Management And Accounting Web

Porter, M. E. 1996. What is a strategy? Harvard Business Review (November-December): 61-78.

Summary by Aarti Nirgudka
Master of Accountancy Program
University of South Florida, Summer 2002

Balanced Scorecard Main Page | Strategy Related Main Page



I. Operational Effectiveness Is Not Strategy

According to Porter, various management tools like total quality management, benchmarking, time-based competition, outsourcing, partnering, reengineering, that are used today, do enhance and dramatically improve the operational effectiveness of a company but fail to provide the company with sustainable profitability. Thus, the root cause of the problem seems to be failure of management to distinguish between operational effectiveness and strategy: Management tools have taken the place of strategy.

Operational Effectiveness: Necessary but Not Sufficient

Although both operational effectiveness and strategy are necessary for the superior performance of an organization, they operate in different ways.

Operational Effectiveness: Performing similar activities better than rivals perform them. Operational effectiveness includes but is not limited to efficiency. It refers to many practices that allow a company to better utilize its inputs.

Strategy: Performing different activities from rivals’ or performing similar activities in different ways.

Porter states that a company can outperform rivals only if it can establish a difference it can preserve. It must deliver greater value to customers or create comparable value at a lower cost, or do both. However, Porter argues that most companies today compete on the basis of operational effectiveness. This concept of competition based on operational effectiveness is illustrated via the productivity frontier, depicted in the figure below.

Operational Effectiveness vs Strategic Positioning

The productivity frontier is the sum of all existing best practices at any given time or the maximum value that a company can create at a given cost, using the best available technologies, skills, management techniques, and purchased inputs. Thus, when a company improves its operational effectiveness, it moves toward the frontier. The frontier is constantly shifting outward as new technologies and management approaches are developed and as new inputs become available. To keep up with the continuous shifts in the productivity frontier, managers have adopted techniques like continuous improvement, empowerment, learning organization, etc. Although companies improve on multiple dimensions of performance at the same time as they move toward the frontier, most of them fail to compete successfully on the basis of operational effectiveness over an extended period. The reason for this being that competitors are quickly able to imitate best practices like management techniques, new technologies, input improvements, etc. Thus, competition based on operational effectiveness shifts the frontier outward and effectively raises the bar for everyone. But such competition only produces absolute improvement in operational effectiveness and no relative improvement for anyone.

"Competition based on operational effectiveness alone is mutually destructive, leading to wars of attrition that can be arrested only limiting competition"(p. 64). Such competition can be witnessed in Japanese companies, which started the global revolution in operational effectiveness in the 1970s and 1980s. However, now companies (including the Japanese) competing solely on operational effectiveness are facing diminishing returns, zero-sum competition, static or declining prices, and pressures on costs that compromise companies’ ability to invest in the business for the long term.

II. Strategy Rests on Unique Activities

"Competitive strategy is about being different. It means deliberately choosing a different set of activities to deliver a unique mix of value" (p. 64). Moreover, the essence of strategy, according to Porter, is choosing to perform activities differently than rivals. Strategy is the creation of a unique and valuable position, involving a different set of activities.

The Origins of Strategic Positions

Strategic positions emerge from three sources, which are not mutually exclusive and often overlap.

1. Variety-based positioning: Produce a subset of an industry’s products or services. It is based on the choice of product or service varieties rather than customer segments. Thus, for most customers, this type of positioning will only meet a subset of their needs. It is economically feasibly only when a company can best produce particular products or services using distinctive sets of activities.

2. Needs-based positioning: Serves most or all the needs of a particular group of customers. It is based on targeting a segment of customers. It arises when there are a group of customers with differing needs, and when a tailored set of activities can serve those needs best.

3. Access-based positioning: 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. 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.

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 in activities (or differences on the supply side). Positioning, moreover, is not always a function of difference on the demand (or customer) side. For instance, variety and access positionings do not rely on any customer differences.

III. A Sustainable Strategic Position Requires Trade-offs

According to Porter, a sustainable advantage cannot be guaranteed by simply choosing a unique position, as competitors will imitate a valuable position in one of the two following ways:

1. A competitor can choose to reposition itself to match the superior performer.

2. A competitor can seek to match the benefits of a successful position while maintaining its existing position (known as straddling).

Thus, in order for a strategic position to be sustainable there must be trade-offs with other positions. "A trade-off means that more of one thing necessitates less of another" (p. 68).

Trade-offs occur when activities are incompatible and arise for three reasons:

1. A company known for delivering one kind of value may lack credibility and confuse customers or undermine its own reputation by delivering another kind of value or attempting to deliver two inconsistent things at the same time.

2. Trade-offs arise from activities themselves. Different positions require different product configurations, different equipment, different employee behavior, different skills, and different management systems. In general, value is destroyed if an activity is over designed or under designed.

3. Trade-offs arise from limits on internal coordination and control. By choosing to compete in one way and not the other, management is making its organizational priorities clear. In contrast, companies that try to be all things to all customers, often risk confusion amongst its employees, who then attempt to make day-to-day operating decisions without a clear framework.

