Understanding Michael Porter: The Essential Guide to Competition and Strategy

by Joan Magretta

Although the spotlight is more often directed at companies that change too little, Porter’s fifth test is about an equal, if not greater, mistake: companies can change too much, and in the wrong ways. It takes time to develop real competitive advantage, to understand the value you create, to achieve tailoring, trade-offs, and fit. If you grasp the role of continuity in strategy, it will change your thinking about change itself.

In business, multiple winners can thrive and coexist. Competition focuses more on meeting customer needs than on demolishing rivals. Just look around.

For Porter, strategic competition means choosing a path different from that of others. Instead of competing to be the best, companies can—and should—compete to be unique. This concept is all about value. It’s about uniqueness in the value you create and how you create it.

“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.”

To recap quickly, 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.

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 segmentation. Instead of belonging to a clear demographic category, the company’s customers will be defined by the common need or set of needs they share at a given time.

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.

A distinctive value proposition, Porter explains, will not translate into a meaningful strategy unless the best set of activities to deliver it is different from the activities performed by rivals. His logic is simple and compelling: “If that were not the case, every competitor could meet those same needs, and there would be nothing unique or valuable about the positioning.”

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.

Even when an industry produces something that looks like a homogenous product, Porter points to many opportunities up and down the value chain for differentiation—in delivery, in disposal, in certification and testing, and in financing, to name just a few dimensions.

The first misconception is about trade-offs themselves. Managers tend to believe that “more is always better.” More customers, more products, more services mean more sales and profits. You can have it all. You can do both A and B. If you choose either one or the other, you’ll be leaving money on the table. Making trade-offs is almost a sign of weakness.

And remember that competitive advantage is not just something you’re good at, it’s something that’s reflected in your P&L.

Maintaining and steepening trade-offs, making them even sharper, is essential to sustaining strategy.

By their very nature, trade-offs are choices that make strategies sustainable because they are not easy to match or to neutralize. If there are no trade-offs, any good idea can be copied. Product features can be copied. Services can be copied. Ways of delivering value can be copied. But where there are trade-offs, the copycat will pay an economic penalty.

This is the slippery slope that leads to competition to be the best. When you try to offer something for everyone, you tend to relax the trade-offs that underpin your competitive advantage.

Executives often resist making trade-offs for fear they will lose some customers. The irony is that unless they make trade-offs and deliberately choose not to serve all customers and needs, then they are unlikely to do a good job of serving any customers and needs.

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 trade-offs, that companies can be genuinely responsive to other needs. Put another way, the role of trade-offs in strategy is deliberately to make some customers unhappy.

An activity map can help you identify ways to strengthen fit. Managers responsible for each activity can usually tell you whether their performance is impaired by other activities. They may also have ideas about how to improve the fit across activities. Look beyond basic consistency. Can you find new ways in which activities can reinforce each other or where one activity can substitute for others?

An activity map might also spur creativity about how to make a strategy more sustainable. Can you find new activities, or enhancements to what you already do, whose cost or effectiveness is improved by your existing activity system? Are there services, features, or product varieties that you can offer (and rivals cannot) because of the other things that you already do? Extensions like these will be the hardest for rivals to imitate.

Instead of trying to determine which activities are core, Porter asks a different question: 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.

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

the first two tests—a unique value proposition and a tailored value chain—are the core of a strategy. Trade-offs, 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.

A good strategy, consistently maintained over time through repeated interactions with customers, is what gives power to a brand.

For the very same reasons that continuity is valuable, companies pay a high price for frequent shifts in strategy. These require reconfiguration of activities and realigning entire systems. Customers and value chain partners have to be reeducated about what the company is now trying to do, which typically means heavy reinvestments in brand and image.

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

First, as customer needs change, a company’s core value proposition may simply become obsolete. Often, as needs shift, companies are able to evolve to serve them, but not always. The real problem occurs when the needs disappear.

Second, innovation of all sorts can serve to invalidate the essential trade-offs on which a strategy relies.

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.

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.

It is debilitating for an organization to feel it must serve every new need that emerges or embrace every new technology that comes its way. But when everyone understands the value proposition, an organization can jump at new trends that allow it to be more distinctive in meeting the needs of its customers. It can sift through the sea of changes around it and quickly grasp which ones are relevant.

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

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Too often, companies believe that any growth is good growth. They have a tendency to overshoot, by adding product lines, market segments, or geographies that blur uniqueness, create compromises, reduce fit, and ultimately undermine competitive advantage.

Here are some thoughts about how to grow profitably without destroying your strategy. First, never copy. Companies always are confronted with opportunities for new products, new services, or moving into adjacent customer groups. How should you think about that? If your competitor has a good idea, learn from it, think about what that innovation accomplishes, but don’t just copy it. Figure out how the idea could be adapted and modified in order to reinforce your strategy. Is it relevant to the needs you’re trying to serve? Could it be used to reinforce what makes you unique? You don’t have to jump on every trend. But if the trend is relevant, tailor it to your strategy.

Second, deepen your strategic position, don’t broaden it. A company can usually grow faster—and far more profitably—by better penetrating needs and customers where it is distinctive than by slugging it out in potentially higher growth arenas in which the company lacks uniqueness. So 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.

Another problem I see is that companies tend to be very diversified. They still compete in lots of businesses that are very different. It’s important to recognize when the time comes to put that model aside, and to move to greater focus in your business groups, where you can put together businesses that can leverage each other, which can enhance your competitive advantage, which can make your position more unique.

There’s no such thing as a good marketing strategy. There’s only a good marketing strategy in the context of the overall strategy. 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.

That’s why a strategic plan needs to involve the whole management team working together to think about the industry, the competitors, the opportunities, the value chain, and then ultimately make some choices about positioning and direction. Then, the team needs to develop the implications for action.