What Is Strategy?: Professor Michael E. Porter Harvard Business School

What is Strategy?
Professor Michael E. Porter

Harvard Business School
World Business Forum

June 6, 2006
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.
Copyright 2006 © Professor Michael E. Porter

How Managers Think About Competition
COMPETING
COMPETING TO
TO BE
BE THE
THE COMPETING
COMPETING TO
TO BE
BE
BEST
BEST UNIQUE
UNIQUE
• The worst error in strategy is to compete with rivals on the same dimensions
20060606 HSM Chicago – 06052006 Final NV.ppt 2 Copyright 2005 © Professor Michael E. Porter
Flawed Concepts of Strategy
• 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 action
– “Our strategy is to merge…”
– “… internationalize…”
– “… consolidate the industry…”
– “… outsource…”
• Strategy as vision
– “Our strategy is to meet our customers’ needs…”
– “…to advance technology for mankind…”
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.
Mission Statements
Leo Burnett
To be the best in the world bar none at building the most valued, leadership
brands.
Home Depot
The Home Depot is in the home improvement business and our goal is to
provide the highest level of service, the broadest selection of products and the
most competitive prices.
Unilever
Unilever's mission is to add Vitality to life.
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
• 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; cash flow margin) are
risky for strategy
• Prevalent accounting adjustments to reported profitability

(e.g., writeoffs, writedowns, 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
Economic Performance versus Shareholder Value
Economic
Economic Shareholder
Shareholder Value
Value
Performance
Performance
• Sustained ROIC • Stock Price

• Sustainable Revenue • EPS
Growth
• EPS Growth
• Shareholder value is the result of creating real economic value

• Pleasing today’s shareholders is not the goal
Setting the Right Goals
Food Retailing
1.6
Whole Foods
1.4
1.2
Market
Value to 1.0 Average
Sales Ratio Food Retailing Publix
2004 Data 0.8 ROIC
0.6
0.4
Winn-
Dixie Kroger Safeway
Average Food
0.2 Albertson’s Supervalu Retailing Market
Value to Sales Ratio
Food Lion
0.0
0% 5% 10% 15% 20% 25%
ROIC Average
Source: Compustat (1999-2004)
Note: ROIC calculated as EBIT divided by Average Invested Capital (Total Assets less Excess Cash less Current Operating Liabilities)
Economic Foundations of Competition
Causes of Profitability
• The fundamental unit of strategic analysis is the industry

− Defining the relevant industry is essential to strategy
• Company economic performance results from two distinct causes:
Relative
Relative Position
Position
Industry
Industry Within
Within the
the
Structure
Structure Industry
Industry
- Overall Rules of Competition - Sources of Competitive Advantage
• Strategy must encompass both
Determinants of Long-Term Industry Profitability
Threat of Substitute
Products or Services
Bargaining Power Rivalry Among Bargaining Power

of Suppliers Existing of Buyers
Competitors
Threat of New
Entrants
Determinants of Relative Performance
Differentiation
(Higher Price)
Competitive
Competitive
Advantage
Advantage
Lower Cost
Linking Strategy to Relative Performance
Southwest Airlines
Revenue and Cost per Available Seat Mile, Average of 1998 - 2000
12
Operating Profit per

Pricing
10 Available Seat Mile
Differential:
1.72
Cost
Advantage:
8 2.44
Cents
per ASM
6
Operating Cost per
Available Seat Mile
0
Southwest Airline Industry Average
Note: ASM (Available Seat Miles) defined as total seats available multiplied by miles flown
Source: Airline annual reports and author’s calculations
Identifying the Value Chain
Homebuilding
Firm Infrastructure
(e.g. Financing, Planning, Investor Relations)
Human Resource Management

Support (e.g. Recruiting, Training, Compensation System)
Activities Technology Development
(e.g. Product Design, Testing, Process Design, Materials Research, Market Research) M
Value
Procurement a
(e.g. Materials, Subcontracted Labor, Advertising, Services) r What
g buyers are
Land Acquisition Construction Marketing Closing After-Sales i
willing to
& Development & Sales Service pay
n
(Identify attractive (Design, (Lead generation, (e.g. Customer (e.g. Warranties,
markets, Secure Engineering, Model home Financing, Customer
land, Procure Schedule and display, Sales Contract, Title, Complaints)
entitlements and manage force, Customer Closing)
permits, Prepare construction selection of
site) process) personalized
options)
Primary Activities
• Competing in a business involves performing a set of discrete activities, in which

