Why are some companies more profitable than others, why are some industries consistently more profitable than others, and what does this mean or the manager developing strategy
Competitive strategy 1980
Competitive advantage 1985
HBR articles: What is strategy 1996 The five competitive forces that shape strategy 2008
I try to give myself a self-diagnosed MBA
Porter’s prescription: aim to be unique, not best – creating value, not beating rivals, is at the heart of competition.
Strategy explains how an organization, faced with competition, will achieve superior performance.
There is no “best” in business. McDonalds is not the same as In-Out-Burger.
Competitive Convergence – when an industry competes for the same customer, a move by on company must be match by the other, leaving both worse off in the end. Airlines are the general example as one must offer free dinner as their competitor does. The industry begins to look the same and differences erode.
Industry’s that compete on price along descend to ‘mutually assured destruction’ where the only way out is consolidation. Note that suppliers and distributors also could be hurt as the price competing company will look for ways to cut cost.
When company’s compete on price, econ 101 says the consumer wins. Porter thinks that isn’t 100% true as the industry that imitates each other’s offerings now limits the end consumer’s choices. When choice is limited, value is often destroyed. You often pay too much for what you want or you are forced to make due with what’s offered.
Companies should not strive to be the best but unique. Competing to be unique thrives on innovation (circle back to fisher – he discusses R&D). Being Unique is a Positive- Sum game, opposite of zero sum game. (in my head this is a network effect for the industry). Example can best be illustrated by the arts industry benefitting from many Unique singers that grow the industry’s allure.
Sum up the first part above … Competition is not winner take all and race to be the best rather innovation and uniqueness should propel you. BMV vs GM
Structure of an industry determines how profitable a company is. Some think its high/low tech, regulated/non-regulated, manufacturing or service. Structural changes to an industry take a long time. Once the earnings of that industry are seen, it takes a long time for them to disappear.
Compare a companies cost and profitability to the industry overall as that is the benchmark you are trying to beat.
Swot analysis isn’t good because it allows bias and human error. Acquisition is “opportunity” but it might not pass the 5 forces.
Bargaining power of buyers: Large buys posses bargaining power. Price sensitivity is highest when their end product is undifferentiated, expensive relative to their other costs or income, and inconsequential to their own performance.
Substitutes: this puts a cap on the industry profitability as prices can only go so high. How do you find out a substitute? Look at the economics behind it, the price –performance trade off of the product. example given in book was redbox selling DVD’s for $1 vs buying the retail Hollywood set for 20x that. Netflix also can be an example.
Switching cost make substitutes hard/easier based on how high the cost is. Something interesting to think about in the book, coffee is an ingrained habit in people that isn’t going to change.
How to tell if there are high barriers to entry: First picture starbucks who must reinvent or competiting can come in since specialty coffee is hard to do. Economies of scale – can a new entrant overcome $1BB in start up cost? Microsoft will cover that in a week. High switching cost, Mac to PC – apple worked to reduce those cost.
Specialty equipment is hard to sell, so businesses will stay around and cut prices because they can’t “sell out”
Perishable products, whether that’s fruit/veggies or airline seats, all go bad if they aren’t ‘sold’ – this promotes lowering prices just to get them filled.
Look at truck companies, they operate almost entirely on the trucks that they purchase so they will be VERY price sensitive when buying. Rail’s are a substitutes for shipping via trucks, so there is a natural cap on how high truck prices can go.
Example: Paccar, a trucking company competing in a very difficult and uninviting industry, was able to earn ROIC of 20% while the industry as a whole was producing 10.5%. The difference? Paccar was able to be ‘unique, not the best’ and target the owner-operator market where people use the truck as a home. They were able to charge a 10% premium because people wanted those amenities.
A real competitive advantage is operating at a lower cost or commanding a premium price, or both within that industry (higher profitability) “superior value creation”
Gauging a competitive advantage by ROIC must be relative to other companies within the same industry
It takes 7-8 years to bring a new aluminum smelter on line
Companies should have the correct goals – look for this when reading through their commentary. Market share goals are not sufficient. Airlines had them and just wanted to get bigger. In the process, they would increase cost by 25% to attain an additional 5% of the market. This really hurts profits.
Cost – Dell vs. HP:
Dell required little capital since the company did not design or make components, nor did it carry much inventory. HP designed and manufactured their own components, built computers to inventory, and then sold the through resellers. Dell sold direct, building computer’s to customer orders using outsourced components and a tightly managed supply chain. Dell had a substantial advantage in days of inventory carried. Cost of components were dropping so fast that they would buy weeks later which translated to lower relative cost per PC. Dell’s customers paid for their PC before dell had to pay its suppliers which translated into negative working capital and further enhance their cost advantage.
