Winning Competitive Strategies in Todays Shifting Global Marketplace

1. Professor Michael E. Porter Harvard Business School Master Class on Strategy University of North Carolina, Chapel Hill March 6, 2009

This presentation draws on ideas from Professor Porter�s books and articles, in particular, Competitive Strategy (The Free Press, 1980); Competitive Advantage (The Free Press, 1985); �What is Strategy?� (Harvard Business Review, Nov/Dec 1996); �Strategy and the Internet� (Harvard Business Review, March 2001); and a forthcoming book. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means�electronic, mechanical, photocopying, recording, or otherwise�without the permission of Michael E. Porter. Additional information may be found at the website of the Institute for Strategy and Competitiveness, www.isc.hbs.edu. Version: March 5, 5pm Winning Competitive Strategies in Today's Shifting Global Marketplace  1) Does your organization have a clear strategy? (surprising how many companies don�t) Will it prove a clear competitive advantage? Can it be sustained? Non-profit Government department Will it lead to a competitive advantage and/or superior performance? It is easy to be distracted; Is the strategy clear to the organization? The need for strategy is well accepted 2) The need for strategy is greater and greater and is well accepted Pressures: financial markets / investors / competition Opportunity is greater: global economy Strategy is easier in a global economy Choices are even more important in global economy ? huge pool of demand, no need to expand Bigger and bigger 3) Many companies are confused about strategy But, unwillingness to make choices Strategic mistakes often come from inside, not changes in external environment Doesn�t come from outside the firm Mistakes companies when make when thinking about how to compete Strategy is easier in a global economy Each manager has to be a strategist; may have to be more explicit How to think about fundamental competitive challenges that organization faces Institutionalize / make structural your advantage 5) How to think about strategy What are some frameworks.. What are some better ways to compete Try to provide a sense of the larger picture ? how to think best about strategy S.T. Stock price irrelevant What role is strategy playing Strategy, especially critical during difficult financial times (such as current period) Being guided by strategy is more important in times of turmoil Focus on economic fundamentals, not cuts to strategy Non-incremental moves are possible1) Does your organization have a clear strategy? (surprising how many companies don�t) Will it prove a clear competitive advantage? Can it be sustained? Non-profit Government department Will it lead to a competitive advantage and/or superior performance? It is easy to be distracted; Is the strategy clear to the organization? The need for strategy is well accepted 2) The need for strategy is greater and greater and is well accepted Pressures: financial markets / investors / competition Opportunity is greater: global economy Strategy is easier in a global economy Choices are even more important in global economy ? huge pool of demand, no need to expand Bigger and bigger 3) Many companies are confused about strategy But, unwillingness to make choices Strategic mistakes often come from inside, not changes in external environment Doesn�t come from outside the firm Mistakes companies when make when thinking about how to compete Strategy is easier in a global economy Each manager has to be a strategist; may have to be more explicit How to think about fundamental competitive challenges that organization faces Institutionalize / make structural your advantage 5) How to think about strategy What are some frameworks.. What are some better ways to compete Try to provide a sense of the larger picture ? how to think best about strategy S.T. Stock price irrelevant What role is strategy playing Strategy, especially critical during difficult financial times (such as current period) Being guided by strategy is more important in times of turmoil Focus on economic fundamentals, not cuts to strategy Non-incremental moves are possible

2. How Managers Think About Competition

COMPETING TO BE THE BEST COMPETING TO BE UNIQUE The worst error in strategy is to compete with rivals on the same dimensions Strategy starts with thinking the right way about competition �frame of reference� When discussing strategy, the first thing is to understand competition/competitors All strategy is based on understanding competition Competing to be the best: win/lose proposition A zero sum game can only be one �best� company; win-lose However, there is usually no �best� way to compete in any businesses Depends on unique needs of user; different customers have different needs Even same customers have variety of needs (Can�t meet all of them well) Lot of confusion surrounding this Many managers compete to be the best (a natural way of thinking) �We need best product, new factory, supply chain, customer service, marketing, after-service support, accounting, etc..� �If we can just compete on all of these dimensions�it will lead to success� This is a dangerous way of thinking Leads you in the wrong direction (competition that nobody can win) There is no best (e.g., what�s the best car, best bank ? retail deposits? high quality advice?), as this depends on the needs of the customer that you�re trying to meet Belief in only one way to compete ensures that competition will be destructive Competing to be unique is a positive sum proposition Worst mistake is to compete on same basis as competition (doing the same thing) Will kill each other, and the outcome will be that price will go down (with customers unable to differentiate except on price), reducing profitability Must try to find another way to compete Job of the strategist is to be unique; leader must be clear ? help others to understand strategy Deliver different value to customer No company can deliver/meet the needs of every customers Key is how to be unique in delivering value to particular set of customersStrategy starts with thinking the right way about competition �frame of reference� When discussing strategy, the first thing is to understand competition/competitors All strategy is based on understanding competition Competing to be the best: win/lose proposition A zero sum game can only be one �best� company; win-lose However, there is usually no �best� way to compete in any businesses Depends on unique needs of user; different customers have different needs Even same customers have variety of needs (Can�t meet all of them well) Lot of confusion surrounding this Many managers compete to be the best (a natural way of thinking) �We need best product, new factory, supply chain, customer service, marketing, after-service support, accounting, etc..� �If we can just compete on all of these dimensions�it will lead to success� This is a dangerous way of thinking Leads you in the wrong direction (competition that nobody can win) There is no best (e.g., what�s the best car, best bank ? retail deposits? high quality advice?), as this depends on the needs of the customer that you�re trying to meet Belief in only one way to compete ensures that competition will be destructive Competing to be unique is a positive sum proposition Worst mistake is to compete on same basis as competition (doing the same thing) Will kill each other, and the outcome will be that price will go down (with customers unable to differentiate except on price), reducing profitability Must try to find another way to compete Job of the strategist is to be unique; leader must be clear ? help others to understand strategy Deliver different value to customer No company can deliver/meet the needs of every customers Key is how to be unique in delivering value to particular set of customers

