This is a primer on the generally accepted “academic” definition of the word STRATEGY. I intend to write a few company specific posts in the coming days so I want build a foundation first. To anyone with a MBA or studied Michael Porter this is probably elementary, but for other hopefully its somewhat enlightening.

While Porter’s five forces are generally considered his most well-known contribution to the field; much more important, in my opinion, is his thesis that:

1. Strategy = tradeoffs. Its about making CHOICES when you are FORCED by the market/customer/competition to make. It’s a deliberate decision that makes your company different from everyone one else

2.Operational Efficiency (OE) /= strategy. OE decisions are things that companies do that they dont have to make choices on. It whats good for EVERYONE that everyone SHOULD be doing.

3.OE /= sustainable competitive advantage. Because the rapid diffusion of most innovations and processes, OE is not sustainable and only connotes temporal advantages while OE is waiting to be diffused. Porter often uses Japan’s auto industry’s focus on OE innovations such as JIT, Kaiban, and the likes as a case in point of the fact that OE provides temporary competitive advantages but in the long-run, competitors catches up and renders those advantages null.

4.OE + Strategy = Fit = Sustainable competitive advantage. Lots of people think that Porter belittles OE, but the truth is that he believes OE is the pre-requisite while strategy is the differentiator for creating competitive advantage. They are equally important, just that strategy requires more thought & choice. Furthermore, individual decision on OE must fit with the overall strategy to re-enforce and create barriers to imitation. (Porter calls them “activity systems”)

5.Failure to make tradeoff = straddling penalty. To quote Porter, “Companies that try to be all things to all customers risk confusion in the trenches…Positioning trade-offs are pervasive in competition and essential to strategy. They create the need for choice and purposefully limit what a company offers. They deter straddling or repositioning, because competitors that engage in those approaches undermine their strategies and degrade the value of their existing activities.”

Taking a page from the finance field using a variation of Markowitz’s efficient frontier, Porter synthesizes his theories using the same concept.

The “efficiency frontier” is the collection of best practices, processes and technologies that allow a company to operate at maximum profitability. Porter states that all companies must operate on this frontier in order to merely be competitive in their industries. The frontier is defined in 2 ways.

1. For a given cost to serve a customer (COGS + SG&A) what is the highest amount the buyers are willing to pay for a product or service.

– OR –

2. For a given price customers are willing to pay what is the lowest cost to serve that particular set of customers

As you can see, both company A and company C resides on the efficiency frontier. They have consciously made the decision to serve different end of the customer base (different willingness to pay) and create the most efficient cost structure for their business given the requirements of their different segments.

Company B is straddling. Given the willingness to pay of its customers, its cost structure is way too high compared to C. On the other hand, given its cost structure, C should be able to produce products and services that targets A’s customer base who are willing to pay more, but C is not.

In short

Deciding where on the efficiency curve to be on is STRATEGY

Getting from inside of the curve ON TO the curve is OPERATIONAL EFFICIENCY

Lastly, and most importantly for the technology industry, innovation in new processes and new products pushes out the efficiency frontier. In such a scenario company A, B, and C are no longer capturing as much profit as they should have. This creates opportunities for new companies (or existing companies) to leverage this new innovation to move to ANY part of the efficiency frontier and garner disproportionate amount of profit compared to its inefficient competitors. If this situation persists (A,B &C don’t re-position themselves) A,B&C will eventually go out of business.