What Is Strategy? PDF

BR NOVEMBER-DECEMBER 1996 I. Operational Effectiveness Is Not Strategy For almost tv^fo decades, managers have been egy. The quest for productivity, quality, and speed learning to play by a new set of rules. Companies...

BR NOVEMBER-DECEMBER 1996 I. Operational Effectiveness Is Not Strategy For almost tv^fo decades, managers have been egy. The quest for productivity, quality, and speed learning to play by a new set of rules. Companies has spawned a remarkable number of management must be flexible to respond rapidly to compet- tools and techniques: total quality management, itive and market changes. They must benchmark benchmarking, time-based competition, outsourc- continuously to ing, partnering, achieve best prac- rcungineer'ing, tice. They must change manage- outsource aggres- sively to gain ef- ficiencies. And they must nur- What Is Strategy r ment. Although the resulting op- erational improve- ments have often ture a few core eompetencies in the by Michael E. Porter ^^^^ dramatic, many companies have race to stay ahead of rivals. been frustrated hy their inability to Positioning-once the heart of strategy-is reject- ! translate those gains into sustainahle profitahility. ed as too static for today's dynamic markets and And hit by bit, almost imperceptibly, management changing technologies. According to the new dog- tools have taken the place of strategy. As manag- ma, rivals can quickly copy any market position, ers push to improve on all fronts, they move farther and competitive advantage is, at hest, temporary. away from viable competitive positions. But those beliefs are dangerous half-truths, and they are leading more and more companies down Operational Effectiveness: the path of mutually destructive competition. True, some barriers to competition are falling as Necessary but Not Sufficient regulation eases and markets become global. True, Operational effectiveness and strategy are both companies have properly invested energy in beeom- essential to superior performance, wbich, after all, ing leaner and more nimble. In many industries, is the primary goal of any enterprise. But they work however, what some call hypcrcompetition is a in very different ways. self-inflicted wound, not the inevitahle outcome of a changing paradigm of competition. Michael E. Porter is the C. Roland Chiistensen Professor The root of the problem is the failure to distin- of Business Adminislralion at the Harvard Business guish between operational effeetiveness and strat- School in Boston, Massachusetts. HARVARD BUSINESS REVIEW N,)vt;mbt;r-D(.ct;mbi;r 1996 61  A company can outperform rivals only if it can establish a difference that it can preserve. It must Operational Effectiveness deliver greater value to customers or create compa- Versus Strategic Positioning rable value at a lower cost, or do both. The arith- metic of superior profitability then follows: deliver- high 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- O 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- Relative cost position all advantage or disadvantage results from all a company's activities, not only a few.' Operational effectiveness (OE) means performing tional effectiveness are an important source of dif- similar activities better than rivals perform them. ferences in profitability among competitors be- Operational effectiveness includes but is not limit- cause they directly affect relative cost positions ed to efficiency. It refers to any number of practices and levels of differentiation. that allow a company to better utilize its inputs by, Differences in operational effectiveness were at for example, reducing defects in products or devel- the heart of the Japanese challenge to Western com- oping better products faster. In contrast, strategic panies in the 1980s. The Japanese were so far ahead positioning means performing different activities of rivals in operational effectiveness that they from rivals' or performing similar activities in dif- could offer lower cost and superior quality at the ferent ways. same time. It is worth dwelling on this point, be- Differences in operational effectiveness among cause so much recent thinking about competition companies are pervasive. Some companies are able depends on it. Imagine for a moment a productivity frontier that constitutes the sum of all existing best practices at any giv- A company can outperform en time. Think of it as the maximum value that a company delivering a rivals only if it can establish particular product or service can cre- ate at a given eost, using the hest a difference that it can preserve. availahle technologies, skills, man- agement techniques, and purchased inputs. The productivity frontier can to get more out of their inputs than others because apply to individual activities, to groups of linked they eliminate wasted effort, employ more ad- activities such as order processing and manufactur- vanced technology, motivate employees better, or ing, and to an entire company's activities. When a have greater insight into managing particular activ- company improves its operational effeetiveness, it ities or sets of activities. Such differences in opera- moves toward the frontier. Doing so may require capital investment, different personnel, or simply new ways of managing. This article has benefited greatly from the assistance of many individuals and companies. The author gives The productivity frontier is constantly shifting special thanks to Ian Rivkin, the coauthor of a related outward as new technologies and management ap- paper. Substantial research contributions have been proaches are developed and as new inputs become made by Nicolaj Siggelkovi/. Dawn Sylvester, and Lucia available. Laptop computers, mobile communica- Marshall. Tarun Khanna, Roger Martin, and Anita Mc- tions, the Internet, and software such as Lotus Gahan have provided especially extensive comments. 