“Strategy explains how an organization, faced with competition, will achieve superior performance.” —Magretta, Joan, Understanding Michael Porter
Below, the first part of an interview with Michael Porter from Understanding Michael Porter: The Essential Guide to Competition and Strategy. Underlining and bold markings are my own.
I. Common Mistakes and Obstacles
Magretta: What are the most common strategy mistakes you see?
Porter: The granddaddy of all mistakes is competing to be the best, going down the same path as everybody else and thinking that somehow you can achieve better results. This is a hard race to win. So many managers confuse operational effectiveness with strategy.
Another common mistake is confusing marketing with strategy. It’s natural for strategy to arise from a focus on customers and their needs. So in many companies, strategy is built around the value proposition, which is the demand side of the equation. But a robust strategy requires a tailored value chain—it’s about the supply side as well, the unique configuration of activities that delivers value. Strategy links choices on the demand side with the unique choices about the value chain (the supply side). You can’t have competitive advantage without both.
Another mistake is to overestimate strengths. There’s an inward-looking bias in many organizations. You might perceive customer service as a strong area. So that becomes the “strength” on which you attempt to build a strategy. But a real strength for strategy purposes has to be something the company can do better than any of its rivals. And “better” because you are performing different activities than they perform, because you’ve chosen a different configuration than they have.
Another common mistake is getting the definition of the business wrong, or getting the geographic scope wrong. There has been a tendency to define industries broadly, following the influential work of Theodore Levitt some decades ago. His famous example was railroads that failed to see that they were in the transportation business, and so they missed the threat posed by trucks and airfreight. The problem with defining the business as transportation, however, is that railroads are clearly a distinct industry with distinct economics and a separate value chain. Any sound strategy in railroads must take these differences into account. Defining the industry as transportation can be dangerous if it leads managers to conclude that they need to acquire an airfreight company so they can compete in multiple forms of transportation.
Similarly, there has been a tendency to define industries as global when they are national or encompass only groups of neighboring countries. Companies, mindful of the drumbeat about globalization, internationalize without understanding the true economics of their business. The value chain is the principal tool to delineate the geographic boundaries of competition, to determine how local or how global that business is. In a local business, every local area will require a complete and largely separate value chain. At the other extreme, a global industry is one where important activities in the value chain can be shared across all countries.
Reflecting on my experience, however, I’d have to say that the worst mistake—and the most common one—is not having a strategy at all. Most executives think they have a strategy when they really don’t, at least not a strategy that meets any kind of rigorous, economically grounded definition.
Magretta: Why is that? Why do so few companies have really great strategies? What are the biggest obstacles to good strategy?
Porter: I used to think that most strategy problems arose from limited or faulty data, or poor analysis of the industry and competitors. To say it differently, I thought the problem was a failure to understand competition. This surely does happen. But the more I have worked in this field, the more I have come to appreciate the more subtle and more pervasive obstacles to clear strategic thinking and how challenging it is for companies to maintain their strategies over time.
There are so many barriers that distract, deter, and divert managers from making clear strategic choices. Some of the most significant barriers come from the many hidden biases embedded in internal systems, organizational structures, and decision-making processes. It’s often hard, for example, to get the kind of cost information you need to think strategically. Or the company’s incentive system rewards the wrong things. Or human nature makes it really hard to make trade-offs, or to stick with them. The need for trade-offs is a huge barrier. Most managers hate to make trade-offs; they hate to accept limits. They’d almost always rather try to serve more customers, offer more features. They can’t resist believing that this will lead to more growth and more profit.
I believe that many companies undermine their own strategies. Nobody does it to them. They do it themselves. Their strategies fail from within.
Then there is the host of strategy killers in the external environment. These range from so-called industry experts to regulators and financial analysts. These all tend to push companies toward what I call “competition to be the best”—the analyst who wants every company to look like the current market favorite, the consultant who helps you benchmark yourself against everyone else in the industry, or who pushes the next big thing, such as the notion that you’re supposed to delight and retain every single customer.
Let’s take this last idea as an example. If you listen to every customer and do what they ask you to do, you can’t have a strategy. Like so many ideas that get sold to managers, there is some truth to it, but the nuances get lost. Strategy is not about making every customer happy. When you’ve got your strategist’s hat on, you want to decide which customers and which needs you want to meet. As to the other customers and the other needs, well, you just have to get over the fact that you will disappoint them, because that’s actually a good thing.
I also believe that as capital markets have evolved they have become more and more toxic for strategy. The single-minded pursuit of shareholder value, measured over the short term, has been enormously destructive for strategy and value creation. Managers are chasing the wrong goal.
These are just some of the obstacles. Cumulatively, they add up. Having a strategy in the first place is hard. Maintaining a strategy is even harder.
Magretta: Would you elaborate on how the capital markets impact strategy?
Porter: This is a multifaceted problem. Let’s start with the way financial analysts and the investor community evaluate companies. For any industry, analysts tend to settle on a set of relevant metrics. If it’s retailing, for example, it’s same-store sales. In another industry, it might be revenue per employee. Of course, it’s good to try to find measures that tell you what’s going on in a company. But the problem for strategy is that the same metrics are applied to all companies in the industry. One of the important lessons about strategy is that if you’re pursuing a different positioning, then different metrics will be relevant. And if you force everybody to show progress on the same metrics, you encourage convergence and undermine strategic uniqueness.
At another level, at any moment in time there’s a tendency for the players in the capital markets to identify a “winner.” Typically it’s the company that seems to be doing well, maybe because it’s growing a bit faster, or its profitability the last few quarters has been better. For the analysts, this becomes the gold standard, and then all the companies in the industry are pressured to replicate what the current industry favorite is doing. If the favorite is Pfizer, and Pfizer has been making acquisitions, then everyone else in the industry is pressured to make acquisitions. Follow Pfizer. Do some deals.
Now it often happens that the current favorite eventually falls out of favor, but usually not before the analysts have herded everyone down the same path. And, of course, in strategy there is no one best path. The essence of strategy is to create your own path. You want to run your own race to reach a distinctive endpoint, which is the way you choose to create value. So in this way the capital markets reinforce the mind-set of competition to be the best. And they set themselves up as the arbiter of what “the best” is.
At a third level, the weight of activity in the markets has gravitated toward short-term trading versus long-term investing. People move in and out of stocks quickly, trying to profit from small gaps and discontinuities. But strategy needs a longer time horizon. Building out a unique position in the market takes a series of investments over time. So what are the consequences of this mismatch? If it’s going to take a few years to build earnings, but only a few months to buy them, then why not take the quicker path, especially if you can conveniently forget about the intangibles you’re writing off after the deal closes. There’s a strong bias for doing deals. At the broadest level, then, there’s a mismatch between the market’s focus on near-term performance and the longer time horizon that would support investment in building a strategic position.
The whole emphasis on shareholder value over the past couple of decades has focused managers on the wrong thing when they should really be focusing on creating economic value sustainably over the long term. The capital markets are better at driving OE, better at keeping pressure on companies to improve efficiency and profitability and to use capital better—these are positive influences. But I have no doubt that the markets damage strategy, even if the impact is subtle and mostly unrecognized.
Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.