competitive advantage resides
• The value chain is unique to each business
Achieving Superior Performance
Operational Effectiveness is Not Strategy
Operational Strategic
Effectiveness Positioning
• Assimilating, attaining, and • Creating a unique and

extending best practices sustainable competitive
position
Run the same races faster Choose to run a different race
Five Tests of a Good Strategy
•• A
A unique
unique value
value proposition
proposition
compared
compared to
to other
other organizations
organizations
•• A
A different,
different, tailored
tailored value
value chain
chain
•• Clear
Clear tradeoffs,
tradeoffs, and
and choosing
choosing what
what
not
not to
to do
do
•• Activities
Activities that
that fit
fit together
together and
and
reinforce
reinforce each
each other
other
•• Continuity
Continuity ofof strategy
strategy with
with
continual
continual improvement
improvement in in realizing
realizing
the
the strategy
strategy
Defining the Value Proposition
What
What Which
Which
Customers?
Customers? Needs?
Needs?
• What end users? • Which products?

• What channels? • Which features?
• Which services?
What
What Relative
Relative
Price?
Price?
• A novel value proposition can also grow the pie/expand the industry
Strategic Positioning
Enterprise Rent-A-Car
Distinctive
Distinctive
Value
Value Proposition
Proposition Activities
Activities
• Home-city replacement cars for drivers • Numerous, small, inexpensive offices in

whose cars are being repaired or who need metropolitan areas, including on-premises offices
at major accounts
an extra vehicle, at low rates (30% below
airport rates) • 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 its fleet
Strategic Positioning
Whole Foods Markets
Distinctive
Distinctive
Value
Value Proposition
Proposition Activities
Activities
• Natural, fresh, organic, and prepared foods and • Well-lit, inviting supermarket store formats with
health items with excellent service at premium appealing displays and extensive prepared foods
prices sections
• Produce section as “theater”
• Educated, middle class, and affluent customers
• Café-style seating areas with wireless internet for
passionate about food as a part of a healthy meetings and meals
lifestyle • 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

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
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
Recent Thinking on the Sources of Competitive Advantage
•• “Key”
“Key”Success
SuccessFactors
Factors
•• “Core”
“Core”Competencies
Competencies
•• “Critical”
“Critical”Resources
Resources
• Competitive advantage is seen as concentrated in a few parts of the

value chain
Mutually Reinforcing Activities
Word-of- Zara Apparel Cutting-
mouth edge fashion
marketing at moderate
and repeat price and
buying Widely quality
popular
styles
Customers
chic but
Very cost-
Global
Little media frequent team of
conscious
advertising product trend-
changes spotters
Advanced
productio
Productio
n
n in
Extensive machiner
Europe
use of y
store
sales data
Tight
Prime store
coordination Very
locations in JIT delivery with 20
high traffic flexible
wholly-owned
areas factories
production
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
Continuity of Strategy
• Continuity of strategy is fundamental to sustainable competitive advantage

– e.g., allows the organization to understand the strategy
– builds truly unique skills and assets related to the strategy
– establishes a clear identity with customers, channels, and other outside entities
– strengthens the fit across the value chain
• Reinvention and frequent shifts in direction are costly and confuse the
customer, the industry, and the organization
• Continuity is required in the value proposition
• Successful companies continuously improve in how they realize their strategy

– 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
Barriers to Strategy
Flawed 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
Barriers to Strategy
Capital Market Biases

• Strong pressures to emulate the currently “successful” peers
• Pressure to grow faster than the industry
• A strong bias for “doing deals” (M&A)
Internal Practices
• Inappropriate goals and performance metrics bias strategy choices
– Short time horizon
• Over-weighting of equity-based compensation amplifies unhealthy stock
market pressures
• Rapid turnover of leadership undermines the strategic direction to achieve
short-term performance benefits
• A desire for consensus undermines tradeoffs
• Inappropriate cost allocation lead to too many products, services, or
customers
• Outsourcing makes activities homogenous and less distinctive
Strategy for What?
Defining the Right Business: Products
Product A Product B Product C
Product D Product E
Threat of Substitute Firm Infrastructure

