For almost two decades, managers have been learning to play by a new
set of rules. Companies must be flexible to respond rapidly to
competitive and market changes. They must benchmark continuously to
achieve best practice. They must outsource aggressively to gain
efficiencies. And they must nurture a few core competencies in race
to stay ahead of rivals.
Positioning—once the heart of strategy—is rejected as too static for
today’s dynamic markets and changing technologies. According to the
new dogma, rivals can quickly copy any market position, and
competitive advantage is, at best, temporary.
But those beliefs are dangerous half-truths, and they are leading
more and more companies down the path of mutually destructive
competition. True, some barriers to competition are falling as
regulation eases and markets become global. True, companies have
properly invested energy in becoming leaner and more nimble. In many
industries, however, what some call hypercompetition is a
self-inflicted wound, not the inevitable outcome of a changing
paradigm of competition.
The root of the problem is the failure to distinguish between
operational effectiveness and strategy. The quest for productivity,
quality, and speed has spawned a remarkable number of management
tools and techniques: total quality management, benchmarking,
time-based competition, outsourcing, partnering, reengineering,
change management. Although the resulting operational improvements
have often been dramatic, many companies have been frustrated by
their inability to translate those gains into sustainable
profitability. And bit by bit, almost imperceptibly, management
tools have taken the place of strategy. As managers push to improve
on all fronts, they move farther away from viable competitive
positions.
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Operational effectiveness and strategy are both essential to
superior performance, which, after all, is the primary goal of any
enterprise. But they work in very different ways.
A company can outperform rivals only if it can establish a
difference that it can preserve. It must deliver greater value to
customers or create comparable value at a lower cost, or do both.
The arithmetic of superior profitability then follows: delivering
greater value allows a company to charge higher average unit prices;
greater efficiency results in lower average unit costs.
Ultimately, all differences between companies in cost or price
derive from the hundreds of activities required to create, produce,
sell, and deliver their products or services, such as calling on
customers, assembling final products, and training employees. Cost
is generated by performing activities, and cost advantage arises
from performing particular activities more efficiently than
competitors. Similarly, differentiation arises from both the choice
of activities and how they are performed. Activities, then are the
basic units of competitive advantage. Overall advantage or
disadvantage results from all a company’s activities, not only a
few.1
Operational effectiveness (OE) means performing similar activities
better than rivals perform them. Operational effectiveness includes
but is not limited to efficiency. It refers to any number of
practices that allow a company to better utilize its inputs by, for
example, reducing defects in products or developing better products
faster. In contrast, strategic positioning means performing
different activities from rivals’ or performing similar activities
in different ways.
Differences in operational effectiveness among companies are
pervasive. Some companies are able to get more out of their inputs
than others because they eliminate wasted effort, employ more
advanced technology, motivate employees better, or have greater
insight into managing particular activities or sets of activities.
Such differences in operational effectiveness are an important
source of differences in profitability among competitors because
they directly affect relative cost positions and levels of
differentiation.
Differences in operational effectiveness were at the heart of the
Japanese challenge to Western companies in the 1980s. The Japanese
were so far ahead of rivals in operational effectiveness that they
could offer lower cost and superior quality at the same time. It is
worth dwelling on this point, because so much recent thinking about
competition depends on it. Imagine for a moment a productivity
frontier that constitutes the sum of all existing best practices at
any given time. Think of it as the maximum value that a company
delivering a particular product or service can create at a given
cost, using the best available technologies, skills, management
techniques, and purchased inputs. The productivity frontier can
apply to individual activities, to groups of linked activities such
as order processing and manufacturing, and to an entire company’s
activities. When a company improves its operational effectiveness,
it moves toward the frontier. Doing so may require capital
investment, different personnel, or simply new ways of managing.
The productivity frontier is constantly shifting outward as new
technologies and management approaches are developed and as new
inputs become available. Laptop computers, mobile communications,
the Internet, and software such as Lotus Notes, for example, have
redefined the productivity frontier for sales-force operations and
created rich possibilities for linking sales with such activities as
order processing and after-sales support. Similarly, lean
production, which involves a family of activities, has allowed
substantial improvements in manufacturing productivity and asset
utilization.
For at least the past decade, managers have been preoccupied with
improving operational effectiveness. Through programs such as TQM,
time-based competition, and benchmarking, they have changed how they
perform activities in order to eliminate inefficiencies, improve
customer satisfaction, and achieve best practice. Hoping to keep up
with shifts in the productivity frontier, managers have embraced
continuous improvement, empowerment, change management, and the
so-called learning organization. The popularity of outsourcing and
the virtual corporation reflect the growing recognition that it is
difficult to perform all activities as productively as specialists.
As companies move to the frontier, they can often improve on
multiple dimensions of performance at the same time. For example,
manufacturers that adopted the Japanese practice of rapid
changeovers in the 1980s were able to lower cost and improve
differentiation simultaneously. What were once believed to be real
trade-offs—between defects and costs, for example—turned out to be
illusions created by poor operational effectiveness. Managers have
learned to reject such false trade-offs.
Constant improvement in operational effectiveness is necessary to
achieve superior profitability. However, it is not usually
sufficient. Few companies have competed successfully on the basis of
operational effectiveness over an extended period, and staying ahead
of rivals gets harder every day. The most obvious reason for that is
the rapid diffusion of best practices. Competitors can quickly
imitate management techniques, new technologies, input improvements,
and superior ways of meeting customers’ needs. The most generic
solutions—those that can be used in multiple settings—diffuse the
fastest. Witness the proliferation of OE techniques accelerated by
support from consultants.
