Compete to Be Unique

The Core Insight

Between 1993 and 2007, the average heavy-truck maker earned 10.5 percent on invested capital. Paccar earned 31.6 percent in the same industry, holding about 20 percent of the North American market. The industry is hostile on every front. Fleet buyers squeeze prices, unions raise costs, rail caps what trucking can charge, and rivals discount to fill factories. Paccar sells to the individual owner-operator, who lives in his truck and pays a 10 percent premium for a custom Kenworth or Peterbilt.

That spread is the subject of Understanding Michael Porter, Joan Magretta's 2012 distillation of Porter's work on competition and strategy. She edited two of his most influential Harvard Business Review articles, and Porter reviewed every chapter here. The compression pays: thousands of pages reduce to one causal chain running from industry structure to your income statement.

The chain starts as arithmetic. Profit equals price minus cost, with cost counting every resource including capital. Every claim in a strategy must land on one of those two numbers, or it is talk.

Most managers compete to be the best. They benchmark rivals, converge on one standard offering, and hand the gains to customers in a price war, the race Porter calls zero-sum. He argues the winners compete to be unique, because in most businesses no best exists. Walmart and Target both won discount retail for decades. McDonald's wins on fast burgers while In-N-Out thrives on slow ones, with customers happy to wait ten minutes. Business pays multiple winners, because there are many different needs to serve.

The Framework

Strategy, in Porter's definition, explains how an organization faced with competition will achieve superior performance. The explanation has two parts. Industry structure sets the average return every player competes against. Position inside the industry sets your spread above or below that average.

Five forces set the average because they cover all of commerce: sellers to buyers, sellers to suppliers, rival to rival, supply to demand. Each force presses on price or cost in a known direction. Powerful buyers push prices down or demand more product for the same money, the way big construction firms squeeze American cement makers. Powerful suppliers charge more or deliver less, and labor counts as a supplier. Microsoft and Intel ran that squeeze on PC makers and captured nearly all the value the industry created. Substitutes cap prices from outside, the way 1 dollar kiosk rentals capped DVDs selling at twenty to forty times the price. The threat of entry caps prices too, and forces incumbents like Starbucks to keep spending on defense. Rivalry passes the value to customers as discounts or burns it in the cost of competing, and price rivalry damages most.

Structure outranks the categories managers reach for, high growth or low, high tech or low. Growth alone guarantees nothing, because growth with low entry barriers invites rivals and can hand power to suppliers. The rankings barely move: airlines sat near the bottom of the profit table for decades while software sat near the top.

Against that baseline, a good strategy passes five tests.

• The value proposition is distinctive: chosen customers, chosen needs, and a chosen relative price.
• A tailored value chain delivers it through activities rivals do not perform, or perform differently.
• Trade-offs make those choices incompatible with a rival's position, so copying carries a penalty.
• Fit ties the activities into one system, so copying a single piece achieves little.
• Continuity holds the direction long enough for the other four to develop.

The first two tests create the advantage. The last three decide whether it survives imitation.

Key Ideas

Advantage Must Show Up in the P&L

Competitive advantage has a hard definition: against your industry, you operate at lower cost, command a higher price, or both. The yardstick is return on invested capital over five to ten years, measured against your own industry only. Pharmacia and Upjohn earned 19.6 percent from 1985 to 2002. Nucor earned about 18. Steel averaged 6 percent while the best drug makers cleared 30, so the steel maker was the star and the drug maker lagged.

The book's worked example splits the spread. A company earning 15 percent against an industry's 10 holds a 5 point advantage. The example builds it from a realized price 8 percent above average and a cost base 3 points higher. Price drivers and cost drivers get different fixes, so the split comes before the plan. Flawed goals corrupt everything downstream: Kelleher watched airlines raise costs 25 percent to buy 5 percent more market share. Porter's wry proof against growth worship is that any company grows fast the day it halves its prices.

Position Where the Forces Are Weakest

CEMEX sells cement on both sides of the American border. In the United States, big construction companies buy most of it and bargain hard. In Mexico, 85 percent of cement revenue comes from thousands of small builders served by a handful of producers, and CEMEX earns more there. Same product, same skill, different structure.

Inside one industry, position does the same work. Sam Walton put good-sized stores in tiny towns of 5,000 to 25,000 people that every other discounter ignored. Many of those markets fed one large retailer only, so being first became the entry barrier. Southwest priced against ground transportation instead of airlines, at 15 dollars from Dallas to San Antonio against Braniff's 62 dollar fare. Kelleher refused to raise it, naming the car as the real rival. When Southwest entered Harlingen, passengers between its base cities and the Valley jumped from 123,000 to 325,000 within a year. Cheap flying pulled new travelers off the road and grew the whole market.

Execution Gains Leak Away

Porter separates operational effectiveness from strategy. Operational effectiveness means running the same activities better than rivals, and its gains leak away, because the techniques diffuse. Everyone improves, no one gains, and the whole industry runs faster to stay in place. Japanese manufacturers mastered that game and earned chronically poor profits from it.

Strategy lives a level down, in the value chain. Southwest turned gates in ten minutes and kept digging into the subactivities under that number. The digging ended with Boeing repositioning the lavatory service panel on the 737-300, because draining it blocked the ground crew. Aravind Eye Hospital shows the same tailoring at the extreme. It runs cataract surgery like an assembly line, with the next patient prepped behind the surgeon. Market rates apply only to patients who want private comforts. Each paying patient funds free surgery for two more. With 1 percent of India's ophthalmic manpower, Aravind performs 5 percent of its eye surgeries. That is about 300,000 operations a year, at least two thirds of them free.

