3 Type of Activities Companies Engage in – an Analysis of Michael Porter’s “What is Strategy”

Disclaimer:

I write this because I believe Porter’s work, “What is Strategy”, shows continuing relevance to the philosophy of strategy and I like to share his thinking to as much people as possible. You can find the article here: http://www.google.co.id/search?q=hbr%3A+what+is+strategy+&ie=utf-8&oe=utf-8&aq=t&rls=org.mozilla:en-US:official&client=firefox-a In order to achieve thoroughness on analyzing Michael Porter’s work, this post heavily quotes his work, thus, this blog place no claim on originating such materials and reserves all credit for such material to Michael Porter and any rightful contributor to the material. This post on its own will never be used for commercial purposes (e.g. advertising site, making copies and sell them on or offline), but I refuse any damages or claim on sharing of benefit if an indirect benefit is bestowed due in some part to this blog (like a future employer using this post as part of their consideration to hire me) or if another party had commercially used this post without my deliberate written knowledge and consent. I think it’s somewhat obvious but I learn from American legal proceedings that you have to spell the obvious to make sure that it’s obvious. This blog however, also has some analysis about his work, this analysis is made by me, and just like any other writer, I like to retain the rights to my work (these analysis). You may not copy, store, or use this blog without referring to the suggested article search site (i.e. http://www.google.co.id/search?q=hbr%3A+what+is+strategy+&ie=utf-8&oe=utf-8&aq=t&rls=org.mozilla:en-US:official&client=firefox-a) and this site (i.e. https://sendy82.wordpress.com/2009/07/03/a-summary-of-michael-porter-what-is-strategy/). You must refer to these 2 internet addresses when you copy or use this post. You may not copy, store, or use this blog for commercial purposes in any form on or offline. And I will never ever give any verbal or written consent to use this blog for even the slightest commercial purposes (aggregator sites beware). When information presented in this post is derived from Michael Porter’s work, the information is true as much as that work claims that the information is true. Brand names or trademarks mentioned are owned by their respective owners.

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Strategy is about deliberate selection of intertwined activities to address a specific position.

Deliberate selection means both to consciously choose the activities we want to engage in and the activities we don’t want to engage in.

Intertwined means that the activities are such that they require trade offs (you select one among several incompatible activities) and that among themselves, the activities are reinforcing each other.

I. Operational Effectiveness is Not Strategy

Positioning should have been at the heart of strategy.

Hypercompetition resulted from the inability to distinguish between operational effectiveness and strategy, this leads to increasing dependence on management tools, instead of strategy

It’s not that operational effectiveness is not necessary, but it’s just that we need to recognize the two are different, and not to be confused for each other.

Companies outperform rivals by developing and maintaining competitive advantage.

Activities are the basic units of competitive advantage, differentiation in all activities the company is engage in are the key of competitive advantage. There are several methods of achieving competitive advantage:

  • What activities are performed > Do different things > Strategy
  • What sub-activities or variation of activities can be done > Do things differently > border line between Strategy and Operational Effectiveness > since Activities need to pose tradeoffs and make great fit with one another to be a sustainable differentiator/ to be called Strategy
  • How activities are performed > Do things better > Operational Effectiveness > rat race of productivity frontier
  • Do things more efficiently (less time, less labor input, less material input, less energy input, less capital input, less defect, less waste) > achieve cost advantage
  • Do things more productively (faster product development, faster go to market, better customer response time, better product delivery, faster fulfillment, better technology, stronger leadership)

Gaining advantage through Operational Effectiveness was important source of profit differentiation and was the focus on Japanese Industrial advance in the 1980s. Japanese has been so successful with operational effectiveness they can cut competitors in both quality and price. Seen in this light, one can claim that Japanese companies, great as they are in operational effectiveness, don’t have strategy (this is perhaps due to the consensus driven culture, where doing different things, strategy, could be frowned upon)

Productivity frontier is the sum of all best practices available in a given industry, an imaginary heaven where all the best practices are known and deployable. Since all company in and industry is constantly thinking on how to do things better than their competitor and put these thoughts into action, the productivity frontier always shifts.

