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1 Copyright 2007 © Professor Michael E. Porter20071129 – Romania - Final.ppt

Professor Michael E. PorterHarvard Business School

Bucharest, RomaniaNovember 30, 2007

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); “Strategy and the Internet” (Harvard Business Review, March 2001); and a forthcoming book. 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. Version: November 26, 2007, 6pm

On Strategy and Leadership


How Managers Think About Competition

COMPETING TO BE THE COMPETING TO BE THE BESTBEST

COMPETING TO BE THE COMPETING TO BE THE BESTBEST

COMPETING TO BE COMPETING TO BE UNIQUEUNIQUE

COMPETING TO BE COMPETING TO BE UNIQUEUNIQUE

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


Flawed Concepts of Strategy

• Strategy as action– “Our strategy is to merge…”

– “… internationalize…”

– “… consolidate the industry…”

– “… outsource…”

• Strategy as aspiration– “Our strategy is to be #1 or #2…”

– “Our strategy is to grow…”

– “Our strategy is to be the world leader…”

• Strategy as vision– “Our strategy is to meet our customers’ needs…”

– “… offer superior products…”

– “…to advance technology for mankind…”


Vision Statements

Autodesk

Transforming business by design

Avon

To be the company that best understands and satisfies the product, service and

self-fulfillment needs of women – globally.

Goodyear Tire and Rubber

Become a market-focused tire company providing superior products and

services to end-users and to our channel partners, leading to superior

returns for our shareholders.

Lafarge

To be the undisputed world leader in building materials

Marriott International, Inc.

To be the number one lodging company in the world.


Setting the Right Goals

• 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

• Profitability must be measured realistically, capturing the actual profits on the full investment

• Prevalent accounting adjustments to reported profitability (e.g., writeoffs, restructuring charges) can obscure true economic performance and lead to bad competitive choices

• Profitability metrics besides ROIC (e.g., return on sales; ebitda margin; pro-forma earnings; and cash flow margin) are risky for strategy

• Goodwill must be treated as part of investment

• Setting unrealistic profitability or growth targets can undermine strategy


Economic Performance versus Shareholder Value

Economic Economic PerformancePerformanceEconomic Economic

PerformancePerformance Shareholder ValueShareholder ValueShareholder ValueShareholder Value

• Sustained ROIC

• Sustainable Revenue Growth

• Stock Price

• EPS

• EPS Growth

• Shareholder value is the result of creating real economic value

• Pleasing today’s shareholders is not the goal


Economic Foundations of Competition

IndustryIndustryStructureStructureIndustryIndustryStructureStructure

Relative Position Relative Position Within the Within the

IndustryIndustry

Relative Position Relative Position Within the Within the

IndustryIndustry

- Overall Rules of Competition - Sources of Competitive Advantage

• The fundamental unit of strategic analysis is the industry− Defining the relevant industry is important to strategy

• Company economic performance results from two distinct causes

• Strategy must encompass both


Disaggregating Economic Performance: Industry vs. Position

0%

5%

10%

15%

20%

25%

30%

35%

Reebok International Paccar

Return on Invested Capital

1985-2002

25.4%

30.8%

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

31.4%

Industry Average

9.6%


0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

AirlinesCatalog, Mail-Order Houses

HotelsKnitting Mills

Soft Drink BottlingOil and Gas MachineryLaboratory Equipment

Book PublishingEngines and Turbines

Bakery ProductsWine and Brandy

Mobile HomesCookies and Crackers

Iron and Steel FoundriesGrocery Stores

Drug StoresHousehold Furniture

Child Day Care ServicesMalt Beverages

Household AppliancesTires

Mens and Boys ClothingSurgical and Medical Instruments

SemiconductorsDistilled Spirits

Advertising AgenciesPerfume,Cosmetic,Toilet Prep

PharmaceuticalsPrepackaged Software

Soft DrinksSecurity Brokers and Dealers

Profitability of Selected U.S. Industries1992 - 2006

Return on invested capital, 1992 – 2006 average

ROIC = Earnings before interest and taxes divided by invested capital less excess

