectiveness does not provide a robust competitive advantage because rarely are “best practice” advantages sustainable

The Economic Fundamentals of Competitive Advantage Popular metrics such as shareholder value, return on sales, growth, and market share are misleading for strategy. The goal of strategy is to earn superior returns on the resources you deploy, and that is best measured by return on invested capital. Competitive advantage is not about beating rivals; it’s about creating superior value and about driving a wider wedge than rivals between buyer value and cost. Competitive advantage means you will be able to sustain higher relative prices or lower relative costs, or both, than your rivals in an industry. If you have a competitive advantage, it will show up on your P&L. For nonprofits, competitive advantage means you will produce more value for society for every dollar spent (the analogue of higher price), or you will produce the same value using fewer resources (the equivalent of lower cost). Differences in relative prices and relative costs can ultimately be traced to the activities that companies perform. A company’s value chain is the collection of all its value-creating and cost-generating activities. The activities, and the overall value chain in which activities are embedded, are the basic units of competitive advantage.

The inevitable diffusion of best practices means that everyone has to run faster just to stay in place

Competitive rivalry, at its core, is a process working against the ability of a company to maintain differences in relative price and relative cost. Competition to be the best is the great leveler. It accelerates that process. In the next four chapters, we will see how strategy, built around a unique configuration of activities, works to achieve and sustain competitive advantage. Strategy is the antidote to competitive rivalry

Part Two: What Is Strategy?

In this section of chapters, we’ll cover five tests every good strategy must pass: A distinctive value proposition

competitive advantage means you have created value for customers and you are able to capture value for yourself because the positioning you have chosen in your industry effectively shelters you from the profit-eroding impact of the five forces

4. Creating Value: The Core

A tailored value chain Tradeoffs different from rivals Fit across value chain Continuity over time

Your value chain must be specifically tailored to deliver your value proposition. A value proposition that can be effectively delivered without a tailored value chain will not produce a sustainable competitive advantage

Porter defines the value proposition as the answer to three fundamental questions (see figure 4-1): Which customers are you going to serve? Which needs are you going to meet? What relative price will provide acceptable value for customers and acceptable profitability for the company?

Typically, value propositions based on needs appeal to a mix of customers who might defy traditional demographic segmentation.

The first test of a strategy is whether your value proposition is different from your rivals. If you are trying to serve the same customers and meet the same needs and sell at the same relative price, then by Porter’s definition, you don’t have a strategy. You’re competing to be the best.

Early in his career, Porter identified a set of generic strategies—focus, differentiation, and cost leadership—that quickly became one of the most widely used tools for thinking about key strategic choices. Each of the three reflects the most basic level of consistency that every effective strategy must have. Focus refers to the breadth or narrowness of the customers and needs a company serves. Differentiation allows a company to command a premium price. Cost leadership allows it to compete by offering a low relative price. These broad characterizations of strategy types capture the fundamental dimensions of strategic choice relevant in any industry.

Choices in the value proposition that limit what a company will do are essential to strategy because they create the opportunity to tailor activities in a way that best delivers that kind of value. Tailoring is possible only if there are limits, only if you are not trying to be all things to all people.

This is a crucially important test that should be applied to any strategy. If the same value chain can deliver different value propositions equally well, then those value propositions have no strategic relevance.

Strategy, then, defines a way of competing, reflected in a set of activities that delivers unique value in a particular set of uses or for a particular set of customers, or both

While not every single activity need be unique, robust strategies always involve a significant degree of tailoring. To establish a competitive advantage, a company must deliver its distinctive value through a distinctive value chain. It must perform different activities than rivals or perform similar activities in different ways.

Thus the value proposition and the value chain—the two core dimensions of strategic choice—are inextricably linked. The value proposition focuses externally on the customer. The value chain focuses internally on operations. Strategy is fundamentally integrative, bringing the demand and supply sides together.

5. Trade-offs: The Linchpin

IN THE LAST CHAPTER, I presented Porter’s first two tests of strategy: a unique value proposition and the tailored value chain required to deliver it. If there is one important takeaway message, it is that strategy requires choice. Competitive advantage depends on making choices that are different from those of rivals, on making tradeoffs. This is Porter’s third test. Tradeoffs play such a critical role that it’s no exaggeration to call them strategy’s linchpin. They hold a strategy together as they contribute to both creating and sustaining competitive advantage.

Tradeoffs are the strategic equivalent of a fork in the road. If you take one path, you cannot simultaneously take the other.