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 Constant improvement in operational effective- possibilities for linking sales with such activities as ness is necessary to achieve superior profitability. order processing and after-sales support. Similarly, However, it is not usually sufficient. Few compa- lean production, which involves a family of activi- nies have competed successfully on the basis of op- ties, has allowed substantial improvements in erational effectiveness over an extended period, and manufacturing productivity and asset utilization. staying ahead of rivals gets harder every day. The For at least the past decade, managers have been most obvious reason for that is the rapid diffusion preoccupied with improving operational effective- of best practices. Competitors can quickly imitate ness. Through progratns such as TQM, time-based management techniques, new technologies, input competition, and benchmarking, they have changed improvements, and superior ways of meeting cus- how they perform activities in order to eliminate tomers' needs. The most generic solutions - those inefficiencies, improve customer satisfaction, and that can be used in multiple settings--diffuse the achieve best practice. Hoping to keep up with fastest. Witness the proliferation of OE techniques shifts in the productivity frontier, managers have accelerated by support from consultants. embraced continuous improvement, empowerment, chan^t management, and the so-called learning OE competition shifts the productivity frontier organization. The popularity of outsourcing and outward, effectively raising the bar for everyone. the virtual corporation reflect the growing recogni- But although such competition produces absolute tion that it is difficult to perform all activities as improvement in operational effectiveness, it leads productively as specialists. to relative improvement for no one. Consider the $5 hillion-plus U.S. commercial-printing industry. As companies move to the frontier, they can often The major players-R.R. Donnelley Sk Sons Com- improve on multiple dimensions of performance at pany, Quehecor, World Color Press, and Big Flower the same time. For example, manufacturers that Press-are competing head to head, serving all types adopted the Japanese practice of rapid changeovers of customers, offering the same array of printing in the 1980s were able to lower cost and improve technologies (gravure and weh offset}, investing differentiation simultaneously. What were once be- heavily in the same new equipment, running their lieved to be real trade-offs - between defeets and presses faster, and reducing crew sizes. But the re- costs, for example - turned out to be illusions cre- sulting major productivity gains are being captured ated by poor operational effectiveness. Managers by customers and equipment suppliers, not re- have learned to reiect such false trade-offs. tained in superior profitability. Even industry- Japanese Companies Rarely Have Strategies The lapanese triggered a global revolution in opera- tnarkets. They appeared unstoppable. But as the gap in tional effectiveness in the 1970s anij 1980s, pioneering operational effectiveness narrows, Japanese compa- practices such as total quality management and con- nies are increasingly caught in a trap of their own tinuous improvement. As a result, Japanese manufac- making. If they are to escape the mutually destmetive turers enjoyed substantial cost and quality advantages battles now ravaging their performance, Japanese for many years, companies will have to learn strategy. But lapanese companies rarely developed distinct To do so, they may have to overcome strong cultural strategic positions of the kind discussed in this article. barriers. Japan is notoriously consensus oriented, and Those that did - Sony, Canon, and Sega, for example - companies have a strong tendency to mediate differ- were the exception rather than the rule. Most Japanese ences among individuals rather than accentuate them. companies imitate and emulate one another. All rivals Strategy, on the other hand, requires hard choices. The offer most if nt)t all product varieties, features, and ser- Japanese also have a deeply ingrained service tradition vices; they employ all channels and match one anoth- that predisposes them to go to great lengths to satisfy ers' phint configurations. any need a customer expresses. Companies that com- The dangers of Japanese-style competition are now pete in that way end up blurring their distinct posi- becoming easier to recognize. In the 1980s, with rivals tioning, becoming all things to all customers. operating far from the productivity frontier, it seemed possible to win on both eost and quality indefinitely. This discussion of Japan is drawn from the authofs Japanese companies were all able to grow in an ex- research with Hirotaka Takeuchi, with help from panding domestic economy and by penetrating global Mariko Sakakibara. HARVARD BUSINESS REVIEW November-December 1996 63  WHAT IS STRATEGY? leader Donnelley's profit margin, consistently ally destructive, leading to wars of attrition that higher than 7% in the 1980s, fell to less than 4.6% can he arrested only hy limiting competition. in 1995. This pattern is playing itself out in indus- The recent wave of industry consolidation try after industry. Even the Japanese, pioneers of through mergers makes sense in the context of OE the new competition, suffer from persistently low competition. Driven by performance pressures but profits. (See the insert "Japanese Companies Rarely lacking strategic vision, company after company Have Strategies.") has had no hetter idea than to huy up its rivals. The The second reason that improved operational competitors left standing arc often those that out- effectiveness is insufficient - competitive conver- lasted others, not companies with real advantage. gence-is more suhtle and insidious. The more After a decade of impressive gains in operational henchmarking companies do, the more they look