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February 11 - March 13, 2023
Strategy is not fast food, and neither is Porter.
“The essence of strategy,” Porter often says, “is choosing what not to do.”
Porter’s is the rare intellect that successfully bridges the divide between economic theory and business practice.
It’s a broader struggle over profits, a tug-of-war over who will capture the value an industry creates.
Instead, use the framework to gain insight about your industry’s performance and your own.
In this way, competitive advantage is about how your value chain will be different and your P&L better than the industry average.
The key to competitive success—for businesses and nonprofits alike—lies in an organization’s ability to create unique value.
Strategy explains how an organization, faced with competition, will achieve superior performance. The definition is deceptively simple.
prices. In business, multiple winners can thrive and coexist.
The best always depends on what you are trying to accomplish. 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.
Competing to be the best leads inevitably to a destructive, zero-sum competition that no one can win.
Meanwhile, BMW, small by industry standards, has a history of superior returns. Over the past decade (2000–2009), its average return on invested capital was 50 percent higher than the industry average.
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.
The lesson taught in Econ 101 is that what’s good for customers (lower prices) is bad for companies (lower profits), and vice versa.
When an industry converges around a standard offering, the “average” customer may fare well. But remember that averages are made up of some customers who want more and some who want less. There will be individuals in both groups who will not be well served by the average.
The needs of some customers may be overserved by what the industry offers. In plain English, you will pay more for features you don’t need.
Instead of competing to be the best, companies can—and should—compete to be unique.
Instead, competition is multidimensional, and strategy is about making choices along many dimensions, not just one. No
It’s not about winning a sale. The point is to earn profits.
These five forces—the intensity of rivalry among existing competitors, the bargaining power of buyers (the industry’s customers), the bargaining power of suppliers, the threat of substitutes, and the threat of new entrants—determine the industry’s structure, an important concept that may sound academic but is not (figure 2-1
Powerful buyers will force prices down or demand more value in the product, thus capturing more of the value for themselves.
It’s no surprise, then, that CEMEX, a leading producer in both countries, earns higher returns in Mexico, and not because it creates more value in its home market. In effect, CEMEX is competing in two distinct industries, each with its own structure.
This rule, now gone, was effectively a job creation program for the high-paid mechanics, and a profit drain for the airline industry.
This is why environmentalists favor higher gas taxes.
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.
Entry barriers protect an industry from newcomers who would add new capacity.
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.
The five forces framework applies in all industries for the simple reason that it encompasses relationships fundamental to all commerce.
Why is current industry profitability what it is? What’s propping it up? What’s changing? How is profitability likely to shift? What limiting factors must be overcome to capture more of the value you create?
then, industry structure is dynamic, not static.
This misses the mark in important ways. For Porter, competitive advantage is not about trouncing rivals, it’s about creating superior value.
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.
It is also, Porter points out, the only measure that matches the multidimensional nature of competition: creating value for customers, dealing with rivals, and using resources productively. ROIC
“‘Market share has nothing to do with profitability,’ he says. ‘Market share says we just want to be big; we don’t care if we make money doing it. That’s what misled much of the airline industry for fifteen years, after deregulation. In order to get an additional 5 percent of the market, some companies increased their costs by 25 percent. That’s really incongruous if profitability is your purpose.’”
If a company has a COMPETITIVE ADVANTAGE, it can sustain higher relative prices and/or lower relative costs than its rivals in an industry.
Create more buyer value and you raise what economists call willingness to pay (WTP), the mechanism that makes it possible for a company to charge a higher price relative to rival offerings.
The ability to command a higher price is the essence of differentiation, a term Porter uses in this somewhat idiosyncratic way.
Strategy choices aim to shift relative price or relative cost in a company’s favor.
The same big idea applies to nonprofits as well. Remember, competitive advantage is fundamentally about superior value creation, about using resources effectively.
We now have a concise, concrete definition of competitive advantage: superior performance resulting from sustainably higher prices, lower costs, or both.
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 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 (or, if your organization is a nonprofit, the activities that result in higher value for those you serve or lower costs in serving them).
Donated wheelchairs: A value chain example
In the United States, from 1992 to 2006, the average company earned about 14.9 percent return on equity
Until a company understands where its profit performance comes from, it will be ill equipped to deal with it strategically.
to understand why the business is performing better or worse than the industry average. Disaggregate your relative performance into its two components: relative price and relative cost. Relative price and cost are essential for understanding strategy and performance.
You begin to see each activity not just as a cost, but as a step that has to add some increment of value to the finished product or service.
Although managers often talk about how their organization’s skills or capabilities create value, activities are where the rubber meets the road.
a difference in relative price or relative costs that arises because of differences in the activities being performed (see figure 3-6).
Wherever a company has achieved competitive advantage, there must be differences in activities.
