Complete a one-page paper after reading Michaels Porters article? The one-pager should be single-spaced, and no less than 200 words. The paper should focus on what strategy means to you and

BR NOVEMBER-DECEMBER 1996

I. Operational Effectiveness Is Not Strategy

What Is Strategy r

For almost tv̂ fo decades, managers have been learning to play by a new set of rules. Companies must be flexible to respond rapidly to compet- itive and market changes. They must benchmark continuously to achieve best prac- tice. They must outsource aggres- sively to gain ef- ficiencies. And they must nur- ture a few core eompetencies in the by Michael race to stay ahead of rivals.

Positioning-once the heart of strategy-is reject- ! ed as too static for today's dynamic markets and changing technologies. According to the new dog- ma, rivals can quickly copy any market position, and competitive advantage is, at hest, temporary.

But those beliefs are dangerous half-truths, and they are leading more and more companies down the path of mutually destructive competition. True, some barriers to competition are falling as regulation eases and markets become global. True, companies have properly invested energy in beeom- ing leaner and more nimble. In many industries, however, what some call hypcrcompetition is a self-inflicted wound, not the inevitahle outcome of a changing paradigm of competition.

The root of the problem is the failure to distin- guish between operational effeetiveness and strat-

egy. The quest for productivity, quality, and speed has spawned a remarkable number of management tools and techniques: total quality management, benchmarking, time-based competition, outsourc-

ing, partnering, rcungineer'ing, change manage- ment. Although the resulting op- erational improve- ments have often

E. Porter ^^^^ dramatic, many companies have been frustrated hy their inability to

translate those gains into sustainahle profitahility. And hit by bit, almost imperceptibly, management tools have taken the place of strategy. As manag- ers push to improve on all fronts, they move farther away from viable competitive positions.

Operational Effectiveness: Necessary but Not Sufficient

Operational effectiveness and strategy are both essential to superior performance, wbich, after all, is the primary goal of any enterprise. But they work in very different ways.

Michael E. Porter is the C. Roland Chiistensen Professor of Business Adminislralion at the Harvard Business School in Boston, Massachusetts.

HARVARD BUSINESS REVIEW N,)vt;mbt;r-D(.ct;mbi;r 1996 61

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A company can outperform rivals only if it can establish a difference that it can preserve. It must deliver greater value to customers or create compa- rable value at a lower cost, or do both. The arith- metic of superior profitability then follows: deliver- ing greater value allows a company to charge higher average unit prices; greater efficiency results in lower average unit costs.

Ultimately, all differences between companies in cost or price derive from the hundreds of activities required to create, produce, sell, and deliver their products or services, such as calling on customers, assembling final products, and training employees. Cost is generated by performing activities, and cost advantage arises from performing particular activi- ties more efficiently than competitors. Similarly, differentiation arises from both the choice of activi- ties and how they are performed. Activities, then, are the hasic units of competitive advantage. Over- all advantage or disadvantage results from all a company's activities, not only a few.'

Operational effectiveness (OE) means performing similar activities better than rivals perform them. Operational effectiveness includes but is not limit- ed to efficiency. It refers to any number of practices that allow a company to better utilize its inputs by, for example, reducing defects in products or devel- oping better products faster. In contrast, strategic positioning means performing different activities from rivals' or performing similar activities in dif- ferent ways.

Differences in operational effectiveness among companies are pervasive. Some companies are able

A company can outperform rivals only if it can establish a difference that it can preserve.

to get more out of their inputs than others because they eliminate wasted effort, employ more ad- vanced technology, motivate employees better, or have greater insight into managing particular activ- ities or sets of activities. Such differences in opera-

Operational Effectiveness Versus Strategic Positioning

Relative cost position

This article has benefited greatly from the assistance of many individuals and companies. The author gives special thanks to Ian Rivkin, the coauthor of a related paper. Substantial research contributions have been made by Nicolaj Siggelkovi/. Dawn Sylvester, and Lucia Marshall. Tarun Khanna, Roger Martin, and Anita Mc- Gahan have provided especially extensive comments.

tional effectiveness are an important source of dif- ferences in profitability among competitors be- cause they directly affect relative cost positions and levels of differentiation.