effectiveness, many companies are facing dimin- alike. The more that rivals outsource activities to ishing returns. Continuous improvement has been efficient third parties, often the same ones, the etched on managers' brains. But its tools unwitting- more generic those activities hecome. As rivals im- ly draw companies toward imitation and homo- itate one another's improvements in quality, cycle geneity. Gradually, managers have let operational times, or supplier partnerships, strategies converge effectiveness supplant strategy. The result is zero- and competition hecomes a series of races down sum competition, static or declining prices, and identical paths that no one can win. Competition pressures on costs that compromise companies' based on operational effectiveness alone is mutu- ability to invest in the business for the long term. II. Strategy Rests on Unique Activities Competitive strategy is about being different. It A full-service airline is configured to get passen- means deliberately choosing a different set of activ- gers from almost any point A to any point B. To ities to deliver a unique mix of value. reach a large number of destinations and serve pas- Southwest Airlines Company, for example, offers sengers with connecting flights, full-service air- short-haul, low-cost, point-to-point service he- lines employ a hub-and-spokc system centered on tween midsize cities and secondary airports in large major airports. To attract passengers who desire cities. Southwest avoids large airports and does more comfort, they offer first-class or husiness- not fly great distances. Its eustomers include husi- class service. To accommodate passengers who ness travelers, families, and students. Southwest's must change planes, they coordinate schedules and frequent departures and low fares attract price- check and transfer baggage. Because some passen- sensitive customers who otherwise would travel hy gers will be traveling for many hours, full-service bus or car, and convenience-oriented travelers who airlines serve meals. would choose a full-service airline on other routes. Southwest, in contrast, tailors all its activities Most managers describe strategic positioning in to deliver low-eost, convenient service on its par- terms of their customers: "Southwest Airlines ticular type of route. Through fast turnarounds serves price- and convenience-sensitive travelers/' 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- The essence of strategy is west does not offer meals, assigned seats, interline baggage checking, or choosing to perform activities premium classes of service. Auto- mated ticketing at the gate encour- differently than rivals do. ages customers to hypass travel agents, allowing Southwest to avoid for example. But the essence of strategy is in the ac- their commissions. A standardized fleet of 737 air- tivities - choosing to perform activities differently craft hoosts the efficiency of maintenance. or to perform different activities than rivals. Other- Southwest has staked out a unique and valuahle wise, a strategy is nothing more than a marketing strategic position based on a tailored set of activi- slogan that will not withstand competition. 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 Ikea uses a self-service model based on clear, in- low cost. store displays. Ratber tban rely solely on tbird- Ikca, the global furniture retailer based in Swe- party manufacturers, Ikea designs its own low-cost, den, also has a clear strategic positioning. Ikca tar- modular, ready-to-assemble furniture to fit its posi- gets young furniture buyers who want style at low tioning. In buge stores, Ikea displays every product cost. Wbat turns tbis marketing concept into a stra- it sells in room-like settings, so customers don't tegic positioning is tbe tailored set of activities tbat need a decorator to belp them imagine bow to put make it work. Like Southwest, Ikea has cbosen to tbe pieces togetber. Adjacent to tbe furnisbcd perform activities differently from its rivals. sbowrooms is a warebouse section witb the prod- Consider tbe typical furniture store. Showrooms ucts in boxes on pallets. Customers are expected to display samples of tbe mercbandise. One area do tbeir own pickup and delivery, and Ikea will migbt contain 25 sofas; anotber will display five even sell you a roof rack for your car tbat you can dining tables. But tbose items represent only a frac- return for a refund on your next visit. tion of tbe cboices available to customers. Dozens Altbough much of its low-cost position comes of books displaying fabric swatcbes or wood sam- from baving customers "do it tbemselves," Ikea of- ples or alternate styles offer customers tbousands fers a number of extra services tbat its competitors of product varieties to cboose from. Salespeople do not. In-storc cbild care is one. Extended bours often escort customers tbrougb tbe store, answer- are anotber. Tbose services are uniquely aligned ing questions and belping tbem navigate tbis maze with the needs of its customers, wbo are young, not of cboices. Once a customer makes a selection, tbe wealtby, likely to bave cbildren (but no nanny), order is relayed to a tbird-party manufacturer. Witb and, because tbey work for a living, bave a need luck, tbe furniture will be delivered to tbe cus- to sbop at odd bours. tomer's home witbin six to eigbt weeks. Tbis is a value cbain tbat maximizes customization and The Origins of Strategic Positions service but does so at bigh eost. In contrast, Ikea serves customers wbo are Strategic positions emerge from three distinct bappy to trade off service for cost. Instead of baving sources, wbicb are not mutually exclusive and a sales associate trail customers around tbe store. often overlap. First, positioning can be based on Finding New Positions: The Entrepreneurial Edge Strategic competition can be thought of as tbe sophisticated use of in-house customer financing - process of perceiving new positions tbat