OE competition shifts the productivity frontier outward, effectively
raising the bar for everyone. But although such competition produces
absolute improvement in operational effectiveness, it leads to
relative improvement for no one. Consider the $5 billion-plus U.S.
commercial-printing industry. The major players—R.R. Donnelley &
Sons Company, Quebecor, World Color Press, and Big Flower Press—are
competing head to head, serving all types of customers, offering the
same array of printing technologies (gravure and web offset),
investing heavily in the same new equipment, running their presses
faster, and reducing crew sizes. But the resulting major
productivity gains are being captured by customers and equipment
suppliers, not retained in superior profitability. Even
industry-leader Donnelley’s profit margin, consistently higher than
7% in the 1980s, fell to less than 4.6% in 1995. This pattern is
playing itself out in industry after industry. Even the Japanese,
pioneers of the new competition, suffer from persistently low
profits. (See the insert “Japanese Companies Rarely Have
Strategies.”)
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The second reason that improved operational effectiveness is
insufficient—competitive convergence—is more subtle and insidious.
The more benchmarking companies do, the more they look alike. The
more that rivals outsource activities to efficient third parties,
often the same ones, the more generic those activities become. As
rivals imitate one another’s improvements in quality, cycle times,
or supplier partnerships, strategies converge and competition
becomes a series of races down identical paths that no one can win.
Competition based on operational effectiveness alone is mutually
destructive, leading to wars of attrition that can be arrested only
by limiting competition.
The recent wave of industry consolidation through mergers makes
sense in the context of OE competition. Driven by performance
pressures but lacking strategic vision, company after company has
had no better idea than to buy up its rivals. The competitors left
standing are often those that outlasted others, not companies with
real advantage.
After a decade of impressive gains in operational effectiveness,
many companies are facing diminishing returns. Continuous
improvement has been etched on managers’ brains. But its tools
unwittingly draw companies toward imitation and homogeneity.
Gradually, managers have let operational effectiveness supplant
strategy. The result is zero-sum competition, static or declining
prices, and pressures on costs that compromise companies’ ability to
invest in the business for the long term.
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Competitive strategy is about being different. It means deliberately
choosing a different set of activities to deliver a unique mix of
value.
Southwest Airlines Company, for example, offers short-haul,
low-cost, point-to-point service between midsize cities and
secondary airports in large cities. Southwest avoids large airports
and does not fly great distances. Its customers include business
travelers, families, and students. Southwest’s frequent departures
and low fares attract price-sensitive customers who otherwise would
travel by bus or car, and convenience-oriented travelers who would
choose a full-service airline on other routes.
Most managers describe strategic positioning in terms of their
customers: “Southwest Airlines serves price- and
convenience-sensitive travelers,” for example. But the essence of
strategy is in the activities—choosing to perform activities
differently or to perform different activities than rivals.
Otherwise, a strategy is nothing more than a marketing slogan that
will not withstand competition.
A full-service airline is configured to get passengers from almost
any point A to any point B. To reach a large number of destinations
and serve passengers with connecting flights, full-service airlines
employ a hub-and-spoke system centered on major airports. To attract
passengers who desire more comfort, they offer first-class or
business-class service. To accommodate passengers who must change
planes, they coordinate schedules and check and transfer baggage.
Because some passengers will be traveling for many hours,
full-service airlines serve meals.
Southwest, in contrast, tailors all its activities to deliver
low-cost, convenient service on its particular type of route.
Through fast turnarounds at the gate of only 15 minutes, Southwest
is able to keep planes flying longer hours than rivals and provide
frequent departures with fewer aircraft. Southwest does not offer
meals, assigned seats, interline baggage checking, or premium
classes of service. Automated ticketing at the gate encourages
customers to bypass travel agents, allowing Southwest to avoid their
commissions. A standardized fleet of 737 aircraft boosts the
efficiency of maintenance.
Southwest has staked out a unique and valuable strategic position
based on a tailored set of activities. On the routes served by
Southwest, a full-service airline could never be as convenient or as
low cost.
Ikea, the global furniture retailer based in Sweden, also has a
clear strategic positioning. Ikea targets young furniture buyers who
want style at low cost. What turns this marketing concept into a
strategic positioning is the tailored set of activities that make it
work. Like Southwest, Ikea has chosen to perform activities
differently from its rivals.
Consider the typical furniture store. Showrooms display samples of
the merchandise. One area might contain 25 sofas; another will
display five dining tables. But those items represent only a
fraction of the choices available to customers. Dozens of books
displaying fabric swatches or wood samples or alternate styles offer
customers thousands of product varieties to choose from. Salespeople
often escort customers through the store, answering questions and
helping them navigate this maze of choices. Once a customer makes a
selection, the order is relayed to a third-party manufacturer. With
luck, the furniture will be delivered to the customer’s home within
six to eight weeks. This is a value chain that maximizes
customization and service but does so at high cost.
In contrast, Ikea serves customers who are happy to trade off
service for cost. Instead of having a sales associate trail
customers around the store, Ikea uses a self-service model based on
clear, in-store displays. Rather than rely solely on third-party
manufacturers, Ikea designs its own low-cost, modular,
ready-to-assemble furniture to fit its positioning. In huge stores,
Ikea displays every product it sells in room-like settings, so
customers don’t need a decorator to help them imagine how to put the
pieces together. Adjacent to the furnished showrooms is a warehouse
section with the products in boxes on pallets. Customers are
expected to do their own pickup and delivery, and Ikea will even
sell you a roof rack for your car that you can return for a refund
on your next visit.
