Strategy: Creating and Sustaining – Michael Porter

Strategy:
Creating and Sustaining

Competitive Advantage

Professor Michael E. Porter

Harvard Business School

Guayaquil, Ecuador

October 25, 2011

This presentation draws on ideas from
Professor Porter"s books and articles, in particular,
Competitive Strategy (The Free Press, 1980);
Competitive Advantage (The Free Press, 1985); "What is
Strategy?" (Harvard Business Review, Nov/Dec 1996); and
On Competition (Harvard Business Review, 2008). No part
of this publication may be reproduced, stored in a retrieval
system, or transmitted in any form or by any
means—electronic, mechanical, photocopying, recording, or
otherwise—without the permission of Michael E. Porter.
Additional information

may be found at the website of the
Institute for Strategy and Competitiveness, www.isc.hbs.edu.

20111024 – Ecuador Strategy Presentation –
v3 – October 21, 2011 – Prepared by RA Jem Hudson

Thinking
Strategically

COMPETING TO BE -> THE BEST COMPETING TO
BE UNIQUE

The worst error in strategy is to compete
with rivals on the same dimensions

Understanding the
Concept of Strategy

• Strategy is different than
aspirations

– "Our strategy is to be #1 or
#2…"

– "Our strategy is to be the world
leader…"

– "Our strategy is to
grow…"

– "Our strategy is to provide superior
returns to our shareholders…"

• Strategy is more than a
particular action

– "Our strategy is to
merge…"

– "…
internationalize…"

– "… consolidate the
industry…"

– "…
outsource…"

– "…double our R&D
budget…"

• Strategy is not the same as
vision

– "Our strategy is to provide superior
products and services…"

– "…to advance technology for
mankind…"

Strategy defines the company"s
distinctive approach to competing and the competitive
advantages on which it will be based

Setting the Right
Financial Goals

• Strategic thinking starts with
setting proper financial goals for the Company

• The fundamental goal of a company is
superior long-term return on investment

• Growth is good only if
superiority in ROIC is achieved and sustained

– ROIC threshold

• Setting unrealistic
profitability or growth targets can
undermine

Strategy

Economic
Performance versus Shareholder Value

Economic Performance ? Shareholder
Value

Economic Performance

• Sustained ROIC

• Sustainable Revenue Growth

Shareholder Value

• Stock Price

• EPS Growth

• EPS Multiple

?

• Shareholder value is the result
  of creating real economic value

• Pleasing today"s shareholders is
  not the goal

Multiple Levels
of Strategy Drive

Competitive Advantage

Competitive or Business
Strategy

• How to compete in each distinct
  business or

Industry

?

Corporate or Portfolio
Strategy

• The company"s mix of
  businesses

• The integration of business unit
  strategies

Economic
Foundations of Competition

• Competition occurs at the level of each
  distinct business or industry

• Company economic performance results
  from two distinct causes

Industry Structure ? Positioning Within the
Industry

– Industry Attractiveness – Sustainable
Competitive Advantage

?

• Strategic thinking must encompass
both areas

• Companies must focus on the health
of the industry, not just their own position

Disaggregating Economic
Performance:

Industry vs. Position

Note: "Invested capital less excess cash"
is the average of the beginning period and the ending period
values. Excess cash is calculated by subtracting cash in excess
of 10% of annual revenue.

Source: Compustat (2007), author"s
analysis

…………..
Industry Average

9. Profitability of Selected U.S.
Industries

1998 – 2008

Note: ROIC calculated as EBIT divided by
Invested Capital

Source: Compustat , author"s
calculations

10. Determinants of Industry
Profitability

Industry Structure

• 1. Rivalry Among Existing
  Competitors

• 2. Threat of Substitute Products
  or Services

• 3. Bargaining Power of
  Buyers

• 4. Threat of New
  Entrants

• 5. Bargaining Power of
  Suppliers

?

• Part of the strategy agenda is to drive
  improvements in industry structure

11. Analyzing Industry
Structure

Heavy Trucks

• 1. Rivalry Among Existing
  Competitors

• Heavy Price competition on standardized
  models

• 2. Threat of Substitute
  Products or Services

• Railroads

• Water transportation

• 3. Bargaining Power of
  Buyers

• Large fleets

• Leasing companies

• Small fleets and owner
  operators

• 4. Threat of New
  Entrants

• Many truck producers are
  assemblers

• 5. Bargaining Power of
  Suppliers

• Large independent suppliers of engines
  and drive train components

• Unionized labor

12. Industry Structure and
Positioning

Paccar

• Focus on
owner-operators

• Compete on
differentiation

– Design trucks with special
features and amenities

– Customization and
build-to-order

– Design for low truck operating
costs

– Offer extensive roadside
assistance to truckers

• Command a premium
price

?