woo cus- that has long been open to incumbents. tomers from established positions or draw new cus- New entrants can prosper by occupying a position tomers into the market. For example, superstores of- tbat a competitor once held but has ceded througb fering depth ot' merchandise in a single product years of imitation and straddling. And entrants com- category take market share from broad-line depart- ing from other industries can create new positions be- ment stores offering a more limited selection in many cause of distinctive activities drawn from their otbci categories. Mail-order catalogs pick off customers who businesses. CarMax borrows heavily from Circuit crave convenience. In principle, incumbents and en- City's expertise in inventory management, credit, and trepreneurs face tbe same challenges in finding new otber activities in consumer electronics retailing. strategic positions. In practice, new entrants often Most commonly, however, new positions open up bave the edge. because of cbange. New customer groups or purchase Strategic positionings arc often not obvious, and occasions arise; new needs emerge as societies evotvc; finding tbem requires creativity and insigbt. New en- new distribution cbannels appear; new technologies trants often discover unique positions that bave been are developed; new machinery or informatiiin systems available but simply overlooked by established com- become available. When such cbanges happen, new petitors. Ikea, for example, recognized a customer entrants, unencumbered by a long history in tbe in- group that had been ignored or served poorly. Circuit dustry, can often more easily perceive tbe potentialfor City Stores' entry into used cars, CarMax, is based on a new way ot" competing. Unlike incumbents, new- a new way of performing activities - extensive refur- comers can be more flexible because tbey face no bishing ol* cars, product guarantees, no-baggle pricing, 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- tomers. I call this needs-based positioning, which vices. I call this variety-based positioning because comes closer to traditional thinking about targeting it is based on the choice of product or service vari- a segment of customers. It arises when there are eties rather than customer segments. Variety-based groups of customers with differing needs, and when positioning makes economic sense when a com- a tailored set of activities can serve those needs pany can best produce particular products or ser- best. Some groups of customers are more price sen- vices using distinctive sets of activities. sitive than otbers, demand different product fea- Jiffy Lube International, for instance, specializes tures, and need varying amounts of information, in automotive lubricants and does not offer other support, and services. Ikea's customers are a good example of sucb a group. Ikea seeks to meet all the home furnishing Strategic positions can be based needs of its target customers, not just a subset of them. on customers' needs, customers' A variant of needs-hased position- ing arises when the same customer accessibility, or the variety of a has different needs on different occa- sions or for different types of transac- 's products or services. tions. The same person, for example, may have different needs when trav- eling on business than wben travel- car repair or maintenance services. Its value chain ing for pleasure witb tbe family. Buyers of cans - produces faster service at a lower cost than broader beverage companies, for example-will likely have line repair shops, a comhination so attractive that different needs from their primary supplier than many customers subdivide their purchases, buying from their secondary source. oil changes from the focused competitor. Jiffy Lube, It is intuitive for most managers to conceive of and going to rivals for other services. their business in terms of tbe customers' needs The Vanguard Group, a leader in the mutual fund they are meeting. But a critical element of needs- industry, is another example of variety-based posi- based positioning is not at all intuitive and is often tioning. Vanguard provides an array of common overlooked. Differences in needs will not translate stock, bond, and money market funds that offer pre- into meaningful positions unless tbe best set of dictable performance and rock-bottom expenses. activities to satisfy them also differs. If that were Tbe company's investment approach deliberately not tbe case, every competitor could meet those sacrifices the possibility of extraordinary perfor- same needs, and there would be notbing unique or mance in any one year for good relative perfor- valuable about the positioning. mance in every year. Vanguard is known, for exam- In private banking, for example, Bessemer Trust ple, for its index funds. It avoids making bets on Company targets families with a minimum of interest rates and steers clear of narrow stock $5 million in investable assets who want capital groups. Fund managers keep trading levels low, preservation combined with wealtb accumulation. which holds expenses down; in addition, the com- By assigning one sophisticated account officer for pany discourages customers from rapid buying and every 14 families, Bessemer has configured its ac- selling because doing so drives up costs and can tivities for personalized service. Meetings, for ex- force a fund manager to trade in order to deploy new ample, are more likely to be beld at a client's ranch capital and raise cash for redemptions. Vanguard or yacht than in the office. Bessemer offers a wide also takes a consistent low-cost approach to manag- array of customized services, including investment ing distribution, customer service, and marketing. management and estate administration, oversight Many investors include one or more Vanguard of oil and gas investments, and accounting for race- funds in their portfolio, while buying aggressively horses and aircraft. Loans, a staple of most private managed or specialized funds from competitors. banks, are rarely needed by Besscmer's clients and The people who use Vanguard or Jiffy Lube are re- make up a tiny fraction of its client balances and sponding to a superior value chain for a particular income. Despite the most generous compensation type of service. A variety-hased positioning can of account officers and the highest personnel cost serve a wide array of customers, but for most it will as a percentage of operating expenses, Bessemer's meet only a subset of their needs. differentiation with its target families produces a A second basis for positioning is that of serving return on equity estimated to be the highest of any most or all the needs of a particular group of cus- private banking competitor. 