On Strategy and Leadership

On Strategy and Leadership
Professor Michael E. Porter Harvard Business School

Bucharest, Romania November 30, 2007
This presentation draws on ideas from Professor Porters 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 meanselectronic, mechanical, photocopying, recording, or otherwisewithout 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. Version: November 26, 2007, 6pm
20071129 Romania - Final.ppt
Copyright 2007 Professor Michael E. Porter
How Managers Think About Competition
COMPETING TO BE THE BEST
COMPETING TO BE UNIQUE
The worst error in strategy is to compete with rivals on the same dimensions
Flawed Concepts of Strategy

Strategy as action
Our strategy is to merge internationalize consolidate the industry outsource
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 vision
Our strategy is to meet our customers needs offer superior products 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.
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
ROIC threshold
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; and cash flow margin) are risky for strategy Prevalent accounting adjustments to reported profitability (e.g., writeoffs, 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 Performance
Shareholder Value
Sustained ROIC
Stock Price
Sustainable Revenue Growth
EPS
EPS Growth
Shareholder value is the result of creating real economic value Pleasing todays shareholders is not the goal
Economic Foundations of Competition

The fundamental unit of strategic analysis is the industry
Defining the relevant industry is important to strategy
Company economic performance results from two distinct causes
Industry Structure
Relative Position Within the Industry
- Overall Rules of Competition
- Sources of Competitive Advantage
Strategy must encompass both
Disaggregating Economic Performance: Industry vs. Position

35%
31.4%
30%
30.8%
Return on Invested Capital 1985-2002
25% 20% 15% 10% 5% 0%
25.4%
9.6%
Reebok International
Industry Average
Paccar
Note: Invested capital less excess cash is the average of the beginning period and the ending period values. Excess cash is calculated by subtracting cash in excess of 10% of annual revenue. Source: Compustat (2007), authors analysis
Profitability of Selected U.S. Industries

1992 - 2006
Security Brokers and Dealers Soft Drinks Prepackaged Software Pharmaceuticals Perfume,Cosmetic,Toilet Prep Advertising Agencies Distilled Spirits Semiconductors Surgical and Medical Instruments Mens and Boys Clothing Tires Household Appliances Malt Beverages Child Day Care Services Household Furniture Drug Stores Grocery Stores Iron and Steel Foundries Cookies and Crackers Mobile Homes Wine and Brandy Bakery Products Engines and Turbines Book Publishing Laboratory Equipment Oil and Gas Machinery Soft Drink Bottling Knitting Mills Hotels Catalog, Mail-Order Houses Airlines 0% 5% 10%
ROIC = Earnings before interest and taxes divided by invested capital less excess cash
Average industry ROIC in the US:14.9%
15%
20%
25%
30%
35%
40%
45%
Return on invested capital, 1992 2006 average

Note: Invested capital less excess cash is the average of the beginning period and the ending period values. Excess cash is calculated by subtracting cash in excess of 10% of annual revenue. Source: Compustat (2007), authors analysis
Determinants of Industry Profitability
Threat of Substitute Products or Services
Bargaining Power of Suppliers
Rivalry Among Existing Competitors
Bargaining Power of Buyers
Threat of New Entrants
10
Strategic Implications of Industry Structure

1. Positioning to Mute the Five Forces
Heavy Truck Industry
Threat of Substitute Products or Services Railroads Water transportation Bargaining Power of Suppliers Large suppliers of engines and drive train components Rivalry Among Existing Competitors Bargaining Power of Buyers Large fleets Leasing companies Owner operators
Heavy price competition on standardized models Threat of New Entrants Many truck producers are assemblers
11
Paccar Competitive Positioning

Focus on owner-operators Design trucks with special features and amenities Customization and build-to-order
Achieve low truck operating costs

Offer extensive roadside assistance to truckers
12
Strategic Implications of Industry Structure