If an activity is either overdesigned or underdesigned for its use, value will be destroyed

Can you have high quality and low cost at the same time? Is quality free? Porter calls this a “dangerous half-truth.” The answer is “Yes, but.” Yes, quality is free when higher quality means eliminating defects and waste. There you are dealing with a false tradeoff, one that should be broken. In general, false tradeoffs arise when organizations fall behind in operational effectiveness—that is, when they lag in how well they perform basic activities, the kind of activities that are generic and not strategy specific

Porter calls what McDonald’s tried to do straddling, and it is the most common form of competitive imitation. The straddler, as the word implies, tries to match the benefits of the successful position while at the same time maintaining its existing position. In other words, a straddler tries to have it all, to get the best of two worlds by grafting new features, services, or technologies onto the activities it already performs. Strategy is an either-or realm; the straddler thinks it can escape into a world of both-and. This usually turns out to be wishful thinking.

Clarity about what you won’t do, then, is the best way to succeed at what you do choose to do. It is only by being deliberately unresponsive to some needs, by embracing strategic tradeoffs, that companies can be genuinely responsive to other needs. Put another way, the role of tradeoffs in strategy is deliberately to make some customers unhappy

6. Fit: The Amplifier

The notion that the customer is always right is one of those half-truths that can lead to mediocre performance

We saw, in chapter 4, that a series of choices about a company’s value proposition and its value chain gives rise to competitive advantage. Where those choices involve tradeoffs, the strategy becomes more valuable and more difficult to imitate (chapter 5). You can think of fit as an amplifier, raising the power of both of those effects. Fit amplifies the competitive advantage of a strategy by lowering costs or raising customer value (and price). Fit also makes a strategy more sustainable by raising barriers to imitation.

fit means that the value or cost of one activity is affected by the way other activities are performed

Each of the three types Porter identifies works in a slightly different way to affect competitive advantage. The first kind of fit is basic consistency, where each activity is aligned with the company’s value proposition and each contributes incrementally to its dominant themes

Inconsistent activities make the whole less than the sum of the parts.

A second type of fit occurs when activities complement or reinforce each other. This is real synergy, where the value of each activity is raised by the other

Porter’s third type of fit is substitution. Here performing one activity makes it possible to eliminate another

Porter has created a tool he calls an “activity system map” to chart a company’s significant activities, their relationship to the value proposition, and to each other.

You can start by identifying the core elements of the value proposition

You then identify the most salient activities performed in the business, those most responsible for creating customer value or those that generate significant cost. Try to list the unique activity choices at each step. This makes contrasts between the company and its competitors more obvious

Next, place activities on the map as shown in the following figure. Draw lines wherever there is fit—where an activity contributes to the value proposition and where two activities affect each other

An activity map can help you see how well each activity supports the overall positioning—the customers served, the needs met, the relative price. For each activity, ask how it could be better linked to the overall strategy, even activities such as order processing or logistics that might seem to be largely generic in character. In most organizations, Porter observes, there are activities whose alignment has been ignored because they were not seen as part of strategy.

competitive advantage comes from a small number of factors, be they intangible skills or hard assets. The way to compete, then, is to acquire and develop those core competences.

A common mistake in strategy is to choose the same core competences as everyone else in your industry

Fit means that the competitive value of individual activities—and the associated skills, competences, or resources—cannot be decoupled from the system or the strategy

Which activities are generic and which are tailored? Generic activities—those that cannot be meaningfully tailored to a company’s position—can be safely outsourced to more efficient external suppliers. However, Porter argues that outsourcing is risky for activities that are or could be tailored to strategy, and especially for those activities that are strongly complementary with others. The fewer elements that remain in the company’s value chain, the fewer the opportunities to extend tailoring, tradeoffs, and fit.

By throwing multiple obstacles in the path of would-be imitators, fit lowers the odds that a strategy can be copied.

7. Continuity: The Enabler

In chapter 4 we saw that a tailored value chain— different activities—was the first line of defense against imitation. In chapter 5, we saw that tradeoffs constitute a second line of defense. Tailoring and tradeoffs prevent existing rivals from copying a good strategy, either by straddling or repositioning. The more activities rivals have to reconfigure, the more damage they will do to their current positions. Finally, fit explains how competitive advantage can be sustained against new entrants, even the most determined of them

Great strategies are like complex systems in which all of the parts fit together seamlessly. Each thing you do amplifies the value of the other things you do. That enhances competitive advantage. And it enhances sustainability as well. “Fit,” Porter says, “locks out imitators by creating a chain that is as strong as its strongest link.”

the first two tests—a unique value proposition and a tailored value chain—are the core of a strategy. Tradeoffs, the third test, are the economic linchpin. They make differences in price and cost possible and sustainable. Fit, the fourth test, is an amplifier, enhancing the cost and price differences that are the essence of competitive advantage, and making it even harder for rivals to copy the strategy. Continuity is the enabler

strategy isn’t a stir fry; it’s a stew. It takes time for the flavors and textures to develop. Over time, as all of a company’s constituents—internal and external—come to a deeper understanding of what a company can offer them, or what they can offer to it, a whole raft of activities become better tailored to the strategy and better aligned with each other. This aspect of strategy is very fundamentally about people and their capacity to absorb and process change.

