A Stout Porter: Business Strategy In the 21st Century
The Family Papers #028
By Nicolas Colin (Co-Founder & Director) | The Family
Exactly 20 years ago, Michael Porter, the mighty lord of business strategy, wrote an article in Harvard Business Review to discuss the simplest question: “What is strategy?” What he put forward were six fundamental principles that form the foundations of business strategy, later reinforced in a 2001 article dedicated to “Strategy and the Internet”.
Today, the strategic implications of software eating the world are easier to figure out — including for Porter himself. As the digital economy has become more visible and tech companies now dominate the global economy, we have a better grasp of how competing firms, both tech and non-tech, can apply the Porterian strategic positioning framework and build a competitive advantage that will be sustainable even on digital markets.
The fact that Porterian strategic positioning would one day apply to our radically new techno-economic paradigm hasn’t always been obvious for all. On the contrary, there has long been the temptation to consider that business strategy couldn’t fit into the radically new digital economy. “Ironically”, wrote Porter in 2001, “the popular business press, focused on hot, emerging industries, is prone to presenting these special cases as proof that we have entered a new era of competition in which none of the old rules are valid.”
But strategy, as it applies to various disciplines such as business, politics, sports, or warfare, is such a generic concept that it will likely survive any radical changes in the technological landscape. It could even prove all the more critical as the digital economy reveals itself as far more competitive than the norms seen in the Fordist economy. The tougher the competition, the more critical the strategic positioning!
This is why it is high time to put Porter’s thinking to use in the tech world and build on what he wrote about both strategy in general and the Internet in particular. As part of a long-term effort to upgrade strategic thinking for both our portfolio companies and established corporations, The Family is looking closely at the economy and competition through a Porterian lens. This paper discusses Porter’s principles from our point of view — that of a firm dedicated to investing in promising tech startups in Europe and turning them into long-term leaders on competitive global markets.
The Right Goal
1/ One of the primary sources of inspiration for founding The Family in 2013 was Babak Nivi’s “The Entrepreneurial Age”. It is worth quoting at length:
In the industrial and information ages, we learned how to put physics and information to great use. Physics and information were also the basis for an organization’s differentiation and victory.
In the entrepreneurial age, physics and information will be replaced by entrepreneurship: the ability to serve a customer at the highest level of quality and scale, simultaneously. We will learn to put entrepreneurship to great use and it will be the basis for an organization’s differentiation and victory.
This is not a statement that the winners are going to win. It is a statement that (1) the best strategy is to attempt to deliver the highest quality with the highest scale and (2) other types of differentiation should only be tactics that serve an organization’s entrepreneurial capability.
In between the lines, Nivi’s story is all about increasing returns, the single microeconomic feature that enables the best tech companies to tackle the heretofore impossible challenge of delivering the highest quality with the highest scale. As stressed in a previous issue, Nivi’s words suggest that increasing returns are now the right goal: business strategy should now be all about maximizing a company’s increasing returns to scale.
There’s a reason why so-called “tech companies” make extensive use of information and communication technologies in every part of their value chain: it is because those technologies, when properly used, make it so much easier to generate and maximize increasing returns (which is now synonymous with ‘to deliver the highest quality with the highest scale’ as well as with ‘to maximize long-term return on investment’). Once a firm starts using those technologies, all its competitors should follow (otherwise they’ll ultimately be wiped out of the market).
Increasing returns have a major consequence from a strategic point of view: they create a new competitive regime in which a single company ends up grabbing most of the market. When two companies driven by increasing returns compete on the same market, only one of them will be able to survive on the long term and realize a substantial return on its investment.
Because increasing returns are not well understood (yet), there is much confusion as to how the principles of business strategy apply to companies aiming to dominate the digital economy. The discussions around tech bubbles make it clear that Porter’s “right goal” is still elusive: at one moment the strategic goal is to grow whatever the cost; at another, it is to ensure longevity based on “unit economics”. If Porterian precepts were assimilated, we wouldn’t need to radically switch directions when a bubble bursts.
So let’s be clear: bubble or not, the right goal in the digital economy is not to be the market share leader or the most profitable company. It is to take the vast majority of the market, at (almost) any cost. Those who generate superior increasing returns are certain to crush their competition and realize a sizable return on investment over the long term: this is the path taken by Amazon in retail. Conversely, those who put the strategic emphasis on goals such as economies of scale or short-term shareholder returns will end up critically weaker in the digital economy’s new competitive regime.
A Value Proposition
2/ Having a clear value proposition is difficult in a more digital economy, for various reasons.