Moreover, trade-offs create the need for choice and protect against repositioners and straddlers. Thus, strategy can also be defined as making trade-offs in competing. The essence of strategy is choosing what not to do.

IV. Fit Drives Both Competitive Advantage and Sustainability

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 focuses on individual activities, strategy concentrates on combining activities.

"Fit locks out imitators by creating a chain that is as strong as its strongest link" (p. 70). Fit, as per Porter, is the central component of competitive advantage because discrete activities often affect one another.

Although 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. There are three types of fit, which are not mutually exclusive:

1. First-order fit: Simple consistency between each activity (function) and the overall strategy. Consistency ensures that the competitive advantages of activities cumulate and do not erode or cancel themselves out. Further, consistency makes it easier to communicate the strategy to customers, employees, and shareholders, and improves implementation through single-mindedness in the corporation.

2. Second-order fit: Occurs when activities are reinforcing.

3. Third-order fit: Goes beyond activity reinforcement to what Porter refers to as optimization of effort. Coordination and information exchange across activities to eliminate redundancy and minimize wasted effort are the most basic types of effort optimization.

In all three types of fit, the whole matters more than any individual part. Competitive advantage stems from the activities of the entire system. The fit among activities substantially reduces cost or increases differentiation. Moreover, according to Porter, companies should think in terms of themes that pervade many activities (i.e., low cost) instead of specifying individual strengths, core competencies or critical resources, as strengths cut across many functions, and one strength blends into others.

Fit and Sustainability

Strategic fit is fundamental not only to competitive advantage but also to the sustainability of that advantage because it is harder for a competitor to match an array of interlocked activities than it is merely to replicate an individual activity. Thus, "positions built on systems of activities are far more sustainable than those built on individual activities" (p. 73). 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 are difficult to untangle and imitate even if the competitors are able to identify the interconnections. Further, a competitor benefits very little by imitating only a few activities within the whole system. Thus, achieving fit is an arduous task as it means integrating decisions and actions across many independent subunits.

Additionally, fit among 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. On the other hand, improvements in one activity will "pay dividends in others" (p. 74).

Strategic positions should have a horizon of a decade or more, not of a single planning cycle, as continuity promotes improvements in individual activities and the fit across activities, allowing an organization to build unique capabilities and skills custom-fitted to its strategy. Continuity also reinforces a company’s identity. Frequent shifts in strategy are not only costly but inevitably leads to hedged activity configurations, inconsistencies across functions, and organizational dissonance.

Thus, strategy can also be defined as creating fit among a company’s activities as 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.

Alternate Views of Strategy
The Implicit Strategy Model
of the Past Decade
Sustainable Competitive Advantage
One ideal competitive position in the industry Unique competitive position for the company 
Benchmarking of all activities and achieving best practice Activities tailored to strategy 
Aggressive outsourcing and partnering to gain efficiencies  Clear trade-offs and choices vis-a-vs competitors 
Advantages rest on a few key success factors, critical resources, and core competencies  Competitive advantage arises from fit across activities 
Flexibility and rapid responses to all competitive market changes  Sustainability comes from the activity system, not the parts 
  Operational effectiveness a given 

V. Rediscovering Strategy

Failure to Choose

According to Porter, although external changes can pose a threat to a company’s strategy, a greater threat to strategy often comes from within the company. "A sound strategy is undermined by a misguided view of competition, by organizational failures, and, especially, by the desire to grow" (p. 75). Moreover, the fundamental problem lies in the "best-practice" mentality of the managers, who believe in making no trade-offs, incessantly pursuing operational effectiveness, and imitating competitors to catch up in the race for operational effectiveness. Thus, managers simply do not understand the need to have a strategy.

The Growth Trap

"Among all other influences, the desire to grow has perhaps the most perverse effect on strategy" (p. 75). Companies often grow by extending their product lines, adding new features, imitating competitors’ popular services, matching processes, and making acquisitions. However, most companies start with a unique strategic position involving clear trade-offs. Nevertheless, with the passage of time and the pressures of growth, companies are led to make compromises, which were at first, almost imperceptible. Thus, through a succession of incremental changes, which seemed sensible at the time, companies have compromised their way to homogeneity with their rivals. Compromises and inconsistencies in the pursuit of growth eventually erode the competitive advantage of a company and their uniqueness. Rivals continue to match each other until desperation breaks this vicious cycle, and results in a merger or downsizing to the original positioning.

According to Porter, efforts to grow blur uniqueness, creates compromises, reduces fit, and ultimately undermines competitive advantage.

Profitable Growth

One approach to persevering growth and reinforcing strategy is to concentrate on deepening a strategic position rather than broadening and compromising it. A company can do so by leveraging the existing activity system by offering features or services that rivals would find impossible or costly to match on a stand-alone basis. Thus, deepening a position means making the company’s activities more distinctive, strengthening fit, and communicating strategy better to those customers who value it. But currently many companies attempt to grow by adding hot features, products, or services without adapting them to their strategy.