Operational Effectiveness is all about moving as near as possible to the productivity frontier

New technologies, kaizen, management fads and techniques, consultants, outsourcing, all helps companies to be better participants in the race to the ever moving productivity frontier

This race has a very positive side effect, where it dispels assumptions about tradeoffs in production or activities, tradeoffs are found to exist due to poor operational effectiveness.

But operational effectiveness is not enough and certainly deficient when it comes to maintaining an competitive advantage over extended period. The main cause is that the proliferation of IT and the existence consultants diffuse best practices.

The shared best practice contribute absolute improvement to the company, but since the best practice is diffused and also being used by the company competitors, the relative advantage is null.

Faster and better acquisition of operationally effective practices doesn’t develop relative advantage against competitors. And since competitors can use the same practices, a competitor will eventually give the profitability improvement back to customers or suppliers to gain an edge with these constituencies, and other competitors are bound to follow suit.

There are 2 ironies of operational effectiveness

  • Rather than give lasting advantage, operational effectiveness drives participants in a monopolistic market into one perfectly competitive in nature, sinking price ever nearer to marginal cost.
  • The more companies pursue operational effectiveness, the more they fail to achieve differentiation, there seem to be ac collective myopia here to the fact that as soon as companies converge at or near the productivity frontier, the more they will become the same. This negates the possibility of achieving advantage through following best practices alone.

M&A can be seen as the last ditch effort at improving operational effectiveness. Running out of Operational Effectiveness idea and space within the company to apply these ideas, company try to capture both through M&As. But cultural and behavioral issues often hamper the implementation of ideas into the acquired/merged environment, denying companies the added Operational Effectiveness ideas and larger space to implement those ideas.

Porter ends this chapter by concluding that managers had focuses on operational effectiveness, and this collective focus brings all companies to the edge of the productive frontier, at which point, they are playing a non-differentiated game that endangers their business now and in the future

II. Strategy rests on unique activities

Strategy is about being different, choosing different activities.

Porter’s example (Soutwest Airlines and Ikea) shows that these companies are doing different things from their competitors AND doing things differently. In fact, it’s not that Southwest doesn’t have activities that are similar to their competitor, it’s just that they are also doing things differently, and the jewel is that they are doing different things.

From this we can conclude that all companies are engaged, or have to be engaged in 3 kinds of activities:

  • Activities that are similar to their competitor
  • Doing activities differently
  • Doing different activities altogether

The percentage of each type of each activities being one by a company determine the level of differentiation the company has, the robustness of its strategy, the strength of its moat.

Put in factors like trade offs (Chapter III) and synergy among activities (Chapter IV), we can “calculate” a company’s strategic edge so to speak.

Continuing with the excerpt, Porter then show how playing out different activities, strategy is implemented by Southwest and Ikea

Key Differentiators
Southwest Ikea
Strategy Focus on low cost, convenient service on its routes Target young furniture buyer who wants style at low cost, trade service for cost
No’s
  • Not a full service airline
  • No First or Business class
  • No meals
  • No assigned seats
  • Interline baggage checking
  • No sales associate
  • No exclusive dependence on suppliers
  • No bulk/ whole size furniture
  • Minimal customizations and revisits
  • No delivery
Do’s
  • Fast gate turnaround time > provide more departure with fewer airplanes
  • Automated ticketing > bypass agents’ commission
  • Standardized fleet of 737s > achieve scale at maintenance
  • Room like setting > customers visualize end product
  • Design own products
  • Products are modular and ready to assemble
  • On the spot shopping and self delivery
  • In store child care > customer don’t have nannies
  • Extended hours > customers work during normal shopping time

Identifying a strategic position, avenues of differentiation is the job of the entrepreneur mind. A strategic position affords a wedge in the market that can be exploited by the entrepreneur mind (new entrant or incumbent). Strategic position comes from:

  • Cracks in the current competitors’ that can be filled by completing, slicing, substituting, or sub setting the competitors’ positioning
  • Available but overlooked positioning
  • A once existing and held position but ceded due to imitation and straddling
  • Draw lesson from other business to create positioning in the target business
  • Responding to change such as customer groups, purchase occasions, society evolution, new distribution channel, new technologies, new machinery or information system.

