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

by Michael E. Porter

Too often, efforts to grow blur uniqueness, create compromises, reduce fit, and ultimately undermine competitive advantage. In fact, the growth imperative is hazardous to strategy.

What approaches to growth preserve and reinforce strategy? Broadly, the prescription is to concentrate on deepening a strategic position rather than broadening and compromising it. One approach is to look for extensions of the strategy that leverage the existing activity system by offering features or services that rivals would find impossible or costly to match on a stand-alone basis. In other words, managers can ask themselves which activities, features, or forms of competition are feasible or less costly to them because of complementary activities that their company performs.

Deepening a position involves making the company’s activities more distinctive, strengthening fit, and communicating the strategy better to those customers who should value it.

Globalization often allows growth that is consistent with strategy, opening up larger markets for a focused strategy. Unlike broadening domestically, expanding globally is likely to leverage and reinforce a company’s unique position and identity.

Companies seeking growth through broadening within their industry can best contain the risks to strategy by creating stand-alone units, each with its own brand name and tailored activities.

Strategy renders choices about what not to do as important as choices about what to do. Indeed, setting limits is another function of leadership. Deciding which target group of customers, varieties, and needs the company should serve is fundamental to developing a strategy. But so is deciding not to serve other customers or needs and not to offer certain features or services. Thus strategy requires constant discipline and clear communication.

one of the most important functions of an explicit, communicated strategy is to guide employees in making choices that arise because of trade-offs in their individual activities and in day-to-day decisions.

The operational agenda is the proper place for constant change, flexibility, and relentless efforts to achieve best practice. In contrast, the strategic agenda is the right place for defining a unique position, making clear trade-offs, and tightening fit.

competition for profits goes beyond established industry rivals to include four other competitive forces as well: customers, suppliers, potential entrants, and substitute products.

A healthy industry structure should be as much a competitive concern to strategists as their company’s own position. Understanding industry structure is also essential to effective strategic positioning. As we will see,

defending against the competitive forces and shaping them in a company’s favor are crucial to strategy.

By analyzing all five competitive forces, you gain a complete picture of what’s influencing profitability in your industry.

New entrants to an industry bring new capacity and a desire to gain market share that puts pressure on prices, costs, and the rate of investment necessary to compete. Particularly when new entrants are diversifying from other markets, they can leverage existing capabilities and cash flows to shake up competition,

It is the threat of entry, not whether entry actually occurs, that holds down profitability.

Supply-side scale economies deter entry by forcing the aspiring entrant either to come into the industry on a large scale, which requires dislodging entrenched competitors, or to accept a cost disadvantage.

Buyers may also value being in a “network” with a larger number of fellow customers.

It is important not to overstate the degree to which capital requirements alone deter entry. If industry returns are attractive and are expected to remain so, and if capital markets are efficient, investors will provide entrants with the funds they need.

These advantages can stem from such sources as proprietary technology, preferential access to the best raw material sources, preemption of the most favorable geographic locations, established brand identities, or cumulative experience that has allowed incumbents to learn how to produce more efficiently.

the strategist must be mindful of the creative ways newcomers might find to circumvent apparent barriers.

Return on invested capital (ROIC) is the appropriate measure of profitability for strategy formulation, not to mention for equity investors.

we utilize earnings before interest and taxes divided by average invested capital less excess cash as the measure of ROIC. This measure controls for idiosyncratic differences in capital structure and tax rates across companies and industries.

Powerful suppliers, including suppliers of labor, can squeeze profitability out of an industry that is unable to pass on cost increases in its own prices.

Many elements of the five forces can be quantified: the percentage of the buyer’s total cost accounted for by the industry’s product (to understand buyer price sensitivity); the percentage of industry sales required to fill a plant or operate a logistical network of efficient scale (to help assess barriers to entry); the buyer’s switching cost (determining the inducement an entrant or rival must offer customers).

can capture more value by forcing down prices, demanding better quality or more service (thereby driving up costs), and generally playing industry participants off against one another, all at the expense of industry profitability.

