What Is Strategy? PDF

What Is Strategy? For starters, it’s not the same as operational e1ectiveness. by Michael E. Porter From the Magazine (November–December 1996) Summary. Today’s dynamic markets and technologies have called into question the sustainability of competitive advantage. Under pressure to improve productivity, quality, and speed, managers have embraced tools such as TQM, benchmarking, and re-engineering....more Post Post Share Save Buy Copies Print This article has beneﬁted greatly from the assistance of many individuals and companies. The author gives special thanks to Jan Rivkin, the coauthor of a related paper. Substantial research contributions have been made by Nicolaj Siggelkow, Dawn Sylvester, and Lucia Marshall. Tarun Khanna, Roger Martin, and Anita McGahan have provided especially extensive comments. [ I ] Operational E8ectiveness Is Not Strategy For almost two decades, managers have been learning to play by a new set of rules. Companies must be ﬂexible to respond rapidly to competitive and market changes. They must benchmark continuously to achieve best practice. They must outsource aggressively to gain e1iciencies. And they must nurture a few core competencies in race to stay ahead of rivals. Positioning—once the heart of strategy—is rejected as too static for today’s dynamic markets and changing technologies. According to the new dogma, rivals can quickly copy any market position, and competitive advantage is, at best, 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 becoming leaner and more nimble. In many industries, however, what some call hypercompetition is a self-inﬂicted wound, not the inevitable outcome of a changing paradigm of competition. The root of the problem is the failure to distinguish between operational e1ectiveness and strategy. The quest for productivity, quality, and speed has spawned a remarkable number of management tools and techniques: total quality management, benchmarking, time- based competition, outsourcing, partnering, reengineering, change management. Although the resulting operational improvements have often been dramatic, many companies have been frustrated by their inability to translate those gains into sustainable proﬁtability. And bit by bit, almost imperceptibly, management tools have taken the place of strategy. As managers push to improve on all fronts, they move farther away from viable competitive positions. Operational E8ectiveness: Necessary but Not Su8icient Operational e1ectiveness and strategy are both essential to superior performance, which, after all, is the primary goal of any enterprise. But they work in very di1erent ways. A company can outperform rivals only if it can establish a di1erence that it can preserve. It must deliver greater value to customers or create comparable value at a lower cost, or do both. The arithmetic of superior proﬁtability then follows: delivering greater value allows a company to charge higher average unit prices; greater e1iciency results in lower average unit costs. Ultimately, all di1erences 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 activities more e1iciently than competitors. Similarly, di1erentiation arises from both the choice of activities and how they are performed. Activities, then are the basic units of competitive advantage. Overall advantage or disadvantage results from all a company’s activities, not only a few.1 Operational e1ectiveness (OE) means performing similar activities better than rivals perform them. Operational e1ectiveness includes but is not limited to e1iciency. It refers to any number of practices that allow a company to better utilize its inputs by, for example, reducing defects in products or developing better products faster. In contrast, strategic positioning means performing diHerent activities from rivals’ or performing similar activities in diHerent ways. Di1erences in operational e1ectiveness among companies are pervasive. Some companies are able to get more out of their inputs than others because they eliminate wasted e1ort, employ more advanced technology, motivate employees better, or have greater insight into managing particular activities or sets of activities. Such di1erences in operational e1ectiveness are an important source of di1erences in proﬁtability among competitors because they directly a1ect relative cost positions and levels of di1erentiation. Di1erences in operational e1ectiveness were at the heart of the Japanese challenge to Western companies in the 1980s. The Japanese were so far ahead of rivals in operational e1ectiveness that they could o1er lower cost and superior quality at the same time. It is worth dwelling on this point, because 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 given time. Think of it as the maximum value that a company delivering a particular product or service can create at a given cost, using the best available technologies, skills, management techniques, and purchased inputs. The productivity frontier can apply to individual activities, to groups of linked activities such as order processing and manufacturing, and to an entire company’s activities. When a company improves its operational e1ectiveness, it moves toward the frontier. Doing so may require capital investment, di1erent personnel, or simply new ways of managing. A company can outperform rivals only if it can establish a di8erence that it can preserve. The productivity frontier is constantly shifting outward as new technologies and management approaches are developed and as new inputs become available. Laptop computers, mobile communications, the Internet, and software such as Lotus Notes, for example, have redeﬁned the productivity 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 activities, has allowed substantial improvements in manufacturing productivity and asset utilization. For at least the past decade, managers have been preoccupied with improving operational e1ectiveness. Through programs such as TQM, time-based competition, and benchmarking, they have changed how they perform activities in order to eliminate ine1iciencies, improve customer satisfaction, and achieve best practice. Hoping to keep up with shifts in the productivity frontier, managers have embraced continuous improvement, empowerment, change management, and the so-called learning organization. The popularity of outsourcing and the virtual corporation reﬂect the growing recognition that it is di1icult 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 di1erentiation simultaneously. What were once believed to be real trade-o1s—between defects and costs, for example—turned out to be illusions created by poor operational e1ectiveness. Managers have learned to reject such false trade-o1s. Constant improvement in operational e1ectiveness is necessary to achieve superior proﬁtability. However, it is not usually su1icient. Few companies have competed successfully on the basis of operational e1ectiveness over an extended period, and staying ahead of rivals gets harder every day. The most obvious reason for that is the rapid di1usion of best practices. Competitors can quickly imitate management techniques, new