HBR's 10 Must Reads on Strategy (including featured article "What Is Strategy?" by Michael E. Porter)

by Michael E. Porter

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 distinguish between operational effectiveness and strategy.

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 follows: delivering greater value allows a company to charge higher average unit prices; greater efficiency results in lower average unit costs.

Cost is generated by performing activities, and cost advantage arises from performing particular activities more efficiently than competitors. Similarly, differentiation arises from both the choice of activities and how they are performed. Activities, then, are the basic units of competitive advantage.

the more benchmarking that companies do, the more competitive convergence you have—that is, the more indistinguishable companies are from one another.

Strategic positioning attempts to achieve sustainable competitive advantage by preserving what is distinctive about a company. It means performing different activities from rivals, or performing similar activities in different ways.

When a company improves its operational effectiveness, it moves toward the frontier. Doing so may require capital investment, different personnel, or simply new ways of managing.

Three key principles underlie strategic positioning. 1. Strategy is the creation of a unique and valuable position, involving a different set of activities.

2. Strategy requires you to make trade-offs in competing—to choose what not to do.

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

Fit has to do with the ways a company’s activities interact and reinforce one another. For example, Vanguard Group aligns all of its activities with a low-cost strategy; it distributes funds directly to consumers and minimizes portfolio turnover. Fit drives both competitive advantage and sustainability: when activities mutually reinforce each other, competitors can’t easily imitate them.

Constant improvement in operational effectiveness is necessary to achieve superior profitability. However, it is not usually sufficient.

The second reason that improved operational effectiveness is insufficient—competitive convergence—is more subtle and insidious. The more benchmarking companies do, the more they look alike.

Competition based on operational effectiveness alone is mutually destructive, leading to wars of attrition that can be arrested only by limiting competition.

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.

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

A variety-based positioning can serve a wide array of customers, but for most it will meet only a subset of their needs.

A second basis for positioning is that of serving 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.

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

First, a competitor can reposition itself to match the superior performer.

A second and far more common type of imitation is straddling. The straddler seeks to match the benefits of a successful position while maintaining its existing position.

Trade-offs arise for three reasons. The first is inconsistencies in image or reputation. A company known for delivering one kind of value may lack credibility and confuse customers—or even undermine its reputation—if it delivers another kind of value or attempts to deliver two inconsistent things at the same time.

Second, and more important, trade-offs arise from activities themselves. Different positions (with their tailored activities) require different product configurations, different equipment, different employee behavior, different skills, and different management systems.

Finally, trade-offs arise from limits on internal coordination and control. By clearly choosing to compete in one way and not another, senior management makes organizational priorities clear. Companies that try to be all things to all customers, in contrast, risk confusion in the trenches as employees attempt to make day-to-day operating decisions without a clear framework.

Positioning trade-offs are pervasive in competition and essential to strategy. They create the need for choice and purposefully limit what a company offers. They deter straddling or repositioning,

the absence of trade-offs is a dangerous half-truth that managers must unlearn. Quality is not always free.

In general, false trade-offs between cost and quality occur primarily when there is redundant or wasted effort, poor control or accuracy, or weak coordination. Simultaneous improvement of cost and differentiation is possible only when a company begins far behind the productivity frontier or when the frontier shifts outward.

if there are no trade-offs companies will never achieve a sustainable advantage. They will have to run faster and faster just to stay in place.

As we return to the question, What is strategy? we see that trade-offs add a new dimension to the answer. Strategy is making trade-offs in competing. The essence of strategy is choosing what not to do. Without trade-offs, there would be no need for choice and thus no need for strategy. Any good idea could and would be quickly imitated. Again, performance would once again depend wholly on operational effectiveness.

While operational effectiveness is about achieving excellence in individual activities, or functions, strategy is about combining activities.

competitive advantage comes from the way its activities fit and reinforce one another.

Fit locks out imitators by creating a chain that is as strong as its strongest link. As in most companies with good strategies, Southwest’s activities complement one another in ways that create real economic value. One activity’s cost, for example, is lowered because of the way other activities are performed. Similarly, one activity’s value to customers can be enhanced by a company’s other activities. That is the way strategic fit creates competitive advantage and superior profitability.

some fit among activities is generic and applies to many companies, the most valuable fit is strategy-specific because it enhances a position’s uniqueness and amplifies trade-offs.2

First-order fit is simple consistency between each activity (function) and the overall strategy. Vanguard, for example, aligns all activities with its low-cost strategy. It minimizes portfolio turnover and does not need highly compensated money managers.

Second-order fit occurs when activities are reinforcing. Neutrogena, for example, markets to upscale hotels eager to offer their guests a soap recommended by dermatologists.

Thus Neutrogena’s medical and hotel marketing activities reinforce one another, lowering total marketing costs.

Third-order fit goes beyond activity reinforcement to what I call optimization of effort. The Gap, a retailer of casual clothes, considers product availability in its stores a critical element of its strategy.

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

In all three types of fit, the whole matters more than any individual part. Competitive advantage grows out of the entire system of activities.

The fit among activities substantially reduces cost or increases differentiation. Beyond that, the competitive value of individual activities—or the associated skills, competencies, or resources—cannot be decoupled from the system or the strategy. Thus in competitive companies it can be misleading to explain success by specifying individual strengths, core competencies, or critical resources.

It is more useful to think in terms of themes that pervade many activities, such as low cost, a particular notion of customer service, or a particular conception of the value delivered. These theme...

Positions built on systems of activities are far more sustainable than those built on individual activities. Consider this simple exercise. The probability that competitors can match any activity is often less than one. The probabilities then quickly compound to make matching the entire system highly unlikely (.9 x .9 = .81; .9 x .9 x .9 x .9 = .66, and so on).

The more a company’s positioning rests on activity systems with second- and third-order fit, the more sustainable its advantage will be. Such systems, by their very nature, are usually difficult to untangle from outside the company and therefore hard to imitate.

Achieving fit is difficult because it requires the integration of decisions and actions across many independent subunits.

Thus finding a new strategic position is often preferable to being the second or third imitator of an occupied position.

Seeing strategy in terms of activity systems only makes it clearer why organizational structure, systems, and processes need to be strategy-specific. Tailoring organization to strategy, in turn, makes complementarities more achievable and contributes to sustainability.

Continuity fosters improvements in individual activities and the fit across activities, allowing an organization to build unique capabilities and skills tailored to its strategy. Continuity also reinforces a company’s identity.

Strategy is creating fit among a company’s activities. The success of a strategy depends on doing many things well—not just a few—and integrating among them. If there is no fit among activities, there is no distinctive strategy and little sustainability. Management reverts to the simpler task of overseeing independent functions, and operational effectiveness determines an organization’s relative performance.

A sound strategy is undermined by a misguided view of competition, by organizational failures, and, especially, by the desire to grow.

A number of approaches can help a company reconnect with strategy. The first is a careful look at what it already does. Within most well-established companies is a core of uniqueness.

Compromises and inconsistencies in the pursuit of growth will erode the competitive advantage a company had with its original varieties or target customers. Attempts to compete in several ways at once create confusion and undermine organizational motivation and focus. Profits fall, but more revenue is seen as the answer. Managers are unable to make choices, so the company embarks on a new round of broadening and compromises. Often, rivals continue to match each other until desperation breaks the cycle, resulting in a merger or downsizing to the original positioning.