First, the boundaries between industries are blurred, which makes the playing field more difficult to define. In the digital economy, competition doesn’t happen on well-delineated markets served by traditional top-down industries. Quite the contrary, many tech companies are actually difficult to position within the boundaries of a single industry. Porter wrote about that in a 2014 HBR article dedicated to the Internet of Things:
The powerful capabilities of smart, connected products not only reshape competition within an industry, but they can expand the very definition of the industry itself. The competitive boundaries of an industry widen to encompass a set of related products that together meet a broader underlying need. The function of one product is optimized with other related products.
both sides of the market on board. Accordingly, they should devote much attention to their
business model, that is, to how they court each side while making money overall.”
Second, multi-sided business models, which are easier to operate in the digital world, make it even more difficult to articulate a value proposition. In the beginning, a company operating a two-sided business model has to focus on the side that doesn’t pay (users of Google’s search engine or of Facebook’s application, Uber’s drivers, Airbnb’s hosts). Then it must switch its focus to the other side (advertisers, riders, guests), which divides its attention. Once the two-sided business model is up and running at scale, the company’s carrying on two different activities, because it most certainly can’t let either of the two sides down. So what’s the value proposition? (Hint: it’s probably the one you make for the side with the wider network.)
Third, for quite some time there has been the illusion that the digital economy would enable endless diversification, with ever more sides added to ever more sophisticated business models. After all, if it’s just a question of moving some digits around, why not diversify without limits? The result, alas, is often the dilution of the initial value proposition into a vast ocean of various businesses that don’t have much in common.
Despite those adverse trends, though, it remains strategically important to have a single, identifiable, powerful value proposition. It is no coincidence that the best tech companies, however diversified, all have that kind of value proposition. Google is about organizing the world’s information. Facebook is about making the world more open and connected. Apple is about selling beautiful, easy-to-use devices. And Yahoo is about… not much, which is the reason why it has lost the privileged relationship it once had with its users. Remember that the value proposition is your message to the market.
While dominant tech companies improve their strategic positioning with a clear value proposition, we are also seeing established companies with value propositions that are either irrelevant or confused, having lost themselves along the way. Some companies diversified too much. Some have restructured their value proposition into thin air, becoming soulless, siloed organizations: those have lost sight of their customers’ interest due to an army of management consultants pushing operational effectiveness above all else. In the end, a company that lacks a value proposition only retains its customers due to a lock-in or a high barrier to entry. And that can’t last long in the digital economy that rewards high quality at a high scale.
Fortunately, it is always possible for those companies to dig a value proposition out of their long history. As put by Walter Kiechel, III, “your original corporate DNA probably continues to be at work somewhere in there”: you only have to find and revive it. Porter said much the same, as “the challenge is to refocus on the unique core and realign the company’s activities with it.” Having that kind of value proposition is critical for strategic positioning, whether software has already eaten your industry or not.
A Distinctive Value Chain
3/ A distinctive value chain, tailored to the company’s value proposition, serves the strategic purpose of differentiation. As written by Porter,
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.
By definition, a distinctive value chain is made of various activities. There are three caveats though.
First, that distinctive value chain should serve the right goal (maximizing increasing returns) and should be consistent with the company’s value proposition (see above).
A good example is an Apple store. Apple is a manufacturer and a tech company, so people initially questioned why it diversified into the retail business. The reason is that launching the Apple stores helped Apple better serve its own value proposition: selling beautiful, easy-to-use devices. And the success of that diversification can be read in the premium prices that only Apple can charge as it has achieved both superior operational effectiveness (better products built at a mastered cost) and strategic positioning through differentiation (Apple is the only tech company to be vertically integrated all the way down to the retail stores). It suffices to quote Babak Nivi again:
The best products require unique means of scaling. The delivery of the best products is tied into the product itself. For example, look at Apple’s efforts to develop new manufacturing techniques and stores for its products.
Chris Dixon’s model of full stack startups—“to build a complete, end-to-end product or service that bypasses existing companies”—is consistent with that approach. It draws the lessons of vertically integrated companies such as Apple, Tesla, and Netflix. And it leads to the conclusion that strategic positioning in the digital economy, instead of focusing on one single activity, should be about combining different activities within a single, distinctive value chain designed to deliver the highest quality with the highest scale. As written in our previous issue dedicated to Berkshire Hathaway:
It’s one (dangerous) thing to go in multiple directions trying to solve different problems at the same time. It’s another one (much better) to diversify along the stack while focusing on your customers and solving their problem. As pointed out by Balaji S. Srinivasan, solving a problem in its entirety may require a large and heterogeneous range of competencies, but it also “builds respect in your vertical. Now you can recruit the best people. Their experience + your code = invincible.”