technologies, input improvements, and superior ways of meeting customers’ needs. The most generic solutions—those that can be used in multiple settings—di1use the fastest. Witness the proliferation of OE techniques accelerated by support from consultants. OE competition shifts the productivity frontier outward, e1ectively raising the bar for everyone. But although such competition produces absolute improvement in operational e1ectiveness, it leads to relative improvement for no one. Consider the $5 billion-plus U.S. commercial-printing industry. The major players—R.R. Donnelley & Sons Company, Quebecor, World Color Press, and Big Flower Press—are competing head to head, serving all types of customers, o1ering the same array of printing technologies (gravure and web o1set), investing heavily in the same new equipment, running their presses faster, and reducing crew sizes. But the resulting major productivity gains are being captured by customers and equipment suppliers, not retained in superior proﬁtability. Even industry- 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 industry after industry. Even the Japanese, pioneers of the new competition, su1er from persistently low proﬁts. (See the insert “Japanese Companies Rarely Have Strategies.”) Japanese Companies Rarely Have Strategies The Japanese triggered a global revolution in operational e1ectiveness in the 1970s and 1980s,... The second reason that improved operational e1ectiveness is insu1icient—competitive convergence—is more subtle and insidious. The more benchmarking companies do, the more they look alike. The more that rivals outsource activities to e1icient third parties, often the same ones, the more generic those activities become. As rivals imitate one another’s improvements in quality, cycle times, or supplier partnerships, strategies converge and competition becomes a series of races down identical paths that no one can win. Competition based on operational e1ectiveness alone is mutually destructive, leading to wars of attrition that can be arrested only by 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 better idea than to buy up its rivals. The competitors left standing are often those that outlasted others, not companies with real advantage. After a decade of impressive gains in operational e1ectiveness, many companies are facing diminishing returns. Continuous improvement has been etched on managers’ brains. But its tools unwittingly draw companies toward imitation and homogeneity. Gradually, managers have let operational e1ectiveness 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 di1erent. It means deliberately choosing a di1erent set of activities to deliver a unique mix of value. Southwest Airlines Company, for example, o1ers short-haul, low-cost, point-to-point service between midsize cities and secondary airports in large cities. Southwest avoids large airports and does not ﬂy great distances. Its customers include business travelers, families, and students. Southwest’s frequent departures and low fares attract price- sensitive customers who otherwise would travel by 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,” for example. But the essence of strategy is in the activities—choosing to perform activities di1erently or to perform di1erent activities than rivals. Otherwise, a strategy is nothing more than a marketing slogan that will not withstand competition. A full-service airline is conﬁgured to get passengers from almost any point A to any point B. To reach a large number of destinations and serve passengers with connecting ﬂights, full- service airlines employ a hub-and-spoke system centered on major airports. To attract passengers who desire more comfort, they o1er ﬁrst-class or business-class service. To accommodate passengers who must change planes, they coordinate schedules and check and transfer baggage. Because some passengers will be traveling for many hours, full- service airlines serve meals. Southwest, in contrast, tailors all its activities to deliver low-cost, convenient service on its particular 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 departures with fewer aircraft. Southwest does not o1er meals, assigned seats, interline baggage checking, or premium classes of service. Automated ticketing at the gate encourages customers to bypass travel agents, allowing Southwest to avoid their commissions. A standardized ﬂeet of 737 aircraft boosts the e1iciency of maintenance. The essence of strategy is choosing to perform activities di8erently than rivals do. Southwest has staked out a unique and valuable strategic position based on a tailored set of activities. On the routes served by Southwest, a full-service airline could never be as convenient or as low cost. Ikea, the global furniture retailer based in Sweden, also has a clear strategic positioning. Ikea targets young furniture buyers who want style at low cost. What turns this marketing concept into a strategic positioning is the tailored set of activities that make it work. Like Southwest, Ikea has chosen to perform activities di1erently from its rivals. Consider the typical furniture store. Showrooms display samples of the merchandise. One area might contain 25 sofas; another will display ﬁve dining tables. But those items represent only a fraction of the choices available to customers. Dozens of books displaying fabric swatches or wood samples or alternate styles o1er customers thousands of product varieties to choose from. Salespeople often escort customers through the store, answering questions and helping them navigate this maze of choices. Once a customer makes a selection, the order is relayed to a third-party manufacturer. With luck, the furniture will be delivered to the customer’s home within six to eight weeks. This is a value chain that maximizes customization and service but does so at high cost. Finding New Positions: The Entrepreneurial Edge Strategic competition can be thought of as the process of perceiving new positions that woo customers... In contrast, Ikea serves customers who are happy to trade o1 service for cost. Instead of having a sales associate trail customers around the store, Ikea uses a self-service model based on clear, in-store displays. Rather than rely solely on third-party manufacturers, Ikea designs its own low-cost, modular, ready-to-assemble furniture to ﬁt its positioning. In huge stores, Ikea displays every product it sells in room-like settings, so customers don’t need a decorator to help them imagine how to put the pieces together. Adjacent to the furnished showrooms is a warehouse section with the products in boxes on pallets. Customers are expected to do their own pickup and delivery, and Ikea will even sell you a roof rack for your car that you can return for a refund on your next visit. Although much of its low-cost position comes from having customers “do it themselves,” Ikea o1ers a number of extra services that its competitors do not. In-store child care is one. Extended hours are another. Those services are uniquely aligned with the needs of its customers, who are young, not wealthy, likely to have children (but