Next in this chapter, Porter explores the 3 sources of strategic position

Variety Based Positioning Needs Based Positioning Access Based Positioning
Definition Producing a subset of an industry’s product or services Serving all or most of the needs of a particular group of customers Segmenting customers who are accessible in different ways (geography, scale, or other differentiator that requires customizing of activities to reach this group of customers)
Best used by –   When companies can produce a particular product or service using distinctive set of activities –   When there are groups of customers with different needs and constraints-   When the same customers has different needs on different occasions or for different types of transactions –   When the best way to configure activities to meet similar needs of distinct groups of customers differs
Key factor –   Responding to superior value chain for a particular type of product/ service –   Configuring set of activities to specifically respond to target segment needs-   Customize the value chain to profitably respond to the need of a specific group –   Configure activities to fulfill to similar needs of a group of customers
Sample Jiffy Lube International:

  • Focus on automotive lubricants
  • No other car repair or maintenance service
  • Resulting in faster service at lower cost, persuading customer to get oil changes at this focused company
Ikea:

  • Focus on fulfilling the need of young adult customers
Carmike Cinemas:

  • Operate in cities and towns with populations under 200,000
  • Standardized low cost theater complexes
  • Fewer screen and less sophisticated projection technology
  • Requires only a single theater manager
  • Lower rent and payroll costs
  • Personal marketing (small communities)
  • Are often the only theater in small towns, better position with distributors
Vanguard Group:

  • Portfolio diversification and rock bottom expenses
  • Trade off extraordinary performance for good, yet stable, performance
  • Minimize bets on interest rates and narrow stock group
  • Discourage customer from incurring transaction costs
  • Become a staple of customer portfolio, its pronounced position allow it to be must-have category on its own
Bessemer Trust:

  • Families with more than US$ 5 million in investable assets
  • 1 officer for 14 families
  • Meeting on client site
  • Services aimed to fulfill need at this segment (investment oversight and mgmt., estate administration, non-traditional asset accounting)
  • Minimal request for loans
  • Rural vs Urban
  • Small customers vs Large customers
  • Densely situated customers vs sparsely situated customers
Citibank Private Banking:

  • Client with minimum assets of US$ 250,000
  • 1 officer for 125 individuals
  • Limited on client site meeting
  • Convenient access to loans
  • RM refers client to product specialist

Although strategy is about focus, deliberately choosing a set of activities and rejecting another set, Porter’s cautioned that strategy doesn’t always mean a niche market approach. The Vanguard Group serves a wide array of customers. What matters is the conscious decision on selecting a set of activities to meet a group of customers’ common needs.

Positioning relies on differences on the supply side, but positioning doesn’t always need to correspond to a specific difference on the demand side (the customers), examples are the variety and access based positioning.

Chapter II are closed by strategy being defined as: “creation of unique and valuable position, involving a different set of activities….the essence of strategic positioning is to choose activities that are different from rivals’”

III. A Sustainable Strategic Position Requires Trade Offs

As I mention in chapter one, doing the same things differently can be a component of strategy or not. The difference lies on whether the how of the activities pose trade offs and fit. In this chapter, Porter elaborates how trade offs co-create differentiation by preventing competitors from easily copying the activities a company engage in.

Trade offs (and later fit) are necessary because an attractive position would attract copycats in 2 ways:

Repositioning Straddling
Repositioning oneself to be an even better version of the original Match the benefit of a successful position while maintaining the original position

Trade offs create the need for choice and purposely limits points of differentiation.

Trade offs requires competitors to abandon one activity for another should they wish to copycat a strategic position, possibly eroding of the benefits afforded by the original activity. This risk deters competitors from repositioning or straddling.

In the world of strategy, you cannot have your cake and eat it too, not without incurring inefficiencies.

Some sample of trade offs erected by Neutrogena Soap, which positioning is somewhat of dermatologist soap:

  • Advertise on medical journals (instead of general magazine) – the italic part is my own assumptions to highlight the trade offs
  • Send direct mail to doctors (instead of end users)
  • Attend medical conferences (instead of participating in consumer trade shows)
  • Focuses distribution on drugstores (instead of supermarkets, sacrifice volume)
  • Avoid price promotions (high quality product cannot afford a price cut)
  • Uses a slow more expensive manufacturing process (achieving promised attributes)

Should competitors try to take Neutrogena on its game, the competitors will need to at least copy Neutrogena’s advantages while incurring all the sacrifices Neutrogena had consciously choose to bear.

