Understanding Michael Porter

The Essential Guide to Competition and Strategy

Joan Magretta

• Publisher: Harvard Business Review Press
• Year: 2011
• ISBN:
  9781422142295
• Topic: Business
• Subtopic: Management
• Index: Business

Competitive advantage. The value chain. Five forces. Industry structure. Differentiation. Relative cost. If you want to understand how companies achieve and sustain competitive success, Michael Porter’s frameworks are the foundation. But while everyone in business may know Porter’s name, many managers misunderstand and misuse his concepts. Understanding Michael Porter sets the record straight, providing the first concise, accessible summary of Porter’s revolutionary thinking. Written with Porter’s full cooperation by Joan Magretta, his former editor at Harvard Business Review, this new book delivers fresh, clear examples to illustrate and update Porter’s ideas.Magretta uses her wide business experience to translate Porter’s powerful insights into practice and to correct the most common misconceptions about them—for instance, that competition is about being unique, not being the best; that it is a contest over profits, not a battle between rivals; that strategy is about choosing to make some customers unhappy, not being all things to all customers.An added feature is an original Q&A with Porter himself, which includes answers to managers’ FAQs.Eminently readable, this book will enable every manager in your organization to grasp Porter’s ideas—and swiftly deploy them to drive your company’s success.

PART ONE

What Is
Competition?

CHAPTER 1

Competition:

The Right Mind-Set

STRATEGY IS ONE OF the most dangerous concepts in business. Why dangerous? Because while most managers agree that it is terrifically important, once you start paying attention to how the word is used you will soon be wondering whether it means anything at all. Fans of GE’s legendary CEO Jack Welch say their strategy is to be number 1 or number 2 in their business (or else!). For the new CEO of a Fortune 100 company, the strategy is “to grow.” For an energy company executive, the strategy is to “make key acquisitions.” A software developer says, “Our strategy is our people.” The strategy of a leading nonprofit is to “double the number of people we serve.” And then there is Google’s famous “Don’t be evil.” Is that a strategy?

By the time you reach the end of this book, you will appreciate why none of the above would qualify as a “strategy,” which for Porter is shorthand for “a good competitive strategy that will result in sustainably superior performance.” None of the above formulations tells you what will enable the organization in question to outperform the competition. Some tell you what their goal or aspiration is; others highlight key actions; some single out values. But none of them really tackles the core question, performance in the face of competition. What value will your organization create? And how will you capture some of that value for yourself? That, Michael Porter tells us, is strategy’s job.

Strategy explains how an organization, faced with competition, will achieve superior performance. The definition is deceptively simple in part because the words are so familiar that we rarely stop to think about what they mean. But if you do, you will quickly realize that these terms are loaded. What is competition? How does it work? How do organizations “win”? What, exactly, does superior performance mean?

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Strategy explains how an organization, faced with competition, will achieve superior performance. The definition is deceptively simple.

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Most managers worry about competition. They know that it’s pervasive. They have an uncomfortable sense that it is breathing down their necks. They know that in order to survive they must deal with it. And in order to thrive, they have to find a “competitive advantage,” a term rarely used before Porter made it popular. And yet, Porter tells us, one of the reasons so many companies fail to develop good strategies is that the people running them operate with fundamental misconceptions about what competition is and how it works. This is critical because if there were no competition, there would be no need for strategy, no need to come up with a way to “win,” to outperform your rivals. But, of course, competition is everywhere, even in so-called market “spaces” served primarily by nonprofit organizations.

How you think about competition will define the choices you make about how you are going to compete. It will impact your ability to assess those choices critically. That is why before we can even begin to talk about strategy, we need to tackle the question of competition and competitive advantage.

Why Not the Best?

Interviewed on the day the “new” General Motors went public in 2010, CEO Dan Akerson said his company, now free of its legacy costs, was ready to compete. “May the best car win!” he told reporters. How often have you heard an organization’s leaders urging their people to be “the best”? How often have you heard the call to make your company the “best in its industry”? Companies proudly proclaim that they produce the “best” products, provide the “best” service, and attract the “best” talent. These phrases reflect an underlying belief about the nature of competition that feels so intuitively correct to most people that it is almost never examined or questioned. If you want to win, it’s obvious that you should be the best. Or is it?