no nanny), and, because they work for a living, have a need to shop at odd hours. The Origins of Strategic Positions Strategic positions emerge from three distinct sources, which are not mutually exclusive and often overlap. First, positioning can be based on producing a subset of an industry’s products or services. I call this variety-based positioning because it is based on the choice of product or service varieties rather than customer segments. Variety-based positioning makes economic sense when a company can best produce particular products or services using distinctive sets of activities. Ji1y Lube International, for instance, specializes in automotive lubricants and does not o1er other car repair or maintenance services. Its value chain produces faster service at a lower cost than broader line repair shops, a combination so attractive that many customers subdivide their purchases, buying oil changes from the focused competitor, Ji1y Lube, and going to rivals for other services. The Vanguard Group, a leader in the mutual fund industry, is another example of variety- based positioning. Vanguard provides an array of common stock, bond, and money market funds that o1er predictable performance and rock-bottom expenses. The company’s investment approach deliberately sacriﬁces the possibility of extraordinary performance in any one year for good relative performance in every year. Vanguard is known, for example, 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 company 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 managing 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 Ji1y Lube are responding to a superior value chain for a particular type of service. A variety-based positioning can serve a wide array of customers, but for most it will meet only a subset of their needs. Strategic positions can be based on customers’ needs, customers’ accessibility, or the variety of a company’s products or services. A second basis for positioning is that of serving most or all the needs of a particular group of customers. 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 di1ering needs, and when a tailored set of activities can serve those needs best. Some groups of customers are more price sensitive than others, demand di1erent product features, and need varying amounts of information, support, and services. Ikea’s customers are a good example of such 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-based positioning arises when the same customer has di1erent needs on di1erent occasions or for di1erent types of transactions. The same person, for example, may have di1erent needs when traveling on business than when traveling for pleasure with the family. Buyers of cans—beverage companies, for example—will likely have di1erent needs from their primary supplier than from their secondary source. It is intuitive for most managers to conceive of their business in terms of the customers’ needs they are meeting. But a critical element of needs-based positioning is not at all intuitive and is often overlooked. Di1erences in needs will not translate into meaningful positions unless the best set of activities to satisfy them also di1ers. If that were not the case, every competitor could meet those same needs, and there would be nothing unique or valuable about the positioning. In private banking, for example, Bessemer Trust Company targets families with a minimum of $5 million in investable assets who want capital preservation combined with wealth accumulation. By assigning one sophisticated account o1icer for every 14 families, Bessemer has conﬁgured its activities for personalized service. Meetings, for example, are more likely to be held at a client’s ranch or yacht than in the o1ice. Bessemer o1ers a wide array of customized services, including investment management and estate administration, oversight of oil and gas investments, and accounting for racehorses and aircraft. Loans, a staple of most private banks, are rarely needed by Bessemer’s clients and make up a tiny fraction of its client balances and income. Despite the most generous compensation of account o1icers and the highest personnel cost as a percentage of operating expenses, Bessemer’s di1erentiation with its target families produces a return on equity estimated to be the highest of any private banking competitor. Citibank’s private bank, on the other hand, serves clients with minimum assets of about $250,000 who, in contrast to Bessemer’s clients, want convenient access to loans—from jumbo mortgages to deal ﬁnancing. Citibank’s account managers are primarily lenders. When clients need other 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 o1ice meetings are o1ered only for the largest clients. Both Bessemer and Citibank have tailored their activities to meet the needs of a di1erent group of private banking customers. The same value chain cannot proﬁtably meet the needs of both groups. The third basis for positioning is that of segmenting customers who are accessible in di1erent ways. Although their needs are similar to those of other customers, the best conﬁguration of activities to reach them is di1erent. I call this access-based positioning. Access can be a function of customer geography or customer scale—or of anything that requires a di1erent set of activities to reach customers in the best way. Segmenting by access is less common and less well understood than the other two bases. Carmike Cinemas, for example, operates movie theaters exclusively in cities and towns with populations under 200,000. How does Carmike make money in markets that are not only small but also won’t support big-city ticket prices? It does so through a set of activities that result in a lean cost structure. Carmike’s small-town customers can be served through standardized, low-cost theater complexes requiring fewer screens and less sophisticated projection technology than big-city theaters. The company’s proprietary information system and management process eliminate the need for local administrative sta1 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 practice a highly personal form of marketing in which the theater manager knows patrons and promotes attendance through personal contacts. By being 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 better terms with distributors. Rural versus urban-based customers are one example of access driving di1erences in activities. Serving small rather than large customers or densely rather than sparsely situated customers are other examples in which the best way to conﬁgure marketing, order processing, logistics, and after-sale service activities to meet the similar needs of distinct groups will often di1er. The Connection with Generic Strategies In Competitive Strategy (The Free Press, 1985), I introduced the concept of generic strategies—cost... Positioning is not only about carving out a niche. A position emerging from any of the sources can be broad or narrow. A focused competitor, such as Ikea, targets the special needs of a subset of customers and designs its activities accordingly. Focused competitors thrive on groups of customers who