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Although much of its low-cost position comes from having customers
“do it themselves,” Ikea offers a number of extra services that its
competitors do not. In-store child care is one. Extended hours are
another. Those services are uniquely aligned with the needs of its
customers, who are young, not wealthy, likely to have children (but
no nanny), and, because they work for a living, have a need to shop
at odd hours.
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Strategic positions emerge from three distinct sources, which are
not mutually exclusive and often overlap. First, positioning can be
based on producing a subset of an industry’s products or services. I
call this variety-based positioning because it is based on the
choice of product or service varieties rather than customer
segments. Variety-based positioning makes economic sense when a
company can best produce particular products or services using
distinctive sets of activities.
Jiffy Lube International, for instance, specializes in automotive
lubricants and does not offer other car repair or maintenance
services. Its value chain produces faster service at a lower cost
than broader line repair shops, a combination so attractive that
many customers subdivide their purchases, buying oil changes from
the focused competitor, Jiffy Lube, and going to rivals for other
services.
The Vanguard Group, a leader in the mutual fund industry, is another
example of variety-based positioning. Vanguard provides an array of
common stock, bond, and money market funds that offer predictable
performance and rock-bottom expenses. The company’s investment
approach deliberately sacrifices the possibility of extraordinary
performance in any one year for good relative performance in every
year. Vanguard is known, for example, for its index funds. It avoids
making bets on interest rates and steers clear of narrow stock
groups. Fund managers keep trading levels low, which holds expenses
down; in addition, the company discourages customers from rapid
buying and selling because doing so drives up costs and can force a
fund manager to trade in order to deploy new capital and raise cash
for redemptions. Vanguard also takes a consistent low-cost approach
to managing distribution, customer service, and marketing. Many
investors include one or more Vanguard funds in their portfolio,
while buying aggressively managed or specialized funds from
competitors.
The people who use Vanguard or Jiffy Lube are responding to a
superior value chain for a particular type of service. A
variety-based positioning can serve a wide array of customers, but
for most it will meet only a subset of their needs.
A second basis for positioning is that of serving most or all the
needs of a particular group of customers. I call this needs-based
positioning, which comes closer to traditional thinking about
targeting a segment of customers. It arises when there are groups of
customers with differing needs, and when a tailored set of
activities can serve those needs best. Some groups of customers are
more price sensitive than others, demand different product features,
and need varying amounts of information, support, and services.
Ikea’s customers are a good example of such a group. Ikea seeks to
meet all the home furnishing needs of its target customers, not just
a subset of them.
A variant of needs-based positioning arises when the same customer
has different needs on different occasions or for different types of
transactions. The same person, for example, may have different needs
when traveling on business than when traveling for pleasure with the
family. Buyers of cans—beverage companies, for example—will likely
have different needs from their primary supplier than from their
secondary source.
It is intuitive for most managers to conceive of their business in
terms of the customers’ needs they are meeting. But a critical
element of needs-based positioning is not at all intuitive and is
often overlooked. Differences in needs will not translate into
meaningful positions unless the best set of activities to satisfy
them also differs. If that were not the case, every competitor could
meet those same needs, and there would be nothing unique or valuable
about the positioning.
In private banking, for example, Bessemer Trust Company targets
families with a minimum of $5 million in investable assets who want
capital preservation combined with wealth accumulation. By assigning
one sophisticated account officer for every 14 families, Bessemer
has configured its activities for personalized service. Meetings,
for example, are more likely to be held at a client’s ranch or yacht
than in the office. Bessemer offers a wide array of customized
services, including investment management and estate administration,
oversight of oil and gas investments, and accounting for racehorses
and aircraft. Loans, a staple of most private banks, are rarely
needed by Bessemer’s clients and make up a tiny fraction of its
client balances and income. Despite the most generous compensation
of account officers and the highest personnel cost as a percentage
of operating expenses, Bessemer’s differentiation with its target
families produces a return on equity estimated to be the highest of
any private banking competitor.
Citibank’s private bank, on the other hand, serves clients with
minimum assets of about $250,000 who, in contrast to Bessemer’s
clients, want convenient access to loans—from jumbo mortgages to
deal financing. Citibank’s account managers are primarily lenders.
When clients need other services, their account manager refers them
to other Citibank specialists, each of whom handles prepackaged
products. Citibank’s system is less customized than Bessemer’s and
allows it to have a lower manager-to-client ratio of 1:125. Biannual
office meetings are offered only for the largest clients. Both
Bessemer and Citibank have tailored their activities to meet the
needs of a different group of private banking customers. The same
value chain cannot profitably meet the needs of both groups.
The third basis for positioning is that of segmenting customers who
are accessible in different ways. Although their needs are similar
to those of other customers, the best configuration of activities to
reach them is different. I call this access-based positioning.
Access can be a function of customer geography or customer scale—or
of anything that requires a different set of activities to reach
customers in the best way.
Segmenting by access is less common and less well understood than
the other two bases. Carmike Cinemas, for example, operates movie
theaters exclusively in cities and towns with populations under
200,000. How does Carmike make money in markets that are not only
small but also won’t support big-city ticket prices? It does so
through a set of activities that result in a lean cost structure.
