{"id":10903,"date":"2020-07-21T18:41:00","date_gmt":"2020-07-21T22:41:00","guid":{"rendered":"https:\/\/www.shortform.com\/blog\/?p=10903"},"modified":"2020-07-27T19:20:38","modified_gmt":"2020-07-27T23:20:38","slug":"what-makes-a-good-business-strategy","status":"publish","type":"post","link":"https:\/\/www.shortform.com\/blog\/what-makes-a-good-business-strategy\/","title":{"rendered":"What Makes a Good Business Strategy? Passing The 5 Tests"},"content":{"rendered":"\n<p>What makes a good strategy in business, and why? How do you know if your strategy is good or bad?<\/p>\n\n\n\n<p>Here are five key tests for defining a good strategy, as defined by famed business professor Michael Porter. We&#8217;ll also discuss what bad strategies tend to be, and how to avoid them\/<\/p>\n\n\n\n<!--more-->\n\n\n\n<h2 class=\"wp-block-heading\"><strong>What Make a Good Business Strategy?<\/strong><\/h2>\n\n\n\n<p>If you have a real <a href=\"https:\/\/www.shortform.com\/blog\/business-competitive-advantage\/\">competitive advantage<\/a>, compared with rivals, you operate at a lower cost, command a premium price, or both. A <strong>good strategy is a set of activities that achieves competitive advantage<\/strong>.&nbsp;<\/p>\n\n\n\n<p>Strategy is not simply the value proposition itself &#8211; <strong>strategy must describe how the value is being created and delivered<\/strong>.<\/p>\n\n\n\n<p><strong>A good strategy should pass five tests:<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\"><li>Is there a distinctive value proposition?<\/li><li>Is there a unique set of activities?<\/li><li>Are the trade-offs different from rivals?<\/li><li>Do the activities fit with each other?<\/li><li>Is there continuity over time?<\/li><\/ul>\n\n\n\n<p>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.<\/p>\n\n\n\n<p>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.<\/p>\n\n\n\n<p>In one sense, <strong>strategy is choosing what not to do<\/strong>.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>Bad Strategies<\/strong><\/h3>\n\n\n\n<p>Strategy is the means by which a company, faced with competition, achieves superior profitability. Profits = Prices &#8211; Costs<\/p>\n\n\n\n<p>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.<\/p>\n\n\n\n<p>Here are examples of bad strategies that won\u2019t lead to a viable long-term advantage.<\/p>\n\n\n\n<h4 class=\"wp-block-heading\"><strong>Operational Effectiveness<\/strong><\/h4>\n\n\n\n<p>Competing using the same activities as competitors, but hoping to do it better, is often called <strong>operational effectiveness<\/strong>. This is an unsustainable strategy. Your best practices will quickly be copied by others, with the help of eager consultants, leading to <strong>competitive convergence<\/strong>.&nbsp;<\/p>\n\n\n\n<p>This leads to a competition based solely on price, where products are undifferentiated and competitors erode each other\u2019s profits.&nbsp;<\/p>\n\n\n\n<p>Competition here is zero-sum. While in the short-term this improves consumer surplus, in the long term competitors merge or die, thus decreasing <a href=\"https:\/\/www.shortform.com\/blog\/shopping-choices\/\">consumer choice<\/a>, leaving customers under-served or over-served.<\/p>\n\n\n\n<p>Poor profitability undermines investment, making it harder to improve <a href=\"https:\/\/www.shortform.com\/blog\/how-to-create-value-for-customers\/\">value for customers<\/a> or fend off rivals.<\/p>\n\n\n\n<h4 class=\"wp-block-heading\"><strong>Economies of Scale<\/strong><\/h4>\n\n\n\n<p>There are advantages to being bigger in most businesses. This insidiously promotes \u201cwinner-takes-all\u201d thinking. Mergers and acquisitions also fall into this bucket.<\/p>\n\n\n\n<p>Unfortunately, <strong><a href=\"https:\/\/www.shortform.com\/blog\/advantages-of-economies-of-scale\/\">economies of scale<\/a> are exhausted at a relatively small share of sales<\/strong>. There\u2019s little evidence showing that companies with the largest market share are the most profitable. It\u2019s critical to examine the numbers and <strong>examine the mechanism <\/strong>by which size leads to better profits.<\/p>\n\n\n\n<p>Seek to be <strong>\u201cbig enough\u201d<\/strong> &#8211; say 10% of the market &#8211; rather than to dominate it.<\/p>\n\n\n\n<h4 class=\"wp-block-heading\"><strong>Serving All Market Needs<\/strong><\/h4>\n\n\n\n<p>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.<\/p>\n\n\n\n<p>A common pitfall is that companies expect their customers to stay loyal to their brand when the company releases new products. \u201cIf customers come to us for auto loans, surely they would also come to us for home mortgages.\u201d <strong>This loyalty is often overestimated.<\/strong> Consumers are fine going to different vendors for different products, if the value is superior.<\/p>\n\n\n\n<p>In the extreme, consumer packaged goods companies like Johnson &amp; Johnson have totally different brands for different categories &#8211; you don\u2019t see Tide toilet cleaners.<\/p>\n\n\n\n<p>For example, it\u2019d be a mistake for In-N-Out to start a fancier sit-down restaurant brand like In-N-Out Gourmet, for a few reasons:<\/p>\n\n\n\n<ul class=\"wp-block-list\"><li>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.