66 HARVARD BUSINESS REVIEW November-December 1996  Citibank's private bank, on tbe other hand, jection technology than big-city theaters. The com- serves clients with minimum assets of about pany's proprietary information system and manage- S250,000 wbo, in contrast to Bessemer's clients, ment process elimmate the need for local adminis- want convenient access to loans-from jumho mort- trative staff beyond a single theater manager. gages to deal financing. Citibank's account man- Carmike also reaps advantages from centralized agers are primarily lenders. When clients need oth- purchasing, lower rent and payroll costs (because of er services, their account manager refers them to its locations), and rock-bottom corporate overhead other Citibank specialists, each of whom handles of 2% (the industry average is 5%|. Operating in prepackaged products. Citibank's system is less small communities also allows Carmike to prac- customized than Bessemer's and allows it to have a tice a highly personal form of marketing in which lower manager-to-client ratio of 1:125. Biannual of- the theater manager knows patrons and promotes fice meetings are offered only for the largest clients. attendance through personal contacts. By heing the Both Bessemer and Citibank have tailored their ac- dominant if not the only theater in its markets-the tivities tu meet the needs of a different group of pri- main competition is often the high school football vate hanking customers. The same value chain can- team-Carmike is also able to get its pick of films not profitably meet the needs of both groups. and negotiate hetter terms with distributors. Tbe third basis for positioning is that of seg- Rural versus urhan-based customers are one ex- menting customers who are accessible in different ample of access driving differences in activities. ways. Aitbough their needs are similar to those of Serving small rather than large eustomers or dense- other customers, the hest configuration of activi- ly rather than sparsely situated customers are other ties to reach them is different. I call this access- examples in which the best way to configure mar- based positioning. Access can be a function of cus- keting, order processing, logistics, and after-sale tomer geography or customer scale-or of anything service activities to meet the similar needs of dis- that requires a different set of activities to reach tinct groups will often differ. customers in the best way. Positioning is not only ahout carving out a niche. Segmenting hy access is less common and less A position emerging from any of the sources ean be well understood than the other two hases. Carmike hroad or narrow. A focused competitor, such as Cinemas, for example, operates movie theaters ex- Ikea, targets the special needs of a suhset of eus- clusively in cities and towns witb populations un- tomers and designs its activities accordingly. Fo- der 200,000. How dues Carmike make money in cused competitors thrive on groups of customers markets that are not only small hut also won't sup- who are overserved (and hence overpriced) hy more port big-city ticket prices? It does so through a set broadly targeted competitors, or underserved (and of aetivities that result in a lean eost structure. hence underpriced). A broadly targeted competitor- Carmike's small-town customers can be served for example, Vanguard or Delta Air Lines - serves through standardized, low-cost theater complexes a wide array of customers, performing a set of ac- requiring fewer screens and less sophisticated pro- tivities designed to meet their common needs. It The Connection v^ith Generic Strategies In Competitive Strategy (The Free Press, 1985), I greater level of specificity. Ikea and Southwest are introduced the concept of generic strategies - cost both cost-based focusers, for example, but Ikea's focus leadership, differentiation, and focus - to represent is based on the needs of a cust(mier group, and the alternative strategic positions in an in- Southwest's is based on offering a particular dustry. The generic strategies remain useful service variety. to characterize strategic positions at the sim- The generic strategies framework intro- plest and broadest level. Vnnj;uard, for in- duced the need to choose in order to avoid be- stance, is an example of a cost leadership strat- cominj^ caught between what I then described egy, whereas Ikea, with its narrow customer as the inherent contradictions of different group, is an example of cost-based focus. Neu- strategies. Trade offs between the activities trogena is a focused differentiator. The bases of incompatible positions explain those con- for positioning - varieties, needs, and access - carry tradictions. Witness Continental Lite, which tried and the understanding of those generic strategies to a 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- entertainment. Carmike does not run any films cratic needs of particular customer groups. ratedNC-17. Whatever the basis - variety, needs, access, or Having defined positioning, we can now hegin to some combination of the three - positioning re- answer the question, "What is strategy?" Strategy quires a tailored set of activities