Products or (e.g. Financing, Planning, Investor Relations)
Services
Activities
Technology Development
(e.g. Product Design, Testing, Process Design, Material Research, Market Research)
M
Value
Procurement a
Bargaining Rivalry Among Bargaining (e.g. Components, Machinery, Advertising, Services) What
r
Power Existing Power buyers
Competitors g
of Suppliers of Buyers are
Inbound Operations Outbound Marketing After-Sales i
Logistics Logistics & Sales Service willing to
(e.g. n pay
Incoming (e.g. (e.g. Order (e.g. Sales (e.g.
Material Assembly, Processing, Force, Installation,
Storage, Componen Warehousin Promotion Customer
Data t g, Report , Support,
Collection, Fabrication Preparation) Advertisin Complaint
Threat of New Service, , Branch g, Resolution,
Entrants Customer Operations Proposal Repair)
Access) ) Writing,
Web site)
Primary Activities
• A distinct strategy is needed for each business

Defining the Right Business
Foodservice Distribution
Broadline Distribution Systems Distribution
• Customers are independent restaurants • Customers are national chains

and institutions
• The product line consists of well over • The product line consists of several
10,000 SKUs hundred SKUs
• Sales and service activities are carried • Customer relationships and services
out by local sales reps are specified by national contracts
• Value-added services, credit terms, and • Price is the key basis for selection;
distributors’ private-label products are customers do not purchase value-
valued and allow support product/service added services or private-label
differentiation products
• Logistical activities are heavily local in • A national distribution and

nature (local warehouses and trucks) warehousing network is required
Strategy for What?
Defining the Right Business: Geography
Cross-
Cross-
Local
Local Regional
Regional National
National Global
Global
National
National
• Separate local • Integrated global

value chains Ability to Leverage Key Activities Across Geography value chain
Firm Infrastructure
(e.g. Financing, Planning, Investor Relations)

Activities
Technology Development
(e.g. Product Design, Testing, Process Design, Material Research, Market Research) M
Value
Procurement a
(e.g. Components, Machinery, Advertising, Services) r What
g buyers are
Inbound Operations Outbound Marketing After-Sales willing to
i
Logistics Logistics & Sales Service pay
n
(e.g. Incoming (e.g. Assembly, (e.g. Order (e.g. Sales (e.g. Installation,
Material Component Processing, Force, Customer
Storage, Data Fabrication, Warehousing, Promotion, Support,
Collection, Branch Report Advertising, Complaint
Service, Operations) Preparation) Proposal Resolution,
Customer Writing, Web Repair)
Access) site)
Primary Activities
• A distinct strategy is needed for each relevant geographic market

Creating a Strategy
Segmenting the Industry Strategically Harnessing Tradeoffs

• Creatively segmenting product • Finding tradeoffs in the value
varieties, customer groups, and proposition or in the value chain
purchase occasions
Leveraging Unique Activities Capitalizing on Industry Dynamics

• Building off activities with true • Identifying strategic positions opened
uniqueness up by industry changes
• Looking for new activity
configurations and combinations
• Migrate toward the chosen strategic position

• Focus incremental investments on reinforcing the chosen position
Segmentation and Strategic Positioning
Automobile Insurance
Progressive
Progressive Geico
Geico
Customer Group Customer Group
• High-risk drivers shunned by standard • “Preferred”, lowest risk drivers
automobile insurers
Set of Activities Set of Activities

• Distribution primarily through independent • Direct customer interaction through direct mail,
agents telephone, and the Internet
• Sales force that educates independent agents in • Sophisticated direct mail targeting low risk
complex information gathering techniques households
• 30-year database on high-risk drivers • 35+ year database and modeling utilities on
preferred drivers
• Complex rating scheme
• Complex rating and pricing system
• 14,000 different prices
• Heavy advertising to drive requests for rate
• 50-300% premium pricing over standard
quotes (“I’ve got good news.”)
segment
• Quote rates to only 50% of customers who
• Adjusters work from offices on wheels to provide
inquire about coverage
immediate response. Adjusters trained and
empowered to write out check at scene of • 15-20% lower prices than competition
accident • Network of insurance adjusters with cell phones
• Steep incentives to make a 4% underwriting working out of own vehicles for immediate
profit response
• Conservative, liquid investment portfolio • 24-hour customer service to handle sales, policy
inquires, and claims
• Conservative, liquid investment portfolio
Growing Strategically
1. Make the strategy even more distinctive
− Introduce new technologies, features, products or services that are tailored to
the strategy and which leverage other distinctive activities within the value
chain
2. Deepen the strategic position (rather than broaden it)
– Raise the penetration of chosen customers / needs
3. Expand geographically to tap new regions or countries using the same
positioning
– Aggressively reposition foreign acquisitions around the company’s strategy
4. Expand the market for what the company can uniquely deliver
– Find other customers and segments that would most value the strategy
• It is an illusion that growth (and especially profitability)

