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Understanding Michael Porter by Joan Magretta.
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What is Competition?

Aim to be unique, not the “best.” Create unique value, don’t focus on just beating rivals. There is no “best” in any industry, just like there is no “best performance artist.” There are different buyer needs, and there can be multiple winners.

For example, McDonald’s is a winner in fast food and fast burgers. But In-N-Out deliberately focuses on slow burgers, with non-processed meat and fresher ingredients. Both are winners in their own right. They’re each playing their own sport.

Competition is about profits, not market share. There is no glory in growth if it’s profitless.

The Five Forces

Why are some industries consistently more profitable than others? What makes information technology so stereotypically profitable, while airlines are a cutthroat, low-margin grind?

To see an industry holistically, consider Porter’s famous Five Forces. The Five Forces that matter in any industry are:

  • Buyers
  • Suppliers
  • Substitutes
  • Incumbents
  • New entrants

The more powerful the force, the more pressure it will put on decreasing prices or increasing costs, or both.

What is Strategy?

A distinctive value proposition, and a tailored value chain to deliver it, are the foundation of strategy. Your activities need to be different from rivals to have a meaningful strategic difference.

If you have a real competitive advantage, compared with rivals, you operate at a lower cost, command a premium price, or both. A good strategy is a set of activities that achieves competitive advantage.

A good strategy should pass five tests:

  • Is there a distinctive value proposition?
  • Is there a unique set of activities?
  • Are the trade-offs different from rivals?
  • Do the activities fit with each other?
  • Is there continuity over time?

A good strategy delivers distinctive value through a distinctive value chain. It must perform different activities from rivals, or perform similar activities in different ways.

If the activities reinforce each other, imitating them all is difficult. If they involve trade-offs, your activities may contradict those of competitors, making it difficult for them to plunge in.

In one sense, strategy is choosing what not to do.

Don’t feel you have to make every customer happy. Trying to be something for everyone means you’re nothing to everyone. Make some customers unhappy.

Define what your company will not do. This is as important as defining what your company will do. Trade-offs make competitive advantage sustainable - rivals with different value chains will find it difficult to adopt your activities.

Instead of a single core competence, think of an interconnected web of activities that reinforce each other. This makes replication much more difficult.

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Understanding Michael Porter Summary Chapter 1: What is Competition?

Business is often compared to sports or war because of dramatic appeal. A clash between business titans is dramatized to the conflict between nation-states or to a national sports championship.

However, this metaphor is counterproductive when taken too far. War and sports are unidimensional and imply one victor. In business, this leads to the syndrome of “competition to be the best.”

But business is multidimensional. Buyers have a wide range of needs, and different companies can exist to service those different needs without demolishing each other. There are multiple contests that can support multiple winners.

For example, McDonald’s is a winner in fast food and fast burgers. But In-N-Out deliberately focuses on slow burgers, with non-processed meat and fresher ingredients. Both are winners in their own right. They’re each playing their own sport.

In business, your default thought should not be “how do I win this market,” but rather “which segment of the industry can I service well?”

There’s no such thing as “the best.” Is there a best car? A best hamburger? The best meal? If the answer is no, why would it make any more sense in your industry?

A better analogy than war might be performing arts. There can be many good singers, each outstanding in a distinctive way, each with its own captive audience.

The point of competition is not beating your rivals. The point is to earn profits.

Bad Strategies

Strategy is the means by which a company, faced with competition, achieves superior profitability. Profits = Prices - Costs

As explained in the rest of the book, a superior strategy is a combination of unique activities that is hard to replicate, allowing you to increase prices for superior value and/or decrease costs uniquely.

Here are examples of bad strategies that won’t lead to a viable long-term advantage.

Operational Effectiveness

Competing using the same activities as competitors, but hoping to do it better, is often called operational effectiveness. This is an unsustainable strategy. Your best practices will quickly be copied by others, with the help of eager consultants, leading to competitive convergence.

This leads to a competition based solely on price, where products are undifferentiated and competitors erode each other’s profits.

Competition here is zero-sum. While in the short-term this improves consumer surplus, in the long term competitors merge or die, thus decreasing consumer choice, leaving customers under-served or over-served.

Poor profitability undermines investment, making it harder to improve value for customers or fend off rivals.

Economies of Scale

There are advantages to being bigger in most businesses. This insidiously promotes “winner-takes-all” thinking. Mergers and acquisitions also fall into this bucket.