3. Setting the Right Goals

Good strategy starts with setting appropriate financial goals for the company The fundamental goal of a company is superior long-term return on investment Growth is good only if superiority in ROIC is achieved and sustained ROIC threshold Profitability must be measured realistically, capturing the actual profits on the full investment Prevalent accounting adjustments to reported profitability (e.g., writeoffs, restructuring charges) can obscure true economic performance and lead to bad competitive choices Profitability metrics besides ROIC (e.g., return on sales; ebitda margin; pro-forma earnings; and cash flow margin) are risky for strategy Goodwill must be treated as part of investment Setting unrealistic profitability or growth targets can undermine strategy Both companies and investors ROIC is the most important goal Utilization of capital Operator ?? capitalist (a lot of private equity, activist investors) ? (pi) > growth Many bad choices start here Easy to grow Measuring ROIC Goodwill amortization / extraordinary changes Pro-forma earnings can be misleading for decisions Disney Case Growth > Industry very hard to do forever Should be practical in setting profitability or growth targets (setting same target in every industry) How to develop strategy? Start with a proper goal (which is absolutely clear) Attractive, superior ROIC Not in the short term, but over the business cycle (this may be 3-4 years, or as long as 20 years in mining) Only if you achieve good ROIC are you creating true economic value, which says that you can produce a product for a price that�s greater than the cost of making it (including the cost of capital employed) Goal #2 is growth Growth is only good if it is consistent with superior ROIC No honor in growth without profitability (easy to do, just buy up companies, slash prices) Focus on growth can lead to bad decisions (especially when growth is number 1 priority) All strategy should support superior long term ROIC Fun to ride the growth bubble (though any idiot can be successful when the economy is growing at 9%). Must prove that you�re creating economic value, otherwise company will make bad decisions This is a problem in China Some companies don�t earn good ROIC (and don�t even measure capital well) Chinese managers need to start thinking like capitalists (capital is scare) Japan made a similar mistake, then in 1989 it had a 13 year depression (Japanese companies weren't profitable, therefore not successful) Japanese managers now care about / focus on profitability ? and the country�s economic situation is improvingBoth companies and investors ROIC is the most important goal Utilization of capital Operator ?? capitalist (a lot of private equity, activist investors) ? (pi) > growth Many bad choices start here Easy to grow Measuring ROIC Goodwill amortization / extraordinary changes Pro-forma earnings can be misleading for decisions Disney Case Growth > Industry very hard to do forever Should be practical in setting profitability or growth targets (setting same target in every industry) How to develop strategy? Start with a proper goal (which is absolutely clear) Attractive, superior ROIC Not in the short term, but over the business cycle (this may be 3-4 years, or as long as 20 years in mining) Only if you achieve good ROIC are you creating true economic value, which says that you can produce a product for a price that�s greater than the cost of making it (including the cost of capital employed) Goal #2 is growth Growth is only good if it is consistent with superior ROIC No honor in growth without profitability (easy to do, just buy up companies, slash prices) Focus on growth can lead to bad decisions (especially when growth is number 1 priority) All strategy should support superior long term ROIC Fun to ride the growth bubble (though any idiot can be successful when the economy is growing at 9%). Must prove that you�re creating economic value, otherwise company will make bad decisions This is a problem in China Some companies don�t earn good ROIC (and don�t even measure capital well) Chinese managers need to start thinking like capitalists (capital is scare) Japan made a similar mistake, then in 1989 it had a 13 year depression (Japanese companies weren't profitable, therefore not successful) Japanese managers now care about / focus on profitability ? and the country�s economic situation is improving

4. Economic Performance versus Shareholder Value

Economic Performance Shareholder Value Sustained ROIC Sustainable Revenue Growth Stock Price EPS EPS Growth Vivid illustration � true today! Holding periods are short Share holder value is outcome not the goal Economic performance must be central activity/goal Stock price will reflect economic value over the long term Today�s particular shareholders have no special standing In the short term, shareholder interests = company interests, are not the same Measured by current stock price, not a good measure of value (though over 3-4 years ? very high correlation) Listen too much is a mistake Must influence how shareholders measure the company Should select shareholders, not just inherit them If goal is shareholder value (maximizing economic value), then stock price is not a good measure of value Odds that current stock price is correct: close to zero Fundamental value driven by economic performance (ROIC and growth) Over a 3-4 year period (e.g., business cycle), the price will correct itself In the short term, prices can go up/down because of various external pressures Worst mistake is to believe that today�s stock price always represents the real value of the firm Only that that matters is the economic performance of the firm Must stay grounded on economic value ? mistakes/bad decisions when people get caught up in stock prices Today, average shareholder holds on to stock for 6 months (they want share price to increase tomorrow, making a quick money) Managers must act as a buffer between the stock price and the company Employees must be focused on ROIC, and growth but only in a profitable manner Once manager gets too caught up in today�s stock price, she�s in trouble.Vivid illustration � true today! Holding periods are short Share holder value is outcome not the goal Economic performance must be central activity/goal Stock price will reflect economic value over the long term Today�s particular shareholders have no special standing In the short term, shareholder interests = company interests, are not the same Measured by current stock price, not a good measure of value (though over 3-4 years ? very high correlation) Listen too much is a mistake Must influence how shareholders measure the company Should select shareholders, not just inherit them If goal is shareholder value (maximizing economic value), then stock price is not a good measure of value Odds that current stock price is correct: close to zero Fundamental value driven by economic performance (ROIC and growth) Over a 3-4 year period (e.g., business cycle), the price will correct itself In the short term, prices can go up/down because of various external pressures Worst mistake is to believe that today�s stock price always represents the real value of the firm Only that that matters is the economic performance of the firm Must stay grounded on economic value ? mistakes/bad decisions when people get caught up in stock prices Today, average shareholder holds on to stock for 6 months (they want share price to increase tomorrow, making a quick money) Managers must act as a buffer between the stock price and the company Employees must be focused on ROIC, and growth but only in a profitable manner Once manager gets too caught up in today�s stock price, she�s in trouble.