2. Shaping Industry Structure
Foodservice Distribution Industry
Threat of Substitute Products or Services Go direct Use retail / warehouse channels
Bargaining Power of Suppliers Food processors Food cooperatives Farmers
Rivalry Among Existing Competitors Distributors Purchasing Warehousing Delivery

Threat of New Entrants Low barriers to entry
Bargaining Power of Buyers
Restaurants Schools Hospitals Cafeterias Other food service establishments
13
Reshaping Industry Structure

Foodservice Distribution
Offering value-added services Offering private-label products Moving to national procurement contracts Increasing the use of sophisticated information technology
14
Determinants of Relative Performance
Differentiation (Higher Price)
Competitive Advantage
Lower Cost
15
Economics of Strategic Positioning

Southwest Airlines
Revenue and Cost per Available Seat Mile, Average of 1998 - 2000
12
Operating Profit per Available Seat Mile Cost Advantage: 2.44
10
Pricing Differential: 1.72
8
Cents per ASM
6
Operating Cost per Available Seat Mile
0 Southwest
Note: Source:
Airline Industry Average
ASM (Available Seat Miles) defined as total seats available multiplied by miles flown Airline annual reports and authors calculations
16
Foundations of Economic Performance

The Value Chain
Firm Infrastructure
(e.g. Financing, Planning, Investor Relations)
Human Resource Management
Support Activities
(e.g. Recruiting, Training, Compensation System)
Technology Development
(e.g. Product Design, Testing, Process Design, Material Research, Market Research)
M a
Value
r g
Procurement
(e.g. Components, Machinery, Advertising, Services)
Inbound Logistics
(e.g. Incoming Material Storage, Data Collection, Service, Customer Access)
Operations
(e.g. Assembly, Component Fabrication, Branch Operations)
Outbound Logistics
(e.g. Order Processing, Warehousing, Report Preparation)
Marketing & Sales

(e.g. Sales Force, Promotion, Advertising, Proposal Writing, Web site)
After-Sales Service
(e.g. Installation, Customer Support, Complaint Resolution, Repair)
i n
What buyers are willing to pay
Primary Activities
Competing in a business involves performing a set of discrete activities, in which competitive advantage resides
17
Defining the Value Chain

Commercial Construction
Firm Infrastructure (Strategic Planning, Finance, Control, Administration, Legal, Safety, Risk Management) Human Resource Management (HR, Training, Recruiting) Technology Development (Information Technology, Business Systems) Procurement (Materials, Subcontractors, Services) Client Bidding and Development Selection

Support Activities
M a
r
Project Closeout

PreConstruction
Construction Management
AfterCompletion Support

g i n
Marketing Business development Client relationship management Pipeline management
Bidding Project risk assessment Securing insurance coverage
Obtaining permits and licenses Site preparation Estimation of pricing, materials, and schedule Advanced ordering of materials Subcontractor contracting
Managing the client interface Architect and engineering coordination Site management Coordinating logistics Updating documentation
Site cleanup Manage subcontractors transition out of the site Preparing final documentation Client satisfaction survey
Ongoing customer support Warranties
Primary Activities
There can be different ways of configuring the value chain in the same industry
Source: Interviews with Suffolk managers Note: Risk Management and Legal department are part of the firm infrastructure, but they also play a role specific to each project during the contracting phase 18 20071129 Romania - Final.ppt
Achieving Superior Performance