Unfortunately, economies of scale are exhausted at a relatively small share of sales. There’s little evidence showing that companies with the largest market share are the most profitable. It’s critical to examine the numbers and examine the mechanism by which size leads to better profits.

Seek to be “big enough” - say 10% of the market - rather than to dominate it.

Serving All Market Needs

By trying to be something for everyone, you risk being everything to no one. In contrast, competitors who focus on a specific need will attract that segment of customers.

A common pitfall is that companies expect their customers to stay loyal to their brand when the company releases new products. “If customers come to us for auto loans, surely they would also come to us for home mortgages.” This loyalty is often overestimated. Consumers are fine going to different vendors for different products, if the value is superior.

In the extreme, consumer packaged goods companies like Johnson & Johnson have totally different brands for different categories - you don’t see Tide toilet cleaners.

For example, it’d be a mistake for In-N-Out to start a fancier sit-down restaurant brand like In-N-Out Gourmet, for a few reasons:

  • Their current activities are ill-suited for servicing the new segment. Starting a sit-down restaurant and operating a fast food restaurant require very different activities, some of them contradictory.
  • This expansion would pollute the brand and what In-N-Out stands for in customers’ minds.
  • Customers are happy going to other restaurants for fancier burgers. They don’t need In-N-Out specifically to...

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Understanding Michael Porter Summary Chapter 2: The Five Forces

Why are some industries consistently more profitable than others? What makes information technology so stereotypically profitable, while airlines are a cutthroat, low-margin grind?

When trying to find an answer, it’s tempting to focus on the competition between rivals. But the bigger is picture than this. Rivals aren’t just competing with each other. They’re also engaged in a struggle for profits with all the other players in the ecosystem - like customers, who would always like to pay less and get more, and are eager to substitute a product for a better alternative.

To see an industry holistically, consider Porter’s famous Five Forces. The Five Forces that matter in any industry are:

  • Buyers
  • Suppliers
  • Substitutes
  • Incumbents
  • New entrants

The more powerful the force, the more pressure it will put on decreasing prices or increasing costs, or both.

We’ll examine each force in turn, considering scenarios in your advantage as an incumbent. Scenarios in your disadvantage are usually the inverse of advantageous scenarios, so only notable alternatives will be listed.

Note that every adjacent industry has its own Five Forces, so that their relative disadvantage can be your gain (e.g. a fragmented supplier group is bad for suppliers but good for you).

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Force 1: Buyers

What this is:

  • Customers who pay for your product
  • Channels that influence the purchase decisions of end-users
    • Retailers like Home Depot, Amazon
    • Advisers like doctors, investment managers

What it does:

  • Lowers prices, since powerful buyers will demand lower prices or else
  • Increases costs, since powerful buyers demand more value or else

Scenarios in your advantage:

  • If you’re large relative to buyers (i.e. buyers are fragmented)
    • Truck maker Paccar appeals directly to individual owner-operators through comfort and customization, rather than brands like Peterbilt that appeal to large corporate buyers (more consolidated).
  • High switching costs to your competitors
    • Risk aversion dissuades buyers from trying new things.
    • Habits get people accustomed to your product.
  • Low switching costs to you
  • Information asymmetry - inability to price compare, measure quality

Scenarios in your disadvantage:

  • Price sensitivity by buyers. This is more likely when your industry’s products are:
    • Undifferentiated
    • Expensive relative to the buyer’s other costs
    • Inconsequential to the buyer’s own performance
  • Buyers are consolidated relative to you and competitors

Force 2: Suppliers

What this is:

  • Providers of any direct input into your product
  • Distribution channels, marketing
  • Labor

What it does:

  • Increases costs, since powerful suppliers can demand higher prices or else

Scenarios in your advantage:

  • Your size relative to a supplier (higher % of supplier’s sales coming from you)
    • (Shortform example: Groupon aggregated buyers to exert pricing power over small restaurants, yielding tremendous short-term success. Unfortunately, over time restaurants realized this was unprofitable and dropped out.)
    • (Shortform example: the Internet brought marginal distribution cost to zero, allowing aggregators like Google and Facebook to amass consumer attention to exert control over information suppliers like media companies, eventually commoditizing them.)
  • Low switching costs for you to change to alternate suppliers
  • You can credibly threaten to vertically integrate into the supplier’s industry.
    • Coca-Cola can threaten to produce its own cans.
    • (Shortform example: Google produces its own phones to lower bargaining power of manufacturers who use Android.)