Michael Porter has a name for this syndrome. He calls it competition to be the best. It is, he will tell you, absolutely the wrong way to think about competition. If you start out with this flawed idea of how competition works, it will lead you inevitably to a flawed strategy. And that will lead to mediocre performance.

For most managers, vying to be the best is what competition is all about. This belief is reinforced by popular metaphors drawn from warfare and sports. Management writers—and leaders trying to inspire people—are drawn to these metaphors because they are vivid and engaging. They lend emotion, drama, and consequence to business competition. But metaphors can be misleading. Although they highlight how one thing has elements that are like another, they never mean that one thing is identical to another.

In war, there can be only one winner. Victory requires that the enemy be crippled or destroyed. In business, however, you can win without annihilating your rivals. For decades, Walmart has been a winner in discount retailing, for example, but so has Target. Each offers a different and distinctive mix of merchandise, aimed at meeting different customer needs. Walmart is the workhorse of discounters, offering “everyday low prices.” Target is more of a show horse, appealing to customers who want flair along with low prices. In business, multiple winners can thrive and coexist. Competition focuses more on meeting customer needs than on demolishing rivals. Just look around. Because there are so many needs to serve, there are many ways to win.

The sports analogy is just as misleading. Athletes vie with each other to see who will be crowned “the best.” They focus on outperforming their rivals. They compete to win. But in sports, there is one contest with one set of rules. There can be only one winner. Business competition is more complex, more open ended and multidimensional. Within an industry, there can be multiple contests, not just one, based on which customers and needs are to be served. McDonald’s is a winner in fast food, specifically fast burgers. But In-N-Out Burger thrives on slow burgers. Its customers are happy to wait ten minutes or more (an eternity by McDonald’s stopwatch) to get nonprocessed, fresh burgers cooked to order on homemade buns. Rather than enter a particular race with a particular rival, as Porter would put it, companies can choose to create their own event.

It’s always hard to break a mental habit, but harder still if you are unaware that you have one in the first place. That’s the problem with the competition-to-be-the-best mind-set. It is typically a tacit way of thinking, not an explicit model. The nature of competition is simply taken for granted. But, says Porter, it shouldn’t be. In the vast majority of businesses, there is simply no such thing as “the best.” Think about it for a moment. Is there a best car? A best hamburger? A best mobile phone?

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In the vast majority of businesses, there is simply no such thing as “the best.”

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Consider a business as prosaic as seating for airport waiting areas. You would think that there would be a “best” here—standardized seating that is functional and durable. Well, you would be wrong. Different airports have different needs. Some want waiting passengers to shop. They don’t want seats that are too comfortable. Some need the flexibility to reconfigure waiting areas. They don’t want long rows of fixed seats. Many airports have to watch their spending. For others, however, money is no object. Airports in the Middle East, for example, have been big buyers of luxury designs. Some airports, those that handle a steady flow of deported refugees, for example, value seats built to take extraordinary abuse. London-based OMK makes “prison-worthy” seating, the industry’s highest standard, using self-sealing polyurethane that can withstand a stabbing without showing the knife scar. So much for the idea that there is one “best” airport seat.

Now think about all of the industries in the economy. In how many does the idea of “being the best” make real sense? In most industries, there are many different customers with different needs. The best hotel for one customer is not the best for another. The best sales encounter for one customer is not the best for another. There is no best art museum, no one best way to promote environmental sustainability.

Nor is there such a thing as an absolute best when it comes to performing functions such as production or logistics or marketing. For a nonprofit organization, there is no best way to do fundraising or attract volunteers. The best always depends on what you are trying to accomplish. Thus, the first flaw of competition to be the best is that if an organization sets out to be the best, it sets itself an impossible goal.

But that’s not all. If rivals all pursue the “one best way” to compete, they will find themselves on a collision course. Everyone in the industry will listen to the same advice and follow the same prescription. Companies will benchmark each other’s practices and products (see “One-Upmanship Is Not Strategy”). Competing to be the best leads inevitably to a destructive, zero-sum competition that no one can win. As offerings converge, gain for one becomes loss for the other. This is the very essence of “zero sum.” I win only if you lose.

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If rivals all pursue the “one best way” to compete, they will find themselves on a collision course.