Carmike’s small-town customers can be served through standardized,
low-cost theater complexes requiring fewer screens and less
sophisticated projection technology than big-city theaters. The
company’s proprietary information system and management process
eliminate the need for local administrative staff beyond a single
theater manager. Carmike also reaps advantages from centralized
purchasing, lower rent and payroll costs (because of its locations),
and rock-bottom corporate overhead of 2% (the industry average is
5%). Operating in small communities also allows Carmike to practice
a highly personal form of marketing in which the theater manager
knows patrons and promotes attendance through personal contacts. By
being the dominant if not the only theater in its markets—the main
competition is often the high school football team—Carmike is also
able to get its pick of films and negotiate better terms with
distributors.
Rural versus urban-based customers are one example of access driving
differences in activities. Serving small rather than large customers
or densely rather than sparsely situated customers are other
examples in which the best way to configure marketing, order
processing, logistics, and after-sale service activities to meet the
similar needs of distinct groups will often differ.
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Positioning is not only about carving out a niche. A position
emerging from any of the sources can be broad or narrow. A focused
competitor, such as Ikea, targets the special needs of a subset of
customers and designs its activities accordingly. Focused
competitors thrive on groups of customers who are overserved (and
hence overpriced) by more broadly targeted competitors, or
underserved (and hence underpriced). A broadly targeted
competitor—for example, Vanguard or Delta Air Lines—serves a wide
array of customers, performing a set of activities designed to meet
their common needs. It ignores or meets only partially the more
idiosyncratic needs of particular customer customer groups.
Whatever the basis—variety, needs, access, or some combination of
the three—positioning requires a tailored set of activities because
it is always a function of differences on the supply side; that is,
of differences in activities. However, positioning is not always a
function of differences on the demand, or customer, side. Variety
and access positionings, in particular, do not rely on any customer
differences. In practice, however, variety or access differences
often accompany needs differences. The tastes—that is, the needs—of
Carmike’s small-town customers, for instance, run more toward
comedies, Westerns, action films, and family entertainment. Carmike
does not run any films rated NC-17.
Having defined positioning, we can now begin to answer the question,
“What is strategy?” Strategy is the creation of a unique and
valuable position, involving a different set of activities. If there
were only one ideal position, there would be no need for strategy.
Companies would face a simple imperative—win the race to discover
and preempt it. The essence of strategic positioning is to choose
activities that are different from rivals’. If the same set of
activities were best to produce all varieties, meet all needs, and
access all customers, companies could easily shift among them and
operational effectiveness would determine performance.
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Choosing a unique position, however, is not enough to guarantee a
sustainable advantage. A valuable position will attract imitation by
incumbents, who are likely to copy it in one of two ways.
First, a competitor can reposition itself to match the superior
performer. J.C. Penney, for instance, has been repositioning itself
from a Sears clone to a more upscale, fashion-oriented, soft-goods
retailer. A second and far more common type of imitation is
straddling. The straddler seeks to match the benefits of a
successful position while maintaining its existing position. It
grafts new features, services, or technologies onto the activities
it already performs.
For those who argue that competitors can copy any market position,
the airline industry is a perfect test case. It would seem that
nearly any competitor could imitate any other airline’s activities.
Any airline can buy the same planes, lease the gates, and match the
menus and ticketing and baggage handling services offered by other
airlines.
Continental Airlines saw how well Southwest was doing and decided to
straddle. While maintaining its position as a full-service airline,
Continental also set out to match Southwest on a number of
point-to-point routes. The airline dubbed the new service
Continental Lite. It eliminated meals and first-class service,
increased departure frequency, lowered fares, and shortened
turnaround time at the gate. Because Continental remained a
full-service airline on other routes, it continued to use travel
agents and its mixed fleet of planes and to provide baggage checking
and seat assignments.
But a strategic position is not sustainable unless there are
trade-offs with other positions. Trade-offs occur when activities
are incompatible. Simply put, a trade-off means that more of one
thing necessitates less of another. An airline can choose to serve
meals—adding cost and slowing turnaround time at the gate—or it can
choose not to, but it cannot do both without bearing major
inefficiencies.
Trade-offs create the need for choice and protect against
repositioners and straddlers. Consider Neutrogena soap. Neutrogena
Corporation’s variety-based positioning is built on a “kind to the
skin,” residue-free soap formulated for pH balance. With a large
detail force calling on dermatologists, Neutrogena’s marketing
strategy looks more like a drug company’s than a soap maker’s. It
advertises in medical journals, sends direct mail to doctors,
attends medical conferences, and performs research at its own
Skincare Institute. To reinforce its positioning, Neutrogena
originally focused its distribution on drugstores and avoided price
promotions. Neutrogena uses a slow, more expensive manufacturing
process to mold its fragile soap.
In choosing this position, Neutrogena said no to the deodorants and
skin softeners that many customers desire in their soap. It gave up
the large-volume potential of selling through supermarkets and using
price promotions. It sacrificed manufacturing efficiencies to
achieve the soap’s desired attributes. In its original positioning,
Neutrogena made a whole raft of trade-offs like those, trade-offs
that protected the company from imitators.
Trade-offs arise for three reasons. The first is inconsistencies in
image or reputation. A company known for delivering one kind of
value may lack credibility and confuse customers—or even undermine
its reputation—if it delivers another kind of value or attempts to
deliver two inconsistent things at the same time. For example, Ivory
soap, with its position as a basic, inexpensive everyday soap would
have a hard time reshaping its image to match Neutrogena’s premium
“medical” reputation. Efforts to create a new image typically cost
tens or even hundreds of millions of dollars in a major industry—a
powerful barrier to imitation.