Scenarios in your disadvantage:

  • Labor unions
    • Unions consolidate labor into a forceful bloc, wielding large negotiating power with employers.
    • In the airline industry, unions restricted who could be employed to wave planes back from gate, increasing costs for airports and airlines.
  • When the industry needs suppliers more than suppliers need the industry
    • In other words: when suppliers have many alternative buyers in other industries, or when your industry is a small fraction of sales for your suppliers.
  • High switching costs for you to change suppliers
    • The PC industry has been beholden to Microsoft, because the switching cost of its customers to another operating system is huge.

Force 3: Substitutes

What this is:

  • Any product not directly in your industry that basically can do the same job as you
  • Examples:
    • For coffee as a caffeine vehicle, substitutes are energy drinks, tea.
    • For food delivery, substitutes are eating in restaurants, microwaved food, and groceries.
    • For human tax preparers, substitutes are TurboTax and doing it independently.
    • OPEC has fended off substitutes by managing the price of oil to prevent prices from going so high that investment in oil alternatives becomes attractive.

What it does:

  • Lowers prices to avoid buyers going to substitutes
  • Increases costs, since incumbents compete with substitutes to provide superior value

Scenarios in your advantage:

  • If you can offer a better price-to-performance ratio
    • Note this does not mean that the lower price always wins. It’s a higher value for the same price, or same value for lower price, or variations thereof.
  • Solving a segment’s problems better than alternatives
    • A segment of buyers may hire human accountants to outsource complexity and time in preparing their own tax returns. For this segment, TurboTax is insufficient for their needs.
  • High switching cost

Notes:

  • Substitution has a cascading effect from upstream...

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Shortform Exercise: Study Your Five Forces

Study the Five Forces in your industry to understand its overall profitability. Discover which forces influence your success the most.


Who are the buyers in your industry? Are they concentrated or fragmented? Do they have high or low switching costs to competitors? Are they price sensitive? Overall, how strong is this force?

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Understanding Michael Porter Summary Chapter 3: Competitive Advantage

The Five Forces analysis suggests the profitability of an industry, but it does not automatically suggest how you should operate in the industry to maximize profits.

First, we’ll unpack why some companies are more profitable than average. Then we’ll see how a unique value chain is the mechanism by which superior profits are achieved.

Competitive Advantage

If you have a real competitive advantage, compared with rivals, you operate at a lower cost, command a premium price, or both.

The goal of every organization is to produce goods or services whose value exceeds the sum of the costs of all inputs. Thus, Porter proposes the best metric is Return on Invested Capital (ROIC). ROIC tells you how well a company is using all its resources.

If you have a real competitive advantage, your ROIC will be sustainably higher than the industry average.

Instead of ROIC, many companies focus on inferior metrics:

  • Return on sales: ignores the capital invested in the business
  • Growth or market share: the game is not to be the biggest in the industry. Too many companies pursue unprofitable growth that never leads to good ROIC.
    • “Market share says we just want to be big; we don’t care if we make money doing it.” - Herb Kelleher
    • If you think growing large will be a winning strategy, remember that returns to scale may be illusory and cap out sooner than you think.
  • Stock price: these reflect value only in the long run. In the short-term, focusing on stock prices causes earnings management and encourages mimicking other companies.

Because Profits = Prices - Costs, you can achieve superior profits through increasing your relative price, or decreasing your relative cost, or both. As we’ll discuss later, these advantages should be achieved through a unique mix of activities that are difficult to replicate.

Quantify your org’s long-term profitability against the overall economy, then against the average return in your industry. Keep digging to understand why it’s performing better or worse than average - relative price and relative cost.

  • If you have a 5% higher return, is that because your price is 8% higher and cost 3% higher, or price is 5% lower and costs 10% lower?

Relative Price

Create more buyer value and you raise willingness to pay. The ability to command a higher price is differentiation, in Michael Porter’s terminology.

  • With corporate buyers, decisions are often rational and relative value can be quantified (eg a superior machine offsetting labor costs).
  • With consumers, buying decisions are more likely to have an emotional or intangible dimension. Rarely do they figure out what they are paying for convenience.
    • The author notes that consumers pay $100/hour for grating cheese.

Examples

  • People are more willing to pay for Apple products than Android products of similar specifications, because of Apple’s software ecosystem, habit, and emotion.
  • Organic foods sell at higher prices than conventional foods because of health, taste, and environmental concerns.

Relative Cost

You can also produce at lower cost than your rivals. This might come from lower operating costs or using capital more efficiently.