5. Economic Foundations of Competition

Industry Structure Relative Position Within the Industry - Overall Rules of Competition - Sources of Competitive Advantage The fundamental unit of strategic analysis is the business or industry Defining the relevant industry is important to strategy Company economic performance results from two distinct causes Strategic thinking must encompass both Will talk about definition of industries later What determines business performance? Two drivers 1) Structure of the industry as a whole Understand industry, nature inherent structure Success has partly to do with attractiveness of the industry What is driving inherent attractiveness of industry? 2) Relative position you occupy within the industry Has to do with competitive advantage Higher than industry average Must take steps to enhance competitiveness Get company into the right industry How to achieve superior performance? Together they determine profitability McDonalds Two or three industries Will talk about definition of industries later What determines business performance? Two drivers 1) Structure of the industry as a whole Understand industry, nature inherent structure Success has partly to do with attractiveness of the industry What is driving inherent attractiveness of industry? 2) Relative position you occupy within the industry Has to do with competitive advantage Higher than industry average Must take steps to enhance competitiveness Get company into the right industry How to achieve superior performance? Together they determine profitability McDonalds Two or three industries

6. See new updated and extended 5 forces article Notion of industry structure, with profitability based on 5 forces Profitability usually means weak forces Dividing the value pool Must understand the structure of industry and how it is changing ? what are the trends, identify the problem areas e.g., Critical analysis needs to be done to understand intensity of rivalry What dimensions of competition (e.g., price, service, quality, features, etc.) Competing on price is the worst, its simply giving money to customers How is the industry structure changing? Cyclical versus structural Threat of Substitutes What are the substitutes? Same function, different means (e.g., aluminum worries about plastics, etc.) �do it yourself� air vs. bus Supplier Bargaining Power Who are supplier groups Power of suppliers to increase price, buyers to decrease prices To pull out profits Buyers Bargaining Power Leverage plus price sensitivity Can sometimes have customer/supplier being the same entity (e.g., financial institutions) Industry Rivalry Nature and intensity of rivalry How viciously/aggressively do companies compete Basis of competition Price rivalry is the most destructive (competing on services, variety, features, etc. can sustain higher returns)See new updated and extended 5 forces article Notion of industry structure, with profitability based on 5 forces Profitability usually means weak forces Dividing the value pool Must understand the structure of industry and how it is changing ? what are the trends, identify the problem areas e.g., Critical analysis needs to be done to understand intensity of rivalry What dimensions of competition (e.g., price, service, quality, features, etc.) Competing on price is the worst, its simply giving money to customers How is the industry structure changing? Cyclical versus structural Threat of Substitutes What are the substitutes? Same function, different means (e.g., aluminum worries about plastics, etc.) �do it yourself� air vs. bus Supplier Bargaining Power Who are supplier groups Power of suppliers to increase price, buyers to decrease prices To pull out profits Buyers Bargaining Power Leverage plus price sensitivity Can sometimes have customer/supplier being the same entity (e.g., financial institutions) Industry Rivalry Nature and intensity of rivalry How viciously/aggressively do companies compete Basis of competition Price rivalry is the most destructive (competing on services, variety, features, etc. can sustain higher returns)

7. First level of thinking about positioning Understanding structure also informs positioning (insights) Take existing structure as given; but identify where there are opportunities Find a position of industry less exposed When we understand industry structure, it helps us understand the forces that drive profitability E.g., heavy trucks � which has low profitability Buyers: buy many trucks at the same time Big orders (20-50 trucks) which can make/break economics of production; lots of standardization Pressure to cut prices (lots of price competition) Leasing companies take responsibility of maintenance Roughly 30% of the market are owner-operators are one-truck businesses Suppliers: labour (e.g., unionized, can strike, extract profits), engines (e.g., made by 2 companies who have bigger scale than truck assemblers), drive trains (e.g., large companies that produce larger volumes than truck companies) Entrants: easy to come in b/c there are many suppliers (low barriers) Substitution: b/c more flexible better than trains Higher energy prices will begin to limit overall pool of demand Rivalry: regulatory requirements, heavy competition on price, standardized product Trucks Threat of Substitute Products or Services ( + ) Bargaining Power of Suppliers ( -- ) Rivalry Among Existing Competitors ( -- ) Bargaining Power of Buyers ( -- ) Threat of New Entrants ( -- ) First level of thinking about positioning Understanding structure also informs positioning (insights) Take existing structure as given; but identify where there are opportunities Find a position of industry less exposed When we understand industry structure, it helps us understand the forces that drive profitability E.g., heavy trucks � which has low profitability Buyers: buy many trucks at the same time Big orders (20-50 trucks) which can make/break economics of production; lots of standardization Pressure to cut prices (lots of price competition) Leasing companies take responsibility of maintenance Roughly 30% of the market are owner-operators are one-truck businesses Suppliers: labour (e.g., unionized, can strike, extract profits), engines (e.g., made by 2 companies who have bigger scale than truck assemblers), drive trains (e.g., large companies that produce larger volumes than truck companies) Entrants: easy to come in b/c there are many suppliers (low barriers) Substitution: b/c more flexible better than trains Higher energy prices will begin to limit overall pool of demand Rivalry: regulatory requirements, heavy competition on price, standardized product Trucks Threat of Substitute Products or Services ( + ) Bargaining Power of Suppliers ( -- ) Rivalry Among Existing Competitors ( -- ) Bargaining Power of Buyers ( -- ) Threat of New Entrants ( -- )