• Paccar"s positioning limits
the negative aspects of industry structure.

13. Industry Structure in Emerging
Economies

• 1. Rivalry Among Existing
  Competitors

• Monopoly concessions

• SOEs with non-economic goals

• Distortion of competition due to price
  controls or regulations

• Protection against imports

• 2. Threat of Substitute
  Products or Services

• 3. Bargaining Power of
  Buyers

• Weak consumer protection
  laws

• Fragmented/small local
  buyers

• 4. Threat of New
  Entrants

• High barriers to entry due to local
  regulations and access to channels

• Protection limits foreign
  entry

• 5. Bargaining Power of
  Suppliers

• Protection of local
  suppliers

• Powerful foreign suppliers of know-how,
  licenses and equipment

– Industry competition in emerging
economies is often limited or distorted by government
policy or by the presence of entrenched monopolies

* Any industry can potentially
achieve high returns on investment

– Removal of government distortions
can lead to radical shifts in industry structure and
profitability

14. Strategic Positioning

Achieving Superior Relative
Performance

Differentiation (Higher Price) Lower
Cost

?

Competitive Advantage

?

Lower Cost

15. Competitive Advantage and the Value
Chain

Margin

Primary Activities

• 1. Inbound Logistics – (e.g.
  Incoming Material Storage, Data Collection, Service, Customer
  Access)

• 2. Operations – (e.g. Assembly,
  Component Fabrication, Branch Operations)

• 3. Outbound Logistics – (e.g.
  Order Processing, Warehousing, Report Preparation)

• 4. Marketing & Sales – (e.g.
  Sales Force, Promotion, Advertising, Proposal Writing, Web
  site)

• 5. After-Sales Service – (e.g.
  Installation, Customer Support, Complaint Resolution,
  Repair)

Support Activities

• 1. Firm Infrastructure – (e.g.
  Financing, Planning, Investor Relations)

• 2. Human Resource Management –
  (e.g. Recruiting, Training, Compensation System)

• 3. Technology Development – (e.g.
  Product Design, Testing, Process Design, Material Research,
  Market Research)

• 4. Procurement – (e.g. Components,
  Machinery, Advertising, Services)

* Value: What buyers are willing to
pay

• All competitive advantage resides in
  the value chain. Strategy is manifested in how activities in
  the value chain are configured and linked together

16. Defining the Value
Chain

Homebuilding

Margin

Primary Activities

• 1. Land Acquisition &
  Development – (Identify attractive markets, Secure land,
  Procure entitlements and permits, Prepare site

• 2. Construction – (Design,
  Engineering, Schedule and manage construction
  process)

• 3. Marketing & Sales – (Lead
  generation, Model home display, Sales force, Customer
  selection of personalized options)

• 4. Closing – (e.g. Customer
  Financing, Contract, Title, Closing)

• 5. After-Sales Service – (e.g.
  Warranties, Customer Complaints)

Support Activities

• 5. Firm Infrastructure – (e.g.
  Financing, Planning, Investor Relations)

• 6. Human Resource Management –
  (e.g. Recruiting, Training, Compensation System)

• 7. Technology Development – (e.g.
  Product Design, Testing, Process Design, Material Research,
  Market Research)

• 8. Procurement – (e.g. Components,
  Machinery, Advertising, Services)

• There are different ways of
  configuring the value chain in the same
  industry

17. Achieving Superior
Performance

Operational Effectiveness is Not
Strategy

OperationalEffectiveness ? Strategic
Positioning

OperationalEffectiveness

• Assimilating, attaining, and
extending best practices

?

Do the same thing better

Strategic Positioning

• Creating a unique and
sustainable competitive position

?

Do things differently to achieve a
different purpose

18. Reshaping Industry
Competition

Zero Sum Competition ? Positive Sum
Competition

Zero Sum Competition

• Compete head to
head

• One company"s gain requires
another company"s loss

• Competition often undermines
industry profitability

Positive Sum Competition

• Compete on
strategy

• More than one company can be
successful

• Competition expands the value
pool

19. What Is a Successful
Strategy?

• A unique value proposition
compared to other organizations

• A distinctive value chain
tailored to the value proposition

• Making clear tradeoffs, and choosing
what not to do

• Choices across the value chain that
fit together and reinforce each other

• Strategic continuity, with
continual improvement in realizing the strategy

Strategic
Positioning

IKEA, Sweden

Value Proposition

• Young, first time, or
price-sensitive buyers with design sophistication

• Stylish, space efficient and
compatible furniture lines and accessories at very low price
points.

