On Strategy and Leadership
Professor Michael E. Porter
Harvard Business School
Bucharest, Romania
November 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
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Copyright 2007 © Professor Michael E. Porter
How Managers Think About Competition
COMPETING TO BE THE
BEST
COMPETING TO BE UNIQUE
• The worst error in strategy is to compete with rivals on the same
dimensions
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Copyright 2007 © Professor Michael E. Porter
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…”
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Copyright 2007 © Professor Michael E. Porter
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.
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Copyright 2007 © Professor Michael E. Porter
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
• Profitability metrics besides ROIC (e.g., return on sales; ebitda
margin; pro-forma earnings; and cash flow margin) are risky for
strategy
• Prevalent accounting adjustments to reported profitability
(e.g., writeoffs, restructuring charges) can obscure true
economic performance and lead to bad competitive choices
• Goodwill must be treated as part of investment
• Setting unrealistic profitability or growth targets can undermine
strategy
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Copyright 2007 © Professor Michael E. Porter
Economic Performance versus Shareholder Value
Economic
Performance
Shareholder Value
• Sustained ROIC
• Stock Price
• Sustainable Revenue Growth
• EPS
• EPS Growth
• Shareholder value is the result of creating real economic value
• Pleasing today’s shareholders is not the goal
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Copyright 2007 © Professor Michael E. Porter
Economic Foundations of Competition
• 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
Industry
Structure
Relative Position
Within the
Industry
- Overall Rules of Competition
- Sources of Competitive Advantage
• Strategy must encompass both
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Copyright 2007 © Professor Michael E. Porter
Disaggregating Economic Performance:
Industry vs. Position
35%
31.4%
30.8%
30%
Return on
Invested
Capital
1985-2002
25%
25.4%
20%
15%
10%
9.6%
5%
0%
Reebok International
Paccar
Industry Average
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
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Copyright 2007 © Professor Michael E. Porter
Profitability of Selected U.S. Industries
1992 - 2006
Security Brokers and Dealers
Soft Drinks
Prepackaged Software
Pharmaceuticals
Perfume,Cosmetic,Toilet Prep
Advertising Agencies
Distilled Spirits
Semiconductors
Surgical and Medical Instruments
Mens and Boys Clothing
Tires
Household Appliances
Malt Beverages
Child Day Care Services
Household Furniture
Drug Stores
Grocery Stores
Iron and Steel Foundries
Cookies and Crackers
Mobile Homes
Wine and Brandy
Bakery Products
Engines and Turbines
Book Publishing
Laboratory Equipment
Oil and Gas Machinery
Soft Drink Bottling
Knitting Mills
Hotels
Catalog, Mail-Order Houses
Airlines
ROIC = Earnings before
interest and taxes divided by
invested capital less excess
cash
Average industry ROIC
in the US:14.9%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Return on invested capital, 1992 – 2006 average
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
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Copyright 2007 © Professor Michael E. Porter
Determinants of Industry Profitability
Threat of Substitute
Products or Services
Bargaining Power
of Suppliers
Rivalry Among
Existing
Competitors
Bargaining Power
of Buyers
Threat of New
Entrants
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Copyright 2007 © Professor Michael E. Porter
Strategic Implications of Industry Structure