Differences in operational effectiveness were at the heart of the Japanese challenge to Western com- panies in the 1980s. The Japanese were so far ahead of rivals in operational effectiveness that they could offer lower cost and superior quality at the same time. It is worth dwelling on this point, be- cause so much recent thinking about competition depends on it. Imagine for a moment a productivity

frontier that constitutes the sum of all existing best practices at any giv- en time. Think of it as the maximum value that a company delivering a particular product or service can cre- ate at a given eost, using the hest availahle technologies, skills, man- agement techniques, and purchased inputs. The productivity frontier can

apply to individual activities, to groups of linked activities such as order processing and manufactur- ing, and to an entire company's activities. When a company improves its operational effeetiveness, it moves toward the frontier. Doing so may require capital investment, different personnel, or simply new ways of managing.

The productivity frontier is constantly shifting outward as new technologies and management ap- proaches are developed and as new inputs become available. Laptop computers, mobile communica- tions, the Internet, and software such as Lotus Notes, for example, have redefined the produetivity

62 HARVARD BUSINESS REVIEW November-December 1996

WHAT IS STRATEGY?

frontier for sales-force operations and created rich possibilities for linking sales with such activities as order processing and after-sales support. Similarly, lean production, which involves a family of activi- ties, has allowed substantial improvements in manufacturing productivity and asset utilization.

For at least the past decade, managers have been preoccupied with improving operational effective- ness. Through progratns such as TQM, time-based competition, and benchmarking, they have changed how they perform activities in order to eliminate inefficiencies, improve customer satisfaction, and achieve best practice. Hoping to keep up with shifts in the productivity frontier, managers have embraced continuous improvement, empowerment, chan^t management, and the so-called learning organization. The popularity of outsourcing and the virtual corporation reflect the growing recogni- tion that it is difficult to perform all activities as productively as specialists.

As companies move to the frontier, they can often improve on multiple dimensions of performance at the same time. For example, manufacturers that adopted the Japanese practice of rapid changeovers in the 1980s were able to lower cost and improve differentiation simultaneously. What were once be- lieved to be real trade-offs – between defeets and costs, for example – turned out to be illusions cre- ated by poor operational effectiveness. Managers have learned to reiect such false trade-offs.

Constant improvement in operational effective- ness is necessary to achieve superior profitability. However, it is not usually sufficient. Few compa- nies have competed successfully on the basis of op- erational effectiveness over an extended period, and staying ahead of rivals gets harder every day. The most obvious reason for that is the rapid diffusion of best practices. Competitors can quickly imitate management techniques, new technologies, input improvements, and superior ways of meeting cus- tomers' needs. The most generic solutions – those that can be used in multiple settings–diffuse the fastest. Witness the proliferation of OE techniques accelerated by support from consultants.

OE competition shifts the productivity frontier outward, effectively raising the bar for everyone. But although such competition produces absolute improvement in operational effectiveness, it leads to relative improvement for no one. Consider the $5 hillion-plus U.S. commercial-printing industry. The major players-R.R. Donnelley Sk Sons Com- pany, Quehecor, World Color Press, and Big Flower Press-are competing head to head, serving all types of customers, offering the same array of printing technologies (gravure and weh offset}, investing heavily in the same new equipment, running their presses faster, and reducing crew sizes. But the re- sulting major productivity gains are being captured by customers and equipment suppliers, not re- tained in superior profitability. Even industry-

Japanese Companies Rarely Have Strategies

The lapanese triggered a global revolution in opera- tional effectiveness in the 1970s anij 1980s, pioneering practices such as total quality management and con- tinuous improvement. As a result, Japanese manufac- turers enjoyed substantial cost and quality advantages for many years,

But lapanese companies rarely developed distinct strategic positions of the kind discussed in this article. Those that did – Sony, Canon, and Sega, for example – were the exception rather than the rule. Most Japanese companies imitate and emulate one another. All rivals offer most if nt)t all product varieties, features, and ser- vices; they employ all channels and match one anoth- ers' phint configurations.

