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Articles
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Ten Principles for Business Strategy
Developed from Competition Demystified, by Greenwald and Kahn
Originally published on Executive Excellence Publishing.
1. Strategy has to be clear, provide unambiguous direction, and set priorities. Otherwise, it will never provide the common direction that employees need and will become the source of endless debate among managers. General Electric has always been clear about it stated objectives - to be first or second in its individual markets and to focus relentlessly on operating efficiency. A major shortcoming of most current approaches to strategy formulation, including Michael Porter’s five forces model, is that they rarely generate such clear, durable strategic prescriptions. The competitive imperatives that underlie strategy formulation can lead to the kind of clarity that characterizes GE and also generate novel insights into a firm’s strategic possibilities.
2. Commodity businesses have only one strategic choice - efficiency. No one expects farmers to have business strategies. They cannot worry about dominating markets or outthinking competitors. Instead, they must operate as efficiently as possible: control costs, select appropriate mixes of crops to plant, and resist the temptation to invest resources in wasteful activities. Yet, in an important sense, this is a strategy. It sets clear priorities: operate as efficiently as possible; do not be distracted by dreams of market domination. The same rules apply to all commodity businesses, like oil, steel, mining, computer memory chips, and other products that are widely available, uniform, and trade in densely populated markets. Even the largest companies, like ExxonMobil, cannot worry about manipulating other world oil producers to their advantage or controlling distribution. Instead, they focus on being efficient throughout all their activities.
3. Many differentiated businesses are in the same boat. The critical factor in markets is not uniformity versus differentiation, but the process of entry and/or expansion by competitors. Even in the highly differentiated market of luxury cars, powerful brands like Cadillac are ultimately driven to the edge of profitability by new entrants. First the European car makers and then the Japanese entered the U.S. market for a share of the juicy profits that Cadillac and Lincoln had been earning. Even without undermining prices, this entry reduced both sales and margins. With fixed costs spread over fewer units, GM and Lincoln, like commodity producers, had to seek salvation in a relentless drive for efficiency. The process was repeated in Europe to brands like Mercedes and Jaguar. In general, without barriers to entry, an endless stream of potential and current competitors will undermine the profitability of even the most highly differentiated product. Moreover, the ever expanding list of competitors in these markets will make managing specific competitors both impossible and useless. Like more obvious commodity businesses, these are markets in which efficiency is the limit of strategy.
4. Barriers to entry are the most crucial determining factor in defining the kind of market in which a business competes. Only in markets with barriers to entry are strategic choices (other than efficiency) necessary and possible. Understanding barriers to entry is the essential starting point for strategy formulation.
5. Competitive advantages and barriers to entry go hand in hand. Barriers to entry, in turn, depend on competitive advantages that incumbent firms enjoy over potential entrants. If incumbent firms are not able to do economically valuable things that competitors cannot match, then they will operate, by definition, on a level competitive playing field, one with no barriers to entry to keep out other competitors. Identifying the existence and nature of competitive advantages is where strategy proper begins.
6. There are three types of competitive advantages. First, an incumbent firm may have a lower cost structure, i.e. supply advantages, than competitors, due either to proprietary technology or special resources that cannot be hired away. Second, the incumbent firm can have unmatchable access to customers, i.e. demand advantages. Customers may be captive due to habit, the cost of searching for better alternatives, or the cost of switching to those alternatives. Finally, if economies of scale exist, then an incumbent firm that is able to defend its greater market share (this requires some degree of customer captivity or at least inertia) will enjoy the scale advantages of lower costs, or with network effects, greater demand.
Economies of scale produce the most durable competitive advantages. Resource and technology advantages will disappear with technological change. Captive customers ultimately pass on to other markets; they move, age, or die. The key to sustainability is a competitive advantage in acquiring new technologies and/or new customers, and here economies of scale are essential. Intel has dominated the market for CPU chips over many generations because it is many times the size of competitors like AMD and so can spend much more on R&D in pursuit of each new generation of chips. The same process applies to Microsoft and to Coca Cola (with advertising replacing R&D) in the race for new customers.
7. Strategy concerns markets. Business strategy must be formulated on a market by market basis. Strategies are about competition, and competition exists within markets, not across all the lines of business in which a company may participate. As General Electric has long recognized, strategy is a matter of dominating a particular market, either alone or in concert with a limited number of competitors. The key to such dominance is superior technology, customer captivity, and ultimately economies of scale.
8. Identify advantages, strengthen them, deal with identifiable competitors. If, in a particular market, a company can identify advantages that it enjoys over competitors, then it should design a strategy that makes the most of those advantages - maintaining its cost advantage, strengthen customer captivity, and paying attention to limiting potential entry or expansion by small competitors. It also has to consider a wary cooperation with equally advantaged firms, especially taking steps to avoid costly price wars. If it cannot identify its competitive advantages, then efficient operation is the only strategy. If it turns out that other firms enjoy these advantages and the company does not, it should have the discipline not to enter or expand in this market, no matter how lucrative it may appear.
9. Think local; limited markets are easier to dominate. An implication of this emphasis on barriers to entry is that narrowly defined, local markets, are likely to be far more strategically attractive than broad ones. Large global markets will usually accommodate a number of competitors at efficient scale and therefore are not ones in which a small number of firms can reserve scale advantages for themselves. Small local markets, local in either geographic or product space, can be more easily occupied and dominated. Expansion at the edges of these markets, to which the basic scale advantages may be extended, becomes a sustainable and profitable growth strategy. This is precisely the course that the great value creators of the recent past, Microsoft, Intel, and Wal-Mart, have pursued in stark contrast to the broader strategies of less successful competitors like Apple, Texas Instruments, and Kmart. And it almost certainly accounts for the greater success in telecommunications that local companies, such as the former Bell operating companies, have achieved, when compared to national competitors like AT&T and MCI.
10. Services are largely local; in a global economy, well run services businesses have the potential to be islands of profitability. Economies of scale in functions like advertising, distribution, management supervision, and service networks are inherently local; expansion beyond the region requires another round of capital investments. And knowledge of customer-client-patient tastes and needs is also rooted in a local presence. As services become ever more dominant in developed economies, the prospects are bright for those firms that can establish a local dominance and satisfy their customers.
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