Operational Effectiveness is Not Strategy
Operational Effectiveness
Strategic Positioning
Assimilating, attaining, and extending best practices
Creating a unique and sustainable competitive position
Run the same race faster
Choose to run a different race
19
Five Tests of a Good Strategy
A unique value proposition compared to other organizations A different, tailored value chain Clear tradeoffs, and choosing what not to do Activities that fit together and reinforce each other Strategic continuity with continual improvement in realizing the strategy
20
Enterprise Rent-A-Car
Value Proposition
Home-city replacement cars for drivers whose cars are being repaired or who need an extra vehicle, at low rates (30% below airport rates)
Distinctive Activities
Numerous, small, inexpensive offices in each
metropolitan area, including on-premises offices at major accounts
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 the fleet
21
Defining the Value Proposition
What Customers?
What end users? What channels?
Which Needs?
Which products? Which features? Which services?
What Relative Price?
A novel value proposition can also grow the pie/expand the industry
22
IKEA, Sweden
Value Proposition
Young, first time, or price-sensitive buyers who
want stylish, space efficient and scalable furniture and accessories at very low price points.
Modular, ready-to-assemble, easy to package
designs In-house design of all products Wide range of styles in huge warehouse stores with large on-site inventories Self-selection Extensive customer information in the form of catalogs, explanatory ticketing, do-it-yourself videos, and assembly instructions Use Ikea designer names on products to inform coordinated purchases Child care provided in the store On-site, low-cost, restaurants Long hours of operation Suburban locations with large parking lots Principally self-delivery by customers
23
GOL Airlines, Brazil
Value Proposition
Convenient, no-frills airline service between 41
Brazilian and nearby international cities at very low prices competing with bus transportation
No-frills service
Many flights during late night hours

On time performance Quick airport turn-around Utilize aircraft more hours per day Single aircraft type (Boeing 737s) 80% reservations made via the Internet
Price sensitive business (60%) and leisure

travelers
24
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
25
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
26
Strategic Tradeoffs
IKEA, Sweden
IKEA
Product Low-priced, modular, ready-to-assemble designs No custom options Furniture design driven by cost, manufacturing simplicity, and style Value Chain
Typical Furniture Retailer

Product Higher priced, fully assembled products Customization of fabrics, colors, finishes, and sizes Design driven by image, materials, varieties
Value Chain
Centralized, in-house design of all products

All styles on display in huge warehouse stores Large on-site inventories Extensive customer information but limited sales support Long hours of operation
Source some or all lines from outside suppliers Medium sized showrooms with limited portion of available models on display Limited inventories / order with lead time Extensive sales assistance Traditional retail hours
27
Recent Thinking on the Sources of Competitive Advantage
Key Success Factors Core Competencies
Critical Resources
Competitive advantage is seen as concentrated in a few parts of the value chain

28
Mutually Reinforcing Activities

Zara Apparel
Word-ofmouth marketing and repeat buying
Wide range of styles
Customers chic but costconscious
Cuttingedge fashion at moderate price and quality
Global team of trendspotters
Little media advertising
Very frequent product changes
Majority of productio n in Europe
Advanced productio n machiner y
Prime store locations in high traffic areas

JIT delivery
Extensive use of store sales data
Tight coordination with 20 wholly-owned factories
Very flexible productio n 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 29 20071129 Romania - Final.ppt
Strategic Continuity
Continuity of strategy is fundamental to sustainable competitive advantage
e.g., allows the organization to understand the strategy building truly unique skills and assets related to the strategy establishing a clear identity with customers, channels, and other outside entities strengthening the fit across the value chain
Reinvention and frequent shifts in direction are costly and confuse the customer, the industry, and the organization
Maintain continuity in the value proposition Successful companies continuously improve in how they realize their value proposition
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
30
Barriers to Strategy
Flawed Management 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
31
Overcoming Barriers to Strategy

Internal Practices
Inappropriate goals and performance metrics bias strategy choices
Short time horizon
Rapid turnover of leadership undermines strategic direction to achieve short-term performance benefits A desire for consensus blurs strategic tradeoffs Inappropriate cost allocation leads to too many products, services, or customers
Outsourcing makes activities homogenous and less distinctive
32
Internal Barriers to Strategy