8. Paccar Competitive Positioning

Focus on owner-operators Design trucks with special features and amenities Customization and build-to-order Achieve low truck operating costs Offer extensive roadside assistance to truckers NOTE: need value proposition / Strategic Positioning slide for PACCAR Paccar built strategy around owner-operators to capture premium price for their product Less clout Less price sensitive for truck itself Fleet, have own facilities Avoid �prestige� Avoid large buyers PACCAR understood that many buyers are powerful, except owner-operators Basically small businesses, these customers drive 300+ days a year, sleep in their own trucks, contract out to big trucking firms What do they want? Their own truck (which is basically their own house) Like chrome, special paint-jobs, comfortable sleeping compartments, microwaves, sophisticated audio/radio systems, tv�s, etc. Very concerned about operating cost � b/c they�re contracted out Higher willingness to pay for customization Sensitive to break-downs b/c if they aren�t moving they�re losing income (livelihood is under threat) PACCAR focused on these customers, and thus moved away from the powerful groups within the industry Designed trucks with various, special features; built to order Devised flexible production process; with factories built to customize ? meaning less inventory risk Looked to lower operating costs for truck owners (e.g., aerodynamic designs, other cost savings) Provide lots of service, and a large national network This has resulted in tremendous customer loyalty (with a high resale value for customized trucks) PACCAR successfully isolated itself from the negative forces ? thus the high long-run ROICNOTE: need value proposition / Strategic Positioning slide for PACCAR Paccar built strategy around owner-operators to capture premium price for their product Less clout Less price sensitive for truck itself Fleet, have own facilities Avoid �prestige� Avoid large buyers PACCAR understood that many buyers are powerful, except owner-operators Basically small businesses, these customers drive 300+ days a year, sleep in their own trucks, contract out to big trucking firms What do they want? Their own truck (which is basically their own house) Like chrome, special paint-jobs, comfortable sleeping compartments, microwaves, sophisticated audio/radio systems, tv�s, etc. Very concerned about operating cost � b/c they�re contracted out Higher willingness to pay for customization Sensitive to break-downs b/c if they aren�t moving they�re losing income (livelihood is under threat) PACCAR focused on these customers, and thus moved away from the powerful groups within the industry Designed trucks with various, special features; built to order Devised flexible production process; with factories built to customize ? meaning less inventory risk Looked to lower operating costs for truck owners (e.g., aerodynamic designs, other cost savings) Provide lots of service, and a large national network This has resulted in tremendous customer loyalty (with a high resale value for customized trucks) PACCAR successfully isolated itself from the negative forces ? thus the high long-run ROIC

9. Determinants of Relative Performance

Differentiation (Higher Price) Lower Cost Competitive Advantage Positioning within the industry is most obvious role of strategists Superior performance within industry Seeking out competitive advantage is the reason for strategic positioning, and should translate into one of two things: a premium price or low costs Many companies �muddle� along, and don�t think to become superior: look for �white space� within the industry Look for new trends, features, etc. In last decade, there have been lots of companies deploying the internet Lost sight of profitability (which created a disaster) Important to connect strategy to income statement and balance sheet How can a company increase relative profitability? Drive up prices (premium pricing) Drive down costs, while maintaining acceptable quality Any strategic position needs to do one of these two things Focus on price or lower structural costs Fundamental to strategic thinking Must connect to profitability, otherwise, will get into lots of trouble. Firm must decided what is it�s position Should be based on quantifiable metrics/analysis Premium Price Value for customer Lower total costs of doing business Better meet against needs Lower costs relative to competitors Structural, enduring efficiency in doing business versus one time Positioning within the industry is most obvious role of strategists Superior performance within industry Seeking out competitive advantage is the reason for strategic positioning, and should translate into one of two things: a premium price or low costs Many companies �muddle� along, and don�t think to become superior: look for �white space� within the industry Look for new trends, features, etc. In last decade, there have been lots of companies deploying the internet Lost sight of profitability (which created a disaster) Important to connect strategy to income statement and balance sheet How can a company increase relative profitability? Drive up prices (premium pricing) Drive down costs, while maintaining acceptable quality Any strategic position needs to do one of these two things Focus on price or lower structural costs Fundamental to strategic thinking Must connect to profitability, otherwise, will get into lots of trouble. Firm must decided what is it�s position Should be based on quantifiable metrics/analysis Premium Price Value for customer Lower total costs of doing business Better meet against needs Lower costs relative to competitors Structural, enduring efficiency in doing business versus one time

10. Foundations of Competitive AdvantageThe Value Chain

In any business company performs many different activities (every company is a value chain) All differentiation comes from something you do in the Value Chain that customer is willing to pay for, or which lowers cost Price + cost advantage emanates from value chain All competitive advantage comes from the value chain Higher price? (b/c you give some higher benefit to clients) Lower cost? (b/c of specific activities that the company does especially/uniquely Strategy is choices about how to conduct activities in the value chain How to generate superior position? How can configure each activity? How relate to other activities? Set of choices For each business ? how configure each activity, then relate activities. Key systemic tool is the value chain ? identifies where competitive advantages/disadvantages come from Value chain lays out systematically the activities performed by the business well) Must tie competitive advantage to value chain �Business Model� ? value chain is more rigorous Performance emanates from value chain In any business company performs many different activities (every company is a value chain) All differentiation comes from something you do in the Value Chain that customer is willing to pay for, or which lowers cost Price + cost advantage emanates from value chain All competitive advantage comes from the value chain Higher price? (b/c you give some higher benefit to clients) Lower cost? (b/c of specific activities that the company does especially/uniquely Strategy is choices about how to conduct activities in the value chain How to generate superior position? How can configure each activity? How relate to other activities? Set of choices For each business ? how configure each activity, then relate activities. Key systemic tool is the value chain ? identifies where competitive advantages/disadvantages come from Value chain lays out systematically the activities performed by the business well) Must tie competitive advantage to value chain �Business Model� ? value chain is more rigorous Performance emanates from value chain

