Understanding Michael Porter: The Essential Guide to Competition and Strategy

by Joan Magretta

The thing about classics, as Mark Twain once observed, is that they are often books “that everybody wants to have read and nobody wants to read.”

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

In his own words, “My frameworks provide a set of logical relationships that are really fundamental. They’re like physics—if you’re going to have higher profitability, you’ve got to have a higher price or a lower cost. That industry competition is driven by the five forces. That the firm is a collection of activities. These frameworks provide basic, fundamental, and I believe unchangeable relationships about the ‘matter’ of competition.”

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.

Fans of GE’s legendary CEO Jack Welch say their strategy is to be number 1 or number 2 in their business (or else!). For the new CEO of a Fortune 100 company, the strategy is “to grow.” For an energy company executive, the strategy is to “make key acquisitions.” A software developer says, “Our strategy is our people.” The strategy of a leading nonprofit is to “double the number of people we serve.” And then there is Google’s famous “Don’t be evil.” Is that a strategy? By the time you reach the end of this book, you will appreciate why none of the above would qualify as a “strategy,” which for Porter is shorthand for “a good competitive strategy that will result in sustainably superior performance.”

But none of them really tackles the core question, performance in the face of competition.

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

If you want to win, it’s obvious that you should be the best. Or is it?

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.

Business competition is more complex, more open ended and multidimensional. Within an industry, there can be multiple contests, not just one, based on which customers and needs are to be served.

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.

If rivals all pursue the “one best way” to compete, they will find themselves on a collision course.

But even if this particular move benefited the industry overall, when all rivals compete on the same dimension, no one gains a competitive advantage.

Too often the goal is chosen because it sounds good, whether or not the economics of the business support the logic. In industry after industry, Porter notes that economies of scale are exhausted at a relatively small share of industry sales.

Companies only have to be “big enough,” which rarely means they have to dominate.

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.*

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.

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

value is ultimately defined by customers.

Competing to be the best feeds on imitation. Competing to be unique thrives on innovation.

Actual practice is always messier than the frameworks that help us to see important patterns.

competition is multidimensional, and strategy is about making choices along many dimensions, not just one.

The real point of competition is not to beat your rivals. It’s not about winning a sale. The point is to earn profits. Competing for profits is more complex. It’s a struggle involving multiple players, not just rivals, over who will capture the value an industry creates.

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

First, as different from one another as industries might appear on the surface, the same forces are at work under the skin.

Second, industry structure determines profitability—not,

Structure trumps these other, more intuitive, categories.

Before Porter, the prevailing framework for sizing up the environment was called SWOT, short for strengths, weaknesses, opportunities, and threats. Its intent was correct—to relate the company to its environment—but the tool was weak. If you’ve sat through a SWOT exercise, you know what I mean.

the more powerful the force, the more pressure it will put on prices or costs or both, and therefore the less attractive the industry will be to its incumbents.

The Fundamental Equation: Profit = Price – Cost

Costs include all of the resources used in competing, including the cost of capital.

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

Does producing in larger volumes translate into lower unit costs? If there 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?

It costs about a billion dollars to develop a new operating system for a PC, costs that are recovered in a matter of weeks if you have Microsoft’s scale.

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.

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.

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

Growth alone says nothing about the power of customers or the availability of substitutes.

The untested assumption that a fast-growing industry is a “good” industry, Porter warns, often leads to bad strategy decisions.

Typical Steps in Industry Analysis

Define the relevant industry by both its product scope and geographic scope. What’s in, what’s out?

“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.”

good strategies are like shelters in a storm. Five forces analysis will give you a weather forecast.

competitive advantage. You hear it in companies all the time, but rarely as Porter intended. Used loosely, as it most often is, it has come to mean little more than anything an organization thinks it is good at.

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.

If strategy is to have any real meaning at all, Porter argues, it must link directly to your comp...

What is the right goal for strategy? How should you measure competitive success? Porter is sometimes criticized for not paying enough attention to people, to management’s softer side. Yet he is adamant about the importance of setting the right goal, a view that couldn’t be more people-centric.

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.