Second, and more important, trade-offs arise from activities
themselves. Different positions (with their tailored activities)
require different product configurations, different equipment,
different employee behavior, different skills, and different
management systems. Many trade-offs reflect inflexibilities in
machinery, people, or systems. The more Ikea has configured its
activities to lower costs by having its customers do their own
assembly and delivery, the less able it is to satisfy customers who
require higher levels of service.
However, trade-offs can be even more basic. In general, value is
destroyed if an activity is overdesigned or underdesigned for its
use. For example, even if a given salesperson were capable of
providing a high level of assistance to one customer and none to
another, the salesperson’s talent (and some of his or her cost)
would be wasted on the second customer. Moreover, productivity can
improve when variation of an activity is limited. By providing a
high level of assistance all the time, the salesperson and the
entire sales activity can often achieve efficiencies of learning and
scale.
Finally, trade-offs arise from limits on internal coordination and
control. By clearly choosing to compete in one way and not another,
senior management makes organizational priorities clear. Companies
that try to be all things to all customers, in contrast, risk
confusion in the trenches as employees attempt to make day-to-day
operating decisions without a clear framework.
Positioning trade-offs are pervasive in competition and essential to
strategy. They create the need for choice and purposefully limit
what a company offers. They deter straddling or repositioning,
because competitors that engage in those approaches undermine their
strategies and degrade the value of their existing activities.
Trade-offs ultimately grounded Continental Lite. The airline lost
hundreds of millions of dollars, and the CEO lost his job. Its
planes were delayed leaving congested hub cities or slowed at the
gate by baggage transfers. Late flights and cancellations generated
a thousand complaints a day. Continental Lite could not afford to
compete on price and still pay standard travel-agent commissions,
but neither could it do without agents for its full-service
business. The airline compromised by cutting commissions for all
Continental flights across the board. Similarly, it could not afford
to offer the same frequent-flier benefits to travelers paying the
much lower ticket prices for Lite service. It compromised again by
lowering the rewards of Continental’s entire frequent-flier program.
The results: angry travel agents and full-service customers.
Continental tried to compete in two ways at once. In trying to be
low cost on some routes and full service on others, Continental paid
an enormous straddling penalty. If there were no trade-offs between
the two positions, Continental could have succeeded. But the absence
of trade-offs is a dangerous half-truth that managers must unlearn.
Quality is not always free. Southwest’s convenience, one kind of
high quality, happens to be consistent with low costs because its
frequent departures are facilitated by a number of low-cost
practices—fast gate turnarounds and automated ticketing, for
example. However, other dimensions of airline quality—an assigned
seat, a meal, or baggage transfer—require costs to provide.
In general, false trade-offs between cost and quality occur
primarily when there is redundant or wasted effort, poor control or
accuracy, or weak coordination. Simultaneous improvement of cost and
differentiation is possible only when a company begins far behind
the productivity frontier or when the frontier shifts outward. At
the frontier, where companies have achieved current best practice,
the trade-off between cost and differentiation is very real indeed.
After a decade of enjoying productivity advantages, Honda Motor
Company and Toyota Motor Corporation recently bumped up against the
frontier. In 1995, faced with increasing customer resistance to
higher automobile prices, Honda found that the only way to produce a
less-expensive car was to skimp on features. In the United States,
it replaced the rear disk brakes on the Civic with lower-cost drum
brakes and used cheaper fabric for the back seat, hoping customers
would not notice. Toyota tried to sell a version of its best-selling
Corolla in Japan with unpainted bumpers and cheaper seats. In
Toyota’s case, customers rebelled, and the company quickly dropped
the new model.
For the past decade, as managers have improved operational
effectiveness greatly, they have internalized the idea that
eliminating trade-offs is a good thing. But if there are no
trade-offs companies will never achieve a sustainable advantage.
They will have to run faster and faster just to stay in place.
As we return to the question, What is strategy? we see that
trade-offs add a new dimension to the answer. Strategy is making
trade-offs in competing. The essence of strategy is choosing what
not to do. Without trade-offs, there would be no need for choice and
thus no need for strategy. Any good idea could and would be quickly
imitated. Again, performance would once again depend wholly on
operational effectiveness.
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Positioning choices determine not only which activities a company
will perform and how it will configure individual activities but
also how activities relate to one another. While operational
effectiveness is about achieving excellence in individual
activities, or functions, strategy is about combining activities.
Southwest’s rapid gate turnaround, which allows frequent departures
and greater use of aircraft, is essential to its high-convenience,
low-cost positioning. But how does Southwest achieve it? Part of the
answer lies in the company’s well-paid gate and ground crews, whose
productivity in turnarounds is enhanced by flexible union rules. But
the bigger part of the answer lies in how Southwest performs other
activities. With no meals, no seat assignment, and no interline
baggage transfers, Southwest avoids having to perform activities
that slow down other airlines. It selects airports and routes to
avoid congestion that introduces delays. Southwest’s strict limits
on the type and length of routes make standardized aircraft
possible: every aircraft Southwest turns is a Boeing 737.
What is Southwest’s core competence? Its key success factors? The
correct answer is that everything matters. Southwest’s strategy
involves a whole system of activities, not a collection of parts.
Its competitive advantage comes from the way its activities fit and
reinforce one another.