11. Achieving Superior PerformanceOperational Effectiveness is Not Strategy

Do the same thing better Do things differently to achieve a different purpose How to achieve superior performance: two components Both are important, and both must be done by managers Operational Effectiveness is 95% of the job / work (this is a given) Managers need to assimilate and extend best practices (which are being developed every day) Hard to stay ahead Strategic position ? about being different to achieve different result Risk: there is a gravitational pull toward operational effectiveness Unique value is usually generated in strategic positioning Strategic Positioning ? not because its better Airbus (product design, custom wiring businesses) What is the role of technology? OE is not strategy Many businesses, many best practices e.g., production machinery, IT systems, control of supply chain, bar-coding (RFID) Learn and assimilate best practices (one part of success is operational effectiveness) if improving operational effectiveness requires a better CAD system ? go out and get it Though, need to be quick to learn from best companies Very big part of leadership management is best practices Operational effectiveness (OE) is not a choice, it�s a necessity If company is not operationally effective, strategy doesn�t matter However, simply being operationally effective will not usually produce a lasting competitive advantage Because others can copy new techniques/best practices Operational effectiveness is about doing some things better Strategic positioning is about doing things differently; to create sustained competitive advantage Most firms do both simultaneous ? and must make choices about how to act PACCAR is always looking for new machinery/techniques, but clearly differentiating based on chosen customers #1 mistake is focusing on operational effectiveness as strategy (ie., imitate the other guy) Can spend all your time doing this Unlikely to be truly successful If you neglect strategic positioning, you can find yourself like a hamster on a wheel � running hard, but standing stillHow to achieve superior performance: two components Both are important, and both must be done by managers Operational Effectiveness is 95% of the job / work (this is a given) Managers need to assimilate and extend best practices (which are being developed every day) Hard to stay ahead Strategic position ? about being different to achieve different result Risk: there is a gravitational pull toward operational effectiveness Unique value is usually generated in strategic positioning Strategic Positioning ? not because its better Airbus (product design, custom wiring businesses) What is the role of technology? OE is not strategy Many businesses, many best practices e.g., production machinery, IT systems, control of supply chain, bar-coding (RFID) Learn and assimilate best practices (one part of success is operational effectiveness) if improving operational effectiveness requires a better CAD system ? go out and get it Though, need to be quick to learn from best companies Very big part of leadership management is best practices Operational effectiveness (OE) is not a choice, it�s a necessity If company is not operationally effective, strategy doesn�t matter However, simply being operationally effective will not usually produce a lasting competitive advantage Because others can copy new techniques/best practices Operational effectiveness is about doing some things better Strategic positioning is about doing things differently; to create sustained competitive advantage Most firms do both simultaneous ? and must make choices about how to act PACCAR is always looking for new machinery/techniques, but clearly differentiating based on chosen customers #1 mistake is focusing on operational effectiveness as strategy (ie., imitate the other guy) Can spend all your time doing this Unlikely to be truly successful If you neglect strategic positioning, you can find yourself like a hamster on a wheel � running hard, but standing still

12. Five Tests of a Strategy

A unique value proposition compared to other organizations A different, tailored value chain Clear tradeoffs, and choosing what not to do Activities in the value chain that fit together and reinforce each other Strategic continuity with continual improvement in realization Strategy requires different choices in the value chain based on unique needs that the company is trying to meet Now we talk about how to develop a good strategy Do you (or does your company) have a strategy? Illustrate with interesting business examples; you�ll have to address in your own context if non-profit / government department Activities that fit together should be leveraged across the whole value chain Five characteristics of a good strategy Provide a unique value proposition for customers compared to competitors What is it? How do you conduct your business differently How is the value chain different? What giving up to be unique? Clear tradeoffs in the value proposition Integrated set of choices across the value chain Have long-term horizon (e.g., multiple years)+ Should be over a 3-5 year time horizonStrategy requires different choices in the value chain based on unique needs that the company is trying to meet Now we talk about how to develop a good strategy Do you (or does your company) have a strategy? Illustrate with interesting business examples; you�ll have to address in your own context if non-profit / government department Activities that fit together should be leveraged across the whole value chain Five characteristics of a good strategy Provide a unique value proposition for customers compared to competitors What is it? How do you conduct your business differently How is the value chain different? What giving up to be unique? Clear tradeoffs in the value proposition Integrated set of choices across the value chain Have long-term horizon (e.g., multiple years)+ Should be over a 3-5 year time horizon

13. Strategic PositioningIKEA, Sweden

Young, first time, or price-sensitive buyers who want stylish, space efficient and scalable furniture and accessories at very low price points. Modular, ready-to-assemble, easy to package designs In-house design of all products Wide range of styles displayed in huge warehouse stores with large on-site inventories Self-selection Extensive customer information in the form of catalogs, explanatory ticketing, do-it-yourself videos, and assembly instructions Ikea designer names attached to related products to inform coordinated purchases Long hours of operation Suburban locations with large parking lots On-site, low-cost, restaurants Child care provided in the store Self-delivery by most customers Distinctive Activities Value Proposition Is Ikea the best furniture retailer? Wrong question. Ikea has a brilliant strategy, based on a distinct value proposition They have competitive advantage in serving the needs of those customers they�ve chose Faced with many choices to differentiate from competitors Don�t imitate others (and are hard to imitate themselves) If no tradeoffs, easy to imitate Understand customers, and how Ikea can meet their needs Often need to foreclose options to create advantage Created a different/unique value proposition from other furniture retailers Unique approach (e.g., modular design leads to huge logistical savings) Not simple cuts at segmentation Aggregate or segment at common needs Note: In Europe, the proper Swedish pronunciation [ee-KAY-ah] is used throughout the region--not just in Sweden (e.g., in Germany, France, and elsewhere). What's interesting is that the American pronunciation [eye-KEY-ah] is the pronunciation they use in advertising here.Is Ikea the best furniture retailer? Wrong question. Ikea has a brilliant strategy, based on a distinct value proposition They have competitive advantage in serving the needs of those customers they�ve chose Faced with many choices to differentiate from competitors Don�t imitate others (and are hard to imitate themselves) If no tradeoffs, easy to imitate Understand customers, and how Ikea can meet their needs Often need to foreclose options to create advantage Created a different/unique value proposition from other furniture retailers Unique approach (e.g., modular design leads to huge logistical savings) Not simple cuts at segmentation Aggregate or segment at common needs Note: In Europe, the proper Swedish pronunciation [ee-KAY-ah] is used throughout the region--not just in Sweden (e.g., in Germany, France, and elsewhere). What's interesting is that the American pronunciation [eye-KEY-ah] is the pronunciation they use in advertising here.