Second, the kind of value chain a company operates depends entirely on the development stage. At the earliest stage, an Entrepreneur should sell their product themselves, take charge of communication, meet potential customers, do things that don’t scale—all by themselves, if only to learn critical tasks before they hire others to perform them.
Past product/market fit, the same Entrepreneur should focus on their customers while outsourcing many tasks to other companies. Outsourcing is all the more relevant as so many activities are now performed by other Entrepreneurs at a very high level of quality in exchange for a low price. As written by Nivi, “the continuous improvements in our ability to manipulate physics and information enable entrepreneurs to deliver services to other entrepreneurs — and these services are commoditizing every type of differentiation except product development and delivery.” Indeed Entrepreneurs have already begun taking over enterprise markets, advancing the collective goal of commoditizing scale. This interview with Marc Andreessen is worth reading:
Walmart’s advantage in logistics and in pricing and in data analytics was just so great that they could kill small retailers at will.
Today all the consumerized enterprise stuff is as easily usable by the small business as it is by the large business. In fact, it’s probably more easily usable by the small business than it is by the large business, because with a small business it’s like you can just use it, like you don’t have to go through a long process, you don’t have to have a lot of meetings, you don’t have to have committees, you don’t have to have all this stuff, you can just start picking up and using it.
So the best technology for inventory management and for financial planning and for sales-force management and for online marketing can now be used just as easily or more easily by a small business. There is an opportunity here for a shift of the balance of power for big businesses to small businesses.
It is only at the following stage, that of domination, that growing tech companies are confronted with the necessity to do many things in-house so as to integrate along the stack and build a sustainable competitive advantage. This doesn’t mean that firms should integrate too many heterogeneous activities. What it means is that decisions to integrate certain activities or not should be made in service to the firm’s strategy.
Indeed strategic positioning is the reason why Amazon operates its own logistics—and maybe it will soon operate its own last-mile delivery service, as last-mile logistics are crucial to create an exceptional customer experience. It’s also the reason why Netflix decided to enter the production business with original series such as House of Cards and Narcos: it looks like it’s far away from its business of operating a streaming application, but producing original series radically improves Netflix’s strategic positioning vis-à-vis right holders as well as competitors such as Amazon, HBO, and Hulu.
Diversifying along the stack at later stages also helps free companies from their dependence on competitors. Amazon Web Services helped Dropbox scale up and beat most of its competitors, but Dropbox has recently taken on the tough challenge of deploying its own cloud computing infrastructure. Similarly, Apple has ceased using Google Maps, choosing to deploy its own map system instead (and at great peril, although it now seems to be working quite well). As of this summer, it appears that Uber has similar plans.
The third caveat is that maybe—just maybe—the very notion of a value chain may be obsolete as the economy becomes more digital. The value chain was relevant in an economy where the various industries were clearly separated from one another, with those familiar pipeline-type industry-wide value chains. Now that more heterogeneous activities combine to serve the largest tech companies’ strategic positioning, it becomes more difficult to fit the concept of a value chain into business reality.
Two competing concepts can be found in the literature. One is the “value loop”, described in our previous issue “The Five Stages of Denial”:
We’re no longer in the paradigms of the mass production economy, where businesses competed against one another within a sector to divide up the total market. In the digital economy’s paradigms, businesses compete to win the one strategic resource that allows them to continue growing: the multitude. Capturing this resource involves deploying a value loop around individuals, “where everything has a place within a coherent whole, completely conceived around the quality of the user experience, and where the total value is difficult to slice apart” (see Henri Verdier’s original article — in French.) In this value loop, the user is enveloped, cajoled, dissuaded from looking elsewhere and potentially ceding to the siren song of other digital businesses.
(A slightly different notion of a “value loop” has been put forward more recently by Deloitte’s Michael E. Raynor and Mark Cotteleer.)
Another concept is the “stacked architecture” devised by the Boston Consulting Group’s Philip Evans and Patrick Forth, which stresses that in a digital economy marked by the fast pace of technology, business architecture (which sounds like a synonym for value chain) is not a given anymore:
Amazon is now run as four loosely coupled platforms, three of which are profit centers: a community host, supported by an online shop, supported by a logistics system, supported by data services. Unlike many of his rivals, Bezos saw business architecture as a strategic variable, not a given. He did not harness technology to the imperatives of his business model; he adapted his business model to the possibilities — and the imperatives — of technology.