  • Sustainable cost advantages usually involve many parts of the company, not just one function. The culture of low cost permeates the entire company.
  • Distinguish this from being “low-cost producers,” which implies that cost advantages come only from production.

Examples

  • Unlike vertically integrated rivals like HP, Dell built custom computers using outsourced components. It carried little inventory and didn’t make its own components. As the prices of components rapidly fell, Dell’s balance sheet was kept healthier.
  • Vanguard, IKEA, Southwest all have business models and cultures that reinforce low-cost value. Their network of low-cost activities go far beyond merely being low-cost producers.

Value Chain

Ultimately, a company’s strategy needs to be mapped onto what is actually done - the activities of a company. Activities are discrete economic functions or processes, like managing parts of a supply chain, operating a sales force, developing products, or delivering to the customer.

  • Thinking about a company in terms of functions, like marketing or logistics, is too broad for strategy. Activities need to get granular.

The value chain is the sequence of activities that transform inputs into your products - including design, production, selling, delivery, and support. The value chain disaggregates a company into its strategically relevant activities to focus on the sources of competitive advantage.

  • This provides a transformation on what a business does. See each activity not just as a cost, but a step that has to add some increment of value.
  • Each activity may then be compared for the advantage it provides the company. Low-value high-cost activities might be discarded to better serve your target customer.

Your value chain is part of a larger value system, the set of activities involved in creating value from the end user (including activities that are outside your company, like in suppliers or distributors).

  • Upstream, a car company buys tires from a tire specialist, and will need to think about whether to vertically integrate to produce its own tires.
  • Downstream, a car company needs to think about how people can afford cars, and may support financing credit.

Ultimately, you bear responsibility to your customers for all steps of the value system. Customers don’t care if your suppliers are at fault, so you have to cover potential upstream and downstream problems.

  • McDonald’s needs to ensure supply of potatoes, which requires seeing potato farmers as part of the value system.

Companies that have different strategies should have different value chains. If you have the same value chain as another competitor, you’re competing on...

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Understanding Michael Porter Summary Part 2: What Is Strategy?

If you have a real competitive advantage, compared with rivals, you operate at a lower cost, command a premium price, or both. A good strategy is a set of activities that achieves competitive advantage.

Strategy is not simply the value proposition itself - strategy must describe how the value is being created and delivered.

A good strategy should pass five tests:

  • Is there a distinctive value proposition?
  • Is there a unique set of activities?
  • Are the trade-offs different from rivals?
  • Do the activities fit with each other?
  • Is there continuity over time?

A good strategy delivers distinctive value through a distinctive value chain. It must perform different activities from rivals, or perform similar activities in different ways.

If the activities reinforce each other, imitating them all is difficult. If they involve trade-offs, your activities may contradict those of...

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Understanding Michael Porter Summary Chapter 4: Creating Value

The value proposition is the piece of strategy that looks outward at customers, the demand side. The value chain looks internally on operations. Strategy is integrative, bringing supply and demand sides together.

Unique Value Proposition

A distinctive value proposition answers three questions:

  • Which customers are you going to serve?
  • Which of your customers’ needs are you going to meet?
  • What price will provide acceptable customer value and acceptable company profitability?

Value propositions tend to focus on one aspect as a pillar, with the other applying to varying degrees. For example, focusing on a particular customer need can blur traditional demographic bounds. Likewise, a company can focus on a demographic and serve most of their needs.

Compare your value proposition to your rivals. If you’re servicing the same customers, with the same needs, at the same price, you don’t have a strategy. You’re just competing to the best.

Less obviously, it’s possible to be stuck in the middle - if you try to be too many things, you’ll be outflanked by cost leaders on one side (who are “just good enough”) and by differentiators on the other side (who satisfy customers who want more). Avoid the temptation to serve more customers and offer more features.

Your value proposition may also imply advantages based on the Five Forces.

Examples of a Unique Value Proposition

Serving a distinctive demographic

  • Walmart began by servicing small towns with populations below 10,000, which other discount retailers deliberately stayed away from. (These towns could usually support only one store, increasing barrier of entry.)
  • Progressive Insurance began by servicing higher risk customers that other insurance companies rejected. (With few alternatives, they had lower bargaining power.)

Serving distinctive customer needs

  • Hertz provided cars at airports to business and leisure travelers. Enterprise focused on short-term rentals for city residents. One use case was for a driver whose regular car needed repairs; this led to insurance companies being buyers and making up a third of revenues.
  • In turn, Zipcar offered even shorter rental periods of hours, and extreme convenience of location, booking, and simple pricing.