Distinctive Activities

• Modular, ready-to-assemble, easy to
ship furniture designs

• In-house design of all
products

• Wide range of styles which are all
displayed in huge warehouse stores with large on-site
inventories

• Self-selection by the
customer

• Extensive customer information in
the form of catalogs, explanatory ticketing, do-it-yourself
videos, and assembly instructions

• IKEA designer names attached to
related products to inform coordinated purchases

• Suburban locations with large
parking lots

• Long hours of operation

• On-site, low-cost,
restaurants

• Child care provided in the
store

• Self-delivery by most
customers

21. Defining the Value
Proposition

?

• A novel value proposition often
expands the market

• 1. What
  Customers?

• What end users?

• What channels?

• 2. Which Needs?

• Which products?

• Which features?

• Which services?

• 3. What Relative
  Price?

• Premium? Parity?
Discount?

Strategic
Positioning

PACCAR

Value Proposition

• Highly customized trucks targeted at
owneroperators with superior amenities but low cost of use and
extensive customer support

• Command a 10% premium
price

Distinctive Activities

• Customized features and amenities
geared toward owner-operators (e.g., luxurious sleeper cabins,
plush leather seats, noise-insulated cabins, sleek exterior
styling, etc.)

• Products designed for durability and
resale value

• Industry leader in fuel efficiency
and emissions reduction, including medium duty hybrids

• Offer truck financing, leasing and
insurance services

• Provide diagnostic services for
customers (e.g., fuel efficiency, remote service
analysis)

• Flexible manufacturing system
configured for customization

• Built to order, not to
stock

• Extensive dealer network (1,800
locations) to provide extensive customer contact and aftermarket
support

• Extensive roadside assistance
network

• 24-hour parts distribution system
providing rapid

Service

23. Making Strategic
Tradeoffs

• Tradeoffs occur when strategic
positions are incompatible

Sources of Tradeoffs

– Incompatible product or service
features / attributes

– Differences in the value chain
required to best deliver the chosen value proposition

– Inconsistencies in image or
reputation across value propositions

– Organizational complexity of
delivering different value propositions

?

• Tradeoffs create the need for
choice

• Tradeoffs make a strategy
sustainable against imitation by established
rivals

• An essential part of strategy is
choosing what not to do

24. Strategic Tradeoffs

IKEA, Sweden

IKEA

Product

• Low-priced, modular,
ready-to-assemble

designs

• No custom options

• Furniture design driven by
cost,

manufacturing simplicity, and
style

Value Chain

• Centralized, in-house design of all
products

• All styles on display in huge
warehouse stores

• Large on-site inventories

• Limited sales help, but extensive
customer

information

• Long hours of operation

Typical Furniture
Retailer

Product

• Higher priced, fully assembled
products

• Customization of fabrics, colors,
finishes,

and sizes

• Design driven by image, materials,
varieties

Value Chain

• Source some or all lines from
outside

suppliers

• Medium sized showrooms with
limited

portion of available models on
display

• Limited inventories / order with
lead time

• Extensive sales
assistance

• Traditional retail hours

25. Typical Thinking About the Sources
of Competitive Advantage

• "Key" Success
Factors

• "Core"
Competencies

• "Critical"
Resources

?

• Competitive advantage is usually
seen as concentrated in a few parts

of the value chain

26. Mutually Reinforcing Activity
Choices

IKEA

• 1. Complete line of furniture
  and accessories to furnish home (MAIN)

Designer identification of compatible
lines

All items on display and instock

Year-round stocking to even out
production

• 2. Customer self delivery and
  assembly

All items on display and instock

Instructions and support for customer
assembly

Suburban locations with ample
parking

Ease of transport and assembly

"Knock-down" kit packaging

Suburban locations with ample
parking

Very large stores

• 3. Modular, scalable furniture
  designs

Designer identification of compatible
lines

Ease of transport and assembly

"Knock-down" kit packaging

In-house design focused on cost of
manufacturing

High variety, but ease of
manufacturing

• 4. Low manufacturing and
  logistical costs

In-house design focused on cost of
manufacturing

High variety, but ease of
manufacturing

100 percent sourcing from long-term
suppliers

Year-round stocking to even out
production

• 5. Self-selection by
  customer

All items on display and instock

Explanatory catalogs, informative displays
and labels

High traffic store layout

27. Strategic Continuity

• Continuity of strategy is
essential to creating and sustaining competitive
advantage

– e.g., understanding the
strategy

– building truly unique skills and
assets related to the strategy

– establishing a clear identity with
customers, channels, and other outside entities

– strengthening fit across the value
chain

• "Reinvention" and frequent
shifts in direction are costly and confuse the customer, the
industry, and the organization

?

