Today, we'll be covering the most useful business strategy article ever written, Michael Porter's What is Strategy? In the article, Porter discusses the critical elements of competitive advantage, so we'll be covering his three core business strategies and two follow-up topics. The three strategies are industry position, trade-offs, and activity fit, and then we'll cover operational effectiveness and straddling.
For each of the topics, I'll give some of Porter's examples, some of my own examples, And since this is a special edition, hipster examples. Because everyone loves to hate hipsters. So what do you say, Auden and Odette?
Grab some kale and a vinyl recording of Tame Impala. Let's do this. The first strategy examines how firms find a unique and valuable position within their industry.
This requires understanding how a wide range of potential customers interact with a wide range of potential products or services. The first type of industry position targets the few needs of many customers. In this approach, firms target specific services instead of specific customers. Therefore, the products or services meet only a subset of customers'needs.
Let's look at Porter's example of Jiffy Lube. Imagine two types of potential customers. And let's imagine that there are two types of automobile services, simple oil changes and complex engine work. Jiffy Lube succeeds because they focus on one specific need, that is, oil changes, that cover economy and luxury owners alike. Porter calls this type of product offering variety-based positioning because it covers a specific need across a wide variety of potential customers.
Consider a second example, Lyft. Lyft provides a simple transportation option that gets you from point A to point B, typically in a city and typically at a reasonable cost. And now they also have scooters. So Lyft offers cars and scooters for short-distance trips, but they do not offer other common transportation options like rental cars, flights, trains, buses, or for that matter, donkey carts or blimps. And that's a good thing.
This means that Lyft is targeting the few needs of the many. They offer a few potential transportation options to many potential customers. This keeps their strategy simple and maximizes opportunities for success in their chosen niche. Hipster examples of the few needs of many include offering one type of food to many customers.
Avocado toast, anyone? Or... selling a specific IPA to a mass audience.
The second industry niche that Porter identifies is the broad needs of the few. This approach targets the needs of few customers, but throughout an entire range of products or services. Urban Outfitters is the perfect example. They sell a wide range of lifestyle products to a very specific audience, the urban hipster with money to burn. The clothing and product line is extensive, so you can buy everything the hipster needs, including plaid, joggers, beanies, southwest print hoodies, chunky reading glasses, and of course, beard oil and mustache wax.
Why not? So if we look at another two-by-two matrix, we'll find that Urban Outfitters is targeting a specific customer, hipsters, across the full range of offerings from clothes to beard care and everything in between. Porter calls this needs-based positioning because they are meeting the full needs of their specific customer. The third type of industry niche that that Porter identifies is the broad needs of the many in a narrow geographical market.
He calls this access-based positioning, and his example in the article is Carmike Cinemas, which offer nearly all movies to nearly all potential movie watchers in a narrow geographic market. To recap, the first Porter strategy tells us that successful businesses should create a unique and valuable industry position by choosing one of three industry niches, the few needs of many, the broad needs of the few, or the broad needs of the many in a narrow geographical area. The second strategy Porter discusses is making strategic trade-offs.
It's a fundamental rule of economics that high potential profits in an industry attract new competitors that will copy what you do. Uber's entry into ride-sharing led to copycat entries by Lyft, Via, Sidecar, among a host of others. Therefore, good strategy requires you to make trade-offs. You have to say no to some potential profit opportunities order to focus on the capabilities that you do well.
Oh, hey, Michael Porter. Okay, thanks, big guy. Trade-offs lead to product differentiation and create a straddling penalty for competitors who try to do too much. So let's take Southwest as an example.
To create their unique service offerings, which can't be directly copied by their competitors, Southwest says no to many things. They don't offer seat assignments. They don't offer in-flight meals. They don't have a first-class seating section.
They don't sell on sites like Kayak. They don't charge baggage fees. And unlike some airlines, and we all know who I'm talking about, they love their passengers and don't abuse them. Saying no is critical for firm strategy. Have you ever wondered why Southwest doesn't have a first-class section?
Southwest has the fastest passenger boarding times of any major airline due to the lack of seating assignments. It would be impossible for them to have a first-class section and still retain the speed advantage of not having assigned seats. All companies with great business strategies continuously make these types of trade-off decisions. Hipster companies have to make trade-off decisions too. If you produce bikes for hipsters, You'll need to trade off having gears in exchange for maintaining street cred.
The third business strategy that Porter identifies is called Activity Fit. This goes along with the previous two strategies and adds the idea of combining activities to entrench your product differentiation. Fit makes it difficult for competitors to imitate your product and ensures synergies between firm activities. The first type of fit that Porter identifies is called First Order Fit.