Focusing on a distinctive price point

  • Focus on customers who are currently underserved (by building a premium offering), or overserved (by stripping away a premium offering).
  • Traditional airlines focused on expansive service between any point A to point B, with perks like food built in. Southwest offered low-cost fares with no frills. It saw its competition as cars and buses, not other airlines.

Unique Value Chain

A good strategy delivers distinctive value through a distinctive value chain. It must perform different activities from rivals, or perform similar activities in different ways.

Otherwise, a “unique” value proposition delivered through the same activities will prohibit differentiation/cost advantage, leading to competition to be the best. Also, if the same value chain can deliver the same value proposition, it has no strategic relevance.

Even if the product looks identical, there are many opportunities along the value chain for differentiation - delivery, disposal, support, financing, and more.

When finding a new strategic position, starting with the value proposition is intuitive, but starting with the value chain is equally valid. This is what companies do when they identify their strengths, then figure out how they can apply it to a customer need.

Examples of Unique Value Chains

  • How could Progressive make high-risk customers work financially, where others had failed? They further segmented groups to find pockets of lower risk - motorcycle riders over 40 years old; drivers with accident history who have children. They also decreased cost of accidents by having inspectors issue checks on the spot, thus decreasing lawsuits.
  • Enterprise leased locations in the city rather than airport rental areas, which were more convenient for their customers and also cheaper. Their target customers were less picky about cars, allowing Enterprise to stock budget, older vehicles. It marketed to insurance companies and car dealerships, rather than expensive consumer ads.
  • Low-cost, high-volume Aravind Eye Hospital operationalized eye surgery, optimizing surgeon’s time by prepping the next patient as the operation was ongoing.
  • Southwest made a host of changes to support their lower prices. Where traditional airlines serviced every point A to point B through a hub...

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Understanding Michael Porter Summary Chapter 5: Strategic Trade-offs

Trade-offs are strategic forks in the road. If you take one path, you cannot simultaneously take the other. The choices are incompatible.

  • For example, in contrast to hub-and-spoke models, Southwest uses a direct-flight model. You’re either hub-and-spoke, or you’re direct-flight. There is little middle ground.
  • Likewise, Southwest didn’t serve meals at a time when most airlines did. You either serve food, or you don’t.

Trade-offs force you to limit your value proposition. With trade-offs, your activities can be tailored/optimized to your value proposition. Without tailoring, your value chain will have inefficiencies that more focused competitors will exploit.

Trade-offs also make it difficult for competitors to copy what you do without compromising their own strategies. In a situation with strong trade-offs, your competitors’ activities, tailored to their value proposition, are incompatible with your activities.

Trade-offs arise in three ways:

  • Product trade-offs: Tailoring a product to suit one need makes it less capable of servicing another need.
    • McDonald’s fast and cheap hamburgers are incompatible with the needs of a health-conscious farm-to-table eater.
    • In 1987, major semiconductor companies manufactured their own chips and sold excess capacity to smaller firms. These smaller firms feared that the major companies would steal their IP. Taiwan Semiconductor made the choice to be a strictly OEM manufacturer, selling IP security as part of its offering.
    • Home Depot innovated with huge warehouses with well-trained associates to appeal to DIYers and contractors, mostly male. In response, Lowe’s appealed to women (the driving force for home improvement projects) through more inviting stores and inventory emphasizing home fashion, appliances, and decoration.
  • Operational trade-offs: Activities that deliver one kind of value are less efficient at producing another kind of value. If an activity is over- or under-designed for its use, value will be destroyed.
    • A value chain for deliveries that optimizes cheap shipping that arrives in weeks requires different activities from fast shipping that arrives in hours.
    • The value chain that services In-N-Out’s fresh never-frozen hamburgers is not suited for McDonald’s frozen, lower-cost hamburgers.
  • Brand trade-offs: Muddling the brand identity compromises why fans support the brand.
    • Ferrari can’t put out a minivan, and Mini can’t put out a supercar.

Robust strategies incorporate multiple trade-offs. The best strategies have trade-offs at almost every step in the value chain.

Mistakes with Trade-Offs

Straddling/Scope Creep

The temptations to be something for everyone are strong. Willfully ignoring large segments of customers feels like leaving growth on the table. Product designers want their products to do more to get more users. “The customer is always right,” and we want to make all customers happy!