1. Positioning to Mute the Five Forces
Heavy Truck Industry
Threat of Substitute
Products or
Services
• Railroads
• Water transportation
Bargaining Power
of Suppliers
• Large suppliers of
engines and drive
train components
Rivalry Among
Existing
Competitors
• Heavy price
competition on
standardized models
Bargaining Power
of Buyers
• Large fleets
• Leasing companies
• Owner operators
Threat of New
Entrants
• Many truck producers
are assemblers
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Copyright 2007 © Professor Michael E. Porter
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
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Copyright 2007 © Professor Michael E. Porter
Strategic Implications of Industry Structure
2. Shaping Industry Structure
Foodservice Distribution Industry
Threat of Substitute
Products or Services
• Go direct
• Use retail / warehouse channels
Bargaining Power of
Suppliers
• Food processors
• Food cooperatives
• Farmers
Rivalry Among
Existing
Competitors
• Distributors
–Purchasing
–Warehousing
–Delivery
Threat of New
Entrants
Bargaining Power
of Buyers
•
•
•
•
•
Restaurants
Schools
Hospitals
Cafeterias
Other food service
establishments
• Low barriers to entry
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Copyright 2007 © Professor Michael E. Porter
Reshaping Industry Structure
Foodservice Distribution
• Offering value-added services
• Offering private-label products
• Moving to national procurement contracts
• Increasing the use of sophisticated information technology
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Copyright 2007 © Professor Michael E. Porter
Determinants of Relative Performance
Differentiation
(Higher Price)
Competitive
Advantage
Lower Cost
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Copyright 2007 © Professor Michael E. Porter
Economics of Strategic Positioning
Southwest Airlines
Revenue and Cost per Available Seat Mile, Average of 1998 - 2000
12
10
Operating Profit per
Available Seat Mile
Pricing
Differential:
1.72
Cost
Advantage:
2.44
8
Cents
per ASM
6
Operating Cost per
Available Seat Mile
4
2
0
Southwest
Note:
Source:
Airline Industry Average
ASM (Available Seat Miles) defined as total seats available multiplied by miles flown
Airline annual reports and author’s calculations
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Copyright 2007 © Professor Michael E. Porter
Foundations of Economic Performance
The Value Chain
Firm Infrastructure
(e.g. Financing, Planning, Investor Relations)
Human Resource Management
Support
Activities
(e.g. Recruiting, Training, Compensation System)
Technology Development
(e.g. Product Design, Testing, Process Design, Material Research, Market Research)
M
(e.g. Components, Machinery, Advertising, Services)
Inbound
Logistics
Operations
(e.g. Incoming
Material
Storage, Data
Collection,
Service,
Customer
Access)
(e.g. Assembly,
Component
Fabrication,
Branch
Operations)
Value
a
Procurement
r
g
Outbound
Logistics
Marketing
& Sales
After-Sales
Service
(e.g. Order
Processing,
Warehousing,
Report
Preparation)
(e.g. Sales
Force,
Promotion,
Advertising,
Proposal
Writing, Web
site)
(e.g. Installation,
Customer
Support,
Complaint
Resolution,
Repair)
i
n
What
buyers are
willing to
pay
Primary Activities
• Competing in a business involves performing a set of discrete
activities, in which competitive advantage resides
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Copyright 2007 © Professor Michael E. Porter
Defining the Value Chain
Commercial Construction
Firm Infrastructure
(Strategic Planning, Finance, Control, Administration, Legal, Safety, Risk Management)
Human Resource Management
(HR, Training, Recruiting)
Support
Activities
M
Technology Development
(Information Technology, Business Systems)
a
Procurement
(Materials, Subcontractors, Services)
Client
Bidding and
Development Selection