By the way, the absence of reasoning in terms of a distinctive value chain in the digital economy could be related to the preference for reasoning in terms of business models. Indeed the dominance of the business model as a key structural concept in the digital economy may destroy incentives for strategic thinking: a strategy is designed for the prospective pursuit of Porter’s “right goal”, whereas a business model is discovered in retrospect as the company grows. Porter himself is highly skeptical when it comes to reasoning in terms of business models:
The misguided approach to competition that characterizes business on the Internet has even been embedded in the language used to discuss it. Instead of talking in terms of strategy and competitive advantage, Internet players talk about “business models.” This seemingly innocuous shift in terminology speaks volumes. The definition of a business model is murky at best. Most often, it seems to refer to a loose conception of how a company does business and generates revenue. Yet simply having a business model is an exceedingly low bar to set for building a company. Generating revenue is a far cry from creating economic value, and no business model can be evaluated independently of industry structure. The business model approach to management becomes an invitation for faulty thinking and self-delusion.
I won’t go as far as Porter, as I very much like and frequently use Steve Blank’s definition of a business model—it “describes how your company creates, delivers and captures value.” But there are problems with the concept. One such problem is the static nature of the common business model’s representation. As it assembles and arranges the puzzle pieces in juxtaposed boxes, the business model canvas lacks a dynamic dimension and as a result doesn’t do justice to what really makes a company thrives. (And even if I do like Blank’s definition, it’s true that we at The Family have actually ceased using the business model canvas altogether.)
Another problem is that business models inspire you to think about things like they’re a recipe. What recipe will you choose? Will it be social network, SaaS or marketplace? Will you build the “Facebook of Y” or the “Uber for X”? Will you monetize with sales or advertising? This is definitely not the way to build a distinctive value chain; indeed, quite the contrary: in the hyper-competitive environment that is the digital economy, the clearer your business model, the less distinctive your value chain—and the less strategic your positioning.
Take Amazon, whose business model we discussed at length here. Amazon is not a retailer. It’s not a conglomerate either. It is a constantly evolving technology company that (1) seals an alliance with its users primarily through an exceptional retail experience (driven by the systematic and regular monitoring of user-generated data), (2) subsidizes this experience’s constant improvement with the net revenue derived from operating a marketplace, and (3) protects its position by being a strong leader on the global cloud computing market as well as by diversifying in markets such as online video streaming. This, taken as a whole, is in fact a strategy more than it is a business model. And the only reason why most people still think that Amazon is nothing more than a larger retailer with cheaper prices is because nobody reads 35-minute-long stories ;-)
Trade-Offs
4/ Trade-offs are a critical milestone on the path to strategic positioning. And to be fair, trade-offs are a lesson that tech Entrepreneurs usually learn: as a startup, it matters less what you do and more what you don’t do. We can vouch that the best tech Entrepreneurs (at least in The Family) are trained to make trade-offs from Day One, and they hold onto this as a virtue as their companies scale up.
However, trade-offs tend to evolve as technology progresses and techno-economic paradigms shift as a result. Some trade-offs exist in a certain moment, and then disappear the next. If strategy is the art of embracing constraints, it should take into account the fact that the set of constraints evolves as time goes by. For instance, Porter points out that “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.” Thanks to operational innovation, Japanese car manufacturers broke that constraint and forced a realignment of the industry as a whole.
Likewise, in the digital economy, many Fordist trade-offs have become illusions: they persist in appearance, as Fordist companies driven by economies of scale refuse to seize the opportunities brought about by technology; but they effectively cease to exist as soon as a given company converts to the game of maximizing increasing returns. Suddenly you don’t need to make certain trade-offs; on the contrary, you must seek to have it all (because ultimately one of your competitors will do just that and will proceed to smash you into pieces).
One trade-off that doesn’t exist anymore is that between quality and scale. Increasing returns, the new “right goal” and a critical microeconomic feature in the digital economy, are key here. Once you generate them, the more you grow, the easier it is to provide high quality. Let me quote Nivi again:
In the past, scale (low cost, high distribution) was so difficult that organizations with bad products and great scale could win. And it was so difficult to scale the very best products that they never left the boutique.
The challenges of scale are now diminishing rapidly. Scale is now available as a service — see Foxconn (manufacturing), AWS (hosting) or Facebook Platform (distribution).
[In any case,] if you don’t scale quality, you will be shut out of the marketplace.
Another obsolete trade-off is that between growth and profitability. Traditional strategic positioning has an adversarial relationship with growth, as we’re reminded when reading Porter:
Too often, efforts to grow blur uniqueness, create compromises, reduce fit, and ultimately undermine competitive advantage. In fact, the growth imperative is hazardous to strategy.
But in fact, the magic with increasing returns is that it is possible for large companies to sustain growth and profitability simultaneously. As written in a previous issue:
Growth is just a byproduct of increasing returns after all, not a goal in itself. If strategic positioning is now about increasing returns, then growth is not the enemy of profitability: quite the contrary, growth is now correlated with profitability, as opposed to what existed in the Fordist economy. As suggested by this McKinsey paper, growth is even the best moat you can dig in a digital economy that’s becoming more competitive every day.