are overserved (and hence overpriced) by 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 activities designed to meet their common needs. It ignores or meets only partially the more idiosyncratic needs of particular customer customer groups. Whatever the basis—variety, needs, access, or some combination of the three— positioning requires a tailored set of activities because it is always a function of di1erences on the supply side; that is, of di1erences in activities. However, positioning is not always a function of di1erences on the demand, or customer, side. Variety and access positionings, in particular, do not rely on any customer di1erences. In practice, however, variety or access di1erences often accompany needs di1erences. The tastes—that is, the needs—of Carmike’s small-town customers, for instance, run more toward comedies, Westerns, action ﬁlms, and family entertainment. Carmike does not run any ﬁlms rated NC-17. Having deﬁned positioning, we can now begin to answer the question, “What is strategy?” Strategy is the creation of a unique and valuable position, involving a di1erent set of activities. If there were only one ideal position, there would be no need for strategy. Companies would face a simple imperative—win the race to discover and preempt it. The essence of strategic positioning is to choose activities that are di1erent from rivals’. If the same set of activities were best to produce all varieties, meet all needs, and access all customers, companies could easily shift among them and operational e1ectiveness would determine performance. [ III ] A Sustainable Strategic Position Requires Trade-o8s Choosing a unique position, however, is not enough to guarantee a sustainable advantage. A valuable position will attract imitation by incumbents, who are likely to copy it in one of two ways. First, a competitor can reposition itself to match the superior performer. J.C. Penney, for instance, has been repositioning itself from a Sears clone to a more upscale, fashion- oriented, soft-goods retailer. A second and far more common type of imitation is straddling. The straddler seeks to match the beneﬁts of a successful position while maintaining its existing position. It grafts new features, services, or technologies onto the activities it already performs. For those who argue that competitors can copy any market position, the airline industry is a perfect test case. It would seem that nearly any competitor could imitate any other airline’s activities. Any airline can buy the same planes, lease the gates, and match the menus and ticketing and baggage handling services o1ered by other airlines. Essential Background The Five Competitive Forces That Shape Strategy Competitive Strategy Feature Michael E. Porter They determine the long-run proﬁtability of any industry. Save Share Continental Airlines saw how well Southwest was doing and decided to straddle. While maintaining its position as a full-service airline, Continental also set out to match Southwest on a number of point-to-point routes. The airline dubbed the new service Continental Lite. It eliminated meals and ﬁrst-class service, increased departure frequency, lowered fares, and shortened turnaround time at the gate. Because Continental remained a full-service airline on other routes, it continued to use travel agents and its mixed ﬂeet of planes and to provide baggage checking and seat assignments. But a strategic position is not sustainable unless there are trade-o1s with other positions. Trade-o1s occur when activities are incompatible. Simply put, a trade-o1 means that more of one thing necessitates less of another. An airline can choose to serve meals—adding cost and slowing turnaround time at the gate—or it can choose not to, but it cannot do both without bearing major ine1iciencies. Trade-o1s create the need for choice and protect against repositioners and straddlers. Consider Neutrogena soap. Neutrogena Corporation’s variety-based positioning is built on a “kind to the skin,” residue-free soap formulated for pH balance. With a large detail force calling on dermatologists, Neutrogena’s marketing strategy looks more like a drug company’s than a soap maker’s. It advertises in medical journals, sends direct mail to doctors, attends medical conferences, and performs research at its own Skincare Institute. To reinforce its positioning, Neutrogena originally focused its distribution on drugstores and avoided price promotions. Neutrogena uses a slow, more expensive manufacturing process to mold its fragile soap. In choosing this position, Neutrogena said no to the deodorants and skin softeners that many customers desire in their soap. It gave up the large-volume potential of selling through supermarkets and using price promotions. It sacriﬁced manufacturing e1iciencies to achieve the soap’s desired attributes. In its original positioning, Neutrogena made a whole raft of trade-o1s like those, trade-o1s that protected the company from imitators. Trade-o1s arise for three reasons. The ﬁrst is inconsistencies in image or reputation. A company known for delivering one kind of value may lack credibility and confuse customers—or even undermine its reputation—if it delivers another kind of value or attempts to deliver two inconsistent things at the same time. For example, Ivory soap, with its position as a basic, inexpensive everyday soap would have a hard time reshaping its image to match Neutrogena’s premium “medical” reputation. E1orts to create a new image typically cost tens or even hundreds of millions of dollars in a major industry—a powerful barrier to imitation. Second, and more important, trade-o1s arise from activities themselves. Di1erent positions (with their tailored activities) require di1erent product conﬁgurations, di1erent equipment, di1erent employee behavior, di1erent skills, and di1erent management systems. Many trade-o1s reﬂect inﬂexibilities in machinery, people, or systems. The more Ikea has conﬁgured its activities to lower costs by having its customers do their own assembly and delivery, the less able it is to satisfy customers who require higher levels of service. However, trade-o1s can be even more basic. In general, value is destroyed if an activity is overdesigned or underdesigned for its use. For example, even if a given salesperson were capable of providing a high level of assistance to one customer and none to another, the salesperson’s talent (and some of his or her cost) would be wasted on the second customer. Moreover, productivity can improve when variation of an activity is limited. By providing a high level of assistance all the time, the salesperson and the entire sales activity can often achieve e1iciencies of learning and scale. Finally, trade-o1s arise from limits on internal coordination and control. By clearly choosing to compete in one way and not another, senior management makes organizational priorities clear. Companies that try to be all things to all customers, in contrast, risk confusion in the trenches as employees attempt to make day-to-day operating decisions without a clear framework. Positioning trade-o1s are pervasive in competition