Trade-offs Make Imitation Expensive

A trade-off is a fork in the road: taking one path closes the other, so a rival copies you only by damaging itself. Morris Chang built Taiwan Semiconductor in 1987 on one refusal, manufacturing for chip designers while never designing chips. The refusal deleted the fear that a manufacturer steals your design, so customers paid more while his focused costs fell. Sales reached about 9 billion dollars by 2009. IKEA designs a coffee table backward from a 30 dollar price, and its flat packs fit six times the furniture per truck. Edward Jones charges 100 dollars a trade where discount brokers charge 8 dollars, and refuses online trading because its conservative customers buy a relationship.

Straddlers pay the penalty in public. McDonald's spent close to half a billion dollars refitting kitchens for its Made for You customization push. The move matched Burger King and traded away the speed the McDonald's system was built on. British Airways launched Go to fight the budget carriers, muddled both positions, and sold it to a private equity firm. A year later that firm resold a larger Go to EasyJet at four times its purchase price. The sign of a good strategy, in Porter's telling, is that it deliberately makes some customers unhappy.

Fit Compounds Until Copying Fails

Fit means the value or cost of one activity depends on how the other activities are performed. Zara is the clean case. Its scouts find trends in shows and nightclubs, its own European plants produce small batches, and its trucks restock every store twice a week. Lead times run two to four weeks against the industry's three months, feeding one hundred collections a year. Scarce stock and prominent windows substitute for advertising. Zara spends under one third of one percent of revenue on ads, against about 5 percent at H&M. Full-price selling shows up in markdowns, about 10 percent of items against the industry's 17 to 20.

The compounding is the defense. Give a rival 90 percent odds of matching any one activity. A four activity system then drops the whole copy to 66 percent odds, and five activities drop it to 59. The opposite bet, buying one core competence, fails on the same logic. AT&T paid 130 billion dollars for cable systems in 1999 and 2000, then sold them to Comcast for 44 billion dollars two years later.

Continuity Lets the Strategy Emerge

The great systems were discovered, then held. Lamar Muse sold Southwest's fourth plane after a court penned the airline inside Texas, then kept the fuller schedule anyway. The ten minute gate turnaround fell out of that constraint. Ingvar Kamprad founded IKEA in 1943, opened the first store in 1958, and tested the signature self-service format in the mid-1960s. None of this required heroic predictions. Southwest bet only that people will keep wanting cheap, convenient flights. From 1980 to 2010 it averaged 11.4 percent on invested capital against the industry's 3.1.

Porter reserves strategy change for three conditions. The need can die: Liz Claiborne dressed the first generation of women entering professional work, and that insecurity faded as dress codes loosened. Earnings fell from 223 million dollars in 1991 to 83 million in 1994. Innovation can void the trade-offs: Taiwanese design manufacturers let rivals match Dell's costs and erased a two decade advantage. And a true disruption can invalidate the assets, as digital photography did to Kodak. Porter guesses that last class touches fewer than 5 to 10 percent of industries in a decade. Everything else is a reason to deepen, and flexibility without a position guarantees mediocrity.

Practical Applications

Start with the two spreads. Pull five to ten years of return on invested capital for your business, and set it against your industry average. Split any gap into relative price and relative cost. The industry gap and the position gap have different causes, and the split tells you which problem you own.

Then run the forces in the book's order. Define the industry by product and geography first, because motor oil for cars and motor oil for trucks are different industries. Rate each force, name the one or two that control profitability, and write down their trend. A founder in fresh ground runs the same exercise as a forecast, since four of the five forces are knowable before the first rival appears.

Write the value proposition as three answers: which customers, which needs, what relative price. Then list the activities that only this proposition requires. If a rival's existing chain delivers it equally well, you hold a marketing message, and the second test fails.

Publish the refusals. List the customers, features, and channels you will not serve. Edward Jones does it on a page named When We Say No, and defends the list when growth pressure arrives. Check that each refusal forces a specific rival into a trade-off. Porter's growth rule is deepen before broaden. The common failure settles for half of the core segment, while 80 percent is reachable, and chases arenas with no edge.

Who This Is For

Founders choosing a market get the most from this book, because the forces are entry due diligence and the forecast version works before rivals exist. Operators inside benchmark cultures get language for the treadmill they are on. Anyone whose stated strategy is a growth target gets the correction in chapter one.

Skip it if you want an execution playbook. Magretta calls it a how to think book, aerodynamics rather than a pilot's license, and it hands you no templates. Close readers of Porter's originals will find compression here, and little new machinery.

Read the sourcing with open eyes. Magretta is Porter's longtime editor and a senior associate at his institute. The book reads every dispute Porter's way, against core competence, blue ocean, and disruption talk. The case figures are journalistic and frozen near 2011. Blockbuster filed for bankruptcy while she wrote, and Dell's advantage collapses inside the book's own chapters. Keep the mechanisms, and recheck any specific return before you build on it.

The Decision

Run the first test this week. Write the three answers of your value proposition, then list five activities you perform differently from your closest rival because of them. A short list means you are competing to be the best, and the industry average is your ceiling.

Then pick one refusal, write it down, and hold it for a quarter. The essence of strategy, in Porter's words, is choosing what not to do.