Pressures from financial and management observers are also strong:

  • Financial analysts want every company to look like the market favorite.
  • Consultants benchmark you against everyone else in the industry, perhaps choosing the wrong metrics for your business (same-store sales, or revenue per employee). If you’re choosing a different positioning, different metrics will be relevant.
  • Short-term stock traders put pressure on companies to enact change, while strategy takes years to build.

These itches push companies to straddle their trade-offs, matching the benefits of a different successful position while maintaining its existing position. This can mean designing a product or value chain that services contradictory needs. This leads to inefficiencies, creating openings for focused rivals to deliver superior value or lower prices to customers.

Example: BA started a low-cost airline Go Fly as an independent subsidiary. But Go Fly retained features from BA that were hard to remove, like seat assignments and food service. It sold Go Fly to a private equity firm, which was able to make more of it.

  • (Shortform note: this also suggests the difficulty of having a company disrupt itself, especially when the new subsidiary is funded by the parent org. The subsidiary will tend not to be as aggressive as a fully independent competitor that actively seeks to harm its rivals.)

The lesson: deliberately choose not to serve all customers and needs. Otherwise, you risk doing a poor job of serving any customers and needs. Deliberately make some customers unhappy.

Enduring companies have been surprisingly adamant about not compromising their original mission, willfully forsaking short-term growth and defending its key trade-offs against many attacks. Instead of broadening your strategic position, deepen and extend it.

(Shortform note: note that this necessarily suggests inflexibility in company strategy, even in the face of disruption. Applied to Blockbuster in 2000, this approach would suggest, “Your value chain is focused on in-store rentals. Trying to service mail rentals will compromise your advantage.” This can lead to wishful thinking like “people love the experience of walking through stores and holding DVDs. We need to preserve this advantage.” In hindsight, this would be wrong.

From a societal point of view, Porter might say “companies come and go; it’s better for companies that are disrupted to stick to their guns in the case their need endures, rather than straddle and burn capital on a losing strategy.”

So Understanding Michael Porter isn’t as strong in prescribing what to do in the face of rivalry or disruption - it doesn’t guide on how to respond to encroachment from rivals, and how to tell when expanding scope compromises your value chain or not.)

Operational Ineffectiveness Paradox

Typically, cost and quality need to trade against each other. It’s difficult to find a situation where you can reduce cost while...

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Shortform Exercise: What Not to Do

Look at your value chain, and think about the tradeoffs.


What is your unique value proposition? Which customers are you going to serve? Which of your customers’ needs are you going to meet? What relative price will you offer?

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Understanding Michael Porter Summary Chapter 6: Fit Between Activities

Good strategies depend on the connection among many things. Fit means the value or cost of one activity is affected by by the way other activities are performed - in other words, “synergy.” If the activities fit together, they each meaningfully contribute to the company’s increased value or lower cost, and they work strongly together.

This is a clear departure from the (mistaken) idea of the one core competence. If strategy truly is based on one core competence, then it becomes relatively easy to replicate. More often, industries compete fiercely to control the one key “resource” - distribution channels, product portfolios - thus driving up cost. In reality, strong strategies are built on many unique activities that fit together to deliver the unique value proposition.

Fit arises in 3 ways:

  • Basic consistency: each activity aligns with the company’s value proposition and contributes incrementally.
    • Example: many of Southwest’s activities are directionally pointed toward lowering cost and increasing convenience.
    • When activities are inconsistent, they cancel each other out.
  • Activities complement or reinforce each other: real synergy.
    • Netflix’s large catalogue gives more chances to collect data points to make better recommendations.
  • Substitution: Performing one activity makes it possible to eliminate another - within the company, or for customers/suppliers in the value system.
    • IKEA’s room displays substitute for sales associates, thus lowering cost.
    • Dell will preload software onto PCs, substituting for the customer’s IT department.

Fit discourages rivals in a few ways:

  • With a large range of activities, it becomes unclear which of the company’s activities are most valuable to replicate.
  • For a rival to achieve the same competitive advantage, they would need to replicate all the activities, which becomes exponentially harder with each activity.
    • As a simplistic example, say there are 5 activities that give a company a competitive advantage. If the chance of replicating one activity is 90%, then the chance of replicating all of them is 0.9^5, or 62%.
  • An activity that fits one value chain can punish a different value chain, if it lacks synergies with the other activities or contradicts them.
  • Activities with fit make it easier to see where the weak link in the chain is.