The dangers of Japanese-style competition are now becoming easier to recognize. In the 1980s, with rivals operating far from the productivity frontier, it seemed possible to win on both eost and quality indefinitely. Japanese companies were all able to grow in an ex- panding domestic economy and by penetrating global

tnarkets. They appeared unstoppable. But as the gap in operational effectiveness narrows, Japanese compa- nies are increasingly caught in a trap of their own making. If they are to escape the mutually destmetive battles now ravaging their performance, Japanese companies will have to learn strategy.

To do so, they may have to overcome strong cultural barriers. Japan is notoriously consensus oriented, and companies have a strong tendency to mediate differ- ences among individuals rather than accentuate them. Strategy, on the other hand, requires hard choices. The Japanese also have a deeply ingrained service tradition that predisposes them to go to great lengths to satisfy any need a customer expresses. Companies that com- pete in that way end up blurring their distinct posi- tioning, becoming all things to all customers.

This discussion of Japan is drawn from the authofs research with Hirotaka Takeuchi, with help from Mariko Sakakibara.

HARVARD BUSINESS REVIEW November-December 1996 63

WHAT IS STRATEGY?

leader Donnelley's profit margin, consistently higher than 7% in the 1980s, fell to less than 4.6% in 1995. This pattern is playing itself out in indus- try after industry. Even the Japanese, pioneers of the new competition, suffer from persistently low profits. (See the insert "Japanese Companies Rarely Have Strategies.")

The second reason that improved operational effectiveness is insufficient – competitive conver- gence-is more suhtle and insidious. The more henchmarking companies do, the more they look alike. The more that rivals outsource activities to efficient third parties, often the same ones, the more generic those activities hecome. As rivals im- itate one another's improvements in quality, cycle times, or supplier partnerships, strategies converge and competition hecomes a series of races down identical paths that no one can win. Competition based on operational effectiveness alone is mutu-

ally destructive, leading to wars of attrition that can he arrested only hy limiting competition.

The recent wave of industry consolidation through mergers makes sense in the context of OE competition. Driven by performance pressures but lacking strategic vision, company after company has had no hetter idea than to huy up its rivals. The competitors left standing arc often those that out- lasted others, not companies with real advantage.

After a decade of impressive gains in operational effectiveness, many companies are facing dimin- ishing returns. Continuous improvement has been etched on managers' brains. But its tools unwitting- ly draw companies toward imitation and homo- geneity. Gradually, managers have let operational effectiveness supplant strategy. The result is 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 activ- ities to deliver a unique mix of value.

Southwest Airlines Company, for example, offers short-haul, low-cost, point-to-point service he- tween midsize cities and secondary airports in large cities. Southwest avoids large airports and does not fly great distances. Its eustomers include husi- ness travelers, families, and students. Southwest's frequent departures and low fares attract price- sensitive customers who otherwise would travel hy bus or car, and convenience-oriented travelers who would choose a full-service airline on other routes.

Most managers describe strategic positioning in terms of their customers: "Southwest Airlines serves price- and convenience-sensitive travelers/'

The essence of strategy is choosing to perform activities differently than rivals do.

for example. But the essence of strategy is in the ac- tivities – choosing to perform activities differently or to perform different activities than rivals. Other- wise, a strategy is nothing more than a marketing slogan that will not withstand competition.

A full-service airline is configured to get passen- gers from almost any point A to any point B. To reach a large number of destinations and serve pas- sengers with connecting flights, full-service air- lines employ a hub-and-spokc system centered on major airports. To attract passengers who desire more comfort, they offer first-class or husiness- class service. To accommodate passengers who must change planes, they coordinate schedules and check and transfer baggage. Because some passen- gers will be traveling for many hours, full-service airlines serve meals.

Southwest, in contrast, tailors all its activities to deliver low-eost, convenient service on its par- ticular type of route. Through fast turnarounds at the gate of only 15 minutes. Southwest is able

to keep planes flying longer hours than rivals and provide frequent de- partures with fewer aircraft. South- west does not offer meals, assigned seats, interline baggage checking, or premium classes of service. Auto- mated ticketing at the gate encour- ages customers to hypass travel agents, allowing Southwest to avoid

their commissions. A standardized fleet of 737 air- craft hoosts the efficiency of maintenance.

Southwest has staked out a unique and valuahle strategic position based on a tailored set of activi- ties. On the routes served by Southwest, a fuU-

64 HARVARD BUSINESS REVIEW November-Decemher 1996

service airline could never be as convenient or as low cost.