14. Defining the Value Proposition

What Relative Price? What Customers? Which Needs? What end users? What channels? Which products? Which features? Which services? A novel value proposition often expands the market Premium? Discount? When considering value proposition, should answer three questions What customers do you want to serve to deliver unique value? What needs of customers are you trying to meet? What relative price are you offering? (premium? discount? same?) Must have different answers from competitors Otherwise, just competing on operational excellence Must do something different And be able/in a position to explain that to customers Competing on operational effectiveness may allow a customer to survive, but not thrive Each company needs a different answer Is it clear that the value proposition is different? Does the customer understand the difference? When considering value proposition, should answer three questions What customers do you want to serve to deliver unique value? What needs of customers are you trying to meet? What relative price are you offering? (premium? discount? same?) Must have different answers from competitors Otherwise, just competing on operational excellence Must do something different And be able/in a position to explain that to customers Competing on operational effectiveness may allow a customer to survive, but not thrive Each company needs a different answer Is it clear that the value proposition is different? Does the customer understand the difference?

15. Strategic PositioningBMW

Value Proposition Distinctive Activities Source: Draws on research conducted by Harvard Business School students M. Collardin, F. Cueto, J. Encinar, A. Gonzalez, A. Kulyk, and D. Smith, April 1997 Most automotive companies don�t have strategies Compete on tiny differences (e.g., style) Very few are successful Operate in an industry where being big isn�t necessarily a benefit GM makes every type of car, thought it would make them grow (not a good strategy) BMW has a clear understanding of who they are, and what their customers want What type of products they offer BMW does not have a mission or a vision statement. Source: Email from Andreas Metzner on behalf of; Konzernbuero Muenchen [Konzernbuero.Muenchen@bmw.de]Most automotive companies don�t have strategies Compete on tiny differences (e.g., style) Very few are successful Operate in an industry where being big isn�t necessarily a benefit GM makes every type of car, thought it would make them grow (not a good strategy) BMW has a clear understanding of who they are, and what their customers want What type of products they offer BMW does not have a mission or a vision statement. Source: Email from Andreas Metzner on behalf of; Konzernbuero Muenchen [Konzernbuero.Muenchen@bmw.de]

16. Five Tests of a Strategy

A unique value proposition compared to other organizations A different, tailored value chain Clear tradeoffs, and choosing what not to do Activities in the value chain that fit together and reinforce each other Strategic continuity with continual improvement in realization Strategy requires different choices in the value chain based on unique needs that the company is trying to meet Now we talk about how to develop a good strategy Do you (or does your company) have a strategy? Illustrate with interesting business examples; you�ll have to address in your own context if non-profit / government department Activities that fit together should be leveraged across the whole value chain Five characteristics of a good strategy Provide a unique value proposition for customers compared to competitors What is it? How do you conduct your business differently How is the value chain different? Clear tradeoffs in the value proposition Integrated choices across the value chain Have long-term horizon (e.g., multiple years)+ Should be over a 3-5 year time horizonStrategy requires different choices in the value chain based on unique needs that the company is trying to meet Now we talk about how to develop a good strategy Do you (or does your company) have a strategy? Illustrate with interesting business examples; you�ll have to address in your own context if non-profit / government department Activities that fit together should be leveraged across the whole value chain Five characteristics of a good strategy Provide a unique value proposition for customers compared to competitors What is it? How do you conduct your business differently How is the value chain different? Clear tradeoffs in the value proposition Integrated choices across the value chain Have long-term horizon (e.g., multiple years)+ Should be over a 3-5 year time horizon

17. Stress tradeoffs IKEA Whole Foods (not one stop shopping) Paccar Enterprise Tradeoffs: can�t implement two strategies at the same time You won�t appeal to everyone Good strategies involve tradeoffs To have a good strategy, a firm must decide what not to do as well What have you chosen not to do? What do you stand for? Not offer services Not meet every need Not serve every customer, bid on every contract Deliberately not doing something can sometimes be seen as an excellent adherent to strategy Should be able to answer the question: �what won�t you do?� Will you turn down an order? Don�t want to confuse strategy or defocus the marketing plan Salesman should not call on certain types of customers (not if you have an clear/effective strategy) All business is not good (should focus on where firm has an advantage) No honor in simply getting lots of ordersStress tradeoffs IKEA Whole Foods (not one stop shopping) Paccar Enterprise Tradeoffs: can�t implement two strategies at the same time You won�t appeal to everyone Good strategies involve tradeoffs To have a good strategy, a firm must decide what not to do as well What have you chosen not to do? What do you stand for? Not offer services Not meet every need Not serve every customer, bid on every contract Deliberately not doing something can sometimes be seen as an excellent adherent to strategy Should be able to answer the question: �what won�t you do?� Will you turn down an order? Don�t want to confuse strategy or defocus the marketing plan Salesman should not call on certain types of customers (not if you have an clear/effective strategy) All business is not good (should focus on where firm has an advantage) No honor in simply getting lots of orders