Neutrogena Soap (2005)
Prior to the 1990s Neutrogena was the number one brand recommended by dermatologists
Neutrogena had a relatively narrow target market but deep penetration and high customer loyalty
Beginning in the early- to mid-1990s, new growth-oriented management shifted Neutrogena from a dermatologist-focused marketing concept to mass market television advertisements and celebrity endorsements Neutrogena lost market share while Galldermas Cetaphil captured the loyalty of dermatologists, and prospered
Source: Draws on research conducted at the Institute for Strategy and Competitiveness and interviews conducted with a former Neutrogena executive.
33
Integrating Strategy and Corporate Social Responsibility

There is a long-term synergy between economic and social objectives
Company competitiveness and social conditions can both improve

Business cannot solve all of societys problems, nor bear the cost of doing so Business must approach its social agenda strategically
Where is a company able to have the greatest social impact?
34
Whole Foods Markets
Value Proposition
Natural, fresh, organic, and prepared foods and health items with excellent service at premium prices Educated, middle class, and affluent customers passionate about food as a part of a healthy lifestyle

Well-lit, inviting supermarket store formats with appealing displays and extensive prepared foods sections Produce section as theater Caf-style seating areas with wireless internet for meetings and meals 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

35
Strategic CSR
ChoicePoint
ChoicePoints core business is providing personal identification, screening, and credit verification
e.g., access to ChoicePoint databases, employment background screening, credit verification, DNA identification and authentication, drug testing, etc.
The companys CSR program focuses on providing services and advice to social organizations:
e.g., Background checks of volunteers working with children such as Boys & Girls Club volunteers Identity verification for Katrina victims Assisting NGOs to find missing children and prevent identity theft
ChoicePoint leverages its skills, data, technological knowledge, and staff to maximize social impact Its CSR approach is aligned with ChoicePoints founding principle: creating a safer and more secure society through responsible use of information CSR activities improve the companys capabilities around identity issues
Working with social organizations helps develop new methodologies and capabilities
36
Strategic CSR
Nestl in India
Nestls entered the poor Moga region of India in 1962 Local milk supply was hampered by small parcels of land, poor soil, periodic droughts, animal disease, and lack of a commercial market Nestl established local milk purchasing organizations in each town Nestl invested in improving competitive context
Collection infrastructure such as refrigerated dairies was accompanied by veterinarians, nutritionists, agronomists, and quality assurance experts to assist small farmers Medicines and nutritional supplements were provided to improve animal health Monthly training sessions were held for local farmers Wells to secure water supply for animals were dug with financing and technical assistance from Nestl
Nestl has built a productive milk cluster in Moga, buying milk from more than 75,000 farmers through 650 local dairies
Moga has dramatically improved social conditions Nestl has developed a long-term competitive advantage in the milk cluster
37
Strategy
What Is a Strategy?
A unique value proposition versus competitors A different, tailored value chain Clear tradeoffs, and choosing what not to do Activities that fit together and reinforce each other Continuity of strategy with continual improvement in realizing the strategy
38
What is Not a Strategy?

Best practice improvement Execution Aspirations A vision Learning Agility Flexibility Innovation The Internet (or any technology) Downsizing Restructuring Mergers / Consolidation Alliances / Partnering Outsourcing Internationalizing
The Process of Developing Business Unit Strategy

Strategy should be developed and periodically reviewed in a formal process rather than being left to occur spontaneously
The process need not be highly structured
Strategy development is best done in a multifunctional team including the general manager and heads of important functions The role of the strategic planning executive or department is to serve as staff to the team, not be responsible for strategy development The strategy team itself should be relatively small to ensure frank and productive discussion between the leader and senior peers
Strategy development involves making tradeoffs and exploring options that can be unsettling and disruptive if lower level people are involved Other managers can be invited for particular meetings/input
The strategy team should conduct its work jointly rather than delegating components of the strategy to functional areas
39
Communicating a Strategy
Strategy involves everyone in an organization, not just top management
The benefits of strategy are greatest when it is communicated widely in the organization
Communicating strategy requires a simple and vivid way of describing the essence of the companys unique position
Symbols of the strategy are invaluable tools Repetition
The basic strategy and value proposition must also be communicated to customers, channels, suppliers, and financial markets
What about confidentiality?
Leaders should not assume that subordinates understand the strategy, or that they agree with it
Help each organizational unit translate the strategy into implications for its own mandate
Individuals who do not ultimately accept the strategy cannot have an ongoing role in the company
40
The Role of Leaders in Strategy