While certain trade-offs disappear, others rise in importance as the economy becomes more digital. Business executives must learn to understand them in order to find the right balance in the new techno-economic paradigm.
One such trade-off is that between the Northern side (activities ruled by economies of scale and traditional competitive advantages) and the Southern side (those activities which generate increasing returns). As a tech company, you may want to maximize your increasing returns by focusing on demand-side network effects. The problem is that, however dominant your company is at a given moment, it remains vulnerable because the competitive pressure never eases on digital markets. Hence you need a moat to keep competitors at a distance—even though that moat, because it embeds tangible assets in your organization, slows your growth down. The trade-off leads to deciding how much tangible substance you will embed in your intangible business (how much you’re exposed to the North).
The North/South trade-off can otherwise be seen as one between agility (Southern Side) and security (Northern Side). Digital technology makes it easy to grow fast, thanks to built-in network effects and supply-side platform effects: they contribute to increasing agility. Tangible assets, on the other hand, while they trigger dangerous diminishing returns, also constitute a moat that is more difficult for competitors to cross: they provide higher security. A few examples:
- Uber has chosen agility over security. Its increasing returns enable it to grow fast, but it also has to constantly fight with competitors (who seek to attract more drivers) and regulators (who would like Uber to comply with obsolete regulations);
- Netflix, on the other hand, has chosen security over agility. Its Southern side is mostly reduced to its recommendation algorithm, while diversifying into producing original series has enabled Netflix to strengthen its Northern Side, gaining security in the process;
- Amazon, in my eyes, is one of the few companies that have found the perfect balance between the two sides: a strong Northern Side, dominated with its world-class logistics (and soon delivery services), is balanced with an equally strong Southern Side that offers an exceptional experience to an exponentially growing number of customers.
Finally, one trade-off is becoming key in devising business strategy in a world eaten by software: that between efficiency and innovation. No author, obviously, has ever said that a company should cease to innovate and focus exclusively on efficiency. But, as reminded by William Janeway, the concepts are clearly antagonistic:
Efficiency is the enemy of innovation. The processes of innovation move through trial and error, and error and error.
Indeed studies in capital allocation and our own observances from inside big corporations lead us to conclude that the pendulum has swung much too far in favor of efficiency. This is very dangerous in a digital economy that has made innovation easier because technology is so cheap. Silicon Valley-style startups impose a faster pace of innovation, and fast-growing tech companies, in their pursuit of superior increasing returns, are constantly innovating to break constraints. According to Dion Hinchcliffe’s “Red Queen Hypothesis”, companies now must run faster and faster just to stay in place.
Continuous innovation doesn’t mean that managers should have the goal of eliminating every trade-off through a speeding race toward ever more innovation. Digital innovation can be copied; hence, as written by Porter, continuous innovation would mean that their “companies will never achieve a sustainable advantage. They will have to run faster and faster just to stay in place”. What continuous innovation means is that the intensity of innovation within a given strategy should be much higher, including through buying promising startups, growing one’s own startups at the margins, and imposing constant trial-and-error onto the company’s distinctive value chain.
Fortunately, in the digital economy, you don’t have to innovate in the dark anymore: on the contrary, innovation is more and more data-driven as its impact can be measured almost in real time. This particular property minimizes the risk of innovation in and of itself and helps align allocating capital with a given strategy. We are now witnessing the convergence of innovation (“anything that breaks a constraint”) and strategy (which is “about the constraints you embrace”).
Fit
5/ It’s not enough to have a distinctive value chain. Its various components should also fit tightly together. Another Porter quote here:
Strategy is creating fit among a company’s activities. The success of a strategy depends on doing many things well — not just a few — and integrating among them. If there is no fit among activities, there is no distinctive strategy and little sustainability. Management reverts to the simpler task of overseeing independent functions, and operational effectiveness determines an organization’s relative performance.
Fit, I think, is the key strategic principle that has been the most ignored by traditional companies in the past 30 years. From what I have observed working with those companies and speaking with their managers, most transformative efforts in the past have tried to loosen fit rather than strengthen it. Inspired by management consultants who ignore strategy in favor of operational effectiveness and portfolio management, those companies have drawn deep lines between their business units and made those units’ managers accountable for profits and losses.