Globalization often allows growth that is consistent with a company’s strategy, as it opens larger markets for a focused strategy. Thus, expanding globally is more likely to reinforce a company’s unique position than broadening domestically.

The Role of Leadership

"The challenge of developing or reestablishing a clear strategy is often primarily an organizational one and depends on leadership" (p. 77). Moreover, strong leaders, who are willing to make choices, are essential. General management should do more than just stewardship of individual functions. They should define and communicate the core company’s unique position, make trade-offs, and forge fit among the various activities of the company. Further, the leader should decide which changes in the industry and customer demands, is the company going to respond to. The leader should be able to teach others in the organization about strategy - and to say no.

Strategy is about choosing what to do as well as what not to do. Deciding which target group of customers, varieties, and needs the company should serve is fundamental to developing a strategy. Strategy is also however, in deciding not to serve other customers or needs and not to offer certain features or services. Thus, strategy requires continuous discipline and clear communication. Strategy should guide employees in making choices that arise because of trade-offs in their individual activities and in day-to-day decisions.

Moreover, managers need to understand that operational effectiveness, although a necessary part of management, is not strategy. Managers should be able to clearly distinguish between the two.

Conclusion

"Strategic continuity does not imply a static view of competition. A company must continually improve its operational effectiveness and actively try to shift the productivity frontier; at the same time, there needs to be ongoing effort to extend its uniqueness while strengthening the fit among its activities" (p. 78). However, a company may have to change its strategic position due to a major structural change in the industry. A company should choose its new position depending on its ability to find new trade-offs and leverage a new system of complementary activities into a sustainable advantage.

_________________________________________________

Related summaries:

Christensen, C. M. 1997. Making strategy: Learning by doing. Harvard Business Review (November-December): 141-142, 144, 146, 148, 150-154, 156. (Summary).

Clinton, B. D. and A. H. Graves. 1999. Product value analysis: Strategic analysis over the entire product life cycle. Journal of Cost Management (May/June): 22-29. (Summary).

De Geus, A. 1999. The living company. Harvard Business Review (March-April): 51-59. (Summary).

Fonvielle, W. and L. P. Carr. 2001. Gaining strategic alignment: Making scorecards work. Management Accounting Quarterly (Fall): 4-14. (Summary).

Gosselin, M. 1997. The effect of strategy and organizational structure on the adoption and implementation of activity-based costing. Accounting, Organizations and Society 22(2): 105-122. (Summary).

Iansiti, M. and R. Levien. 2004. Strategy as ecology. Harvard Business Review (March): 68-78. (Summary).

Kaplan, R. S. and D. P. Norton. 1996. Using the balanced scorecard as a strategic management system. Harvard Business Review (January-February): 75-85. (Summary).

Kaplan, R. S. and D. P. Norton. 2000. Having trouble with your strategy? Then map it. Harvard Business Review (September-October): 167-176. (Summary).

Kaplan, R. S. and D. P. Norton. 2001. Transforming the balanced scorecard from performance measurement to strategic management: Part I. Accounting Horizons (March): 87-104. (Summary).

Kaplan, R. S. and D. P. Norton. 2001. Transforming the balanced scorecard from performance measurement to strategic management: Part II. Accounting Horizons (June): 147-160. (Summary).

Kaplan, R. S. and D. P. Norton. 2004. Measuring the strategic readiness of intangible assets. Harvard Business Review (February): 52-63. (Summary).

Kim, W. C. and R. Mauborgne. 1997. Value innovation: The strategic logic of high growth. Harvard Business Review (January-February): 103-112. (Summary).

Kim, W. C. and R. Mauborgne. 1999. Creating new market space: A systematic approach to value innovation can help companies break free from the competitive pack. Harvard Business Review (January-February): 83-93. (Summary).

Kim, W. C. and R. Mauborgne. 2002. Charting your company's future. Harvard Business Review (June): 77-83. (Summary).

Langfield-Smith, K. 1997. Management control systems and strategy: A critical review. Accounting, Organizations and Society 22(2): 207-232. (Summary).

Luehrman, T. A. 1998. Strategy as a portfolio of real options. Harvard Business Review (September-October): 89-99. (Summary).

O'Clock, P. and K. Devine. 2003. The role of strategy and culture in the performance evaluation of international strategic business units. Management Accounting Quarterly (Winter): 18-26. (Summary).

O'Reilly, C. A. III. and M. L. Tushman. 2004. The ambidextrous organization. Harvard Business Review (April): 74-81. (Summary).

Porter, M. E. 2001. Strategy and the internet. Harvard Business Review (March): 63-78. (Summary).

Reeves, M., C. Love and P. Tillmanns. 2012. Your strategy needs a strategy. Harvard Business Review (September): 76-83. (Note).

Simons, R. 1995. Control in an age of empowerment. Harvard Business Review (March-April): 80-88. (Summary).