hecause it is al- is the creation of a unique and valuable position, in- ways a function of differences on the supply side; volving a different set of activities. If there were that is, of differences in activities. However, posi- only one ideal position, there would be no need tioning is not always a function of differences on for strategy. Companies would face a simple imper- the demand, or customer, side. Variety and access ative - win the race to discover and preempt it. The positionings, in particular, do not rely on any cus- essence of strategic positioning is to choose ac- tomer differences. In practice, however, variety or tivities that are different from rivals'. If the same aecess differences often aecompany needs differ- set of activities were hest to produce all varieties, ences. The tastes-that is, the needs-of Carmike's meet all needs, and access all customers, companies small-town customers, for instance, run more to- could easily shift among them and operational ef- ward comedies. Westerns, action films, and family fectiveness would determine performance. III. A Sustainable Strategic Position Requires Trade-offs Choosing a unique position, however, is not occur when activities are incompatible. Simply enough to guarantee a sustainahle advantage. A put, a trade-off means tbat more of one thing neces- valuahle position will attract imitation hy incum- sitates less of anotber. An airline can choose to bents, who are likely to copy it in one of two ways. serve meals - adding cost and slowing turnaround First, a competitor can reposition itself to match time at the gate-or it can choose not to, but it can- the superior performer. J.C. Penney, for instance, not do both without bearing major inefficiencies. has been repositioning itself from a Sears clone to a Trade-offs create the need for choice and protect more upscale, fashion-oriented, soft-goods retailer. against repositioners and straddlers. Consider Neu- A second and far more common type of imitation is trogena soap. Neutrogena Corporation's variety- straddling. The straddler seeks to match the bene- based positioning is built on a "kind to the skin," fits of a successful position while maintaining its residue-free soap formulated for pH balance. With existing position. It grafts new features, services, or a large detail force calling on dermatologists, Neu- technologies onto the activities it already performs. trogena's marketing strategy looks more like a drug For those who argue that competitors can copy company's than a soap maker's. It advertises in any market position, the airline industry is a per- medical journals, sends direct mail to doctors, at- fect test case. It would seem that nearly any com- tends medical conferences, and performs research petitor could imitate any other airline's activities. at its own Skincare Institute. To reinforce its posi- Any airline can buy the same planes, lease the tioning, Neutrogena originally focused its distribu- gates, and match the menus and ticketing and hag- tion on drugstores and avoided price promotions. gage handling services offered by other airlines. Neutrogena uses a slow, more expensive manufac- Continental Airlines saw how well Southwest turing process to mold its fragile soap. was doing and decided to straddle. While main- In choosing this position, Neutrogena said no to taining its position as a full-service airline. Conti- the deodorants and skin softeners that many cus- nental also set out to match Southwest on a num- tomers desire in their soap. It gave up the large- ber of point-to-point routes. The airline dubbed volume potential of selling tbrough supermarkets the new service Continental Lite. It eliminated and using price promotions. It sacrificed manufac- meals and first-class service, increased departure turing efficiencies to achieve the soap's desired at- frequency, lowered fares, and shortened turnaround tributes. In its original positioning, Neutrogena time at tbe gate. Because Continental remained made a whole raft of trade-offs like those, trade-offs a full-service airline on other routes, it continued to that protected the company from imitators. use travel agents and its mixed fleet of planes and Trade-offs arise for three reasons. The first is in- to provide baggage checking and seat assignments. consistencies in image or reputation. A company But a strategic position is not sustainable unless known for delivering one kind of value may lack tbere are trade-offs with other positions. Trade-offs credibility and confuse customers-or even under- 68 HARVARD BUSINESS REVIEW Novembet-December 1996 mine its reputation - if it delivers another kind of generated a thousand complaints a day. Continen- value or attempts to deliver two inconsistent tal Lite could not afford to compete on price and things at the same time. For example. Ivory soap, still pay standard travel-agent eommissions, hut with its position as a basic, inexpensive everyday neither could it do without agents for its full- soap would have a hard time reshaping its image to service business. The airline compromised by cut- match Neutrogena's premium "medical" reputa- ting commissions for all Continental flights across tion. Efforts to create a new image typically cost the board. Similarly, it could not afford to offer the tens or even hundreds of millions of dollars in a same frequent-flier benefits to travelers paying the major industry-a powerful barrier to imitation. much lower ticket prices for Lite service. It com- Second, and more important, trade-offs arise promised again hy lowering tbe rewards of Conti- from activities themselves. Different positions nental's entire frequent-flier program. Tbe results: (with their tailored activities) require different angry travel agents and full-service customers. product configurations, different equipment, differ- Continental tried to compete in two ways at ent employee behavior, different skills, and dif- once. In trying to be low cost