Such managerial practices have long been denounced by Michael Porter as proof of the confusion around the notion of strategy. Whereas it improves the experience curve in every single activity, making business units more independent deprives the firm as a whole of many options for strategic positioning. It’s impossible to tighten the fit among different activities if they are independent, each managed with their own separate P&L. By promoting separate P&L and portfolio management, it appears that generations of management consultants have weakened fit within their clients’ business systems instead of the opposite.
This, by the way, is a lesson that had been learned by Steve Jobs, as explained in a May 2011 article published in Fortune:
Most companies view the P&L as the ultimate proof of a manager’s accountability; Apple turns that dictum on its head by labeling P&L a distraction only the finance chief needs to consider. The result is a command-and-control structure where ideas are shared at the top — if not below. Jobs often contrasts Apple’s approach with its competitors’. Sony, he has said, had too many divisions to create the iPod. Apple instead has functions. “It’s not synergy that makes it work” is how one observer paraphrases Jobs’ explanation of Apple’s approach. “It’s that we’re a unified team.”
Like Apple, successful tech companies are characterized by an impressive fit among their various activities. This is mostly because those companies were startups not that long ago: they’ve grown by tightening their business and focusing their multiple activities on providing their customers with an exceptional experience, instead of restructuring their operations following the advice of backward-looking consultants. (The exception would be Google, which acknowledged its failure to tighten fit among its many activities and ended up transforming into a conglomerate, Alphabet, dedicated to implementing a portfolio management approach.)
It is always difficult to devise the fit that is so critical for those tech companies’ strategic positioning. The reason is the constant temptation to explain a given company’s success through one feature only. As pointed out by Porter, “in competitive companies it can be misleading to explain success by specifying individual strengths, core competencies, or critical resources.”
Uber is a good reminder of how appearances can be misleading. There are many theories as to the reason for Uber’s success: whether the fact that you are forced to rate the driver, or the fact that drivers are independent contractors, or the seamless payment system, or the absence of a meter, or the proprietary algorithm hidden deep within their impressive information system. Many startups—or established taxi companies for that matter—have attempted to mimic Uber by replicating one of these features. They all failed miserably because Uber has no such thing as a secret sauce—or rather its secret sauce is the fit between all those features and many others that nobody sees (that, and their obsession with increasing returns, of course).
As for traditional companies in which fit has been lost somewhere on the way, the only chance to reestablish it while complying with the digital economy’s rules of engagement is to focus on the right goal—increasing returns. But three mistakes must be avoided.
The first mistake would be to try and replace existing businesses with new technology-driven businesses. This was once tried in France when the old Compagnie générale des eaux, a leader in the mature water supply management business, was transformed into Vivendi Universal, a global player in media and entertainment. For various reasons (including, to be fair, the tech bubble bursting in 2000), it proved to be a disastrous move. Building up through expensive M&A is not the proper way to achieve fit.
A second mistake would be to try and build a separate digital business on the side. Porter has harsh words for those tempted by that course of action:
Some words in the Internet lexicon have unfortunate consequences. The terms “e-business” and “e-strategy” have been particularly problematic. By encouraging managers to view their Internet operations in isolation from the rest of the business, they can lead to simplistic approaches to competing using the Internet and increase the pressure for competitive imitation. Established companies fail to integrate the Internet into their proven strategies and thus never harness their most important advantages.
A third mistake would be to put one executive in charge of everything related to technology. Big French corporations are currently overwhelmed by a new breed of “chief digital officers”, supposedly in charge of transforming the entire organization when in fact they don’t really have a say on product, finance, human resources, mergers and acquisitions, and… corporate strategy. Do they succeed, you might ask? No, they don’t.
A slightly different version has been brought forward by Jeff Bussgang and Nadav Benbarak, who have written about the need for every company to appoint a “growth manager”. It is in fact the corporate version of a growth hacker—but we have reason to believe that the clout that a growth hacker enjoys in a startup desperate for growth would not exist in a big corporation that has already gained a firm foothold on its market.
Likewise, in a 2013 HBR article, Michael Schrage has written about the need for a “CNEO — a Chief Network Effects Officer — to integrate and align how your enterprise gets value from ‘harvesting collective intelligence.’” While I certainly support the idea that “tomorrow’s organizations are going to give as much thought and care about investing in network effects as they do to new products and services”, I disagree with the conclusion: no particular executive should be in charge of network effects, no more than there has ever been any executive in charge of strategic positioning or supply-side economies of scale.
As explained in more detail in a previous issue, “In Search of Scalability”, the key for making activities fit together is to make sure that their combination amplifies the positive feedback loops that contribute to maximizing a business’s increasing returns. To help top executives better understand how their current assets and functions can be reevaluated from an increasing returns point of view, we’ve designed what could be called the positive feedback loop framework, which tracks the various microeconomic effects that contribute to increasing returns on both the Northern Side (tangible assets) and the Southern Side (user experience).