18. Strategic TradeoffsIKEA, Sweden

Product Low-priced, modular, ready-to-assemble designs No custom options Furniture design driven by cost, manufacturing simplicity, and style Value Chain Centralized, in-house design of all products All styles on display in huge warehouse stores Large on-site inventories Limited sales help, but extensive customer information Long hours of operation IKEA Typical Furniture Retailer Need to foreclose options to create advantage: if no tradeoffs, easy to imitate Choices in value chain involve Ikea: makes clear decisions Value Proposition Young, space sensitive, or price sensitive buyers Low-priced, modular, ready-to-assemble designs No custom options Set of Activities Centralized, in-house design of all products Furniture design and manufacture driven by cost and style All styles on display in huge warehouse stores Large on-site inventories Extensive customer information to support self-selection Long hours of operation Child care provided in the store Principally self delivery by customers Typical Furniture Store Value Proposition Middle income customers Higher priced, fully assembled products Customization of fabrics, colors, finishes, and sizes Set of Activities Source some or all lines from outside suppliers Design and manufacturing driven by image, materials, varieties Medium sized showrooms with limited portion of available models on display Limited inventories / order with lead time Store sales personnel provide extensive product information and assistance Traditional retail hours No arrangements for children Store provides deliveryNeed to foreclose options to create advantage: if no tradeoffs, easy to imitate Choices in value chain involve Ikea: makes clear decisions Value Proposition Young, space sensitive, or price sensitive buyers Low-priced, modular, ready-to-assemble designs No custom options Set of Activities Centralized, in-house design of all products Furniture design and manufacture driven by cost and style All styles on display in huge warehouse stores Large on-site inventories Extensive customer information to support self-selection Long hours of operation Child care provided in the store Principally self delivery by customers Typical Furniture Store Value Proposition Middle income customers Higher priced, fully assembled products Customization of fabrics, colors, finishes, and sizes Set of Activities Source some or all lines from outside suppliers Design and manufacturing driven by image, materials, varieties Medium sized showrooms with limited portion of available models on display Limited inventories / order with lead time Store sales personnel provide extensive product information and assistance Traditional retail hours No arrangements for children Store provides delivery

19. Typical Thinking on the Sources of Competitive Advantage

�Key� Success Factors �Core� Competencies �Critical� Resources Competitive advantage is seen as concentrated in a few parts of the value chain See at work at Progressive for use in diversification Science Current management thinking here has been dangerous Focus on �core competencies�, etc. Successful companies don�t have one or two key core competencies. Strategy must be implemented across the entire value chain. See at work at Progressive for use in diversification Science Current management thinking here has been dangerous Focus on �core competencies�, etc. Successful companies don�t have one or two key core competencies. Strategy must be implemented across the entire value chain.

20. Mutually Reinforcing Activities Zara Apparel

Source: Draws on research by Jorge Lopez Ramon (IESE) at the Institute for Strategy and Competitiveness, HBS Wide range of styles Customers chic but cost-conscious Fit is leveraging what is different to be more different Tight coordination with 20 wholly-owned factories JIT delivery Little media advertising Word-of-mouth marketing and repeat buying Global team of trend-spotters Advanced production machinery Cutting- edge fashion at moderate price and quality Prime store locations in high traffic areas Extensive use of store sales data Majority of production in Europe Very flexible production system Very frequent product changes Activity choices not one at a time Strategy, is getting different activities to interconnect Choices that are all made together Zara owns its own trucks High-traffic area for stores Production in Europe (further production flexibility) If a competitor wishes to copy the business model, it must copy it all in order to succeed A successful strategy cannot be copied piecemeal ? it must be copied in its entirety Opposite of KSFs Activity choices not one at a time Strategy, is getting different activities to interconnect Choices that are all made together Zara owns its own trucks High-traffic area for stores Production in Europe (further production flexibility) If a competitor wishes to copy the business model, it must copy it all in order to succeed A successful strategy cannot be copied piecemeal ? it must be copied in its entirety Opposite of KSFs

21. Involves commitment / must make a bet Find/need robust customer needs Expanding vs. contracting needs Dell case Companies that often change direction are simply responding to trends Structural advantage Are you going to stick with it? Need a minimum of 3 years for strategy to bear fruit Employees and customers need recognize your strategy, suppliers need time to adapt Align brand with reality Mistake to try and change strategies all the time (this is disruptive) Change can occur in how you realize the value proposition Involves commitment / must make a bet Find/need robust customer needs Expanding vs. contracting needs Dell case Companies that often change direction are simply responding to trends Structural advantage Are you going to stick with it? Need a minimum of 3 years for strategy to bear fruit Employees and customers need recognize your strategy, suppliers need time to adapt Align brand with reality Mistake to try and change strategies all the time (this is disruptive) Change can occur in how you realize the value proposition

22. Best versus unique Through customer surveys ? they ask for incompatible features/products that do not fit strategy Conventional wisdom leads to imitation Customers that request products that do not fit into the strategy / ask for incompatible features must be told �no� Conceptual Psychological incentivesBest versus unique Through customer surveys ? they ask for incompatible features/products that do not fit strategy Conventional wisdom leads to imitation Customers that request products that do not fit into the strategy / ask for incompatible features must be told �no� Conceptual Psychological incentives

23. Setting corporate strategy cannot be democratic The leader must decide with input from the team There can be no compromise � this leads to clear choices Strong leadership, requires a willingness to make choices Setting corporate strategy cannot be democratic The leader must decide with input from the team There can be no compromise � this leads to clear choices Strong leadership, requires a willingness to make choices

