3 Type of Activities Companies Engage in an Analysis of Michael Porters What is Strategy

Posted on July 3, 2009 by sendy82 Disclaimer:

I write this because I believe Porters 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:enUS:official&client=firefox-a In order to achieve thoroughness on analyzing Michael Porters 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 its somewhat obvious but I learn from American legal proceedings that you have to spell the obvious to make sure that its 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:enUS:official&client=firefox-a) and this site (i.e. http://sendy82.wordpress.com/2009/07/03/a-summary-of-michael-porter-what-isstrategy/). 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 Porters 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.

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 dont 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 Its not that operational effectiveness is not necessary, but its 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, dont 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 doesnt 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. Porters example (Soutwest Airlines and Ikea) shows that these companies are doing different things from their competitors AND doing things differently. In fact, its not that Southwest doesnt have activities that are similar to their competitor, its 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 companys 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 Target young furniture buyer who wants service on its routes style at low cost, trade service for cost Nos Not a full service airline No sales associate No First or Business class No exclusive dependence on No meals suppliers No assigned seats No bulk/ whole size furniture Interline baggage checking Minimal customizations and revisits No delivery Dos

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 dont 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 Needs Based Access Based Positioning Positioning Positioning Definition Producing a subset of Serving all or most of Segmenting customers an industrys product or the needs of a particular who are accessible in

different ways (geography, scale, or other differentiator that requires customizing of activities to reach this group of customers) Best used - When companies can - When there are - When the best way to by produce a particular groups of customers configure activities to product or service using with different needs and meet similar needs of distinctive set of constraints- When the distinct groups of activities same customers has customers differs different needs on different occasions or for different types of transactions Key factor - Responding to - Configuring set of - Configure activities to superior value chain for activities to specifically fulfill to similar needs of a particular type of respond to target a group of customers product/ service segment needsCustomize the value chain to profitably respond to the need of a specific group Sample Jiffy Lube Ikea: Carmike Cinemas: International: Focus on Operate in cities fulfilling the and towns with Focus on automotive need of young populations lubricants adult customers under 200,000 No other car Standardized low repair or cost theater maintenance complexes service Fewer screen and Resulting in less sophisticated faster service at projection lower cost, technology persuading Requires only a customer to get single theater oil changes at manager this focused Lower rent and company payroll costs Personal marketing (small communities) Are often the only theater in small towns, better position with distributors

services

group of customers

Vanguard Group:

Bessemer Trust:

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

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, Porters cautioned that strategy doesnt 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 doesnt 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 Match the benefit of a successful position version of the original 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 Neutrogenas 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

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

Limits on internal coordination and control 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 Neutrogenas 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 Why it failed points Continued use of Cannot be profitable if it keep paying agents commission, but it travel agents need agents for its full service business Mixed fleet of planes Unable to realize scale at maintenance at turn around time Keep providing Baggage transfers increases turnaround timeBaggage transfers baggage checking and seat assignments add complexity and costs to the business and seat assignments 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, theres 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 cosupport, 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 doesnt 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. Its 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. Its like hijacking an executive from a successful competitors and found that the guy doesnt 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 Simple consistency Example 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 Placement of Neutrogena soap in more activities upscale hotels. Enhance customer awareness for one and exclusive image for the other one Optimization of Entire chain of activities Gap. Strong product availability > effort support and reinforces each daily restocking > minimize in-store other or eliminating entrenched inventory. functions. 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 its so easy to read that phrase as a word and forgot how much power its actually trying to convey) Porter ends this chapter by stating that we have complete information to define strategy. Description Aligning all activity with the overall 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 dont 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 its 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 companys 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 companys 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 companys 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 companys unique position is a much harder job because its 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.