cash

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

Average industry ROIC in the US:14.9%


Determinants of Industry Profitability

Threat of SubstituteProducts or Services

Threat of New Entrants

Rivalry AmongExisting

Competitors

Bargaining Powerof Suppliers

Bargaining Powerof Buyers


Strategic Implications of Industry Structure

• Large suppliers of engines and drive train components

Bargaining Power Bargaining Power of Suppliersof Suppliers

Bargaining Power Bargaining Power of Suppliersof Suppliers


Competitors


Competitors



Threat of New Threat of New EntrantsEntrants


Threat of SubstituteThreat of SubstituteProducts or Products or

ServicesServices

Threat of SubstituteThreat of SubstituteProducts or Products or

ServicesServices

• Many truck producers are assemblers

• Heavy price competition on standardized models

• Large fleets• Leasing companies• Owner operators

• Railroads• Water transportation

1. Positioning to Mute the Five Forces

Heavy Truck Industry


Paccar Competitive Positioning

• Focus on owner-operators

• Design trucks with special features and amenities

• Customization and build-to-order

• Achieve low truck operating costs

• Offer extensive roadside assistance to truckers


Strategic Implications of Industry Structure

Bargaining Power of Bargaining Power of SuppliersSuppliers

Bargaining Power of Bargaining Power of SuppliersSuppliers


Competitors


Competitors

Bargaining PowerBargaining Powerof Buyersof Buyers

Bargaining PowerBargaining Powerof Buyersof Buyers



Threat of SubstituteThreat of SubstituteProducts or ServicesProducts or ServicesThreat of SubstituteThreat of Substitute

Products or ServicesProducts or Services

• Food processors

• Food cooperatives

• Farmers

• Low barriers to entry

• Distributors–Purchasing–Warehousing–Delivery

• Restaurants

• Schools

• Hospitals

• Cafeterias

• Other food service establishments

• Go direct

• Use retail / warehouse channels

2. Shaping Industry Structure

Foodservice Distribution Industry


Reshaping Industry StructureFoodservice Distribution

• Offering value-added services

• Offering private-label products

• Moving to national procurement contracts

• Increasing the use of sophisticated information technology


Determinants of Relative Performance

Differentiation(Higher Price)

Lower Cost

CompetitiveAdvantage

CompetitiveAdvantage


Economics of Strategic PositioningSouthwest Airlines

0

2

4

6

8

10

12

Southwest Airline Industry Average

Cents per ASM

Note: ASM (Available Seat Miles) defined as total seats available multiplied by miles flownSource: Airline annual reports and author’s calculations

Operating Profit per Available Seat Mile

Operating Cost per Available Seat Mile

Cost Advantage:2.44

Pricing Differential:1.72

Revenue and Cost per Available Seat Mile, Average of 1998 - 2000


• Competing in a business involves performing a set of discrete activities, in which competitive advantage resides

Foundations of Economic PerformanceThe Value Chain

SupportActivities

Marketing& Sales

(e.g. Sales Force,

Promotion, Advertising,

Proposal Writing, Web

site)

InboundLogistics

(e.g. Incoming Material

Storage, Data Collection,

Service, Customer Access)

Operations

(e.g. Assembly, Component Fabrication,

Branch Operations)

OutboundLogistics

(e.g. Order Processing,

Warehousing, Report

Preparation)

After-Sales Service

(e.g. Installation, Customer Support,

Complaint Resolution,

Repair)

M

a

r

g

i

n

Primary Activities

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

Procurement(e.g. Components, Machinery, Advertising, Services)

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

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

Value

What buyers are willing to pay


Firm Infrastructure(Strategic Planning, Finance, Control, Administration, Legal, Safety, Risk Management)

Human Resource Management(HR, Training, Recruiting)

Technology Development(Information Technology, Business Systems)

M

a

SupportActivities

Defining the Value ChainCommercial Construction

Source: Interviews with Suffolk managersNote: Risk Management and Legal department are part of the firm infrastructure, but they also play a role specific to each project during the contracting phase