and essential to strategy. They create the need for choice and purposefully limit what a company o1ers. They deter straddling or repositioning, because competitors that engage in those approaches undermine their strategies and degrade the value of their existing activities. Trade-o1s ultimately grounded Continental Lite. The airline lost hundreds of millions of dollars, and the CEO lost his job. Its planes were delayed leaving congested hub cities or slowed at the gate by baggage transfers. Late ﬂights and cancellations generated a thousand complaints a day. Continental Lite could not a1ord to compete on price and still pay standard travel-agent commissions, but neither could it do without agents for its full- service business. The airline compromised by cutting commissions for all Continental ﬂights across the board. Similarly, it could not a1ord to o1er the same frequent-ﬂier beneﬁts to travelers paying the much lower ticket prices for Lite service. It compromised again by lowering the rewards of Continental’s entire frequent-ﬂier program. The results: angry travel agents and full-service customers. Continental tried to compete in two ways at once. In trying to be low cost on some routes and full service on others, Continental paid an enormous straddling penalty. If there were no trade-o1s between the two positions, Continental could have succeeded. But the absence of trade-o1s is a dangerous half-truth that managers must unlearn. Quality is not always free. Southwest’s convenience, one kind of high quality, happens to be consistent with low costs because its frequent departures are facilitated by a number of low-cost practices—fast gate turnarounds and automated ticketing, for example. However, other dimensions of airline quality—an assigned seat, a meal, or baggage transfer—require costs to provide. Trade-o8s are essential to strategy. They create the need for choice and purposefully limit what a company o8ers. In general, false trade-o1s between cost and quality occur primarily when there is redundant or wasted e1ort, poor control or accuracy, or weak coordination. Simultaneous improvement of cost and di1erentiation is possible only when a company begins far behind the productivity frontier or when the frontier shifts outward. At the frontier, where companies have achieved current best practice, the trade-o1 between cost and di1erentiation is very real indeed. After a decade of enjoying productivity advantages, Honda Motor Company and Toyota Motor Corporation recently bumped up against the frontier. In 1995, faced with increasing customer resistance to higher automobile prices, Honda found that the only way to produce a less-expensive car was to skimp on features. In the United States, it replaced the rear disk brakes on the Civic with lower-cost drum brakes and used cheaper fabric for the back seat, hoping customers would not notice. Toyota tried to sell a version of its best- selling Corolla in Japan with unpainted bumpers and cheaper seats. In Toyota’s case, customers rebelled, and the company quickly dropped the new model. For the past decade, as managers have improved operational e1ectiveness greatly, they have internalized the idea that eliminating trade-o1s is a good thing. But if there are no trade-o1s companies will never achieve a sustainable advantage. They will have to run faster and faster just to stay in place. As we return to the question, What is strategy? we see that trade-o1s add a new dimension to the answer. Strategy is making trade-o1s in competing. The essence of strategy is choosing what not to do. Without trade-o1s, there would be no need for choice and thus no need for strategy. Any good idea could and would be quickly imitated. Again, performance would once again depend wholly on operational e1ectiveness. [ IV ] Fit Drives Both Competitive Advantage and Sustainability Positioning choices determine not only which activities a company will perform and how it will conﬁgure individual activities but also how activities relate to one another. While operational e1ectiveness is about achieving excellence in individual activities, or functions, strategy is about combining activities. Southwest’s rapid gate turnaround, which allows frequent departures and greater use of aircraft, is essential to its high-convenience, low-cost positioning. But how does Southwest achieve it? Part of the answer lies in the company’s well-paid gate and ground crews, whose productivity in turnarounds is enhanced by ﬂexible union rules. But the bigger part of the answer lies in how Southwest performs other activities. With no meals, no seat assignment, and no interline baggage transfers, Southwest avoids having to perform activities that slow down other airlines. It selects airports and routes to avoid congestion that introduces delays. Southwest’s strict limits on the type and length of routes make standardized aircraft possible: every aircraft Southwest turns is a Boeing 737. Fit locks out imitators by creating a chain that is as strong as its strongest link. What is Southwest’s core competence? Its key success factors? The correct answer is that everything matters. Southwest’s strategy involves a whole system of activities, not a collection of parts. Its competitive advantage comes from the way its activities ﬁt and reinforce one another. Fit locks out imitators by creating a chain that is as strong as its strongest link. As in most companies with good strategies, Southwest’s activities complement one another in ways that create real economic value. One activity’s cost, for example, is lowered because of the way other activities are performed. Similarly, one activity’s value to customers can be enhanced by a company’s other activities. That is the way strategic ﬁt creates competitive advantage and superior proﬁtability. Types of Fit The importance of ﬁt among functional policies is one of the oldest ideas in strategy. Gradually, however, it has been supplanted on the management agenda. Rather than seeing the company as a whole, managers have turned to “core” competencies, “critical” resources, and “key” success factors. In fact, ﬁt is a far more central component of competitive advantage than most realize. Fit is important because discrete activities often a1ect one another. A sophisticated sales force, for example, confers a greater advantage when the company’s product embodies premium technology and its marketing approach emphasizes customer assistance and support. A production line with high levels of model variety is more valuable when combined with an inventory and order processing system that minimizes the need for stocking ﬁnished goods, a sales process equipped to explain and encourage customization, and an advertising theme that stresses the beneﬁts of product variations that meet a customer’s special needs. Such complementarities are pervasive in strategy. Although some ﬁt among activities is generic and applies to many companies, the most valuable ﬁt is strategy-speciﬁc because it enhances a position’s uniqueness and ampliﬁes trade-o1s.2 There are three types of ﬁt, although they are not mutually exclusive. First-order ﬁt is