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November–December 1996 Issue EXPLORE THE ARCHIVE
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 Effectiveness 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 efficiencies. 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
effectiveness 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 Effectiveness: Necessary but Not Sufficient
Operational effectiveness and strategy are both essential to superior
performance, which, after all, is the primary goal of any enterprise. But they
work in very different ways.
A company can outperform rivals only if it can establish a difference 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 efficiency results in lower average
unit costs. A company can outperform rivals only if it can establish a difference that it
can preserve.
Ultimately, all differences 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
efficiently than competitors. Similarly, differentiation 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 effectiveness (OE) means performing similar
activities betterthan rivals perform them. Operational effectiveness includes
but is not limited to efficiency. 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 different activities from rivals’ or performing
similar activities in different ways.
Differences in operational effectiveness among companies are pervasive.
Some companies are able to get more out of their inputs than others because they eliminate wasted effort, employ more advanced technology,
motivate employees better, or have greater insight into managing particular
activities or sets of activities. Such differences in operational effectiveness
are an important source of differences in profitability among competitors
because they directly affect relative cost positions and levels of
differentiation.
Differences in operational effectiveness were at the heart of the Japanese
challenge to Western companies in the 1980s. The Japanese were so far
ahead of rivals in operational effectiveness that they could offer 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 effectiveness, it moves toward the frontier. Doing so
may require capital investment, different personnel, or simply new ways of
managing.
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 effectiveness. Through programs such as TQM, timebased competition, and benchmarking, they have changed how they perform
activities in order to eliminate inefficiencies, 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 difficult 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 differentiation simultaneously. What were once believed to be real trade-offs—between defects and costs, for example
—turned out to be illusions created by poor operational effectiveness.
Managers have learned to reject such false trade-offs.
Constant improvement in operational effectiveness is necessary to achieve
superior profitability. However, it is not usually sufficient. Few companies
have competed successfully on the basis of operational effectiveness over an
extended period, and staying ahead of rivals gets harder every day. The
most obvious reason for that is the rapid diffusion 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—diffuse
the fastest. Witness the proliferation of OE techniques accelerated by
support from consultants.
OE competition shifts the productivity frontier outward, effectively raising the
bar for everyone. But although such competition produces absolute
improvement in operational effectiveness, 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, offering the same array of printing technologies (gravure and
web offset), 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, suffer from persistently low
profits. (See the insert “Japanese Companies Rarely Have Strategies.”)
The second reason that improved operational effectiveness is insufficient—
competitive convergence—is more subtle and insidious. The more
benchmarking companies do, the more they look alike. The more that rivals
outsource activities to efficient 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 effectiveness 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 effectiveness, 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
effectiveness 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 different. It means deliberately choosing
a different set of activities to deliver a unique mix of value.
Southwest Airlines Company, for example, offers short-haul, low-cost, pointto-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 differently or to perform different 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 offer 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, fullservice 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 offer 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 efficiency of maintenance.
The essence of strategy is choosing to perform activities differently 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 differently 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 offer 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.
In contrast, Ikea serves customers who are happy to trade off 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 offers 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 varietybased 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.
Strategic positions can be based on customers’ needs, customers’
accessibility, or the variety of a company’s products or services.
Jiffy Lube International, for instance, specializes in automotive lubricants and
does not offer 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, Jiffy 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 offer 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 lowcost 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 Jiffy 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.
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 differing needs, and when
a tailored set of activities can serve those needs best. Some groups of
customers are more price sensitive than others, demand different 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
different needs on different occasions or for different types of transactions.
The same person, for example, may have different needs when traveling on
business than when traveling for pleasure with the family. Buyers of cans—
beverage companies, for example—will likely have different 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. Differences in needs
will not translate into meaningful positions unless the best set of activities to
satisfy them also differs. 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 officer 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 office. Bessemer offers 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
officers and the highest personnel cost as a percentage of operating
expenses, Bessemer’s differentiation 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 office meetings are offered only for the largest
clients. Both Bessemer and Citibank have tailored their activities to meet the
needs of a different 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 different ways. Although their needs are similar to those of
other customers, the best configuration of activities to reach them is
different. I call this access-based positioning. Access can be a function of
customer geography or customer scale—or of anything that requires a
different 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 staff 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
differences 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 differ.
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 differences on the supply side; that is, of differences in activities.
However, positioning is not always a function of differences on the demand,
or customer, side. Variety and access positionings, in particular, do not rely
on any customer differences. In practice, however, variety or access
differences often accompany needs differences. 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 o...
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