Continuity reinforces a company’s identity—it builds a company’s brand, its reputation, and its customer relationships

Continuity helps suppliers, channels, and other outside parties to contribute to a company’s competitive advantage. This

Continuity fosters improvements in individual activities and fit across activities; it allows an organization to build unique capabilities and skills tailored to its strategy. The

Continuity of strategy does not mean that an organization should stand still. As long as there is stability in the core value proposition, there can, and should, be enormous innovation in how it’s delivered.

if you operate in a highly uncertain environment, it’s easy to get caught in a false syllogism that goes something like this: I can’t predict the future. Strategy requires a prediction of the future. Therefore, I can’t commit to a strategy. If you can’t predict what’s going to happen next quarter, let alone three to five years from now, maybe it’s safer to stay flexible, run harder, and sleep faster

Great strategies are rarely, if ever, built on a particularly detailed or concrete prediction of the future. You need only a very broad sense of which customers and needs are going to be relatively robust five or ten years from now. Strategy is implicitly a bet that the chosen customers or needs—and the essential tradeoffs for meeting them at the right price—will be enduring.

Good strategies have staying power, but there are clearly times when a strategy must be changed. In Porter’s view, these so-called inflection points are relatively rare, and companies are more likely to pull away from their strategies prematurely. It is therefore important to understand the conditions that absolutely require new strategies.

First, as customer needs change, a company’s core value proposition may simply become obsolete

Second, innovation of all sorts can serve to invalidate the essential tradeoffs on which a strategy relies

A company needs a new strategy if its value chain does not allow it to outperform its competitors in delivering its unique value proposition.

Third, a technological or managerial breakthrough can completely trump a company’s existing value proposition

To determine whether a technology is truly disruptive, ask whether it can be integrated into the company’s existing value chain or customized in a way that enhances the company’s existing activities. In practice, Porter argues, truly disruptive technologies are quite rare.

The problem, Porter argues, is that when you substitute flexibility for strategy, your organization never stands for anything or becomes good at anything. Flexibility sounds good in theory, but trace it down to the concrete level of the activities you perform and you’ll see why flexibility without strategy will guarantee mediocrity—tailoring will be poor, tradeoffs nonexistent, fit impossible. All of these require a company to maintain a direction

Continuity gives an organization the time it needs to deepen its understanding of the strategy.

Strategies often emerge through a process of discovery that can take years of trial and error as the company tests its positioning and learns how best to deliver it.

Often, strategies begin with two or three essential choices. Over time, as the strategy becomes clearer, additional choices complement and extend the original ones

There is no denying that dumb luck has played a role in some extraordinary business successes. But, as Porter likes to ask, would you be eager to invest in someone whose “strategy” is to rely on dumb luck? You may not be able to analyze your way to spectacular success—creativity and serendipity play a role. But armed with an understanding of strategy essentials, you are more likely—far more likely—to make better decisions along the way.

If you don’t have a strategy, then anything and everything could be important. A strategy helps you to decide what’s important because you know who you’re trying to serve, what needs you’re trying to meet, and how your value chain is distinctively configured to do so at the right price. These elements ground a company, enabling it to sort out what matters and what doesn’t. Strategy makes priorities clearer. Moreover, if the organization has a purpose that people understand, their willingness to change and their sense of urgency will be higher.

Put in human terms, it is easier to change when you know who you are and what you stand for, and very difficult to change when you don’t

Epilogue: A Short List of Implications

Ten Practical Implications

1. Vying to be the best is an intuitive but self-destructive approach to competition.

2. There is no honor in size or growth if those are profitless. Competition is about profits, not market share.

3. Competitive advantage is not about beating rivals; it’s about creating unique value for customers. If you have a competitive advantage, it will show up on your P&L.

4. A distinctive value proposition is essential for strategy. But strategy is more than marketing. If your value proposition doesn’t require a specifically tailored value chain to deliver it, it will have no strategic relevance.

5. Don’t feel you have to “delight” every possible customer out there. The sign of a good strategy is that it deliberately makes some customers unhappy.

6. No strategy is meaningful unless it makes clear what the organization will not do. Making tradeoffs is the linchpin that makes competitive advantage possible and sustainable.

7. Don’t overestimate or underestimate the importance of good execution. It’s unlikely to be a source of a sustainable advantage, but without it even the most brilliant strategy will fail to produce superior performance.

8. Good strategies depend on many choices, not one, and on the connections among them. A core competence alone will rarely produce a sustainable competitive advantage.