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

Client Development

Marketing Business

development Client

relationship management

Pipeline management

Bidding and Selection

Bidding Project risk

assessment Securing

insurance coverage

Pre-Construction

Obtaining permits and licenses

Site preparation Estimation of

pricing, materials, and schedule

Advanced ordering of materials

Subcontractor contracting

ConstructionManagement

Managing the client interface

Architect and engineering coordination

Site management

Coordinating logistics

Updating documentation

ProjectCloseout

Site cleanup Manage

subcontractors’ transition out of the site

Preparing final documentation

Client satisfaction survey

r

g

i

n

After-Completion

Support Ongoing

customer support

Warranties

Procurement(Materials, Subcontractors, Services)

Primary Activities


• Creating a unique and sustainable competitive position

• Assimilating, attaining, and extending best practices

OperationalOperationalEffectivenessEffectiveness

StrategicStrategicPositioningPositioning

Run the same race faster Choose to run a different race

Achieving Superior PerformanceOperational Effectiveness is Not Strategy


Five Tests of a Good Strategy

• A unique value proposition compared to other organizations

• A different, tailored value chain

• Clear tradeoffs, and choosing what not to do

• Activities that fit together and reinforce each other

• Strategic continuity with continual improvement in realizing the strategy

• A unique value proposition compared to other organizations




• Strategic continuity with continual improvement in realizing the strategy


Strategic PositioningEnterprise Rent-A-Car

• Home-city replacement cars for drivers whose cars are being repaired or who need an extra vehicle, at low rates (30% below airport rates)

• Numerous, small, inexpensive offices in each metropolitan area, including on-premises offices at major accounts

• Open during daylight hours

• Deliver cars to customers’ homes or rental sites, or deliver 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 the fleet

Value PropositionValue PropositionValue PropositionValue PropositionDistinctiveDistinctiveActivitiesActivities

DistinctiveDistinctiveActivitiesActivities


Defining the Value Proposition

What Relative What Relative Price?Price?

What Relative What Relative Price?Price?

What What Customers?Customers?

What What Customers?Customers?

Which Which Needs?Needs?Which Which

Needs?Needs?

• What end users?

• What channels?

• Which products?

• Which features?

• Which services?

• A novel value proposition can also grow the pie/expand the industry


Strategic PositioningIKEA, Sweden

• Young, first time, or price-sensitive buyers who want stylish, space efficient and scalable furniture and accessories at very low price points.

• Modular, ready-to-assemble, easy to package designs

• In-house design of all products

• Wide range of styles in huge warehouse stores with large on-site inventories

• Self-selection

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

• Use Ikea designer names on products to inform coordinated purchases

• Child care provided in the store

• On-site, low-cost, restaurants

• Long hours of operation

• Suburban locations with large parking lots

• Principally self-delivery by customers

Distinctive Distinctive ActivitiesActivities

Distinctive Distinctive ActivitiesActivitiesValue PropositionValue PropositionValue PropositionValue Proposition


Strategic PositioningGOL Airlines, Brazil

• Convenient, no-frills airline service between 41 Brazilian and nearby international cities at very low prices competing with bus transportation

• Price sensitive business (60%) and leisure travelers

• No-frills service

• Many flights during late night hours

• On time performance

• Quick airport turn-around

• Utilize aircraft more hours per day

• Single aircraft type (Boeing 737s)

• 80% reservations made via the Internet




Making Strategic Tradeoffs

• Tradeoffs occur when strategic positions are incompatible

– the need for a choice

Sources of Tradeoffs

– Incompatible product / service features or attributes

– Differences in the best configuration of activities in the value chain to deliver the chosen value proposition

– Inconsistencies in image or reputation across positions

– Limits on internal coordination, measurement, motivation, and control

• Tradeoffs make a strategy sustainable against imitation by established rivals

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


Strategic TradeoffsNeutrogena Soap (1990)

• Forgo cleaning, skin softening, and deodorizing features

• Choose higher costs through the configuration of:

– packaging

– manufacturing

– detailing

– medical advertising

– skin research

• Give up the ability to reach customers via:

– promotions

– television

– some distribution channels


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

Strategic TradeoffsIKEA, Sweden

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• Extensive customer information but limited

sales support• Long hours of operation

IKEAIKEAIKEAIKEA Typical Furniture RetailerTypical Furniture RetailerTypical Furniture RetailerTypical Furniture Retailer


Recent Thinking on the Sources of Competitive Advantage

• “Key” Success Factors

• “Core” Competencies

• “Critical” Resources

• “Key” Success Factors

• “Core” Competencies

• “Critical” Resources

• Competitive advantage is seen as concentrated in a few parts of the value chain


Mutually Reinforcing Activities Zara Apparel

Source: Draws on research by Jorge Lopez Ramon (IESE) at the Institute for Strategy and Competitiveness, HBS

Wide range of

styles

Customers Customers chic but chic but

cost-cost-consciousconscious

• Fit is leveraging what is different to be more different

Tight coordination

with 20 wholly-owned

factories

JIT delivery

Little media advertising

Word-of-Word-of-mouth mouth

marketing marketing and repeat and repeat

buyingbuying

Global team of trend-

spotters

Advanced productio

n machiner

y

Cutting- Cutting- edge fashion edge fashion at moderate at moderate

price and price and qualityquality

Prime store Prime store locations in locations in high traffic high traffic

areasareas

Extensive use of store sales data

Majority of

production in

Europe

Very Very flexible flexible

production production systemsystem

Very Very frequent frequent product product changeschanges


Strategic Continuity

• Continuity of strategy is fundamental to sustainable competitive advantage– e.g., allows the organization to understand the strategy– building truly unique skills and assets related to the strategy– establishing a clear identity with customers, channels, and other outside entities– strengthening the fit across the value chain

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

• Maintain continuity in the value proposition

• Successful companies continuously improve in how they realize their value proposition– Strategic continuity and continuous change should occur simultaneously. They are not

inconsistent

• Continuity of strategy allows learning and change to be faster and more effective


Barriers to Strategy

Flawed Management Concepts

• Misunderstanding of strategy itself

• Poor industry definition

Industry Pressures

• Industry conventional wisdom leads all companies to follow common practices

• Labor agreements limit ways of configuring activities

• Regulation constrains price, product, service or process alternatives

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


Overcoming Barriers to Strategy

Internal Practices

• Inappropriate goals and performance metrics bias strategy choices

– Short time horizon

• Rapid turnover of leadership undermines strategic direction to achieve short-term performance benefits

• A desire for consensus blurs strategic tradeoffs

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

• Outsourcing makes activities homogenous and less distinctive


Internal Barriers to StrategyNeutrogena Soap (2005)

• Prior to the 1990’s Neutrogena was the number one brand recommended by dermatologists

• Neutrogena had a relatively narrow target market but deep penetration and high customer loyalty

• Beginning in the early- to mid-1990’s, new growth-oriented management shifted Neutrogena from a dermatologist-focused marketing concept to mass market television advertisements and celebrity endorsements

• Neutrogena lost market share while Gallderma’s Cetaphil captured the loyalty of dermatologists, and prospered

Source: Draws on research conducted at the Institute for Strategy and Competitiveness and interviews conducted with a former Neutrogena executive.


Integrating Strategy and Corporate Social Responsibility

• There is a long-term synergy between economic and social objectives

• Company competitiveness and social conditions can both improve

• Business cannot solve all of society’s problems, nor bear the cost of doing so

• Business must approach its social agenda strategically

• Where is a company able to have the greatest social impact?


Strategic PositioningWhole Foods Markets

• Natural, fresh, organic, and prepared foods and health items with excellent service at premium prices

• Educated, middle class, and affluent customers passionate about food as a part of a healthy lifestyle

• Well-lit, inviting supermarket store formats with appealing displays and extensive prepared foods sections

• Produce section as “theater”

• Café-style seating areas with wireless internet for meetings and meals

• Each store carries local produce and has the authority to contract with the local farmers

• Information and education provided to shoppers along with products

• High touch in-store customer service via knowledgeable, non-unionized, highly motivated personnel

• Egalitarian compensation structure

• Own seafood procurement and processing facilities to control quality (and price) from the boat to the counter

• Donates 5% of profits to non-profits

• Each store has “green projects,” directed by employees to improve environmental performance



• Excellent strategies often include a social dimension of the value proposition


Strategic CSRChoicePoint

• ChoicePoint’s core business is providing personal identification, screening, and credit verification

– e.g., access to ChoicePoint databases, employment background screening, credit verification, DNA identification and authentication, drug testing, etc.