Implications

• Maintain continuity in the value
proposition

• Continuously improve ways to
realize the value proposition

– Strategic continuity and continuous
change should occur simultaneously

• Continuity of strategy allows
faster improvement.

28. Finding a Unique Strategic
Position

• Finding a novel value
proposition

– Creative segmentation

– Understanding tradeoffs

29. Reinventing the Value
Chain

Enterprise Rent-A-Car

Value Proposition

• Home-city replacement cars to
drivers whose cars

are being repaired or who need an extra
vehicle, at

low rates (30% below airport
rates)

Distinctive Activities

• Numerous, small, inexpensive
offices, including

on-premises offices at major
accounts

• Open during daylight
hours

• Delivers cars to customers" homes or
rental sites,

or customers to cars

• Acquire new and older cars, favoring
soon-to-be

discontinued older models

• Keep cars six months longer than
other major

rental companies

• In-house reservations

• Grassroots marketing with limited
television

• Cultivate strong relationships with
auto

dealerships, body shops, and insurance
adjusters

• Hire extroverted college graduates
to encourage

community interaction and customer
service

• Employ a highly sophisticated
computer network to

track its fleet

30. Finding a Unique Strategic
Position

• Finding a novel value
proposition

– Creative segmentation

– Understanding tradeoffs

• Reinventing the value
chain

31. Strategic Positioning

Nespresso

Value Proposition

• Uniquely high quality, easy to
prepare single-serve

espresso coffee at a premium
price

• Demanding, convenience-sensitive,
affluent

consumers, and offices

Distinctive Activities

• Extra-high quality ground coffee in
16+ varieties

• Individually proportioned capsules
for freshness

and ease of use

• Tailored espresso machines
manufactured by

high-end machine vendors

• Capsules sold only online or through
about 200

coffee boutique shops in major cities, not
in mass

market food channels

• Nespresso Club to achieve high
levels of

communication with customers

• Focused image-oriented media
advertising

32. Finding a Unique Strategic
Position

• Finding a novel value
proposition

– Creative segmentation

– Understanding tradeoffs

• Reinventing the value
chain

• Anticipating industry
dynamics

• Successful strategies involve a core
strategic insight that is

improved and expanded over
time

33. Growing Strategically

1. Make the strategy even more
distinctive

– Introduce new technologies, features,
products or services that leverage other

distinctive activities within the
value chain

– Create a social dimension to the
value proposition and value chain

2. Deepen the strategic position
(rather than broaden it)

– Raise the penetration of chosen
customers / needs

3. Expand geographically to tap new
regions or countries using the same positioning

– Aggressively reposition foreign
acquisitions around the company"s strategy

4. Expand the market for what the
company can uniquely deliver

– Find other customers and segments that
value the strategy

?

• It is an illusion that growth
(and especially profitability) are easier to achieve in untapped
or growth segments

• It is difficult, and often
dangerous, to try to grow faster than the underlying
market for an extended period.

• Industry leaders should concentrate
as much, or more, on growing the category as on growing
share

• In many cases, shareholders are
actually best served by earning a high return and returning
capital, especially via dividends

Competing
Regionally and Globally

• Selling in many
nations

?

• Locating activities in
different nations

?

• Coordinating a regional or
global network

• Margin

Firm Infrastructure

Human Resource Management

Technology Development

Procurement

??

• Inbound Logistics

• Operations

• Outbound Logistics

• Marketing And Sales

• After Sales Service

35. Internationalization

Strategic Principles

• Internationalize in ways that
reinforce the company"s strategy

• Internationalize first in product
lines or customer segments where the company has the most
unique advantages

• Prioritize markets to
enter

– Similar needs and segments

– Expatriates

• Gain direct access to foreign
markets as soon as practical rather than relying solely on
intermediaries

• Use alliances selectively as
transitional strategies

– Ensure that alliances do not block
the company"s ability to gain competitive advantage and build its
own capabilities

• Locate and integrate manufacturing
and other activities from a regional
perspective

36. Why Do Good Managers Choose Bad
Strategies?

Flawed Management
Concepts

• Misunderstanding of strategy
principles

• Poor industry definition
obscures the arena in which competitive advantage is actually
determined

Pressures for Industry
Convergence

• Industry conventional wisdom
leads all companies to follow common practices

• Customers ask for
incompatible features or request new products or services that do
not fit the strategy

• Labor agreements or
regulations constrain price, product, service or process
alternatives

37. Why Do Good Managers Choose Bad
Strategies?

Management Practices

• Inappropriate cost allocation
leads to too many products, services, or customers