This is a simple consistency between firm actions and overall firm strategy. For example, Southwest insures lower fares by not selling on kayak, which reduces their commission payments. Also, they don't offer seating assignments, which, as we already know, increases boarding speed. The next type of fit is called, creatively, second order fit.
This is when specific firm activities reinforce one another as part of the firm strategy. Continuing with the Southwest theme, The lack of seat assignments or meals, and the fact that they use standardized 737s, all reinforced a second firm activity, rapid boarding. This leads to higher aircraft utilization rates, and hence, both lower fares and higher profits. Porter has a great visual diagram of this process.
The three activities I just highlighted, no seating assignments, no meals, and standardized planes, all reinforce their rapid gate turnarounds, which leads to sustainable competitive advantage. Other airlines can't copy one of these activities without copying all of them. The final type of activity fit is third-order fit, which Porter defines as full optimization of a firm's effort. I don't think the subtlety of his ideas comes through here, so I'll just note that he covers it in the article and leave you to do further research.
Before we recap, let me drink some kombucha and change over to my academic glasses. Okay, that's better. Porter identifies three critical business strategies.
Number one, create a unique and valuable industry niche. Number two, ensure product differentiation by saying no to some potentially profitable activities. And number three, ensure fit among firm activities to make it hard for competitors to imitate your products and services.
Before we go on to our wrap-up topics, I want to take a second to introduce Michael Porter. He's a Harvard Business School professor who literally wrote the book on strategy. He's known for his easy-to-understand writing style and is therefore considered to be an interpreter of economics and strategy for a wider business audience. The thing I like most about Michael Porter is how adaptable his ideas are.
You can use Michael Porter in just about any situation. For example, need a strategy for a company aimed at millennials who exclusively eat farm-to-table food? Just use hipster Michael Porter. How about a business plan for a fashion company? Just call Runway Michael Porter.
And here's my favorite. If you're working on a video game, dial in God Mode Michael Porter to judge whether companies will succeed or fail. Since we've covered all three core strategies, let's move on to our final two supporting topics. They are operational effectiveness and straddling.
Operational effectiveness is critical for business success, but it is not a business strategy. Operational effectiveness is simply required in order to compete in the marketplace. If we look at the possible relationships between value and cost, the best possible combination of these factors is called the productivity frontier.
A company producing products at the possible frontier of cost and value can be said to be operationally efficient. Hyundai, in my opinion, represents the best value in cars due to their low cost and relatively high reliability delivered to the customer at their given price level. The same could be said of Toyota at the low to mid price level.
or Mercedes-Benz at mid to high price level. Let's use Fiat as a company that might not have 100% operational effectiveness. While Fiat may want to improve their products in order to offer a better price-to-value ratio, it is important to note that this is in and of itself not a business strategy.
It is simply a requirement for being successful. Porter tells us that an outsized focus on operational effectiveness can actually be counterproductive. He relates a story about commercial printers back in the 1980s. Firms in the industry offered nearly identical products and focused extensively on process engineering.
While their products were at the productivity frontier, ultimately, they were all too similar. They were all at the productivity frontier. This led, of course, to a price war, which resulted in low profits for everyone.
Porter has a name for competition led by operational effectiveness. He calls it hyper-competition. Firms can avoid this by focusing on true strategy, which involves, big surprise here, differentiation through activity fit and trade-offs. The last topic is straddling. Porter says that a straddler seeks to match the benefits of a successful position while maintaining its existing position.
It tries to graph new features, services, or technologies onto the activities it already performs. For example, in 1993, Continental Airlines started Continental Light, which offered discount airline fares. The goal was to match the Fly for Peanuts fares offered by Southwest. Of course, Continental still offered some premium services, such as meals and a hub-and-spoke connection model.
Since they were not making real trade-offs and effectively only adding to their current product offerings, costs were high and the venture failed after only two years. Thus, firms often try to do too much and do not recognize that great strategy comes from limiting product offerings and focusing on what your firm does best. So with all of this said, how do we answer the question, what is strategy?
We know that strategy is a about creating sustainable competitive advantage. This means following Porter's three strategic guidelines and avoiding strategic pitfalls. It also means differentiating in ways that provide value to the customer and positioning within your industry in ways that limit direct competition.
That's all for now. If you're not too cool, please like and leave a comment and be sure to check out the rest of the videos in this introduction to strategy series. I'm gonna go put on an ironic scarf. And drink a single origin Ethiopian pour over. Thanks for watching.