MICHAEL PORTER on Strategic Innovation – Creating Tomorrow's Advantages

An Innovation Excellence Classic: From an interview with Rowan Gibson

AS WE ENTER the twenty-first century, there is a pressing need for clear strategies. Because unless companies have a clear vision about how they are going to be distinctly different and unique, offering something different than their rivals to some different group of customers, they are going to get eaten alive by the intensity of competition.

There was a time when markets were forgiving, when there weren’t that many rivals and companies could drift along with ‘me-too’ strategies. But now ‘me-too’ strategies are punished quickly and mercilessly. So the stakes of having a clear strategy are higher.

Three Principles of Competitive Strategy

The first principle is that if everybody is competing on the same set of variables, then the standard gets higher but no company gets ahead. And getting ahead-then staying ahead-is the basis of strategy: creating a competitive advantage. Strategy is about setting yourself apart from the competition. It’s not just a matter of being better at what you do-it’s a matter of being different at what you do.

Increasingly, the companies that will be the true leaders will be those that don’t just optimize within an industry, but that actually reshape and redefine their industry. The important thing is to try to shape the nature of competition, to take control over your own destiny.

The second principle is that a good strategy makes the company different. It gives the company a unique position. And a unique position involves the delivery of a particular mix of value to some array of customers which represents a subset of the industry. The fundamental truth in strategy is that a company simply cannot be all things to all people and do a very good job of it. Strategy requires choices. You have to decide what particular kind of value you want to deliver to whom.

Third, it’s not good enough just to be different. You’ve got to be different in ways that involve trade-offs with other ways of being different. In other words, if you want to serve a particular target customer group with a particular definition of value, this must be inconsistent with delivering other types of value to other customers. If not, the position is easy to imitate or replicate. So there must be trade-offs between what your competitors do and what your company does. If there are no trade-offs, then everything can be easily and cheaply imitated. And that leads, of course, to a mutually destructive battle. Companies end up competing for the same set of customers using the same set of inducements. This is usually a loser’s game.

The trouble is that companies hate making choices, because doing so always looks dangerous and limiting. They always want the best of all worlds. It’s psychologically risky to narrow your product range, to narrow the range of value you are delivering or to narrow your distribution. And this unwillingness to make choices is one of the biggest obstacles to creating a winning strategy.

RG: When does it become necessary to change your competitive strategy?

It becomes necessary when the fundamental needs of the customer group shift. Or when the particular type of product is no longer distinct. A strategy must also change when the trade-offs are eliminated by new technology or customer changes.

Changes of this magnitude don’t happen very often. Strategy should rest on dimensions that are not like the difference between a short hemline and a long hemline. You don’t want to base the success of your company on a particular definition of value that is transient. Instead, it should be things like intensive after-sales support, the sheer durability of the product, the ruggedness of the product in the face of abuse out in the field. These more enduring sources of value are the basis of really great strategies.

The Importance of Strategic Innovation

As I stress in my book The Competitive Advantage of Nations, the ability to sustain an advantage from cheap labor or even from economies of scale – these are the old paradigms. These paradigms are being superseded. Today, the only way to have an advantage is through innovation. But this innovation has to involve a consistent strategic direction. There has to be a strategic vision within which you are

innovating. A company has to have something distinctive at the end of the day that it is reinforcing.

To me, innovation means offering things in different ways, creating new combinations. Innovation doesn’t mean small, incremental improvements – these are just part of being a dynamic organization. Innovation is about finding new ways of combining things generally.

The essential core of strategy is cross-functional or cross-activity integration. It’s not the ability to come up with a better production process or the ability to come up with a great ad. It’s the capacity to link and integrate activities across the whole value chain and to achieve complementarities across many activities. It’s where the way you do one thing allows you to do something else better.

Consider Wal-Mart’s strategy. Its success was based on a whole series of integrated activities. It was location plus warehousing, plus MIS, plus store manager autonomy, plus, plus, plus. So for K-Mart to match Wal-Mart, it would have to match a lot of what Wal-Mart does. It’s like a recipe: if you leave out one ingredient, the cake can collapse. To have a sustainable advantage, a company has to integrate across many activities to create a unique positioning involving trade-offs with rivals. It must be illogical or difficult for rivals to match everything you do, otherwise competition will be mutually destructive.

So if the essence of strategy is cross-functional, cross-activity integration, then  strategy shouldn’t only be the province of the leader. I believe that strategy should be developed in a multifunctional team, involving the leader and the people who are responsible for the principal activities in the business. And that strategy must be the joint product of those people. It’s a great mistake to try to subdivide strategic planning into pieces and then attempt to put the pieces back together. Ultimately, the essential issue is how to integrate across the pieces.

Globalization and “Innovation Clusters”

The first impact of globalization was to diminish the impact of location, by allowing international companies to gain an advantage over companies that were still stuck in a domestic orientation. So, in the first phase of globalization it was globalness itself which provided the advantage. That is, the capacity of a company to martial and mobilize inputs and assets across borders.