are easier to achieve in untapped or growth segments
• It is difficult, and often dangerous, to try to grow faster
than the underlying market for an extended period.
• Industry leaders should concentrate as much, or more,
on growing the category as on growing share
• In many cases, the appropriate goal is to earn a high
return and pay dividends
Strategy
What Is a Strategy? What is Not a Strategy?
•• A
A unique
unique value
value proposition
proposition •• Best
Best practice
practice improvement
improvement
versus
versus competitors
competitors •• Execution
Execution
•• Aspirations
Aspirations
•• A
A different,
different, tailored
tailored value
value chain
chain •• A
A vision
vision
•• Learning
Learning
•• Clear
Clear tradeoffs,
tradeoffs, and
and choosing
choosing what
what •• Agility
Agility
not
not to
to do
do •• Flexibility
Flexibility
•• Innovation
Innovation
•• Activities
Activities that
that fit
fit together
together and
and •• The
The Internet
Internet (or
(or any
any technology)
technology)
reinforce
reinforce each
each other
other •• Downsizing
Downsizing
•• Restructuring
Restructuring
•• Continuity
Continuity ofof strategy
strategy with
with •• Mergers
Mergers // Consolidation
Consolidation
continual
continual improvement
improvement in in realizing
realizing •• Alliances
Alliances // Partnering
Partnering
the
the strategy
strategy •• Outsourcing
Outsourcing
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 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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What is Strategy?

Professor Michael E. Porter

World Business Forum

Copyright 2006 © Professor Michael E. Porter

Goodyear Tire and Rubber

Marriott International, Inc.

• The fundamental goal of a company is superior long-term return

• Prevalent accounting adjustments to reported profitability

• Goodwill must be treated as part of investment

• Setting unrealistic profitability or growth targets can undermine

• Sustained ROIC • Stock Price

• Shareholder value is the result of creating real economic value

• The fundamental unit of strategic analysis is the industry

• Company economic performance results from two distinct causes:

- Overall Rules of Competition - Sources of Competitive Advantage

• Strategy must encompass both

Bargaining Power Rivalry Among Bargaining Power

Operating Profit per

Human Resource Management

• Competing in a business involves performing a set of discrete activities, in which

• Assimilating, attaining, and • Creating a unique and

Run the same races faster Choose to run a different race

• What end users? • Which products?

• Home-city replacement cars for drivers • Numerous, small, inexpensive offices in

• Excellent strategies often include a social dimension of the value proposition

• Tradeoffs occur when strategic positions are incompatible

• Tradeoffs make a strategy sustainable against imitation by established

• An essential part of strategy is choosing what not to do

• Forgo cleaning, skin softening, and deodorizing

• Choose higher costs through the configuration of:

• Give up the ability to reach customers via:

• Competitive advantage is seen as concentrated in a few parts of the

• Fit is leveraging what is different to be more different

• Continuity of strategy is fundamental to sustainable competitive advantage

• Continuity is required in the value proposition

• Successful companies continuously improve in how they realize their strategy

• Misunderstanding of strategy itself

• Poor industry definition

• 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

Capital Market Biases

Product A Product B Product C

Threat of Substitute Firm Infrastructure

• A distinct strategy is needed for each business

Broadline Distribution Systems Distribution

• Customers are independent restaurants • Customers are national chains

• Logistical activities are heavily local in • A national distribution and

• Separate local • Integrated global

Human Resource Management

• A distinct strategy is needed for each relevant geographic market

Segmenting the Industry Strategically Harnessing Tradeoffs

Leveraging Unique Activities Capitalizing on Industry Dynamics

• Migrate toward the chosen strategic position

Set of Activities Set of Activities

• It is an illusion that growth (and especially profitability)

• Clearly distinguish operational effectiveness improvement and strategy

• Communicate the strategy relentlessly to all constituencies

• Maintain discipline around the strategy, in the face of many distractions.

• Decide which industry changes, technologies, and customer needs to

• Commitment to strategy is tested every day

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