• Over-outsourcing makes
products and activities homogenous and less
distinctive

Organizational Incentives

• Inappropriate goals and
performance metrics bias strategy choices

– Size over profitability

– Short time horizon

• A desire for consensus blurs
strategic tradeoffs

• Rapid turnover of leadership
undermines strategy in favor of short-term performance

38. Why Do Good Managers Choose Bad
Strategies?

Capital Markets

• Search for short-term
"surprises" in earnings or revenue

• Use of industry-wide metrics
are misaligned with true economic value and drive strategic
convergence

• Encourage companies to
emulate currently "successful" peers

• Strong pressure to grow
faster than the industry

• Bias in favor of "doing
deals" (M&A)

39. Multiple Levels of Strategy Drive
Competitive Advantage

Competitive or Business
Strategy

• How to compete in each distinct
business or

Industry

?

Corporate Strategy

• Advantaged positions in
attractive industries

• Capturing synergies across
business units

40. Premises of Corporate
Diversification

• Overall corporate size per se
does not create economic value

• Competition occurs at the level of
individual businesses

• Being part of a diversified company
involves inevitable costs for business units

• Shareholders can diversify
directly at lower cost

• Successful corporate strategy must
produce a clear and offsetting benefit to the competitive
advantage of business units

– That are not possible with alternative
governance structures (e.g. alliances)

?

• The central issue in corporate
strategy is how the corporation adds competitive value to
its businesses.

41. Diversification in Emerging
Economies

Typical Business Groups

• Financial Services

• Sugar

• Airline

• Hotel

• Real Estate

• Services

• Computer

• Wholesaler

• Grocery

• Stores

• Fast Food

• Franchises

• Industrial

• Parts

• Imports/

• Distribution

• Food

• Processing

• TobaccoTextiles

• Car Dealership

42. Corporate Strategy

• Shared characters

• Shared brand

• Shared family
values

• Cross-promotions

MAIN DISNEY COMPANYS

• 1. Theme Parks

• 2. Family Motion
  Pictures

• 3. Consumer Products

• 4. Television
  Programming

• 5. Disney Records

• 6. Youth Books and Educational
  Materials

• 7. Traveling Shows

43. Creating Corporate Value
Added

• Harnessing fit across the value
chains of business units

– Sharing activities across business
units

– Leveraging proprietary knowledge and
skills across units

• Sharing corporate overhead is not
enough

44. The Process of Developing a
Strategy

• Strategy should be developed and
periodically reviewed in a formal process rather than
being left to occur spontaneously

– The process need not be highly
structured

• Business unit strategy development
is best done in a multifunctional team including the
general manager and heads of important
functions

– The strategic planning department serves
as staff

– The strategy team is relatively
small

– The team needs to work together
not separately

• Strategy development is not a
fully democratic process. The leader must ultimately

decide

• The strategy must be
communicated widely, both externally and
internally

• Enhancements to the strategy should
be discussed and implemented continuously

• A strategy review, which examines
the assumptions on which the strategy is based, should
take place formally at least once per year

45. Communicating
Strategy

• Strategy involves everyone in
an organization, not just top management

• The benefits of strategy are
greatest when it is communicated widely in the
organization

• Communicating strategy requires a
simple and vivid way of describing the essence of the
company"s unique position

– Symbols of the strategy are invaluable
tools

– Repetition

• The basic strategy and value
proposition must also be communicated to customers,
channels, suppliers, and financial markets

– What about confidentiality?

• Leaders should not assume
that subordinates understand the strategy, or that they
agree with it

– Help each organizational unit
translate the strategy into implications for its own
mandate

• Individuals who do not ultimately
accept the strategy cannot have an

ongoing role in the
company

46. The Role of Leaders in
Strategy

Commitment to strategy is tested every
day

• Drive operational
improvement, but clearly distinguish it from
strategy

• Lead the process of choosing
the company"s unique position

– The CEO is the chief
strategist

– The choice of strategy cannot be
entirely democratic

• Communicate the strategy
relentlessly to all constituencies

– Harness the moral purpose of
strategy

• Maintain discipline around
the strategy, in the face of many distractions.

• Decide which industry
changes, technologies, and customer needs to respond to, and
how

the response can be tailored to the
company"s strategy

• Measure progress against the
strategy using metrics that capture the implications of
the

strategy for serving customers and
performing particular activities

• Sell the strategy and how
to evaluate progress against the strategy to the financial
markets

?

"Commitment to strategy is tested every
day"

The Role of
Business in Society: Creating Shared Value

Professor Michael E. Porter

Harvard Business School

Guayaquil, Ecuador

October 25, 2011