This could lead to a very interesting conclusion: because it helps top executives evaluate their various businesses and make sure that their current combination generates and maximizes increasing returns, the positive feedback loop framework may be the new growth / share matrix. Porter actually hates the growth / share matrix because it negates the very idea of fit by presenting the various businesses within the company’s portfolio as independent parts. Maybe he would prefer the positive feedback loop model as it is precisely dedicated to combining various activities to form a powerful increasing-returns generating machine.
Fit implies radical choices as well as painful trade-offs. To achieve fit, one must make extensive use of digital technologies in every part of the company’s value chain. This is not as a way to differentiate yourself, as pointed out by Nicholas Carr. Rather, digital technologies are the glue that will make fit easier. So make an extensive use of them.
What’s more, fit retroactively works on the corporate value chain, as it will lead to building network effects within the product itself and, in some cases, to deploying platforms well beyond the corporation’s boundaries in order to harness supply-side platform effects. In other words, it won’t leave the organization and its culture intact. It’ll do something even better: it will force them to change on a continuous basis.
Continuity of Direction
6/ The sixth principle is about a very simple idea: once you’ve decided on a strategy, you should stick to it. A lot of care and attention should be dedicated to designing your strategy. But once it is settled, the company should remain on the track to conquer and then hold its targeted strategic position over the long term. To quote Porter again,
The operational agenda is the proper place for constant change, flexibility, and relentless efforts to achieve best practice. In contrast, the strategic agenda is the right place for defining a unique position, making clear trade-offs, and tightening fit. It involves the continual search for ways to reinforce and extend the company’s position. The strategic agenda demands discipline and continuity; its enemies are distraction and compromise.
Successful tech companies are usually good at continuity of direction. This is because they were startups just a short time ago, and they managed to cross the chasm without stumbling. If they hadn’t been good at continuity of direction, no one would be writing about them. Yet that doesn’t mean that the principle is not affected by software eating the world. A few twists are necessary to upgrade continuity of direction in a more digital economy.
First, the big data boom does not mean the end of Porterian strategy. For a long time, the twin disciplines of strategy and management have been founded on the assumption that strategy was distinct from operations. As written by business historian Alfred Chandler,
General management is more than the stewardship of individual functions. Its core is strategy: defining and communicating the company’s unique position, making trade-offs, and forging fit among activities. The leader must provide the discipline to decide which industry changes and customer needs the company will respond to, while avoiding organizational distractions and maintaining the company’s distinctiveness.
That view of strategy as detached from operations, advocated by both Chandler and Porter, has been fiercely attacked from the 1980s onward by the proponents of a rival theory known as emergence. Arguing against strategic positioning decided at the top, the emergent strategy school considers that an organization is a community of people that is better able to inspire strategy than a management trapped inside what Tom Peters and Robert Waterman, authors of the best-selling book In Search of Excellence, call the “analytical ivory tower”.
Henry Mintzberg, one of Porter’s most famous antagonist, is considered as the father of emergence: “no planning drill, however rich, can capture all the intuitions and nuanced judgments of the experienced manager responding to ever-changing business reality.” Walter Kiechel, III, who extensively wrote about business strategy, helps us understand what’s at stake here:
The emergent school did get one huge point exactly right: You can’t predict the future, no matter how many studies you amass or alternative scenarios you gin up. Critics have used this sad fact to bash the whole idea of strategy. Why should companies go to the trouble if the future isn’t going to turn out the way anyone expected?…
Other thinkers, fascinated by how Linux grew to pose a challenge to the likes of Microsoft, are trying to incorporate network analysis into their calculations. Probably the hottest term in discussions these days is ‘adaptive’ — as in “How can we make sure our strategy continuously, indeed almost automatically, adapts itself to our changing circumstances?”
You could think that the digital economy, with its fast-pace technological change and its corporate sensitivity enabled by big data, would reward emergence against strategic positioning: after all, why hold to your position when everything is constantly moving around you? Porter himself suggests that continuous change is a threat for any company trying to hold its position:
In fact, new strategic positions often arise because of industry changes, and new entrants unencumbered by history often can exploit them more easily. In principle, incumbents and entrepreneurs face the same challenges in finding new strategic positions. In practice, new entrants often have the edge.
And yet the big data boom doesn’t mark the victory of emergence over strategic positioning. Porterian fit shouldn’t be confused with rigidity. Seeking strategic positioning does not mean that the organization shouldn’t change on a day-to-day basis. Hence the unprecedented availability of real-time data doesn’t render strategic positioning obsolete.