Case Study: IKEA Strategy

Let’s examine a masterpiece of strategy in IKEA. Their mission is to deliver stylish furniture at low prices. Their activities show clear trade-offs and strong fit:

  • Furniture is disassembled and requires self-assembly, reducing assembly cost and allowing storage in compact boxes.
    • Assembling furniture yourself also seems to increase your enjoyment of it, maybe because of endowment effect.
  • Compact boxes reduce freight shipping costs from the manufacturer.
  • Compact boxes allow buyers to more easily transport furniture to their homes with little assistance.
    • This means time from buying to having furniture in your house is much faster than shipped furniture.
  • IKEA stores are huge warehouses in large suburban locations with highway access. With large parking lots and loading zones, they allow customers to self-service and deliver their own furniture.
  • IKEA showrooms have minimal staff, with the entire inventory laid out for buyers to peruse.
  • IKEA cafeterias are self-service and customers are encouraged to bus their own trays.
  • IKEA designs its own products, allowing trade-offs in styling and cost.
  • Furniture has few customization options, allowing production in bulk and bargaining at scale.
  • A narrower catalogue also allows IKEA to keep its warehouses fully stocked, instead of requiring shipping.

Many of these activities fit together and reinforce each other to provide low-priced furniture. The furniture’s self-assembled design reduces manufacturing costs, storage costs, shipping costs from manufacturer, and shipping costs to customers. In turn, IKEA’s locations make the furniture’s self-assembled design even more effective.

Note how each activity is distinctly a trade-off: you either have furniture disassembled or not. You either have salespeople on the showroom floor or not.

Many traditional furniture retailers practice the inverse of IKEA’s value chain. If they tried to adopt one of IKEA’s activities, they’d find it less compatible with their own value chain, and so they’d gain very little of IKEA’s competitive advantage.

Note too that, in making these tradeoffs, IKEA is deliberately alienating customer groups - those who want furniture ordered seamlessly to their homes, who want nice salespeople to guide them through options, who want unique and fancifully designed furniture.

Activity System Map

To visualize the strength of fit between activities, place the activities on a map.

  • Start by placing the key components of the value proposition.
  • Make a list of the activities most responsible for competitive advantage
  • Add each activity to the map. Draw lines wherever there is fit: when the activity contributes to value proposition, or when two activities affect each other

Here’s an example for IKEA:

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A densely interconnected activity map is a good sign. A sparsely connected map shows weak strategy.

The activity map isn’t useful just for description of your current strategy. It can also be used for ideation for new strategies:

  • Can you improve fit between activities?
  • Can you find ways for an activity to substitute for another?
  • Can you find new activities or enhancements to what you already do?
  • Are there new products or features you can offer because of your activity map, that rivals will find difficult to emulate?

Case Study: Zara

Fast fashion brand Zara is another strategy powerhouse....

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Understanding Michael Porter Summary Chapter 7: Continuity of Strategy

The last component of strategy is continuity. Companies need breathing room to hone their activities and develop competitive advantage over time. Strategy isn’t a stir fry, it’s a stew - it takes time for the flavors and textures to develop.

  • The richly developed strategies of IKEA or Southwest took years, decades to hone.
  • Strategies often begin with 2 or 3 essential choices, then adding additional activities to extend the fit.

Continuity strengthens a company’s position in three ways:

  • Branding and customer relationships: customers will know what the company stands for, and what needs they can and can’t meet.
  • Partners: suppliers, channels, and complements learn to contribute to a company’s advantage.
    • Dell had suppliers co-locate warehouses nearby
    • (Shortform example: Amazon works with manufacturers to repackage goods in shipping-friendly forms)
  • Team and internal culture: hiring for cultural fit and training employees improves. People make better decisions that fit company strategy

It takes years to implement a strategy. Switching strategies too often is value destroying, causing whiplash in the org and dismantling of value chains.

Maintaining Strategy

Continuity doesn’t mean an organization should stand still. As long as there is stability in the core value proposition, there should be innovation in how it’s delivered.

First, companies must stay on the frontier of operational effectiveness. You must assimilate best practices that do not conflict with your strategy or cause negative trade-offs.

  • BMW embraced OE improvements to decrease design time, but stopped short of steps that would remove its unique design language.

Second, you must change whenever there are ways to extend your value proposition or better ways to deliver it.

  • Reuter started with spreading market information through pigeons, then moving onto telegraph and the Internet.
  • Netflix began with direct to customer movie DVDs, then switched to Internet streaming as soon as it became feasible.