on some routes and ferent management systems. Many trade-offs re- full service on others. Continental paid an enor- flect inflexibilities in macbinery, people, or systems. mous straddling penalty. If there were no trade-offs The more Ikea bas configured its activities to between the two positions. Continental could have lower costs by having its customers do their own succeeded. But the absence of trade-offs is a danger- assemhly and delivery, the less ahle it is to satisfy ous half-truth that managers must unlearn. Quality customers who require higher levels of service. is not always free. Southwest's convenience, one However, trade-offs can be even more basic. In kind of high quality, happens to be consistent with general, value is destroyed if an activity is overde- low costs because its frequent departures are facili- signed or underdesigned for its use. For example, tated by a number of low-cost practices-fast gate even if a given salesperson were capable of provid- turnarounds and automated ticketing, for example. ing a high level of assistance to one customer and However, other dimensions of airline quality - an none to another, the salesperson's talent (and some assigned seat, a meal, or baggage transfer - require of his or her cost) would he wasted on the second costs to provide. customer. Moreover, productivity can improve In general, false trade-offs hetween cost and qual- when variation of an activity is limited. By provid- ity occur primarily wben there is redundant or ing a high level of assistance all tbe time, the sales- wasted effort, poor control or accuracy, or weak co- person and the entire sales activity can often ordination. Simultaneous improvement of cost and achieve efficiencies of learning and scale. differentiation is possible only when a company be- Finally, trade-offs arise from limits on internal gins far bebind the productivity frontier or when coordination and control. By clearly choosing to the frontier shifts outward. At the frontier, where ct)mpete in one way and not another, senior management makes organiza- tional priorities clear. Companies that try to be all things to all cus- Trade-offs are essential to tomers, in contrast, risk confusion in tbe trenches as employees attempt strategy. They create the need to make day-to-day operating deci- for choice and purposefully sions without a clear framework. Positioning trade-offs are perva- limit what a company offers. sive in competition and essential to strategy. They create the need for choice and purposefully limit what a company of- companies have achieved current best practice, the fers. They deter straddling or repositioning, because trade-off between cost and differentiation is very competitors that engage in those approaches under- real indeed. mine their strategies and degrade the value of tbeir After a decade of enjoying productivity advan- existing activities. tages, Honda Motor Company and Toyota Motor Trade-offs ultimately grounded Continental Lite. Corporation recently bumped up against tbe fron- The airline lost hundreds of millions of dollars, and tier. In 1995, faced with increasing customer resis- the CEO lost his job. Its planes were delayed leav- tance to higher automobile prices, Honda found ing congested hub cities or slowed at the gate by that the only way to produce a less-expensive car haggage transfers. Late flights and cancellations was to skimp on features. In the United States, HARVARD BUSINESS REVIEW November-December 1996 69  WHAT IS STRATEGY? it replaced the rear disk brakes on the Civic with never achieve a sustainable advantage. They will lower-cost drum brakes and used cheaper fabric for have to run faster and faster just to stay in place. the back seat, hoping customers would not notice. As we return to the question, What is strategy? Toyota tried to sell a version of its best-selling Co- we see that trade-offs add a new dimension to the rolla in Japan with unpainted bumpers and cheaper answer. Strategy is making trade-offs in competing. seats. In Toyota's case, customers rebelled, and the The essence of strategy is choosing what not to do. company quickly dropped the now model. Without trade-offs, there would be no need for For the past decade, as managers have improved choice and thus no need for strategy. Any good idea operational effectiveness greatly, they have inter- could and would he quickly imitated. Again, perfor- nalized the idea that eliminating trade-offs is a good mance would once again depend wholly on opera- thing. But if there are no trade-offs companies will tional effectiveness. IV. Fit Drives Both Competitive Advantage and Sustainability Positioning choices determine not only which Fit locks out imitators by creating a chain that is activities a company will perform and how it as strong as its strongest link. As in most compa- will configure individual activities but also how nies with good strategies, Southwest's activities activities relate to one another. While operational complement one another in ways that create real effectiveness is ahout achieving excellence in indi- economic value. One activity's cost, for example, is vidual activities, or functions, strategy is about lowered because of the way other activities are per- combining activities. formed. Similarly, one activity's value to customers Southwest's rapid gate turnaround, which allows can be enhanced by a company's other activities. frequent departures and greater use of aircraft, is Tbat is the way strategic fit creates competitive essential to its high-convenience, low-cost posi- advantage and superior profitability. tioning. But how does Southwest achieve it? Part of the answer lies in the company's well-paid gate and ground crews, whose productivity in turn- Types of Fit arounds is enhanced by flexible union rules. But The importance of fit among functional policies the bigger part of the answer lies in how South- is one of the oldest ideas in strategy. Gradually, west performs