There are 3 reasons why trade offs emerge:

Reason Inconsistencies in image or reputation From activities themselves Limits on internal coordination and control
In what ways it become a barrier (or a constraint)
  • A company known for delivering one kind of value may lack the credibility to deliver another kind of value
  • Reshaping an image is expensive
  • The more company has configured its machinery, people, and systems to efficiently execute a set of activities, the more it cannot fulfill services requiring another set of activities
  • Preventing an overdesign or under design of an activity respective to its use
  • Increasing productivity by limiting activity  variations
  • Quality are not free
  • On the flip side, low cost practices need adjustments in all parts of value chain in order to not be ‘cheap’
  • Make organization priorities clear
  • Trying to be a jack of all trade risk confusion at the front end level as employee try to make day to day decision without clear framework
Sample A soap known as basic inexpensive everyday soap would find it very tough to match Neutrogena’s positioning as a premium ‘medical’ soap Ikea achieve its position by asking customers to do their own delivery and assembly, this forbid Nokia from satisfying customers requiring higher level of service

A sample of a company that fails as it tries to stand on two boats are Continental Lite as they try to compete with Southwest, the factors of differentiation and their trade offs as follows:

Failed trade off points

Why it failed

Continued use of travel agents Cannot be profitable if it keep paying agents’ commission, but it need agents for its full service business
Mixed fleet of planes Unable to realize scale at maintenance at turn around time
Keep providing baggage checking and seat assignments Baggage transfers increases turnaround timeBaggage transfers and seat assignments add complexity and costs to the business
Frequent flyer Lite travelers joint the Full Service frequent flyer program, the ‘solution’ is to dilute the entire frequent flyer program

Porter closes this chapter by linking back to Operational Effectiveness, that Operational Effectiveness had lead to the discovery of false trade offs. The unfortunate side effects is that managers learn to have the wrong belief that trade offs can be eliminated, it is unnecessary, it is ‘bad’.

But without trade offs, there will be no lasting advantage, what will be is a arms race to excel at everything.

Trade offs add an essential dimension to strategy, without trade offs, there’s no need to choose activities, no need for strategy. So, trade off is both the prerequisite as well as the tools of strategy.

IV. Fit Drives Both Competitive Advantage and Sustainability

Chapter IV discusses fit, the main point of fit is that a strategist would choose and combine activities in such a manner, it interlocks into each other. Not only they co-support, they make the existence of each other possible.

To be able to imitate differentiated companies, competitors not only need to copy one aspect of their activity set, but possibly the entire ecosystem, furthermore, this ecosystem could contain external factors like a network of customer group.

You can further enhance this locking effect by having interconnectedness at different layers or depth. Porter showed this beautifully with his activity system map for IKEA. A large theme, say “limited customer service” links with “self selection by customer”. But “limited customer service” builds upon “self transport by customer”, “ease of transport and assembly”, and “self assembly by customer”, all of these link to each other.

Achieving these interconnected activities is an enviable position. But it doesn’t mean that the company who achieve such state could not fail or uprooted from its dominant position.

Shift in technology or cultural trend would make an entire ecosystem of differentiation obsolete. A competitor could also enter an untouched or underserved segment, circumventing the moats you have you build. Or competitors could create alternative ecosystems, making the established ecosystem irrelevant for the customers.

To compete with IKEA, you either copy the entire ecosystem altogether, circumvent them, or induce trends that make their ecosystem irrelevant.

It’s interesting to see how the existence of fit challenges concepts like “core competence” and “key success factors”. While fit see success arising from an ecosystem, the two jargons seem to assume that success can be sustained with limited number of individual factors. Since resource and management time is limited we should focus it on identifying and developing an ecosystem, rather than a focus point of “core competence”. Concentrated on developing the ecosystem, not on the individual factor.

Focus on individual factors could be misleading because each factor is inevitably linked to other factor. It’s like hijacking an executive from a successful competitors and found that the guy doesn’t deliver as expected, either because his success comes from his peer group at the old company or his new peers are simply not a good match with him.