We are entering a new phase which is more counterintuitive, because now globalness is assumed. Now, a company must source inputs from the lowest-cost location. It must source capital internationally, not locally. It must locate plants in low-labor-cost nations if it has labor-intensive activities.

The presence of so many global markets and companies has essentially nullified the advantage of globalness per se. Anything a company can access from a distance is no longer a competitive advantage, because now everybody can access it.

This new phase of globalization is paradoxically putting a greater and greater premium on what I call the ‘home base’ – the unique critical mass of skill, expertise, suppliers and local institutions that makes certain locations the innovation centers in a particular business. There are numerous examples of industry clusters that have become the innovation centers in their fields. There’s Silicon Valley in microelectronics, Hollywood in the entertainment business, LosAngeles in multimedia.

A company’s odds of being successful in any given field are dramatically improved by location. The odds of becoming a world-class software company are much higher if you are located in the United States. The Japanese are still nowhere in software, although their government has poured millions into developing the industry. So whereas it used to be that the scale of the firm was important, now it is increasingly the scale of the innovation cluster – the network, the infrastructure – that is important. A given firm’s scale can be smaller if there are a lot of good suppliers around, if there are a lot of good supporting companies around.

In the future, nations are going to be increasingly competing for these home bases, because they are the sources of wealth and high wages. That’s where the development and innovation capabilities in any given business are going to be concentrated.

Technology vs Innovation

Fundamental shifts in technology can have an incredible impact on the importance of geographical location. My perspective is that, as changes in technology diminish the importance of certain aspects of location, these aspects become nullified as competitive advantages. So, in some sense, what happens is that new technology sweeps away potential advantages and therefore the residual advantages get more and more important.

It used to be that if you had access to capital at home, you had a competitive advantage. But now having a lot of capital at home is no longer an advantage, because technology and market developments have allowed companies outside of the country to get access to that capital.

It’s the same thing if we can have employees working at home and not needing to be at the company. It means that the things those people do will no longer be an advantage, because companies anywhere in the United States can tap in to people working at home through the same technology.

There is a constant process by which technology is nullifying traditional advantages of location. And, as it does that, it’s creating and elevating new advantages of location. Those new location advantages are more ‘innovation advantages’. This is a very subtle, much misunderstood issue.

It’s becoming popular for managers to dream about the virtual corporation that has no people, just a CEO who makes decisions. Nobody works at the company; they’re at home wired in on the Internet. Parts come together from India and all over the place. But if that’s the way the world is going to look then anybody can achieve it and advantages will be quickly replicated.

So in some sense, I find that managers have a curious fascination with ways of thinking that essentially destroy their competitive advantages.

Recalibrating Economies around Innovation

If we apply this thinking to economies rather than companies, governments have to understand first and foremost that there is a new paradigm of competitiveness. It’s a paradigm based on innovation. It’s a paradigm based on specialization – countries prosper in areas where they can achieve unique specialization and critical mass. They cannot try to be in everything.

Governments have to understand that everything they do needs to be recalibrated around the paradigm of innovation. Regulation has to shift from slowing change down to speeding it up. Countries need to have strict regulation that pushes companies to the next generation of technology, rather than retarding them at the last generation.

Governments also need to understand that the only way economies can be innovative is by having a lot of local competition. The idea that the way to win is to have a single large firm has been made obsolete by the fact that scale is no longer as important as it once was, and only rapid progress driven by competitive pressure will allow prosperity. If governments can grasp the fact that there is a new paradigm, then many of the policies for improving the competitiveness of their economies become relatively obvious.

RG: What needs to change inside organizations to create the cultural and constitutional conditions for strategic innovation?

First, we’ve got to set the goal of learning. The companies that are going to be able to become successful, or remain successful, will be the ones that can learn fast, can assimilate this learning and can develop new insights. I suspect that companies are going to have to become much more like universities than they have been in the past. Companies tended to think that they knew a lot, and therefore tried to be efficient in doing what they thought they knew. But it’s now a matter of learning.

In addition, companies have to create an environment where people don’t resist change but really expect it. An environment where companies cannibalize their own products, instead of waiting for some competitor to do it. Where companies render their own production processes obsolete rather than letting somebody else do it to them.

Finally, and most importantly, companies must reconnect with the whole idea of strategy. Success is more and more a function of making choices, and having the discipline to avoid the incredible pressures for compromise and distraction that are present if we’re going to compete successfully in the twenty-first century.”

Adapted from the chapter “Creating Tomorrow’s Advantages” originally published in Rethinking the Future (Nicholas Brealey Publishing) by Rowan Gibson.

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Michael Porter is one of the world’s leading experts on competitive strategy and international competitiveness. He is the author of 18 books and numerous articles including Competitive Strategy, Competitive Advantage, Competitive Advantage of Nations, and On Competition. Professor Porter is the most cited author in business and economics.

Rowan Gibson is widely recognized as one of the world’s leading experts on enterprise innovation. He is a co-founder of Innovation Excellence and author of the bestseller Innovation to the Core. Rowan Gibson is a much in-demand public speaker around the globe. On Twitter he is @RowanGibson