other activities. With no meals, no however, it has been supplanted on the manage- seat assignment, and no interline baggage trans- ment agenda. Rather than seeing the company as fers. Southwest avoids having to perform activities a whole, managers have turned to "core" compe- that slow down other airlines. It selects airports tencies, "critical" resources, and "key" success fac- and routes to avoid congestion that introduces tors. In fact, fit is a far more central component of delays. Southwest's strict hmits on the type and competitive advantage than most realize. length of routes make standardized aircraft possi- Fit is important because discrete activities often ble; every aircraft Southwest turns is a Boeing 737. affect one another. A sophisticated sales force, for example, confers a greater advan- tage when the company's product Fit locks out imitators by embodies premium technology and its marketing approach emphasizes creating a chain that is as customer assistance and support. A production line with high levels strong as its strongiest link, of model variety is more valuahle when comhined with an inventory and order processing system that What is Southwest's core competence? Its key minimizes the need for stocking finished goods, success factors? The correct answer is that every- a sales process equipped to explain and encour- thing matters. Southwest's strategy involves a age customization, and an advertising theme that whole system of activities, not a collection of parts. stresses the henefits of product variations that Its competitive advantage comes from the way its meet a customer's special needs. Such complemen- activities fit and reinforce one another. tarities are pervasive in strategy. Although some 70 HARVARD BUSINESS REVIEW November-December 1996 fit among activities is generic and applies to many Second-order fit occurs when activities are re- companies, the most valuable fit is strategy-spe- inforcing. Neutrogena, for example, markets to cific because it enhances a position's uniqueness upscale hotels eager to offer their guests a soap rec- and amplifies trade-offs/ ommended by dermatologists. Hotels grant Neu- There are three types of fit, although they are not trogena the privilege of using its customary packag- mutually exclusive. First-order fit is simple consis- ing while requiring other soaps to feature the tency between each activity (function) and the hotel's name. Once guests have tried Neutrogena in overall strategy. Vanguard, for example, aligns all a luxury hotel, they are more likely to purchase it at activities with its low-cost strategy. It minimizes the drugstore or ask their doctor about it. Thus portfolio turnover and does not need highly com- Neutrogena's medical and hotel marketing activi- pensated money managers. The company distrib- ties reinforce one another, lowering total market- utes its funds directly, avoiding commissions to ing costs. brokers. It also limits advertising, relying instead In another example, Bic Corporation sells a nar- on public relations and word-of-mouth recommen- row line of standard, low-priced pens to virtually dations. Vanguard ties its employees' bonuses to all major eustomer markets (retail, commereial, cost savings. promotional, and giveaway) through virtually all Consistency ensures that the competitive advan- available channels. As with any variety-based posi- tages of activities cimiulate and do not erode or can- tioning serving a broad group of customers, Bic cel tbemselves out. It makes the strategy easier to emphasizes a common need (low price for an ac- communicate to customers, employees, and share- ceptable pen) and uses marketing approaches with holders, and improves implementation through a broad reach (a large sales force and heavy televi- single-mindcdness in the corporation. sion advertising). Bic gains the benefits of consis- Mapping Activity Systems Acfivity-system maps, such as tbis one for Ikea, show how a strategic position, a number of higher-order strategic themes (in company's strategic position is contained in a set of tailored dark purple) can be identified and implemented through adivities designed to deliver it. In companies with a clear clusters of tightly linked activities (in light purple). Explanatory - Suburban More catalogues, locations impulse informative with ample buying displays and parking labels Ease oF Most transport a n d j items in assembly ' inventory Self-assembly by customers Increased "Knock-down" likelihood of Year-round kit packaging future stocking purchase Low manufacturing cast In-house Wide variety design focused 100% with ease of on cost of \ sourcing from manufacturing manufacturing iong term suppliers HARVARD BUSINESS REVIEW November-December 1996 71  Vanguard's Activity System Activity-system maps can be useful tor examining and each activity lo identify how other octivities within the company strengthening strategic fit. A set of basic questions should improve or detract from their performance. Second, are there guide the process. First, is each activity consistent with the ways to strengthen how activities and groups of activities overall positioning - the varieties produced, the needs served, reinforce one another? Finally, could changes in one activity and the type of customers accessed? Ask those responsible for eliminate the need to perform others? Limited Useot Wary of A brood array international of mutuol funds redemption small growth funds due to fees fo jnds excluding some volatility and. fund categories discourage high costs trading Very low Efficient investment expenses management approach Emphasis Employee passed on to In-house offering good, consistent an bonds bonuses client management performance ^ ' and equity tied to for standard index funds cost savings funds Very low rate of trading Shareholder No Strict cost education control Long-term broker-dealer Na marketing cautioning investment relationships changes about risk encouraged No first