Porter offered 3 levels of fit:

Degree of fit Description Example
Simple consistency Aligning all activity with the overall strategy Vanguard: align all activities with low cost strategy. Low portfolio turnover, lower number of investment manager, direct distribution, limit advertising.
Reinforcing Symbiosis between two or more activities Placement of Neutrogena soap in upscale hotels. Enhance customer awareness for one and exclusive image for the other one
Optimization of effort Entire chain of activities support and reinforces each other or eliminating entrenched functions. Gap. Strong product availability > daily restocking > minimize in-store inventory.

Product design that support customer self service.

Fit also promotes sustainability of advantage. Since competitors are facing an entire ecosystem, with elements that allow and strengthen each other existence, they need to be very persistent, capitalize, or creative to be able to replicate or break your strategy. This allows your advantage to be sustainable.

The moment your enter ecosystem, rather than key success factors, is the moment where you have an advantage which can be sustained.

(I know I can just say “Sustainable Advantage”, but it’s so easy to read that phrase as a word and forgot how much power it’s actually trying to convey)

Porter ends this chapter by stating that we have complete information to define strategy.

Strategy is: obtaining sustainable competitive advantage through creating an ecosystem of activities.

V. Rediscovering Strategy

Chapter V discusses the 2 main reasons companies often go stray from finding strategy (the failure to choose and the pursuit of growth), how growth can be achieve without jeopardizing strategy and the role of leaders in directing and finding this strategy.

V.1. Failure to choose

Managers have been confused about the necessity of making choices.

Focusing on the efficiency frontier could lead one to think that companies should be able to beat its rivals simultaneously on all dimensions. Yet this kind of machismo could be unnecessary.

Some external and internal factors might lead managers to believe that they don’t need to choose. Sample of these factors are:

  • Nobody remind managers on the need to make tradeoffs
  • Pursuing technology for its own sake
  • Pursuing operational effectiveness is seductive because it’s concrete and actionable
  • Best practice mentality, reinforce by information provided by business publications and consultants
  • Conventional wisdom within an industry
  • Organizational realities like fear to making trade offs and choose the wrong one

V.2. Growth Trap

Blind pursuit of growth has a diluting effect on a company’s strategy.

Trade off place limits on growth by not allowing access to certain segment, lines of products, or distribution channel.

When company faces pressure to grow, the managers could respond with incremental steps that blur their strategy. Yet these steps often require compromises and inconsistencies with the original strategy.

Once these compromises are taken, a company’s uniqueness become less clear, and company find itself in a new field. This new field has less overall uniqueness and companies are forced to compete on operational effectiveness, further encouraging compromises and inconsistencies.

Managers can achieve growth without spoiling its strategy by deepening a strategic position. This can be achieve in several ways:

  • Look for extension of the strategy that leverage existing activity system
  • Better penetrate needs and varieties where the company can offer distinctiveness
  • Entering international markets

A good example of this would be Apple, who maintain its uniqueness of design and interface while it expand its product line

Finally Porter explores the role of leader in maintaining a strategy.

Leader bears the intellectual and enforcement responsibility of maintaining a strategy.

Leader should not degenerate into exclusively orchestrating operational improvements and making deals. They should be aware of their role in defining the company’s unique position.

Leaders must teach others about strategy and the discipline to which changes the company will respond to while avoiding dilution to its strategy.

Leaders need to set what not to do, as well as what we want to do.

Leaders also need to communicate the strategy to employee at various layers and geography. This communication is needed to guide employees and help employees understand what choices to make when they are face with resource conflict.

We can summarize the leaders role as DTEC: Define, Teach, Enforce, Communicate

This Define part of the job is not static at all.

Operational effectiveness activities are alluring due to the visibility of issue and immediacy of both the effort and results.

Yet a company always face change, industry trends, new entrants, all chasing and threatening not only the operational effectiveness of a company but also its unique position.

Identifying threats to a company’s unique position is a much harder job because it’s often slower to emerge or from corners unseen.

Yet as the changes are identified, leaders need to re-define their strategic position while staying true to the principles of understanding trade offs needed to build an new or revised ecosystem.

3 Responses

  1. Hey, I am just wondering where the rest of the summary is?

  2. Thanks
    but where is the rest of the summary?😦

  3. Thanks so much. Would you mind sending through the rest of the summary?

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