Fit locks out imitators by creating a chain that is as strong as its
strongest link. As in most companies with good strategies,
Southwest’s activities complement one another in ways that create
real economic value. One activity’s cost, for example, is lowered
because of the way other activities are performed. Similarly, one
activity’s value to customers can be enhanced by a company’s other
activities. That is the way strategic fit creates competitive
advantage and superior profitability.
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The importance of fit among functional policies is one of the oldest
ideas in strategy. Gradually, however, it has been supplanted on the
management agenda. Rather than seeing the company as a whole,
managers have turned to “core” competencies, “critical” resources,
and “key” success factors. In fact, fit is a far more central
component of competitive advantage than most realize.
Fit is important because discrete activities often affect one
another. A sophisticated sales force, for example, confers a greater
advantage when the company’s product embodies premium technology and
its marketing approach emphasizes customer assistance and support. A
production line with high levels of model variety is more valuable
when combined with an inventory and order processing system that
minimizes the need for stocking finished goods, a sales process
equipped to explain and encourage customization, and an advertising
theme that stresses the benefits of product variations that meet a
customer’s special needs. Such complementarities are pervasive in
strategy. Although some fit among activities is generic and applies
to many companies, the most valuable fit is strategy-specific
because it enhances a position’s uniqueness and amplifies
trade-offs.2
There are three types of fit, although they are not mutually
exclusive. First-order fit is simple consistency between each
activity (function) and the overall strategy. Vanguard, for example,
aligns all activities with its low-cost strategy. It minimizes
portfolio turnover and does not need highly compensated money
managers. The company distributes its funds directly, avoiding
commissions to brokers. It also limits advertising, relying instead
on public relations and word-of-mouth recommendations. Vanguard ties
its employees’ bonuses to cost savings.
Consistency ensures that the competitive advantages of activities
cumulate and do not erode or cancel themselves out. It makes the
strategy easier to communicate to customers, employees, and
shareholders, and improves implementation through single-mindedness
in the corporation.
Second-order fit occurs when activities are reinforcing. Neutrogena,
for example, markets to upscale hotels eager to offer their guests a
soap recommended by dermatologists. Hotels grant Neutrogena the
privilege of using its customary packaging while requiring other
soaps to feature the hotel’s name. Once guests have tried Neutrogena
in a luxury hotel, they are more likely to purchase it at the
drugstore or ask their doctor about it. Thus Neutrogena’s medical
and hotel marketing activities reinforce one another, lowering total
marketing costs.
In another example, Bic Corporation sells a narrow line of standard,
low-priced pens to virtually all major customer markets (retail,
commercial, promotional, and giveaway) through virtually all
available channels. As with any variety-based positioning serving a
broad group of customers, Bic emphasizes a common need (low price
for an acceptable pen) and uses marketing approaches with a broad
reach (a large sales force and heavy television advertising). Bic
gains the benefits of consistency across nearly all activities,
including product design that emphasizes ease of manufacturing,
plants configured for low cost, aggressive purchasing to minimize
material costs, and in-house parts production whenever the economics
dictate.
Yet Bic goes beyond simple consistency because its activities are
reinforcing. For example, the company uses point-of-sale displays
and frequent packaging changes to stimulate impulse buying. To
handle point-of-sale tasks, a company needs a large sales force.
Bic’s is the largest in its industry, and it handles point-of-sale
activities better than its rivals do. Moreover, the combination of
point-of-sale activity, heavy television advertising, and packaging
changes yields far more impulse buying than any activity in
isolation could.
Third-order fit goes beyond activity reinforcement to what I call
optimization of effort. The Gap, a retailer of casual clothes,
considers product availability in its stores a critical element of
its strategy. The Gap could keep products either by holding store
inventory or by restocking from warehouses. The Gap has optimized
its effort across these activities by restocking its selection of
basic clothing almost daily out of three warehouses, thereby
minimizing the need to carry large in-store inventories. The
emphasis is on restocking because the Gap’s merchandising strategy
sticks to basic items in relatively few colors. While comparable
retailers achieve turns of three to four times per year, the Gap
turns its inventory seven and a half times per year. Rapid
restocking, moreover, reduces the cost of implementing the Gap’s
short model cycle, which is six to eight weeks long.3
Coordination and information exchange across activities to eliminate
redundancy and minimize wasted effort are the most basic types of
effort optimization. But there are higher levels as well. Product
design choices, for example, can eliminate the need for after-sale
service or make it possible for customers to perform service
activities themselves. Similarly, coordination with suppliers or
distribution channels can eliminate the need for some in-house
activities, such as end-user training.
In all three types of fit, the whole matters more than any
individual part. Competitive advantage grows out of the entire
system of activities. The fit among activities substantially reduces
cost or increases differentiation. Beyond that, the competitive
value of individual activities—or the associated skills,
competencies, or resources—cannot be decoupled from the system or
the strategy. Thus in competitive companies it can be misleading to
explain success by specifying individual strengths, core
competencies, or critical resources. The list of strengths cuts
across many functions, and one strength blends into others. It is
more useful to think in terms of themes that pervade many
activities, such as low cost, a particular notion of customer
service, or a particular conception of the value delivered. These
themes are embodied in nests of tightly linked activities.
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Strategic fit among many activities is fundamental not only to
competitive advantage but also to the sustainability of that
advantage. It is harder for a rival to match an array of interlocked
activities than it is merely to imitate a particular sales-force
approach, match a process technology, or replicate a set of product
features. Positions built on systems of activities are far more
sustainable than those built on individual activities.