Amazon’s strategy has been famously fixed from the beginning, whereas Amazon’s business model is constantly evolving through trials and errors as Jeff Bezos and his troops constantly weigh what he calls “type 2 decisions” (‘two-way doors’). “Type 1 decisions” (‘one-way doors’) are a matter of strategy and shouldn’t be taken lightly. “Type 2 decisions” are a question of business model — and this must evolve on a constant basis so as to preserve the company’s strategic positioning in the digital economy.
In other words, continuity of direction (the Porterian way) doesn’t exclude trial-and-error (emergence). Quite the contrary: trial and error in the digital economy creates more value under the form of data-documented feedback, with the ivory tower effectively extended throughout the organization and beyond, in constant touch with the company’s ecosystem, and gathering real-time data from every direction. The key strength of seed-stage Entrepreneurs, their unrivaled customer insight, can now survive the company’s rapid expansion.
Second, the main change for continuity of direction in the digital economy is that it is easier to maintain in the presence of increasing returns. Increasing returns lead to winners taking most of their market. As a result, they spare firms the burden of facing the same competitors for decades: GM has been Ford’s nemesis for almost a century now, while Google has never had a lasting competitor on the search market.
That is why we advise founders within The Family to ignore the competition: at the earliest stage, they shouldn’t spend one second gauging their competitors — because as they grow, they have to get used to the idea that they will be dominant on their market or they will die. As a result, they acquire the good habit of looking forward, not sideways, and they work hard on keeping that habit as they grow at a larger scale. (This is why culture plays such a key role in the digital economy: on winner-takes-most markets, only companies with strong cultures can survive.)
This radical approach of ignoring the competition leads us back to a time when competition didn’t even exist. Walter Kiechel, III wrote about this moment, “extending for a couple of decades after the end of the Second World War, when the biggest companies (most of which were American) didn’t have to worry about such annoyances.” Then the automobile market, that most emblematic of industries, saw Japanese firms entering the American market and forcing a shakeout. The ground was laid for the dominant discussions around strategy in the 1980s and beyond.
The disappearance of competition is a paradox: in a way, competition has only intensified as the digital economy grew. But we are now at a point where competition is so widespread and ubiquitous that it’s become difficult to monitor, which means that it barely matters anymore: firms are better off focusing on their strategic positioning regardless of what present or future competitors will do. With his constant insistence on the long term, Jeff Bezos suggests he’s not really interested in Amazon’s competitors:
If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you’re willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that. Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue. At Amazon we like things to work in five to seven years.
Indeed if companies want to monitor anything, they should turn their attention to increasing returns. Today, a competitive advantage derives less from a careful monitoring of the competition than from a focus on maximizing a company’s increasing returns. Companies will do better to take care of the various feedback loops contributing to their increasing returns rather than reacting to their competitors’ every move — or, worse, colluding with them to make sure that no new startup will ever enter the market.
(By the way, exactly how to measure increasing returns will be the subject of a future Paper. A startup’s fundamental equation, a good practice inspired by growth hacking, is promising in that regard — and it’s one that could be replicated even by established companies.)
Also, rather than monitoring the competition, a better precept in the entrepreneurial age would be “make yourself known to the competition”. In a recent discussion of Berkshire Hathaway, my co-founder Oussama Ammar and I offered many reasons why every company executive should create and share content, which all echo Porter’s advice that “strategy requires constant discipline and clear communication.” Why limit that clear communication to inside your company? A recent story by Yevgeniy (Jim) Brikman brought that point home:
In just about all aspects of life, doing great work is not enough to be successful. You also have to make sure other people know that you’re doing great work… The good news is that sharing your work is a virtuous cycle that can dramatically improve both the work itself and your abilities. And once you realize that sharing the work isn’t an extra step, but an integral part of the work itself — just as writing documentation and tests is an integral part of writing code — you’ll find more success in many aspects of your life, including finding jobs, earning promotions, attracting customers, and hiring coworkers.
The culture of sharing is one of the reasons the software industry and Silicon Valley have been so successful. Compared to something like Wall Street, where secrecy is king, the tech industry is remarkably open. And when we all share, we all win. Or, to paraphrase Isaac Newton, in a culture of sharing, we can all see further by standing on the shoulders of giants.
This is why I give talks, open source code, and write blog posts (including this one): by sharing what I know, I learn new things myself, and can see a little bit farther. I’d love to hear your thoughts!
And this is also what we at The Family do on a daily basis. Enjoy :-)
(This is an issue of The Family Papers, a series which covers various areas such as entrepreneurship, strategy, finance, and policy. Thanks to Oussama Ammar, Annabelle Bignon, Miguel de Fontenay, Kyle Hall.)