Lead the process of choosing the companys 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 companys strategy Measure progress against the strategy using tailored 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

41
The Moral Purpose of Business
The most important thing a corporation can do for society is to contribute to a prosperous economy
Only business can create wealth; other institutions in society are principally involved in redistributing wealth or investing it to meet human needs Corporations are not responsible for all the worlds problems, nor do they have the resources to solve them all
Business has no need to be defensive about its role in society
Business has the tools, capabilities, and resources to make a far greater positive impact on social issues than most other institutions Business is more transparent and more accountable than most foundations and NGOs
Each company can and should identify the particular set of societal problems that it is best equipped to help resolve, and from which it can gain the greatest competitive benefit
Addressing social issues through shared value strategies will lead to self-sustaining solutions
Using these principles, businesses can have a greater impact on social good than any other institution or philanthropic organization
42

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On Strategy and Leadership

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On Strategy and Leadership

Professor Michael E. Porter Harvard Business School

Copyright 2007 Professor Michael E. Porter

How Managers Think About Competition

COMPETING TO BE THE BEST

20071129 Romania - Final.ppt

Copyright 2007 Professor Michael E. Porter

Flawed Concepts of Strategy

20071129 Romania - Final.ppt

Copyright 2007 Professor Michael E. Porter

20071129 Romania - Final.ppt

Copyright 2007 Professor Michael E. Porter

Setting the Right Goals

Setting unrealistic profitability or growth targets can undermine strategy

Copyright 2007 Professor Michael E. Porter

Economic Performance versus Shareholder Value

Sustainable Revenue Growth

20071129 Romania - Final.ppt

Copyright 2007 Professor Michael E. Porter

Economic Foundations of Competition

Company economic performance results from two distinct causes

Relative Position Within the Industry

- Overall Rules of Competition

- Sources of Competitive Advantage

Strategy must encompass both

20071129 Romania - Final.ppt

Copyright 2007 Professor Michael E. Porter

Disaggregating Economic Performance: Industry vs. Position

Return on Invested Capital 1985-2002

25% 20% 15% 10% 5% 0%

Copyright 2007 Professor Michael E. Porter

Profitability of Selected U.S. Industries

Average industry ROIC in the US:14.9%

Return on invested capital, 1992 2006 average

Copyright 2007 Professor Michael E. Porter

Determinants of Industry Profitability

Threat of Substitute Products or Services

Bargaining Power of Suppliers

Rivalry Among Existing Competitors

Bargaining Power of Buyers

Threat of New Entrants

20071129 Romania - Final.ppt

Copyright 2007 Professor Michael E. Porter

Strategic Implications of Industry Structure

20071129 Romania - Final.ppt

Copyright 2007 Professor Michael E. Porter

Paccar Competitive Positioning

Achieve low truck operating costs

20071129 Romania - Final.ppt

Copyright 2007 Professor Michael E. Porter

Strategic Implications of Industry Structure

Bargaining Power of Suppliers Food processors Food cooperatives Farmers

Rivalry Among Existing Competitors Distributors Purchasing Warehousing Delivery

Bargaining Power of Buyers

Restaurants Schools Hospitals Cafeterias Other food service establishments

20071129 Romania - Final.ppt

Copyright 2007 Professor Michael E. Porter

Reshaping Industry Structure

20071129 Romania - Final.ppt

Copyright 2007 Professor Michael E. Porter

Determinants of Relative Performance

Differentiation (Higher Price)

20071129 Romania - Final.ppt

Copyright 2007 Professor Michael E. Porter