Consider this simple exercise. The probability that competitors can
match any activity is often less than one. The probabilities then
quickly compound to make matching the entire system highly unlikely
(.9 × .9 = .81; .9 × .9 × .9 × .9 = .66, and so on). Existing
companies that try to reposition or straddle will be forced to
reconfigure many activities. And even new entrants, though they do
not confront the trade-offs facing established rivals, still face
formidable barriers to imitation.
The more a company’s positioning rests on activity systems with
second- and third-order fit, the more sustainable its advantage will
be. Such systems, by their very nature, are usually difficult to
untangle from outside the company and therefore hard to imitate. And
even if rivals can identify the relevant interconnections, they will
have difficulty replicating them. Achieving fit is difficult because
it requires the integration of decisions and actions across many
independent subunits.
A competitor seeking to match an activity system gains little by
imitating only some activities and not matching the whole.
Performance does not improve; it can decline. Recall Continental
Lite’s disastrous attempt to imitate Southwest.
Finally, fit among a company’s activities creates pressures and
incentives to improve operational effectiveness, which makes
imitation even harder. Fit means that poor performance in one
activity will degrade the performance in others, so that weaknesses
are exposed and more prone to get attention. Conversely,
improvements in one activity will pay dividends in others. Companies
with strong fit among their activities are rarely inviting targets.
Their superiority in strategy and in execution only compounds their
advantages and raises the hurdle for imitators.
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When activities complement one another, rivals will get little
benefit from imitation unless they successfully match the whole
system. Such situations tend to promote winner-take-all competition.
The company that builds the best activity system—Toys R Us, for
instance—wins, while rivals with similar strategies—Child World and
Lionel Leisure—fall behind. Thus finding a new strategic position is
often preferable to being the second or third imitator of an
occupied position.
The most viable positions are those whose activity systems are
incompatible because of tradeoffs. Strategic positioning sets the
trade-off rules that define how individual activities will be
configured and integrated. Seeing strategy in terms of activity
systems only makes it clearer why organizational structure, systems,
and processes need to be strategy-specific. Tailoring organization
to strategy, in turn, makes complementarities more achievable and
contributes to sustainability.
One implication is that strategic positions should have a horizon of
a decade or more, not of a single planning cycle. Continuity fosters
improvements in individual activities and the fit across activities,
allowing an organization to build unique capabilities and skills
tailored to its strategy. Continuity also reinforces a company’s
identity.
Conversely, frequent shifts in positioning are costly. Not only must
a company reconfigure individual activities, but it must also
realign entire systems. Some activities may never catch up to the
vacillating strategy. The inevitable result of frequent shifts in
strategy, or of failure to choose a distinct position in the first
place, is “me-too” or hedged activity configurations,
inconsistencies across functions, and organizational dissonance.
What is strategy? We can now complete the answer to this question.
Strategy is creating fit among a company’s activities. The success
of a strategy depends on doing many things well—not just a few—and
integrating among them. If there is no fit among activities, there
is no distinctive strategy and little sustainability. Management
reverts to the simpler task of overseeing independent functions, and
operational effectiveness determines an organization’s relative
performance.
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Why do so many companies fail to have a strategy? Why do managers
avoid making strategic choices? Or, having made them in the past,
why do managers so often let strategies decay and blur?
Commonly, the threats to strategy are seen to emanate from outside a
company because of changes in technology or the behavior of
competitors. Although external changes can be the problem, the
greater threat to strategy often comes from within. A sound strategy
is undermined by a misguided view of competition, by organizational
failures, and, especially, by the desire to grow.
Managers have become confused about the necessity of making choices.
When many companies operate far from the productivity frontier,
trade-offs appear unnecessary. It can seem that a well-run company
should be able to beat its ineffective rivals on all dimensions
simultaneously. Taught by popular management thinkers that they do
not have to make trade-offs, managers have acquired a macho sense
that to do so is a sign of weakness.
Unnerved by forecasts of hypercompetition, managers increase its
likelihood by imitating everything about their competitors. Exhorted
to think in terms of revolution, managers chase every new technology
for its own sake.
The pursuit of operational effectiveness is seductive because it is
concrete and actionable. Over the past decade, managers have been
under increasing pressure to deliver tangible, measurable
performance improvements. Programs in operational effectiveness
produce reassuring progress, although superior profitability may
remain elusive. Business publications and consultants flood the
market with information about what other companies are doing,
reinforcing the best-practice mentality. Caught up in the race for
operational effectiveness, many managers simply do not understand
the need to have a strategy.
Companies avoid or blur strategic choices for other reasons as well.
Conventional wisdom within an industry is often strong, homogenizing
competition. Some managers mistake “customer focus” to mean they
must serve all customer needs or respond to every request from
distribution channels. Others cite the desire to preserve
flexibility.
Organizational realities also work against strategy. Trade-offs are
frightening, and making no choice is sometimes preferred to risking
blame for a bad choice. Companies imitate one another in a type of
herd behavior, each assuming rivals know something they do not.
Newly empowered employees, who are urged to seek every possible
source of improvement, often lack a vision of the whole and the
perspective to recognize trade-offs. The failure to choose sometimes
comes down to the reluctance to disappoint valued managers or
employees.
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Among all other influences, the desire to grow has perhaps the most
perverse effect on strategy. Trade-offs and limits appear to
constrain growth. Serving one group of customers and excluding
others, for instance, places a real or imagined limit on revenue
growth. Broadly targeted strategies emphasizing low price result in
lost sales with customers sensitive to features or service.
Differentiators lose sales to price-sensitive customers.