simple consistency between each activity (function) and the overall strategy. Vanguard, for example, aligns all activities with its low-cost strategy. It minimizes portfolio turnover and does not need highly compensated money managers. The company distributes its funds directly, avoiding commissions to brokers. It also limits advertising, relying instead on public relations and word-of-mouth recommendations. Vanguard ties its employees’ bonuses to cost savings. Consistency ensures that the competitive advantages of activities cumulate and do not erode or cancel themselves out. It makes the strategy easier to communicate to customers, employees, and shareholders, and improves implementation through single- mindedness in the corporation. Second-order ﬁt occurs when activities are reinforcing. Neutrogena, for example, markets to upscale hotels eager to o1er their guests a soap recommended by dermatologists. Hotels grant Neutrogena the privilege of using its customary packaging while requiring other soaps to feature the hotel’s name. Once guests have tried Neutrogena in a luxury hotel, they are more likely to purchase it at the drugstore or ask their doctor about it. Thus Neutrogena’s medical and hotel marketing activities reinforce one another, lowering total marketing costs. In another example, Bic Corporation sells a narrow line of standard, low-priced pens to virtually all major customer markets (retail, commercial, promotional, and giveaway) through virtually all available channels. As with any variety-based positioning serving a broad group of customers, Bic emphasizes a common need (low price for an acceptable pen) and uses marketing approaches with a broad reach (a large sales force and heavy television advertising). Bic gains the beneﬁts of consistency across nearly all activities, including product design that emphasizes ease of manufacturing, plants conﬁgured for low cost, aggressive purchasing to minimize material costs, and in-house parts production whenever the economics dictate. Yet Bic goes beyond simple consistency because its activities are reinforcing. For example, the company uses point-of-sale displays and frequent packaging changes to stimulate impulse buying. To handle point-of-sale tasks, a company needs a large sales force. Bic’s is the largest in its industry, and it handles point-of-sale activities better than its rivals do. Moreover, the combination of point-of-sale activity, heavy television advertising, and packaging changes yields far more impulse buying than any activity in isolation could. Third-order ﬁt goes beyond activity reinforcement to what I call optimization of eHort. The Gap, a retailer of casual clothes, considers product availability in its stores a critical element of its strategy. The Gap could keep products either by holding store inventory or by restocking from warehouses. The Gap has optimized its e1ort across these activities by restocking its selection of basic clothing almost daily out of three warehouses, thereby minimizing the need to carry large in-store inventories. The emphasis is on restocking because the Gap’s merchandising strategy sticks to basic items in relatively few colors. While comparable retailers achieve turns of three to four times per year, the Gap turns its inventory seven and a half times per year. Rapid restocking, moreover, reduces the cost of implementing the Gap’s short model cycle, which is six to eight weeks long.3 Coordination and information exchange across activities to eliminate redundancy and minimize wasted e1ort are the most basic types of e1ort optimization. But there are higher levels as well. Product design choices, for example, can eliminate the need for after-sale service or make it possible for customers to perform service activities themselves. Similarly, coordination with suppliers or distribution channels can eliminate the need for some in-house activities, such as end-user training. The competitive value of individual activities cannot be separated from the whole. In all three types of ﬁt, the whole matters more than any individual part. Competitive advantage grows out of the entire system of activities. The ﬁt among activities substantially reduces cost or increases di1erentiation. Beyond that, the competitive value of individual activities—or the associated skills, competencies, or resources—cannot be decoupled from the system or the strategy. Thus in competitive companies it can be misleading to explain success by specifying individual strengths, core competencies, or critical resources. The list of strengths cuts across many functions, and one strength blends into others. It is more useful to think in terms of themes that pervade many activities, such as low cost, a particular notion of customer service, or a particular conception of the value delivered. These themes are embodied in nests of tightly linked activities. Fit and Sustainability Strategic ﬁt among many activities is fundamental not only to competitive advantage but also to the sustainability of that advantage. It is harder for a rival to match an array of interlocked activities than it is merely to imitate a particular sales-force approach, match a process technology, or replicate a set of product features. Positions built on systems of activities are far more sustainable than those built on individual activities. Consider this simple exercise. The probability that competitors can match any activity is often less than one. The probabilities then quickly compound to make matching the entire system highly unlikely (.9 ×.9 =.81;.9 ×.9 ×.9 ×.9 =.66, and so on). Existing companies that try to reposition or straddle will be forced to reconﬁgure many activities. And even new entrants, though they do not confront the trade-o1s facing established rivals, still face formidable barriers to imitation. The more a company’s positioning rests on activity systems with second- and third-order ﬁt, the more sustainable its advantage will be. Such systems, by their very nature, are usually di1icult to untangle from outside the company and therefore hard to imitate. And even if rivals can identify the relevant interconnections, they will have di1iculty replicating them. Achieving ﬁt is di1icult because it requires the integration of decisions and actions across many independent subunits. A competitor seeking to match an activity system gains little by imitating only some activities and not matching the whole. Performance does not improve; it can decline. Recall Continental Lite’s disastrous attempt to imitate Southwest. Finally, ﬁt among a company’s activities creates pressures and incentives to improve operational e1ectiveness, which makes imitation even harder. Fit means that poor performance in one activity will degrade the performance in others, so that weaknesses are exposed and more prone to get attention. Conversely, improvements in one activity will pay dividends in others. Companies with strong ﬁt among their activities are rarely inviting targets. Their superiority in strategy and in execution only compounds their advantages and raises the hurdle for imitators. Alternative Views of Strategy The Implicit