<\/li><li>This expansion would pollute the brand and what In-N-Out stands for in customers\u2019 minds.<\/li><li>Customers are happy going to other restaurants for fancier burgers. They don\u2019t need In-N-Out specifically to fill that need, nor will their loyalty to In-N-Out carry over strongly to their new product.<\/li><\/ul>\n\n\n\n<h4 class=\"wp-block-heading\"><strong>Miscellaneous Bad Strategies<\/strong><\/h4>\n\n\n\n<p>The following are not strategies, because they describe goals or tools, not <em>how<\/em> you will accomplish the goal:<\/p>\n\n\n\n<ul class=\"wp-block-list\"><li>Our strategy is to be the best. (<a href=\"https:\/\/www.shortform.com\/blog\/jack-welch-ge-leadership\/\">Jack Welch<\/a> at GE was famous for this.)<\/li><li>Our strategy is people.<\/li><li>Our strategy is to increase shareholder value.<\/li><li>Our strategy is to execute better than competitors.<\/li><li>Our strategy is [our value proposition].<\/li><\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><strong>Fit Between Activities<\/strong><\/h2>\n\n\n\n<p>Good strategies depend on the connection among many things. <strong>Fit means the value or cost of one activity is affected by the way other activities are performed<\/strong> &#8211; in other words, \u201csynergy.\u201d If the activities fit together, they each meaningfully contribute to the company\u2019s increased value or lower cost, and they work strongly together.&nbsp;<\/p>\n\n\n\n<p><strong>This is a clear departure from the (mistaken) idea of the <em>one <\/em>core competence.<\/strong> 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 \u201cresource\u201d &#8211; distribution channels, product portfolios &#8211; thus driving up cost. In reality, strong strategies are built on many unique activities that fit together to deliver the <a href=\"https:\/\/www.shortform.com\/blog\/unique-value-understanding-michael-porter\/\">unique value proposition<\/a>.<\/p>\n\n\n\n<p><strong>Fit arises in 3 ways:<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\"><li>Basic consistency: each activity aligns with the company\u2019s value proposition and contributes incrementally.<ul><li>Example: many of Southwest\u2019s activities are directionally pointed toward lowering cost and increasing convenience.<\/li><li>When activities are inconsistent, they cancel each other out.<\/li><\/ul><\/li><li>Activities complement or reinforce each other: real synergy.<ul><li>Netflix\u2019s large catalogue gives more chances to collect data points to make better recommendations.<\/li><\/ul><\/li><li>Substitution: Performing one activity makes it possible to eliminate another &#8211; within the company, or for customers\/suppliers in the value system.<ul><li>IKEA\u2019s room displays substitute for sales associates, thus lowering cost.<\/li><li>Dell will preload software onto PCs, substituting for the customer\u2019s IT department.<\/li><\/ul><\/li><\/ul>\n\n\n\n<p><strong>Fit discourages rivals in a few ways:<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\"><li>With a large range of activities, it becomes unclear which of the company\u2019s activities are most valuable to replicate.<\/li><li>For a rival to achieve the same competitive advantage, they would need to replicate <em>all<\/em> the activities, which becomes exponentially harder with each activity.<ul><li>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%.<\/li><\/ul><\/li><li>An activity that fits one value chain can punish a different value chain, if it lacks synergies with the other activities or contradicts them.<\/li><li>Activities with fit make it easier to see where the weak link in the chain is.<\/li><\/ul>\n\n\n\n<p>So what is a good strategy? Now that you know about bad strategies, you&#8217;ll have a better sense about good strategies and <a href=\"https:\/\/www.shortform.com\/blog\/how-to-achieve\/\">how to achieve<\/a> them. <\/p>\n","protected":false},"excerpt":{"rendered":"<p>What makes a good strategy in business, and why? How do you know if your strategy is good or bad? Here are five key tests for defining a good strategy, as defined by famed business professor Michael Porter. We&#8217;ll also discuss what bad strategies tend to be, and how to avoid them\/<\/p>\n","protected":false},"author":5,"featured_media":10921,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[45,14],"tags":[102],"class_list":["post-10903","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-business","category-management","tag-understanding-michael-porter","","tg-column-two"],"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v24.3 (Yoast SEO v24.3) - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>What Makes a Good Business Strategy? Passing The 5 Tests - Shortform Books<\/title>\n<meta name=\"description\" content=\"What makes a good business strategy? Not all business strategies are the same\u2014but they do all succeed. Here&#039;s what a good business strategy looks like.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.shortform.com\/blog\/what-makes-a-good-business-strategy\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"What Makes a Good Business Strategy? Passing The 5 Tests\" \/>\n<meta property=\"og:description\" content=\"What makes a good business strategy? Not all business strategies are the same\u2014but they do all succeed. 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