Intermediate customers gain significant bargaining power when they can influence the purchasing decisions of customers downstream.

substitute performs the same or a similar function as an industry’s product by a different means. Videoconferencing is a substitute for travel. Plastic is a substitute for aluminum. E-mail is a substitute for express mail.

When the threat of substitutes is high, industry profitability suffers. Substitute products or services limit an industry’s profit potential by placing a ceiling on prices. If an industry does not distance itself from substitutes through product performance, marketing, or other means, it will suffer in terms of profitability—and often growth potential.

Strategists should be particularly alert to changes in other industries that may make them attractive substitutes when they were not before. Improvements in plastic materials, for example, allowed them to substitute for steel in many automobile components.

Rivalry is especially destructive to profitability if it gravitates solely to price because price competition transfers profits directly from an industry to its customers. Price cuts are usually easy for competitors to see and match, making successive rounds of retaliation likely. Sustained price competition also trains customers to pay less attention to product features and service.

As important as the dimensions of rivalry is whether rivals compete on the same dimensions. When all or many competitors aim to meet the same needs or compete on the same attributes, the result is zero-sum competition. Here, one firm’s gain is often another’s loss, driving down profitability.

Rivalry can be positive sum, or actually increase the average profitability of an industry, when each competitor aims to serve the needs of different customer segments, with different mixes of price, products, services, features, or brand identities. Such competition can not only support higher average profitability but also expand the industry, as the needs of more customer groups are better met.

With a clear understanding of the structural underpinnings of rivalry, strategists can sometimes take steps to shift the nature of competition in a more positive direction.

Industry structure, as manifested in the strength of the five competitive forces, determines the industry’s long-run profit potential because it determines how the economic value created by the industry is divided—how much is retained by companies in the industry versus bargained away by customers and suppliers, limited by substitutes, or constrained by potential new entrants.

By considering all five forces, a strategist keeps overall structure in mind instead of gravitating to any one element.

Indeed, some fast-growth businesses, such as personal computers, have been among the least profitable industries in recent years. A narrow focus on growth is one of the major causes of bad strategy decisions.

The best way to understand the influence of government on competition is to analyze how specific government policies affect the five competitive forces.

Complements affect profitability through the way they influence the five forces.

Eliminating rivals is a risky strategy, however. The five competitive forces tell us that a profit windfall from removing today’s competitors often attracts new competitors and backlash from customers and suppliers.

Every company should already know what the average profitability of its industry is and how that has been changing over time. The five forces reveal why industry profitability is what it is. Only then can a company incorporate industry conditions into strategy.

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

When industry structure is in flux, new and promising competitive positions may appear. Structural changes open up new needs and new ways to serve existing needs. Established leaders may overlook these or be constrained by past strategies from pursuing them. Smaller competitors in the industry can capitalize on such changes, or the void may well be filled by new entrants.

A firm can lead its industry toward new ways of competing that alter the five forces for the better. In reshaping structure, a company wants its competitors to follow so that the entire industry will be transformed. While many industry participants may benefit in the process, the innovator can benefit most if it can shift competition in directions where it can excel.

An industry’s structure can be reshaped in two ways: by redividing profitability in favor of incumbents or by expanding the overall profit pool.

Redividing the industry pie aims to increase the share of profits to industry competitors instead of to suppliers, buyers, substitute...

Expanding the profit pool involves increasing the overall pool of economic value generated by the industry in which rivals, b...

The strategist’s goal here is to reduce the share of profits that leak to suppliers, buyers, and substitutes or are sacrificed to deter entrants.

Defining the industry too broadly obscures differences among products, customers, or geographic regions that are important to competition, strategic positioning, and profitability. Defining the industry too narrowly overlooks commonalities and linkages across related products or geographic markets that are crucial to competitive advantage.

The boundaries of an industry consist of two primary dimensions. First is the scope of products or services.

The second dimension is geographic scope.

Sysco emphasized value-added services to buyers such as credit, menu planning, and inventory management to shift the basis of competition away from just price.