Nucor’s executive HQ was the deli across the street, ran a multi-billion dollar company out of a dentist office sized space – cost advantage
Strategy can also come from 10% higher cost but 25% higher pricing OR 10% lower cost and 5% lower pricing. – still a competitive advantage. BMW and Southwest are examples
Value Chain Analysis:
Lay out the chain – R&D, Supply Chain, Operations, Marketing & Sales, Post Sale service
Where does the company sit on this chain? Lay out competitors value chain and see how it compares to your company
Zero in on price and cost drivers – Apple has the genius bar, In-Out Burger has top ingredients and Southwest is able to turnaround planes the fast giving it the lowest cost per seat mile. (had Boeing resign the lavatory valve so it would increase efficiency)
Example: Honda is a relatively smaller car company so one would think doesn’t have the same scale advantages. Honda is the world’s largest producer of motorcycles and overall it is a huge producer of engines which cost 10% of a car. This advantage in producing the engines makes up for its scale disadvantage.
Operational effectiveness – a company’s ability to perform a task better than their rivals
Walmart started off opposite as their competition, they wanted to be in ‘little one-horse towns which everyone else was ignoring.” This gave them breathing room to improve and optimize their strategy. Most other rivals were focused on big, metropolitan cities. There was a powerful barrier to entry here because the town was only large enough for one store and Walmart was first.
Progressive started by working with the ‘non-standard’ drivers who everyone else didn’t want to insure.
Enterprise started by seeing that their competitors majorly worked with traveler’s, but enterprise saw that people need rental cars on their day to day lives as well. This is an example of a differentiated ‘strategy.’ Zipcar further changed the strategy of home car rental.
Southwest formed because people’s needs were over served. There was a market for simply flying to point B from A without dinners an excess goods and services.
Eye Company went to India because 300,000 people were going blind simply from not having preventative care. This is an underserved market
Something to watch out for: Some companies are ‘stuck in the middle’ in they are not the lowest cost producer and they aren’t the most unique. They attempt to do both but are beaten out by rivals. This is obviously not a good place to be.
McDonalds tried to mimic BK’s strategy which ultimately failed. A company built on convenience and speed should not try to tailor future endeavors to ‘custom’ burgers. They spend half a billion to renovate which only hurt their speed.
In the Home Depot vs. Lowes story, home depot started first by offering a very high value proposition for men. Cheaper prices, bigger stores, and trained assistants in the store to help you ‘do it yourself’ rather than call a contractor. This drove out many competitors at the time which paved the way for Lowes. They did a study and found that women were the major cause of home renovation which sparked their new strategy to appeal to women more. They focused more on home fasion, kitchen, lawn and garden decorating. They were price competitive on Home Depot products but had higher prices on their ‘women items’ for better margins.
Zepa stores turnover their ‘hottest new items’ every 2-4 weeks which is much quicker than typical retailers. They produce their own clothes by mimicking/copying other trends they see from public places. Zepa is mainly located in high traffic area via foot with prominent looking stores. They spend virtually no money on advertising since their customers advertise for them. More on this topic but think and remember self-marketing companies like this.
Porter thinks there are two types of activities, tailored and generic. You can safely outsource generic activities for obvious reasons. Outsource at your own risk however as the more you outsource the less ‘fit’ your company has and the easier a competitor can replicate. Think of the Zara’s example where from start to finish they add value to their business. The more parts of that you outsource, the more you open doors for replication. With outsourcing, over time, the whole industry becomes homogenized and uniqueness disappears. (remember, uniqueness is what drives competitive advantage)
Continuity of a strategy is like the glue that keeps it all together. The longer a brand or company is around, the longer the supplier, distributors, customers get to know them, and more value is created. It strengthens the brand identity in customers mind, example: they will drive out of their way to get it. Suppliers become more ingrained in a process and ultimately make business improvements to help the business with continuity, example: move factories closer to the end location so they can spend less on shipping.
Identity of a company is very important. Think of sears as a tool and appliance maker, then making a move into financial services. Customers, management, and strategy can’t handle that move quickly. Another example, Think about Ford trimming down its brands to focus from trucks and SUV’s to smaller, more environmentally friendly passenger cars. A 200,000 employee company instilled with a routine had to learn new structures, systems, processes, product development had to be overhauled, production capacity had to be changed, labor agreements renegotiated, marketing revamped. This can’t happen overnight and many times businesses won’t get it right.