Marketing
Business
development
Client
relationship
management
Pipeline
management



Bidding
Project risk
assessment
Securing
insurance
coverage
PreConstruction





Obtaining permits
and licenses
Site preparation
Estimation of
pricing, materials,
and schedule
Advanced ordering
of materials
Subcontractor
contracting
r
Construction
Management





Managing the
client interface
Architect and
engineering
coordination
Site
management
Coordinating
logistics
Updating
documentation
Project
Closeout




Site cleanup
Manage
subcontractors’
transition out of
the site
Preparing final
documentation
Client
satisfaction
survey
g
AfterCompletion
Support


Ongoing
customer
support
Warranties
i
n
Primary Activities
• There can be different ways of configuring the value chain in the same industry
Source: Interviews with Suffolk managers
Note: 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
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20071129 – Romania - Final.ppt
Copyright 2007 © Professor Michael E. Porter
Achieving Superior Performance
Operational Effectiveness is Not Strategy
Operational
Effectiveness
Strategic
Positioning
• Assimilating, attaining, and
extending best practices
•
Run the same race faster
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Creating a unique and
sustainable competitive
position
Choose to run a different race
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Copyright 2007 © Professor Michael E. Porter
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
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Copyright 2007 © Professor Michael E. Porter
Strategic Positioning
Enterprise Rent-A-Car
Distinctive
Activities
Value Proposition
• Numerous, small, inexpensive offices in each
• Home-city replacement cars for drivers
whose cars are being repaired or who need
an extra vehicle, at low rates (30% below
airport rates)
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
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Copyright 2007 © Professor Michael E. Porter
Defining the Value Proposition
What
Customers?
Which
Needs?
• What end users?
• What channels?
• Which products?
• Which features?
• Which services?
What Relative
Price?
• A novel value proposition can also grow the pie/expand the industry
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Copyright 2007 © Professor Michael E. Porter
Strategic Positioning
IKEA, Sweden
Distinctive
Activities
Value Proposition
• Young, first time, or price-sensitive buyers who
• Modular, ready-to-assemble, easy to package
want stylish, space efficient and scalable
furniture and accessories at very low price
points.
•
•
•
•
•
•
•
•
•
•
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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
Copyright 2007 © Professor Michael E. Porter
Strategic Positioning
GOL Airlines, Brazil
Distinctive
Activities
Value Proposition
• Convenient, no-frills airline service between 41
• No-frills service
Brazilian and nearby international cities at very
low prices competing with bus transportation
• Many flights during late night hours
• On time performance
• Price sensitive business (60%) and leisure
• Quick airport turn-around
travelers
• Utilize aircraft more hours per day
• Single aircraft type (Boeing 737s)
• 80% reservations made via the Internet
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Copyright 2007 © Professor Michael E. Porter
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
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Copyright 2007 © Professor Michael E. Porter
Strategic Tradeoffs
Neutrogena 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
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Copyright 2007 © Professor Michael E. Porter
Strategic Tradeoffs
IKEA, Sweden
Typical Furniture Retailer
IKEA
Product
Product
• Low-priced, modular, ready-to-assemble
designs
• No custom options
• Higher priced, fully assembled products
• Customization of fabrics, colors, finishes,
and sizes
• Design driven by image, materials, varieties
• Furniture design driven by cost,
manufacturing simplicity, and style
Value Chain
Value Chain
• Centralized, in-house design of all products
• 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
• All styles on display in huge warehouse stores
• Large on-site inventories
• Extensive customer information but limited
sales support
• Long hours of operation
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• Traditional retail hours
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Copyright 2007 © Professor Michael E. Porter
Recent Thinking on the Sources of Competitive Advantage
• “Key” Success Factors
• “Core” Competencies
• “Critical” Resources
• Competitive advantage is seen as concentrated in a few parts of the
value chain
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Copyright 2007 © Professor Michael E. Porter
Mutually Reinforcing Activities
Zara Apparel
Word-ofmouth
marketing
and repeat
buying
Cuttingedge fashion
at moderate
price and
quality
Customers
chic but
costconscious
Wide
range of
styles
Global
team of
trendspotters
Majority
of
productio
n in
Europe
Very
frequent
product
changes
Little media
advertising
Advanced
productio
n
machiner
y
Extensive
use of
store
sales
data
Prime store
locations in
high traffic
areas
JIT delivery
Tight
coordination
with 20
wholly-owned
factories
Very
flexible
productio
n system
• Fit is leveraging what is different to be more different
Source: Draws on research by Jorge Lopez Ramon (IESE) at the Institute for Strategy and Competitiveness, HBS
29
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Copyright 2007 © Professor Michael E. Porter
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
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Copyright 2007 © Professor Michael E. Porter
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
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Copyright 2007 © Professor Michael E. Porter
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
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Copyright 2007 © Professor Michael E. Porter
Internal Barriers to Strategy
Neutrogena 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.
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Copyright 2007 © Professor Michael E. Porter
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?
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Copyright 2007 © Professor Michael E. Porter
Strategic Positioning
Whole Foods Markets
Distinctive
Activities
Value Proposition
•
• 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
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Copyright 2007 © Professor Michael E. Porter
Strategic CSR
ChoicePoint
• 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
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Copyright 2007 © Professor Michael E. Porter
Strategic CSR
Nestlé 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
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Copyright 2007 © Professor Michael E. Porter
Strategy
What is Not a Strategy?
What Is a Strategy?
• A unique value proposition
versus competitors
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
• A different, tailored value chain
• Clear tradeoffs, and choosing what
not to do
• Activities that fit together and
reinforce each other
• Continuity of strategy with
continual improvement in realizing
the strategy
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Best practice improvement
Execution
Aspirations
A vision
Learning
Agility
Flexibility
Innovation
The Internet (or any technology)
Downsizing
Restructuring
Mergers / Consolidation
Alliances / Partnering
Outsourcing
Internationalizing
Copyright 2007 © Professor Michael E. Porter
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
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Copyright 2007 © Professor Michael E. Porter
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
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Copyright 2007 © Professor Michael E. Porter
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
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Copyright 2007 © Professor Michael E. Porter
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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Copyright 2007 © Professor Michael E. Porter