A Dozen Things I’ve Learned About Strategy, Business and Investing From Michael Porter

A Dozen Things I’ve Learned About Strategy, Business and Investing From Michael Porter

1.            “In many companies strategy is built around the value proposition, which is the demand side of the equation.  But …it's [also] about the supply side.” In his classic “Five Minute University” routine on Saturday Night Live the comedian “Father Guido Sarducci” pointed out: “Economics? Supply and Demand. That's it.'" What Michael Porter did after graduating from Harvard Business School was to go across the Charles River and get an Economics PhD.  Porter came back to the Harvard Business School to teach as a professor yelling: "Hey people, *supply* matters too when it comes to generating a profit." It’s that simple. If you have too much supply, then price drops to a point where there is no long term industry profit above the company's cost of capital.  That Michael Porter’s most important insight was to teach business school academics that demand *and supply* matters in determining profit is shocking, but there it is.  Sometimes you will hear a knucklehead saying moats don’t matter since all that matters is delivering customer value in innovative/disruptive ways. This ignores that fact that moats are about dealing with competitors - delivering value to customers is a different issue. Companies with strong moats are in a position to deliver more to customers if they desire. The idea that the supply of alternatives to what you sell does not matter in a business in insanity.

2.            “If there are no barriers to entry… you won't be very profitable.” If there is no impediment to new supply of what you sell competition among suppliers will cause price to drop to a point where there is no long term industry profit greater than the icost of capital.  Michael Porter calls a company’s barriers to entry a “sustainable competitive advantage.” Warren Buffett calls it a “moat.”  The two terms are essentially identical.  The principle is so simple and yet so many people think only about customers and not competitors as well.  Yes, innovate and deliver exceptional value for customers.  No, that is not necessarily enough for sustainable profitability.

3.            “It's incredibly arrogant for a company to believe that it can deliver the same sort of product that its rivals do and actually do better for very long.”  If you deliver the same product or service as your competitor you by definition don’t have a moat.  Competition will in that case be based on price and price-based competition inevitably degrades to a point where profit disappears.   Porter teaches:  “if customers have all the power, and if rivalry is based on price… you won't be very profitable.”  He adds: “Produc[ing] the highest-quality products at the lowest cost or consolidate[ing] their industry [is] trying to improve on best practices. That's not a strategy."

4.            “Competition for profits goes beyond established industry rivals to include four other competitive forces as well: customers, suppliers, potential entrants, and substitute products.” What you pay for inputs into what you make as a product or service determines whether you will have a profit.  If the supplier has wholesale transfer pricing power that company can take your profit in a process sometimes referred to as “supplier hold up.” Having a single supplier of any essential element of your business offering is a very bad idea.  Leave it to an ordinary business person in the food business to describe the problem simply: “There’s no rent control on restaurant rent, so even if we did start to be successful, the landlord could jack up our rent. A lot of restaurants get taken advantage of by landlords this way.” Similarly if you have only one buyer of what you make, you have also a huge wholesale transfer pricing problem.

5.            "Change is faster now than it was 10 or 15 years ago. Does that mean you shouldn't have a direction? Well, probably not." Yes, moats are harder to create and maintain than they ever were. Change is accelerating and more and more of the world is part of Nassim Taleb’s Extremistan. No, that does not mean that strategy, supplier hold up, etc. do not matter.  That it is harder to generate or maintain a moat does not mean that is any less important.

6.            “Strategy is about making choices, trade-offs; it's about deliberately choosing to be different…. “The essence of strategy is choosing what not to do.” One of the hardest things for many people in business is to not do something. One common example is the restaurant with a nearly endless menu. They often serve everything poorly and unprofitably.  

7.            “Operational effectiveness is about things that you really shouldn't have to make choices on; it's about what's good for everybody and about what every business should be doing.” That operational effectiveness is not strategy does not mean that operational effectiveness is any less important. It’s just a different activity. 

8.            “You don't have to have all the answers up front. Most successful companies get two or three or four of the pieces right at the start, and then they elucidate their strategy over time.” Startups may going to need some time to sort out their strategy. That’s perfectly fine and in fact to be expected for a firm that is seeking the massive returns that can come from optionality. Larger more established firms must not only try to profit from optionality but preserve revenue streams that already exist.  

9.            “Strategy can be seen as a set of relationship to profitability. Profitability is revenue minus costs.”  People who believe they can “exclude items” in calculating profit sometimes fool themselves when their original intent was just to fool others. 

10.          “Successful companies do not skate to where the puck will be—they define it.” Speaks for itself and besides I am over my self-imposed limit of 999 words.

11.          "Continuity of strategic direction and continuous improvement in how you do things are absolutely consistent with each other. In fact, they're mutually reinforcing." Speaks for itself.  

12.         “If people in the organization don't understand how a company is supposed to be different, how it creates value compared to its rivals, then how can they possibly make all of the myriad choices they have to make?"  Speaks for itself.