Ikca, the global furniture retailer based in Swe- den, also has a clear strategic positioning. Ikca tar- gets young furniture buyers who want style at low cost. Wbat turns tbis marketing concept into a stra- tegic positioning is tbe tailored set of activities tbat make it work. Like Southwest, Ikea has cbosen to perform activities differently from its rivals.

Consider tbe typical furniture store. Showrooms display samples of tbe mercbandise. One area migbt contain 25 sofas; anotber will display five dining tables. But tbose items represent only a frac- tion of tbe cboices available to customers. Dozens of books displaying fabric swatcbes or wood sam- ples or alternate styles offer customers tbousands of product varieties to cboose from. Salespeople often escort customers tbrougb tbe store, answer- ing questions and belping tbem navigate tbis maze of cboices. Once a customer makes a selection, tbe order is relayed to a tbird-party manufacturer. Witb luck, tbe furniture will be delivered to tbe cus- tomer's home witbin six to eigbt weeks. Tbis is a value cbain tbat maximizes customization and service but does so at bigh eost.

In contrast, Ikea serves customers wbo are bappy to trade off service for cost. Instead of baving a sales associate trail customers around tbe store.

Ikea uses a self-service model based on clear, in- store displays. Ratber tban rely solely on tbird- party manufacturers, Ikea designs its own low-cost, modular, ready-to-assemble furniture to fit its posi- tioning. In buge stores, Ikea displays every product it sells in room-like settings, so customers don't need a decorator to belp them imagine bow to put tbe pieces togetber. Adjacent to tbe furnisbcd sbowrooms is a warebouse section witb the prod- ucts in boxes on pallets. Customers are expected to do tbeir own pickup and delivery, and Ikea will even sell you a roof rack for your car tbat you can return for a refund on your next visit.

Altbough much of its low-cost position comes from baving customers "do it tbemselves," Ikea of- fers a number of extra services tbat its competitors do not. In-storc cbild care is one. Extended bours are anotber. Tbose services are uniquely aligned with the needs of its customers, wbo are young, not wealtby, likely to bave cbildren (but no nanny), and, because tbey work for a living, bave a need to sbop at odd bours.

The Origins of Strategic Positions Strategic positions emerge from three distinct

sources, wbicb are not mutually exclusive and often overlap. First, positioning can be based on

Finding New Positions: The Entrepreneurial Edge

Strategic competition can be thought of as tbe process of perceiving new positions tbat woo cus- tomers from established positions or draw new cus- tomers into the market. For example, superstores of- fering depth ot' merchandise in a single product category take market share from broad-line depart- ment stores offering a more limited selection in many categories. Mail-order catalogs pick off customers who crave convenience. In principle, incumbents and en- trepreneurs face tbe same challenges in finding new strategic positions. In practice, new entrants often bave the edge.

Strategic positionings arc often not obvious, and finding tbem requires creativity and insigbt. New en- trants often discover unique positions that bave been available but simply overlooked by established com- petitors. Ikea, for example, recognized a customer group that had been ignored or served poorly. Circuit City Stores' entry into used cars, CarMax, is based on a new way of performing activities – extensive refur- bishing ol* cars, product guarantees, no-baggle pricing,

sophisticated use of in-house customer financing – that has long been open to incumbents.

New entrants can prosper by occupying a position tbat a competitor once held but has ceded througb years of imitation and straddling. And entrants com- ing from other industries can create new positions be- cause of distinctive activities drawn from their otbci businesses. CarMax borrows heavily from Circuit City's expertise in inventory management, credit, and otber activities in consumer electronics retailing.

Most commonly, however, new positions open up because of cbange. New customer groups or purchase occasions arise; new needs emerge as societies evotvc; new distribution cbannels appear; new technologies are developed; new machinery or informatiiin systems become available. When such cbanges happen, new entrants, unencumbered by a long history in tbe in- dustry, can often more easily perceive tbe potentialfor a new way ot" competing. Unlike incumbents, new- comers can be more flexible because tbey face no trade-offs witb tbeir existing activities. i

HARVARD BUSINESS REVIEW Nuvcmbcr-Deccmhcr 1996 65

WHAT IS STRATEGY?

producing a subset of an industry's products or ser- vices. I call this variety-based positioning because it is based on the choice of product or service vari- eties rather than customer segments. Variety-based positioning makes economic sense when a com- pany can best produce particular products or ser- vices using distinctive sets of activities.