Managers are constantly tempted to take incremental steps that
surpass those limits but blur a company’s strategic position.
Eventually, pressures to grow or apparent saturation of the target
market lead managers to broaden the position by extending product
lines, adding new features, imitating competitors’ popular services,
matching processes, and even making acquisitions. For years, Maytag
Corporation’s success was based on its focus on reliable, durable
washers and dryers, later extended to include dishwashers. However,
conventional wisdom emerging within the industry supported the
notion of selling a full line of products. Concerned with slow
industry growth and competition from broad-line appliance makers,
Maytag was pressured by dealers and encouraged by customers to
extend its line. Maytag expanded into refrigerators and cooking
products under the Maytag brand and acquired other brands—Jenn-Air,
Hardwick Stove, Hoover, Admiral, and Magic Chef—with disparate
positions. Maytag has grown substantially from $684 million in 1985
to a peak of $3.4 billion in 1994, but return on sales has declined
from 8% to 12% in the 1970s and 1980s to an average of less than 1%
between 1989 and 1995. Cost cutting will improve this performance,
but laundry and dishwasher products still anchor Maytag’s
profitability.
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Neutrogena may have fallen into the same trap. In the early 1990s,
its U.S. distribution broadened to include mass merchandisers such
as Wal-Mart Stores. Under the Neutrogena name, the company expanded
into a wide variety of products—eye-makeup remover and shampoo, for
example—in which it was not unique and which diluted its image, and
it began turning to price promotions.
Compromises and inconsistencies in the pursuit of growth will erode
the competitive advantage a company had with its original varieties
or target customers. Attempts to compete in several ways at once
create confusion and undermine organizational motivation and focus.
Profits fall, but more revenue is seen as the answer. Managers are
unable to make choices, so the company embarks on a new round of
broadening and compromises. Often, rivals continue to match each
other until desperation breaks the cycle, resulting in a merger or
downsizing to the original positioning.
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Many companies, after a decade of restructuring and cost-cutting,
are turning their attention to growth. Too often, efforts to grow
blur uniqueness, create compromises, reduce fit, and ultimately
undermine competitive advantage. In fact, the growth imperative is
hazardous to strategy.
What approaches to growth preserve and reinforce strategy? Broadly,
the prescription is to concentrate on deepening a strategic position
rather than broadening and compromising it. One approach is to look
for extensions of the strategy that leverage the existing activity
system by offering features or services that rivals would find
impossible or costly to match on a stand-alone basis. In other
words, managers can ask themselves which activities, features, or
forms of competition are feasible or less costly to them because of
complementary activities that their company performs.
Deepening a position involves making the company’s activities more
distinctive, strengthening fit, and communicating the strategy
better to those customers who should value it. But many companies
succumb to the temptation to chase “easy” growth by adding hot
features, products, or services without screening them or adapting
them to their strategy. Or they target new customers or markets in
which the company has little special to offer. A company can often
grow faster—and far more profitably—by better penetrating needs and
varieties where it is distinctive than by slugging it out in
potentially higher growth arenas in which the company lacks
uniqueness. Carmike, now the largest theater chain in the United
States, owes its rapid growth to its disciplined concentration on
small markets. The company quickly sells any big-city theaters that
come to it as part of an acquisition.
Globalization often allows growth that is consistent with strategy,
opening up larger markets for a focused strategy. Unlike broadening
domestically, expanding globally is likely to leverage and reinforce
a company’s unique position and identity.
Companies seeking growth through broadening within their industry
can best contain the risks to strategy by creating stand-alone
units, each with its own brand name and tailored activities. Maytag
has clearly struggled with this issue. On the one hand, it has
organized its premium and value brands into separate units with
different strategic positions. On the other, it has created an
umbrella appliance company for all its brands to gain critical mass.
With shared design, manufacturing, distribution, and customer
service, it will be hard to avoid homogenization. If a given
business unit attempts to compete with different positions for
different products or customers, avoiding compromise is nearly
impossible.
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The challenge of developing or reestablishing a clear strategy is
often primarily an organizational one and depends on leadership.
With so many forces at work against making choices and tradeoffs in
organizations, a clear intellectual framework to guide strategy is a
necessary counterweight. Moreover, strong leaders willing to make
choices are essential.
In many companies, leadership has degenerated into orchestrating
operational improvements and making deals. But the leader’s role is
broader and far more important. General management is more than the
stewardship of individual functions. Its core is strategy: defining
and communicating the company’s unique position, making trade-offs,
and forging fit among activities. The leader must provide the
discipline to decide which industry changes and customer needs the
company will respond to, while avoiding organizational distractions
and maintaining the company’s distinctiveness. Managers at lower
levels lack the perspective and the confidence to maintain a
strategy. There will be constant pressures to compromise, relax
trade-offs, and emulate rivals. One of the leader’s jobs is to teach
others in the organization about strategy—and to say no.
Strategy renders choices about what not to do as important as
choices about what to do. Indeed, setting limits is another function
of leadership. Deciding which target group of customers, varieties,
and needs the company should serve is fundamental to developing a
strategy. But so is deciding not to serve other customers or needs
and not to offer certain features or services. Thus strategy
requires constant discipline and clear communication. Indeed, one of
the most important functions of an explicit, communicated strategy
is to guide employees in making choices that arise because of
trade-offs in their individual activities and in day-to-day
decisions.
Michael E. Porter is the C. Roland Christensen Professor of Business
Administration at the Harvard Business School in Boston,
Massachusetts.
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