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The airline industry has suffered from this sort of competition for decades. If American Airlines tries to win new customers by offering free meals on its New York to Miami route, then Delta will be forced to match it—leaving both companies worse off. Both will have incurred added costs, but neither will be able to charge more, and neither will end up with more seats filled. Every time one company makes a move, its rivals will jump to match it. With everyone chasing after the same customer, there will be a contest over every sale.

This, says Porter, is competitive convergence. Over time, rivals begin to look alike as one difference after another erodes. Customers are left with nothing but price as the basis for their choices. This has happened in airlines, in many categories of consumer electronics, and in personal computers, with the notable exception of Apple, the one major company in that industry that has consistently marched to its own drummer.

This inevitable descent into price competition is the business equivalent of mutually assured destruction. And it’s not just the producers who suffer. Customers, suppliers, and employees often become collateral damage as rivals are squeezed for resources and forced to cut costs. When all else fails and pressure on prices has destroyed an industry’s profitability, often the remedy is to limit competition through consolidation. Companies swallow each other up, thus reducing the number of rivals and allowing one or a few companies to dominate the market.

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One-Upmanship Is Not Strategy

The first salvo in what came to be known as the Hotel Bed Wars was fired in 1999. After a year of testing mattresses, pillows, and bed linens and investing tens of millions of dollars in the effort, Westin Hotels and Resorts introduced the industry’s first branded bed, its custom-designed Heavenly Bed. “We wanted to differentiate ourselves from the competition,” a Westin executive explained.

As you might expect, rivals didn’t take long to respond, piling on the pillows and swaddling guests in ever-higher thread counts: Hilton with its Serenity Bed, Marriott with its Revive Collection, Hyatt with its Hyatt Grant Bed, Radisson with its Sleep Number Bed, and Crowne Plaza with its Sleep Advantage Program.

By 2006, the press declared that the Bed Wars had come to an end, but not before every major rival had made large investments developing, installing, and promoting its own branded offering. Guests at every hotel in the category can now rest assured that “bed quality” will not differentiate one hotel from another. As is often the case, one company’s attempt to be “the best” ended up raising the bar for everyone. It’s not surprising, with this approach to competing, that long-term profitability in the hotel industry has been chronically low, a topic we’ll explore more rigorously in chapter 2.

Reports are mixed about whether, in this case, the industry was able to raise prices enough to benefit from its investment in upgraded bedding. If not, customers captured the value of this spending. But even if this particular move benefited the industry overall, when all rivals compete on the same dimension, no one gains a competitive advantage.

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Be Number 1 or Number 2

Either be number 1 or number 2 in your industry, or get out. That ultimatum was made famous by former GE CEO Jack Welch, but it is just one version of what is arguably the most influential form of competition to be the best. Another name for the same idea is “winner takes all.” This model holds that companies win by getting bigger and, ultimately, by dominating their industries. If size drives competitive success, then growth is essential to achieving market share and volume. Companies pursue economies of scale and scope in the belief that these will be decisive in determining competitive advantage and profitability.

Of course there is at least a grain of truth in this thinking, which is precisely what makes it so dangerous. There are economies of scale and advantages to being bigger in most businesses. This was certainly the case in some of GE’s scale-intensive businesses during the Welch era. But before you assume that bigger is always better, it is critical to run the numbers for your business. Too often the goal is chosen because it sounds good, whether or not the economics of the business support the logic. In industry after industry, Porter notes that economies of scale are exhausted at a relatively small share of industry sales. There is no systematic evidence that indicates that industry leaders are the most profitable or successful firms. To cite one notorious example, General Motors was the world’s largest car company for a period of decades, a fact that didn’t prevent its descent into bankruptcy. To the extent that size mattered at all, it might be more accurate to say that GM was too big to succeed. Meanwhile, BMW, small by industry standards, has a history of superior returns. Over the past decade (2000–2009), its average return on invested capital was 50 percent higher than the industry average.

Companies only have to be “big enough,” which rarely means they have to dominate. Often “big enough” is just 10 percent of the market. Yet companies under the influence of winner-takes-all thinking tend to pursue illusory scale advantages. In doing so, they are likely to damage their own performance by cutting price to gain volume, by overextending themselves to serve all market segments, and by pursuing overpriced mergers and acquisitions. The auto industry over the past couple of decades has exhibited all of the above tendencies, to disastrous effect.

The winner-takes-all model presupposes incorrectly that there is one scale curve in an industry and that all companies must move down that curve.^* That ...