Adapting Strategy to Changes

Unlike what some argue, a rapidly changing environment is not an excuse to avoid strategy. Their flawed thinking goes: “Strategy requires a prediction of the future. I can’t predict the future. Therefore, I can’t commit to a strategy.” They try to stay flexible by avoiding commitment.

But flexibility never allows the company to stand for anything or become great at anything. The mass of competitors will yield more focused rivals with clear value propositions who will attract customers instead.

Says former Ford CEO Alan Mulally: “Strategy is about a point of view about the future and then making decisions based on that. The worst thing you can do is not have a point of view, and not make decisions.”

Great strategies are rarely built on a concrete prediction of the future. They’re just based on a broad sense of which customers and needs are going to be robust 5-10 years from now. Strategy is implicitly a bet that these needs, and the accompanying trade-offs, will be enduring.

  • Southwest bet that people would continue to want low-cost convenient transportation.
  • In-N-Out bet that people would continue to want simple fresh burgers and fries.

A strategy is a guiding force that shows you how to adapt to the new world. You know who you’re trying to serve, what needs you’re trying to meet, and your price - this filters what matters and makes priorities clearer.

  • Without a strategy, a clear value prop, you don’t know which changes are relevant to your org, and you get distracted by every shiny object. It’s debilitating to embrace every new technology coming your way.

When Should Environmental Changes Prompt Strategy Changes?

  • When changing customer needs mean a company’s core value proposition becomes obsolete.
    • Blockbuster’s focus on physical stores faltered when customers were content browsing a catalog online and renting for cheaper prices.
  • When innovation invalidates the trade-offs on which a strategy relies.
    • Dell’s cost advantage was neutralized by the rise of Taiwanese Original Design Manufacturers, which let rivals outsource design and assembly to efficient producers.
  • When a technological or managerial breakthrough trumps a company’s existing value proposition. A truly disruptive technology invalidates current value chains and makes it difficult for incumbents to match because of their existing assets.
    • ...

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Understanding Michael Porter Summary Epilogue: FAQ with Porter

At the end of the book, the author sits down with Michael Porter to discuss commonly asked questions about strategy.

How do you grow without compromising your strategy?

  • Never copy another company. Learn from it and see how it can be modified to reinforce your strategy.
  • Deepen your strategic position, don’t broaden it. Don’t settle for 50% of your target segment - get 80%.
  • Expand geographically. Look for the segment that values what you do - don’t compete with the existing systems. Don’t worry too much about the differences in the new market. Contact the customer directly instead of through a distributor.

What if you can’t grow?

  • Pay higher dividends and enjoy the creation of wealth. Don’t take massive risks growing beyond the capacity of your strategy and industry structure.

Beware of disruption not just from below (classic Clayton Christiansen) but also from above (when a premium product is stripped down to meet less sophisticated needs).

In a new market space, how do you build strategy and analyze the Five Forces before the industry has matured?

  • Rather than analyzing what exists, you’re forecasting what will happen.
  • You know your customers, suppliers, substitutes, and entry barriers pretty well. What you don’t know yet is what rivals you’ll have - new entrants, incumbents in adjacent industries.

What’s a good strategic planning process?

  • Bring the whole team together and build the plan. You can’t divide the work and staple it together at the end.
    • There is no good marketing strategy in a vacuum - it fits the overall strategy.
  • Have a formal process with regular touchpoints - for instance, once every year or with quarterly reviews.

How do you communicate strategy?

  • Strategy is useless if nobody else in the org knows what the strategy is. Communicating strategy aligns everyone’s behavior and helps them make good choices independently.
  • How do you communicate it to the team?
    • Find a concise and memorable way to explain your strategy.
    • Help individual units translate what that means for every activity.
    • Good leaders are strategy professors - they’re teaching strategy all the time. They repeat the value proposition endlessly and encourage their reports to give the same speech.
  • How do you communicate it externally?
    • Tell your customers, suppliers, channels, and capital markets. This will get them to act to support your strategy.
    • If...

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Table of Contents

  • 1-Page Summary
  • Chapter 1: What is Competition?
  • Chapter 2: The Five Forces
  • Exercise: Study Your Five Forces
  • Chapter 3: Competitive Advantage
  • Part 2: What Is Strategy?
  • Chapter 4: Creating Value
  • Chapter 5: Strategic Trade-offs
  • Exercise: What Not to Do
  • Chapter 6: Fit Between Activities
  • Chapter 7: Continuity of Strategy
  • Epilogue: FAQ with Porter