9. Flexibility in the face of uncertainty may sound like a good idea, but it means that your organization will never stand for anything or become good at anything. Too much change can be just as disastrous for strategy as too little.

10. Committing to a strategy does not require heroic predictions about the future. Making that commitment actually improves your ability to innovate and to adapt to turbulence.

FAQ: An Interview with Michael Porter

The granddaddy of all mistakes is competing to be the best, going down the same path as everybody else and thinking that somehow you can achieve better results. This is a hard race to win. So many managers confuse operational effectiveness with strategy.

a real strength for strategy purposes has to be something the company can do better than any of its rivals. And “better” because you are performing different activities than they perform, because you’ve chosen a different configuration than they have.

there has been a tendency to define industries as global when they are national or encompass only groups of neighboring countries. Companies, mindful of the drumbeat about globalization, internationalize without understanding the true economics of their business. The value chain is the principal tool to delineate the geographic boundaries of competition, to determine how local or how global that business is. In a local business, every local area will require a complete and largely separate value chain. At the other extreme, a global industry is one where important activities in the value chain can be shared across all countries.

The worst mistake—and the most common one—is not having a strategy at all. Most executives think they have a strategy when they really don’t.

I also believe that as capital markets have evolved they have become more and more toxic for strategy. The single-minded pursuit of shareholder value, measured over the short term, has been enormously destructive for strategy and value creation. Managers are chasing the wrong goal

The pressure to grow is among the greatest threats to strategy

the first place to look for growth is to deepen your penetration of your core target of customers. The common mistake is to settle for 50 percent of your target segment when 80 percent is achievable. You can shoot for true leadership when the customer target is properly defined not as the whole industry, but as the set of customers and needs that your strategy serves best.

Economists have been studying mergers for twenty years and they find that the seller gets most of the value, not the buyer. Foreign acquisitions must be forcefully repositioned around your strategy, not allowed to continue theirs (unless, of course, theirs is better!).

A disruptive technology is one that invalidates value chain configurations and product configurations in ways that allow one company to leap ahead of another and/or make it hard for incumbents to match or respond because of the existing assets they have. So a disruptive technology is one that would invalidate important competitive advantages.

But the business model doesn’t help you to develop or to assess competitive advantage, which is what strategy aims to do. Strategy goes beyond the basic viability question, Can we make money? Strategy asks a more complicated question, How can we make more money than our rivals, how can we generate superior returns, and then, How can we sustain that advantage over time? A business model highlights the relationship between your revenues and your costs. Strategy goes an important step further. It looks at relative prices and relative costs, and their sustainability. That is, how your revenues and costs stack up against your rivals’. And then it links those to the activities in your value chain, and ultimately to your income statement and your balance sheet.

So the business model is best used as the most basic step in thinking about the viability of a company. If you’re satisfied with just being viable, stop there. If you want to achieve superior profitability (or avoid inferior profitability) and stay viable, then strategy—as I define it—will take you to the next level.

The danger with sending people off to do their own functional plans is that you’ll end up with a series of unconnected “best practices,” not a coherent strategy

I believe it’s beneficial to have a formal strategic planning process because otherwise the day-today pressures of the business drive out strategy. There needs to be a process once every year or two, and then quarterly reviews. But you can’t let it be simply about budgeting and making guesses about next year’s growth rate. Planning needs to support thinking rather than drive it out.

Communicating the strategy is really important. Strategy is useless if it’s a secret, if nobody else in the organization knows what the strategy is. The purpose of strategy is to align the behavior of everyone in the organization and to help them make good choices when they’re on their own. Those choices happen every day—when your salesman is deciding who to call on and what pitch to give, when the folks in product development are thinking about what sort of new ideas to look at. People are out there, every day, making choices. You want them to make the choice that fits the strategy. So you’ve got to communicate it.

I’ve seen too many organizations where the understanding of the strategy and the agreement about it are superficial. Everyone can agree at some very high level, but then when you get into the detail, you see that people actually don’t understand, and they don’t agree. They act at cross-purposes to each other. So you’ve got to create an opportunity to really understand the way people think and to confront the issues.

And finally, if there are individuals who don’t accept the strategy, who simply refuse to get on board, they cannot have an ongoing role in the company. That’s a polite way of saying they’ve got to go. You can’t debate strategy among yourselves for very long. You just can’t. It’s too hard to implement well even with a willing management team. I’ve seen too many cases where executives just let the dissenters hang on. The resulting negative energy and confusion and waste of time really damage the strategy. It’s healthy for people to disagree and managers should be given a chance to make their case and to change minds, but there comes a time when the discussion has to end. It’s not about democracy, or consensus, or about making everyone happy. Fundamentally, it’s about picking a direction and then getting everybody really excited about it.