24. TradeoffsTradeoffs

25. Pressure to grow faster than industry can drive to loss of strategy Tough to maintain a clear strategy Grow beyond strategy ? impact on return on invested capital If managers understand the strategic mindset, then they can fight these pressures Amplified by poorly designed economic compensation Pressure to emulate peers (e.g., Pfizer) Pressure to grow faster than industry can drive to loss of strategy Tough to maintain a clear strategy Grow beyond strategy ? impact on return on invested capital If managers understand the strategic mindset, then they can fight these pressures Amplified by poorly designed economic compensation Pressure to emulate peers (e.g., Pfizer)

26. Leveraging Unique Activities Building off activities with true uniqueness Looking for new activity configurations and combinations

Migrate toward the chosen strategic position Focus incremental investments on reinforcing the chosen strategy Creatively segmenting product varieties, customer groups, and purchase occasions Exploiting Tradeoffs Identifying tradeoffs in the value proposition or in the value chain Capitalizing on Industry Dynamics Identifying strategic positions opened up by industry structural changes Finding a Unique Strategic Position Segmenting the Industry (not just the Market) Some of the tools that a company can use Examples Segmenting the industry: Enterprise Leveraging Unique Activities: Zara (design) Exploiting tradeoffs: Ikea Capitalizing on Industry Dynamics: Dell, E-Trade Some of the tools that a company can use Examples Segmenting the industry: Enterprise Leveraging Unique Activities: Zara (design) Exploiting tradeoffs: Ikea Capitalizing on Industry Dynamics: Dell, E-Trade

28. Growing Strategically

Make the strategy even more distinctive Introduce new technologies, features, products or services that are tailored to the strategy and which leverage other distinctive activities within the value chain 2. Deepen the strategic position (rather than broaden it) Raise the penetration of chosen customers / needs 3. Expand geographically to tap new regions or countries using the same positioning Aggressively reposition foreign acquisitions around the company�s strategy 4. Expand the market for what the company can uniquely deliver Find other customers and segments that value the strategy It is an illusion that growth (and especially profitability) are easier to achieve in untapped or growth segments It is difficult, and often dangerous, to try to grow faster than the underlying market for an extended period. Industry leaders should concentrate as much, or more, on growing the category as on growing share In many cases, shareholders are best served by earning a high return and returning capital, especially via dividends

29. Strategy

What Is a Strategy? What is Not a Strategy? Best practice improvement Execution Aspirations A vision A brand Learning Agility Flexibility Innovation The Internet (or any technology) Downsizing Restructuring Mergers / Consolidation Alliances / Partnering Outsourcing Internationalizing Networking A unique value proposition compared to other organizations A different, tailored value chain Clear tradeoffs, and choosing what not to do Activities that fit together and reinforce each other Strategic continuity with continual improvement in realization Important to know the answer to both of these questions Important to understand what is not a strategy, but this is not sufficient These represent pitfalls when considering what is strategy Use them to your advantage (but don�t simply follow what others are doing) Firms need to be agile in pursuing strategy, not just jumping in every direction That said, the items on the right may all be good activities to do Networks are not a strategy ? tool that can reinforce strategy To do what? How destructive? How capture value? Important to know the answer to both of these questions Important to understand what is not a strategy, but this is not sufficient These represent pitfalls when considering what is strategy Use them to your advantage (but don�t simply follow what others are doing) Firms need to be agile in pursuing strategy, not just jumping in every direction That said, the items on the right may all be good activities to do Networks are not a strategy ? tool that can reinforce strategy To do what? How destructive? How capture value?

30. The Role of Leaders in Strategy

Commitment to strategy is tested every day Drive operational improvement, but clearly distinguish it from strategy Lead the process of choosing the company�s unique position The CEO is the chief strategist The choice of strategy cannot be entirely democratic Communicate the strategy relentlessly to all constituencies Harness the moral purpose of strategy Maintain discipline around the strategy, in the face of many distractions. Decide which industry changes, technologies, and customer needs to respond to, and how the response can be tailored to the company�s strategy Measure progress against the strategy using metrics that capture the implications of the strategy for serving customers and performing particular activities Sell the strategy and how to evaluate progress against the strategy to the financial markets Firms must commit to strategy in downturns Leaders have a lot of jobs; strategy is the most important one Success in financial markets is a measure of how strategy has progressed (and how well strategy has been sold) Otherwise, outsiders will define the strategy Developing/acting on a strategy doesn�t work well without leadership Making strategic decisions is not about making everyone happy. Don�t: Implement everyone�s ideas Say yes to all ideas Copy competitors strategic decisions (though, adopt industry best practices) It should be uncomfortable to compete in an unique way But that�s how the great companies became greatFirms must commit to strategy in downturns Leaders have a lot of jobs; strategy is the most important one Success in financial markets is a measure of how strategy has progressed (and how well strategy has been sold) Otherwise, outsiders will define the strategy Developing/acting on a strategy doesn�t work well without leadership Making strategic decisions is not about making everyone happy. Don�t: Implement everyone�s ideas Say yes to all ideas Copy competitors strategic decisions (though, adopt industry best practices) It should be uncomfortable to compete in an unique way But that�s how the great companies became great

31. Paradox of Downturn Need strategy even more to guide, set priorities, stay focused Very harsh medicine Return to economic fundamentals vs. change new trends Profitability / ROIC Cut / shrink with strategy in mind, not across board cuts Don�t overreact to distress conditions (unusual not representative) Stock prices out of whack take advantage of freedom Short term stock price doesn�t matter Non-incremental moves are possible (discontinuities)Paradox of Downturn Need strategy even more to guide, set priorities, stay focused Very harsh medicine Return to economic fundamentals vs. change new trends Profitability / ROIC Cut / shrink with strategy in mind, not across board cuts Don�t overreact to distress conditions (unusual not representative) Stock prices out of whack take advantage of freedom Short term stock price doesn�t matter Non-incremental moves are possible (discontinuities)