Think of Walmart who started off small and innovated. Their strategy, value proposition, and stability stayed constant of “everyday low prices” but they continued to expand on that. Rule here, stability is most important when trying to continue a value proposition.
Great strategies are rarely built on predations of the future. Walmart would have no idea what the retailing world would be like in 20 years, In-Out Burger would have no idea what the food industry would be but they stayed consistent and adapted to changes, while staying with their core principles
When does strategy need to change: When customers’ needs changes. Liz Claiborne had a dominant hold on women clothing when women went to work at a fast rate. It only lasted for a decade as dress codes changed, styles changed, and women felt comfortable shopping around more. Another time is when innovation and technological breakthroughs happen. Think of Kodak and digital photography.
“Over time, in the course of serving its customers and vying with its rivals, an organization develops important insights about its strategy that it might not have had at the start. Over time, new opportunities emerge. Continuity gives an organization the time it needs to deepen is understand of the strategy. Sticking with a strategy in other words allows a company to more fully understand the value it creates and to become really good at it. Strategies never arrive full-blown and fully formed Day one. “
Ten Practical Implications:
- Vying to be the best is an intuitive but self-destructive approach to competition
- There is no honor in size or growth if those are profitless. Compeition is about profits, not market share
- Competitive advantage is not about beating rivals; it’s about creating unique value for customers. If you have a competitive advantage, it will show up on yoru P&L.
- A distinctive value proposition is essential for strategy. But strategy is more than marketing. If your value proposition doesn’t require a specifically tailored value chain to deliver it, it will have no strategic relevance
- Don’t feel you have to delight every possible customer out there. The sign of a good strategy is that it deliberately makes some customers happy
- No strategy is meaningful unless it takes clear what the organization will NOT do. Making trade-offs is the linchpin that makes competitive advantage possible and sustainable.
- Don’t overestimate or underestimate the importance of good execution. It’s unlikely to be a source of a sustainable advantage, but without it even the most brilliant strategy will fail to produce superior performance
- Good strategies depend on many choices, not one, and on the connections among them. A core competence alone will rarely produce a sustainable competitive advantage.
- Flexibility in the face of uncertainty may sound like a good idea, but I means that your organization will never stand for anything or become good at anything. Too much change can be just as disastrous for strategy as too little.
- Committing to a strategy does not require heroic predictions about the future. Making that commitment actually improves your ability to innovate and to adapt to turbulence.
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A competitive advantage lies in the ability to do something better than your competitor, not ‘your’ best characteristic.
Public equity markets have a tendency to follow the leader. If Pfizer is the leader and they acquire, there is a push Merek to acquire as well.
The first place to look for growth should be your core target of customers. Many companies try to slug it out in the new hot high growth areas.
Foreign acquisitions can be harmful if you use other peoples strategies, channels, and market research. They also will hurt if you compare the acquisition company to their direct customers and not relate it back to your U.S. strategy.
If you have a good strong position in a space, but little ways to expand significantly, you should focus on high ROIC, pay good dividends, and otherwise return money to shareholders and enjoy creating wealth and value.
Airline industry
“The real profit killer for the airline industry has been the highly unusual combination of low entry barriers and high exit barriers. That’s a very rare configuration of forces. So it’s not all that hard to start a new airline, but if the company goes out of business, the airplanes don’t go away. Airplanes are what we call fungible assets, that is, they can be used by any carrier, on almost any route, at any time. So the plan can change ownership, but the capacity never leaves the market until the plane literally falls apart. If you’re running an airline o, once you’ve acquired your planes, hired your staff, and set a schedule, then the fixed costs are enormous and the variable costs are low. Therefore there’s intense pressure to fill the plane and pressure on discounting to do so. ”
Sysco’s example:
“Sysco transformed the food distribution industry. This was an industry with fragmented customers and powerful suppliers often the big branded food companies. Barriers to entry were low. Rivalry historically had been on price because basically the distributors were all distributing the same products. That’s bad structure. But some of the industry leaders – Sysco, for example – wanted a different kind of competition. They started doing private label to mitigate the power of the suppliers. They ramped up their IT investments, which served as an entry barrier to the small distributors who would be unstable to afford those investments. They started to provide value-added services to their customers such as menu and nutrition planning, inventory management, and inventory financing. This shifted competition to dimensions other than price alone. And her, imitation was a good thing. As others followed Sysco’s lead, the industry became more attractive.”
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