Jiffy Lube International, for instance, specializes in automotive lubricants and does not offer other

Strategic positions can be based on customers' needs, customers' accessibility, or the variety of a

's products or services.

car repair or maintenance services. Its value chain produces faster service at a lower cost than broader line repair shops, a comhination so attractive that many customers subdivide their purchases, buying oil changes from the focused competitor. Jiffy Lube, and going to rivals for other services.

The Vanguard Group, a leader in the mutual fund industry, is another example of variety-based posi- tioning. Vanguard provides an array of common stock, bond, and money market funds that offer pre- dictable performance and rock-bottom expenses. Tbe company's investment approach deliberately sacrifices the possibility of extraordinary perfor- mance in any one year for good relative perfor- mance in every year. Vanguard is known, for exam- ple, for its index funds. It avoids making bets on interest rates and steers clear of narrow stock groups. Fund managers keep trading levels low, which holds expenses down; in addition, the com- pany discourages customers from rapid buying and selling because doing so drives up costs and can force a fund manager to trade in order to deploy new capital and raise cash for redemptions. Vanguard also takes a consistent low-cost approach to manag- ing distribution, customer service, and marketing. Many investors include one or more Vanguard funds in their portfolio, while buying aggressively managed or specialized funds from competitors.

The people who use Vanguard or Jiffy Lube are re- sponding to a superior value chain for a particular type of service. A variety-hased positioning can serve a wide array of customers, but for most it will meet only a subset of their needs.

A second basis for positioning is that of serving most or all the needs of a particular group of cus-

tomers. I call this needs-based positioning, which comes closer to traditional thinking about targeting a segment of customers. It arises when there are groups of customers with differing needs, and when a tailored set of activities can serve those needs best. Some groups of customers are more price sen- sitive than otbers, demand different product fea- tures, and need varying amounts of information, support, and services. Ikea's customers are a good

example of sucb a group. Ikea seeks to meet all the home furnishing needs of its target customers, not just a subset of them.

A variant of needs-hased position- ing arises when the same customer has different needs on different occa- sions or for different types of transac- tions. The same person, for example, may have different needs when trav- eling on business than wben travel-

ing for pleasure witb tbe family. Buyers of cans – beverage companies, for example-will likely have different needs from their primary supplier than from their secondary source.

It is intuitive for most managers to conceive of their business in terms of tbe customers' needs they are meeting. But a critical element of needs- based positioning is not at all intuitive and is often overlooked. Differences in needs will not translate into meaningful positions unless tbe best set of activities to satisfy them also differs. If that were not tbe case, every competitor could meet those same needs, and there would be notbing unique or valuable about the positioning.

In private banking, for example, Bessemer Trust Company targets families with a m i n i m u m of $5 million in investable assets who want capital preservation combined with wealtb accumulation. By assigning one sophisticated account officer for every 14 families, Bessemer has configured its ac- tivities for personalized service. Meetings, for ex- ample, are more likely to be beld at a client's ranch or yacht than in the office. Bessemer offers a wide array of customized services, including investment management and estate administration, oversight of oil and gas investments, and accounting for race- horses and aircraft. Loans, a staple of most private banks, are rarely needed by Besscmer's clients and make up a tiny fraction of its client balances and income. Despite the most generous compensation of account officers and the highest personnel cost as a percentage of operating expenses, Bessemer's differentiation with its target families produces a return on equity estimated to be the highest of any private banking competitor.

66 HARVARD BUSINESS REVIEW November-December 1996

Citibank's private bank, on tbe other hand, serves clients with minimum assets of about S250,000 wbo, in contrast to Bessemer's clients, want convenient access to loans-from jumho mort- gages to deal financing. Citibank's account man- agers are primarily lenders. When clients need oth- er services, their account manager refers them to other Citibank specialists, each of whom handles prepackaged products. Citibank's system is less customized than Bessemer's and allows it to have a lower manager-to-client ratio of 1:125. Biannual of- fice meetings are offered only for the largest clients. Both Bessemer and Citibank have tailored their ac- tivities tu meet the needs of a different group of pri- vate hanking customers. The same value chain can- not profitably meet the needs of both groups.