Strategy Model of the Past Decade One ideal competitive position in the industry... When activities complement one another, rivals will get little beneﬁt from imitation unless they successfully match the whole system. Such situations tend to promote winner-take- all competition. The company that builds the best activity system—Toys R Us, for instance—wins, while rivals with similar strategies—Child World and Lionel Leisure—fall behind. Thus ﬁnding a new strategic position is often preferable to being the second or third imitator of an occupied position. The most viable positions are those whose activity systems are incompatible because of tradeo1s. Strategic positioning sets the trade-o1 rules that deﬁne how individual activities will be conﬁgured and integrated. Seeing strategy in terms of activity systems only makes it clearer why organizational structure, systems, and processes need to be strategy-speciﬁc. Tailoring organization to strategy, in turn, makes complementarities more achievable and contributes to sustainability. One implication is that strategic positions should have a horizon of a decade or more, not of a single planning cycle. Continuity fosters improvements in individual activities and the ﬁt across activities, allowing an organization to build unique capabilities and skills tailored to its strategy. Continuity also reinforces a company’s identity. Strategic positions should have a horizon of a decade or more, not of a single planning cycle. Conversely, frequent shifts in positioning are costly. Not only must a company reconﬁgure individual activities, but it must also realign entire systems. Some activities may never catch up to the vacillating strategy. The inevitable result of frequent shifts in strategy, or of failure to choose a distinct position in the ﬁrst place, is “me-too” or hedged activity conﬁgurations, inconsistencies across functions, and organizational dissonance. What is strategy? We can now complete the answer to this question. Strategy is creating ﬁt among a company’s activities. The success of a strategy depends on doing many things well—not just a few—and integrating among them. If there is no ﬁt among activities, there is no distinctive strategy and little sustainability. Management reverts to the simpler task of overseeing independent functions, and operational e1ectiveness determines an organization’s relative performance. [ V ] Rediscovering Strategy: The Failure to Choose Why do so many companies fail to have a strategy? Why do managers avoid making strategic choices? Or, having made them in the past, why do managers so often let strategies decay and blur? Commonly, the threats to strategy are seen to emanate from outside a company because of changes in technology or the behavior of competitors. Although external changes can be the problem, the greater threat to strategy often comes from within. A sound strategy is undermined by a misguided view of competition, by organizational failures, and, especially, by the desire to grow. Managers have become confused about the necessity of making choices. When many companies operate far from the productivity frontier, trade-o1s appear unnecessary. It can seem that a well-run company should be able to beat its ine1ective rivals on all dimensions simultaneously. Taught by popular management thinkers that they do not have to make trade-o1s, managers have acquired a macho sense that to do so is a sign of weakness. Unnerved by forecasts of hypercompetition, managers increase its likelihood by imitating everything about their competitors. Exhorted to think in terms of revolution, managers chase every new technology for its own sake. The pursuit of operational e1ectiveness is seductive because it is concrete and actionable. Over the past decade, managers have been under increasing pressure to deliver tangible, measurable performance improvements. Programs in operational e1ectiveness produce reassuring progress, although superior proﬁtability may remain elusive. Business publications and consultants ﬂood the market with information about what other companies are doing, reinforcing the best-practice mentality. Caught up in the race for operational e1ectiveness, many managers simply do not understand the need to have a strategy. Companies avoid or blur strategic choices for other reasons as well. Conventional wisdom within an industry is often strong, homogenizing competition. Some managers mistake “customer focus” to mean they must serve all customer needs or respond to every request from distribution channels. Others cite the desire to preserve ﬂexibility. Organizational realities also work against strategy. Trade-o1s are frightening, and making no choice is sometimes preferred to risking blame for a bad choice. Companies imitate one another in a type of herd behavior, each assuming rivals know something they do not. Newly empowered employees, who are urged to seek every possible source of improvement, often lack a vision of the whole and the perspective to recognize trade-o1s. The failure to choose sometimes comes down to the reluctance to disappoint valued managers or employees. The Growth Trap Among all other inﬂuences, the desire to grow has perhaps the most perverse e1ect on strategy. Trade-o1s and limits appear to constrain growth. Serving one group of customers and excluding others, for instance, places a real or imagined limit on revenue growth. Broadly targeted strategies emphasizing low price result in lost sales with customers sensitive to features or service. Di1erentiators lose sales to price-sensitive customers. Managers are constantly tempted to take incremental steps that surpass those limits but blur a company’s strategic position. Eventually, pressures to grow or apparent saturation of the target market lead managers to broaden the position by extending product lines, adding new features, imitating competitors’ popular services, matching processes, and even making acquisitions. For years, Maytag Corporation’s success was based on its focus on reliable, durable washers and dryers, later extended to include dishwashers. However, conventional wisdom emerging within the industry supported the notion of selling a full line of products. Concerned with slow industry growth and competition from broad-line appliance makers, Maytag was pressured by dealers and encouraged by customers to extend its line. Maytag expanded into refrigerators and cooking products under the Maytag brand and acquired other brands—Jenn-Air, Hardwick Stove, Hoover, Admiral, and Magic Chef—with disparate positions. Maytag has grown substantially from $684 million in 1985 to a peak of $3.4 billion in 1994, but return on sales has declined from 8% to 12% in the 1970s and 1980s to an average of less than 1% between 1989 and 1995. Cost cutting will improve this performance, but laundry and dishwasher products still anchor Maytag’s proﬁtability. Reconnecting with Strategy Most companies owe their initial success to a unique strategic position involving clear trade-o1s.... Neutrogena may have fallen into the same trap. In the early 1990s, its U.S. distribution broadened to include mass