• The company’s CSR program focuses on providing services and advice to social organizations:

– e.g., Background checks of volunteers working with children such as Boys & Girls Club volunteers

– Identity verification for Katrina victims– Assisting NGOs to find missing children and prevent identity theft

• ChoicePoint leverages its skills, data, technological knowledge, and staff to maximize social impact

• Its CSR approach is aligned with ChoicePoint’s founding principle: creating a safer and more secure society through responsible use of information

• CSR activities improve the company’s capabilities around identity issues– Working with social organizations helps develop new methodologies and capabilities


Strategic CSRNestlé in India

• Nestlé’s entered the poor Moga region of India in 1962

• Local milk supply was hampered by small parcels of land, poor soil, periodic droughts, animal disease, and lack of a commercial market

• Nestlé established local milk purchasing organizations in each town

• Nestlé invested in improving competitive context– Collection infrastructure such as refrigerated dairies was accompanied by

veterinarians, nutritionists, agronomists, and quality assurance experts to assist small farmers

– Medicines and nutritional supplements were provided to improve animal health– Monthly training sessions were held for local farmers– Wells to secure water supply for animals were dug with financing and technical

assistance from Nestlé

• Nestlé has built a productive milk cluster in Moga, buying milk from more than 75,000 farmers through 650 local dairies

• Moga has dramatically improved social conditions

• Nestlé has developed a long-term competitive advantage in the milk cluster


Strategy

What Is a Strategy? What is Not a Strategy?

• Best practice improvement

• Execution

• Aspirations

• A vision

• Learning

• Agility

• Flexibility

• Innovation

• The Internet (or any technology)

• Downsizing

• Restructuring

• Mergers / Consolidation

• Alliances / Partnering

• Outsourcing

• Internationalizing

• Best practice improvement

• Execution

• Aspirations

• A vision

• Learning

• Agility

• Flexibility

• Innovation

• The Internet (or any technology)

• Downsizing

• Restructuring

• Mergers / Consolidation

• Alliances / Partnering

• Outsourcing

• Internationalizing

• A unique value proposition versus competitors




• Continuity of strategy with continual improvement in realizing the strategy

• A unique value proposition versus competitors




• Continuity of strategy with continual improvement in realizing the strategy


The Process of Developing Business Unit 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

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

• The role of the strategic planning executive or department is to serve as staff to the team, not be responsible for strategy development

• The strategy team itself should be relatively small to ensure frank and productive discussion between the leader and senior peers

– Strategy development involves making tradeoffs and exploring options that can be unsettling and disruptive if lower level people are involved

– Other managers can be invited for particular meetings/input

• The strategy team should conduct its work jointly rather than delegating components of the strategy to functional areas


Communicating a 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


The Role of Leaders in 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

• Clearly distinguish operational effectiveness improvement and strategy

• 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 tailored metrics that capture the implications of the strategy for serving customers and performing particular activities

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

• Commitment to strategy is tested every day


The Moral Purpose of Business

• The most important thing a corporation can do for society is to contribute to a prosperous economy

• Only business can create wealth; other institutions in society are principally involved in redistributing wealth or investing it to meet human needs

• Corporations are not responsible for all the world’s problems, nor do they have the resources to solve them all

– Business has no need to be defensive about its role in society

• Business has the tools, capabilities, and resources to make a far greater positive impact on social issues than most other institutions

• Business is more transparent and more accountable than most foundations and NGOs

• Each company can and should identify the particular set of societal problems that it is best equipped to help resolve, and from which it can gain the greatest competitive benefit

• Addressing social issues through shared value strategies will lead to self-sustaining solutions

• Using these principles, businesses can have a greater impact on social good than any other institution or philanthropic organization

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