Tbe third basis for positioning is that of seg- menting customers who are accessible in different ways. Aitbough their needs are similar to those of other customers, the hest configuration of activi- ties to reach them is different. I call this access- based positioning. Access can be a function of cus- tomer geography or customer scale-or of anything that requires a different set of activities to reach customers in the best way.

Segmenting hy access is less common and less well understood than the other two hases. Carmike Cinemas, for example, operates movie theaters ex- clusively in cities and towns witb populations un- der 200,000. How dues Carmike make money in markets that are not only small hut also won't sup- port big-city ticket prices? It does so through a set of aetivities that result in a lean eost structure. Carmike's small-town customers can be served through standardized, low-cost theater complexes requiring fewer screens and less sophisticated pro-

jection technology than big-city theaters. The com- pany's proprietary information system and manage- ment process elimmate the need for local adminis- trative staff beyond a single theater manager. Carmike also reaps advantages from centralized purchasing, lower rent and payroll costs (because of its locations), and rock-bottom corporate overhead of 2% (the industry average is 5%|. Operating in small communities also allows Carmike to prac- tice a highly personal form of marketing in which the theater manager knows patrons and promotes attendance through personal contacts. By heing the dominant if not the only theater in its markets-the main competition is often the high school football team-Carmike is also able to get its pick of films and negotiate hetter terms with distributors.

Rural versus urhan-based customers are one ex- ample of access driving differences in activities. Serving small rather than large eustomers or dense- ly rather than sparsely situated customers are other examples in which the best way to configure mar- keting, order processing, logistics, and after-sale service activities to meet the similar needs of dis- tinct groups will often differ.

Positioning is not only ahout carving out a niche. A position emerging from any of the sources ean be hroad or narrow. A focused competitor, such as Ikea, targets the special needs of a suhset of eus- tomers and designs its activities accordingly. Fo- cused competitors thrive on groups of customers who are overserved (and hence overpriced) hy more broadly targeted competitors, or underserved (and hence underpriced). A broadly targeted competitor- for example, Vanguard or Delta Air Lines – serves a wide array of customers, performing a set of ac- tivities designed to meet their common needs. It

The Connection v^ith Generic Strategies

In Competitive Strategy (The Free Press, 1985), I introduced the concept of generic strategies – cost leadership, differentiation, and focus – to represent the alternative strategic positions in an in- dustry. The generic strategies remain useful to characterize strategic positions at the sim- plest and broadest level. Vnnj;uard, for in- stance, is an example of a cost leadership strat- egy, whereas Ikea, with its narrow customer group, is an example of cost-based focus. Neu- trogena is a focused differentiator. The bases for positioning – varieties, needs, and access – carry the understanding of those generic strategies to a

greater level of specificity. Ikea and Southwest are both cost-based focusers, for example, but Ikea's focus

is based on the needs of a cust(mier group, and Southwest's is based on offering a particular service variety.

The generic strategies framework intro- duced the need to choose in order to avoid be- cominj^ caught between what I then described as the inherent contradictions of different strategies. Trade offs between the activities of incompatible positions explain those con-

tradictions. Witness Continental Lite, which tried and failed to compete in two ways at once.

HARVARD BUSINESS REVIEW November-December 1996 67

WHAT IS STRATEGY?

ignores or meets only partially the more idiosyn- cratic needs of particular customer groups.

Whatever the basis – variety, needs, access, or some combination of the three – positioning re- quires a tailored set of activities hecause it is al- ways a function of differences on the supply side; that is, of differences in activities. However, posi- tioning is not always a function of differences on the demand, or customer, side. Variety and access positionings, in particular, do not rely on any cus- tomer differences. In practice, however, variety or aecess differences often aecompany needs differ- ences. The tastes-that is, the needs-of Carmike's small-town customers, for instance, run more to- ward comedies. Westerns, action films, and family

entertainment. Carmike does not run any films ratedNC-17.

Having defined positioning, we can now hegin to answer the question, "What is strategy?" Strategy is the

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