merchandisers such as Wal-Mart Stores. Under the Neutrogena name, the company expanded into a wide variety of products—eye-makeup remover and shampoo, for example—in which it was not unique and which diluted its image, and it began turning to price promotions. Compromises and inconsistencies in the pursuit of growth will erode the competitive advantage a company had with its original varieties or target customers. Attempts to compete in several ways at once create confusion and undermine organizational motivation and focus. Proﬁts fall, but more revenue is seen as the answer. Managers are unable to make choices, so the company embarks on a new round of broadening and compromises. Often, rivals continue to match each other until desperation breaks the cycle, resulting in a merger or downsizing to the original positioning. Proﬁtable Growth Many companies, after a decade of restructuring and cost-cutting, are turning their attention to growth. Too often, e1orts to grow blur uniqueness, create compromises, reduce ﬁt, and ultimately undermine competitive advantage. In fact, the growth imperative is hazardous to strategy. What approaches to growth preserve and reinforce strategy? Broadly, the prescription is to concentrate on deepening a strategic position rather than broadening and compromising it. One approach is to look for extensions of the strategy that leverage the existing activity system by o1ering features or services that rivals would ﬁnd impossible or costly to match on a stand-alone basis. In other words, managers can ask themselves which activities, features, or forms of competition are feasible or less costly to them because of complementary activities that their company performs. Deepening a position involves making the company’s activities more distinctive, strengthening ﬁt, and communicating the strategy better to those customers who should value it. But many companies succumb to the temptation to chase “easy” growth by adding hot features, products, or services without screening them or adapting them to their strategy. Or they target new customers or markets in which the company has little special to o1er. A company can often grow faster—and far more proﬁtably—by better penetrating needs and varieties where it is distinctive than by slugging it out in potentially higher growth arenas in which the company lacks uniqueness. Carmike, now the largest theater chain in the United States, owes its rapid growth to its disciplined concentration on small markets. The company quickly sells any big-city theaters that come to it as part of an acquisition. This article also appears in: HBR’s 10 Must Reads The Essentials Book 24.95 View Details Globalization often allows growth that is consistent with strategy, opening up larger markets for a focused strategy. Unlike broadening domestically, expanding globally is likely to leverage and reinforce a company’s unique position and identity. Companies seeking growth through broadening within their industry can best contain the risks to strategy by creating stand-alone units, each with its own brand name and tailored activities. Maytag has clearly struggled with this issue. On the one hand, it has organized its premium and value brands into separate units with di1erent strategic positions. On the other, it has created an umbrella appliance company for all its brands to gain critical mass. With shared design, manufacturing, distribution, and customer service, it will be hard to avoid homogenization. If a given business unit attempts to compete with di1erent positions for di1erent products or customers, avoiding compromise is nearly impossible. The Role of Leadership The challenge of developing or reestablishing a clear strategy is often primarily an organizational one and depends on leadership. With so many forces at work against making choices and tradeo1s in organizations, a clear intellectual framework to guide strategy is a necessary counterweight. Moreover, strong leaders willing to make choices are essential. In many companies, leadership has degenerated into orchestrating operational improvements and making deals. But the leader’s role is broader and far more important. General management is more than the stewardship of individual functions. Its core is strategy: deﬁning and communicating the company’s unique position, making trade-o1s, and forging ﬁt among activities. The leader must provide the discipline to decide which industry changes and customer needs the company will respond to, while avoiding organizational distractions and maintaining the company’s distinctiveness. Managers at lower levels lack the perspective and the conﬁdence to maintain a strategy. There will be constant pressures to compromise, relax trade-o1s, and emulate rivals. One of the leader’s jobs is to teach others in the organization about strategy—and to say no. Strategy renders choices about what not to do as important as choices about what to do. Indeed, setting limits is another function of leadership. Deciding which target group of customers, varieties, and needs the company should serve is fundamental to developing a strategy. But so is deciding not to serve other customers or needs and not to o1er certain features or services. Thus strategy requires constant discipline and clear communication. Indeed, one of the most important functions of an explicit, communicated strategy is to guide employees in making choices that arise because of trade-o1s in their individual activities and in day-to-day decisions. Emerging Industries and Technologies Developing a strategy in a newly emerging industry or in a business undergoing revolutionary... Improving operational e1ectiveness is a necessary part of management, but it is not strategy. In confusing the two, managers have unintentionally backed into a way of thinking about competition that is driving many industries toward competitive convergence, which is in no one’s best interest and is not inevitable. Managers must clearly distinguish operational e1ectiveness from strategy. Both are essential, but the two agendas are di1erent. The operational agenda involves continual improvement everywhere there are no trade- o1s. Failure to do this creates vulnerability even for companies with a good strategy. The operational agenda is the proper place for constant change, ﬂexibility, and relentless e1orts to achieve best practice. In contrast, the strategic agenda is the right place for deﬁning a unique position, making clear trade-o1s, and tightening ﬁt. It involves the continual search for ways to reinforce and extend the company’s position. The strategic agenda demands discipline and continuity; its enemies are distraction and compromise. Strategic continuity does not imply a static view of competition. A company must continually improve its operational e1ectiveness and actively try to shift the productivity frontier; at the same time, there needs to be ongoing e1ort to extend its uniqueness while strengthening the ﬁt among its activities. Strategic continuity, in fact, should make an organization’s continual improvement more e1ective.

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