Jul 17, 2013
Table of contents:
Competitive Advantage - Creating and Sustaining Superior Performance by Michael E. Porter is a business management book that looks to take analytical frameworks for competitive strategy and show how they can be applied to create and sustain competitive advantage.
Competitive strategy and competitive advantage are concepts that relates to all companies and all industries. Whilst much of the research and literature of competitive advantage has focused on industry specific topics, Porter shows how all companies in all industries can be defined by the activities they undertake in order to create value.
Michael E. Porter is a professor at Harvard Business school and is the author of many of the most authoritative works in business strategy and competitive analysis.
Competitive advantage arrises from the collection of activities in the value chain of a company. A company is a collection of activities and so the strategy of that company is determined by those activities. When you look at competitive strategy and competitive advantage through the lens of activities, it becomes more tangible because you can see how things relate in real life.
There are two main types of competitive advantage, cost leadership and differentiation. When a company has chosen to be the cost leader is must select activities that reduce the cost of manufacturing and standardise processes and design. When a company chooses differentiation, the company must choose activities that allow it to differentiate itself from it’s competitors.
Competitive advantage grows out of the company’s ability to provide greater value than it costs to create it. Value is what the buyer is willing to pay for. Superior value stems from offering lower prices than competitors for equivalent benefits or providing unique benefits that more than offset a higher price.
Porter introduces the concept of the Value Chain as an analytical framework for strategically thinking about the activities of a company and how their relative costs contribute towards differentiation. The Value Chain provides a way to understand the sources of buyer value that will command a premium price, and why one product or service substitutes another.
By thinking of strategy as a series of activities, it becomes more tangible rather than just a broad vision. The activities that are required for a low cost strategy are very different from those of a differentiation strategy and the particular configuration one company has chosen can be quite distinct from it’s rivals.
One of the key determinants of a company’s profitability is industry attractiveness. Some industries are inherently more attractive than others. A company can have a poor position in an attractive industry and be better off than a company that has a good position in an unattractive industry.
The rules of competition of an industry are embodied in 5 competitive forces.
Industry profitability is not about the product or the technology, but is determined by the 5 forces. If any of the 5 forces cause intense pressure, the industry will be unattractive. Often the most mundane industries will be far more profitable than the more glamorous ones.
The 5 forces are not the only reason for industry attractiveness. A company can also effect the industry for better or worse depending on their strategy. A firm can gain a competitive advantage by effecting one of the 5 forces. However, a company’s strategy can also make the entire industry less attractive. By lowering the barrier of entry to new competitors or increasing the bargaining power of buyers or suppliers, a company can wreck the industry for everyone. This often happens when a company can gain short term advantage, without considering the industry as a whole.
The 5 forces framework allows a company to analyse an industry and chose a strategy to implement. The 5 forces vary in every industry, and certain ones are more important to some industries. The framework allows a company to pinpoint the factors that are crucial to the industry.
The important question when analysing an industry is whether a company can capture significant value. When any of the 5 forces are too intense, a company will struggle to capture the value they create for buyers. For example, if the barrier to entry for new competitors is too low, new entrants can enter the industry and compete away profits. The threat of substitutes forces a ceiling on prices and thus profit margins. The bargaining power of buyers means that the value will be captured by buyers rather than the companies. The bargaining power of suppliers means that value will be captured by the suppliers. And the rivalry between competitors will mean that the value that is created will be competed away by either passing it on to buyers through lower costs or by increasing the cost of competition.
The second important attribute in competitive strategy is the company’s position in the industry. In order to maintain and improve the position within the industry, a company must have a sustainable competitive advantage.
There are two basic types of competitive advantage, low cost and differentiation and three strategies for achieving above average position, cost leadership, differentiation and focus. Focus can be either cost focus or differentiation focus.
When choosing a competitive strategy, it’s important to make a choice about which competitive advantage you are looking to create. Cost leadership and differentiation require very different strategies. Not choosing a strategy means you won’t have any competitive advantage at all and you will achieve below average performance.
Cost Leadership is where the company aims to become the low-cost provider in the industry. Usually there is not room for more than one low-cost provider, and so if this strategy is going to work, you need to ensure you are the winner.
Cost Leadership can arrive from access to proprietary technology, raw materials or huge scale. Low cost providers usually take advantage of the economies of scale of providing a generic, commoditised product that has no frills.
The cost leader needs to ensure that their product sufficiently meets the demand of the market. If the product does not, the cost leader could lose market share to a competing product that does meet that minimum requirement or be forced to reduce prices even further.
A Differentiation strategy requires a company to pick a certain attribute of a product or service that is valued by the customer. By positioning to meet the specific needs of the differentiation, the company can charge premium prices to people who value that attribute.
In a differentiation strategy, you must also be aware of your costs. The advantages of a well differentiated product will be nullified if you can’t charge more than it costs you to produce it.
Differentiation can vary widely by industry depending on what attributes are valued by the customer. Unlike Cost Leadership, it’s also possible for many differentiation products to co-exist within the same industry.
A focus strategy is where you focus on a particular niche within an industry by either cost leadership or differentiation. This opportunity arrises when a segment of an industry is underserved by the existing competitors. For example, a market leader might offer a generic product that meets the majority of the market’s requirements. A focus strategy would pick out a segment of the market that is underserved by the market leader and focus on satisfying their requirements.
A focus strategy can involve either cost leadership or differentiation and many focus strategies can co-exist within the same industry.
An important aspect of a focus strategy is to ensure that your product is focused enough. If your target segment can be equally served by a competitors generic product, you will achieve below average returns.
Competitive Advantage - Creating and Sustaining Superior Performance is one of the most influential business management books of all time. Despite it being first published nearly 20 years ago, Porter’s 5 forces framework remains one of the most important factors in analysing industry attractiveness.
The book covers many related concepts in gaining and sustaining competitive advantage in a number of different industries. With many real life examples and case studies, Porter is able to give you a clear and actionable path for analysing an industry and he shows you how you can conceive of a strategy as a startup or an established industry leader.
The book is, however, clearly an academic book and so it can be a little bit dense at times. If you are new to reading these types of academic management books, this is probably not the best book to start with. At over 500 pages, Porter covers considerable ground, but he is able to consistently tie together examples and refer back to previous chapters in order to illustrate his point.
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