Porter’s Five Forces Model, Generic Strategies and the Saddle Curve

Most students of strategic planning are at least aware of Michael Porter’s five forces model of competitive advantage.  These forces – supplier power, customer power, threat of new entry, substitute products and industry rivalry – are an excellent way to understand the most powerful forces affecting a company’s competitive position and likelihood of profiting from a market.  In Simplified Strategic Planning, we examine the external variables which are most like to drive these forces for a company by researching the external data (such as the balance between number of customers and number of competitors in a segment, the threat of substitute products or services, and the economics of the supplier market).  Internally, a company’s strategy can be developed to adapt to, and sometimes, mold these forces as well, ideally by focusing on the use of a unique strategic competency that separates the company from competition and likely new entrants.

One great way to think about all of the five forces in your strategic planning is to think about the choices (outside of purchasing from your company) available to your customers and suppliers.  Anything that increases the choices available to customers decreases your power, and anything that decreases their choices increases your power.  

One of the key ideas we use in Simplified Strategic Planning starts with the basic question of how you can gain – or lose – market share to a competitor.  One of the most fundamental insights that affects market share is a behavior continuum we refer to as specialty and commodity behavior.  Michael Porter describes these behaviors in his “generic strategies”, but usually refers to them as “uniqueness as perceived by the customer” and “low cost position”.  As I state in the book “Simplified Strategic Planning:  A No-Nonsense Guide for Busy People Who Want Results”, both of the generic strategies that work for the specialty focused company are viable strategies for a profitable business – that is, the differentiation strategy (specialty/broad market) and part of what Porter calls the “focus” strategy (which he uses to cover both specialty and commodity/niche market).  I would contend that the commodity side of Porter’s “focus” strategy (what I call “alley shop”) is not viable – since it generally results in both low volume and low margins – and that is why we split the niche strategies into “segmentation” and “alley shop”.

In “Simplified Strategic Planning”, I noted the existence of the “Saddle Curve”, which is simply the tendency of companies to achieve higher profit on either end of the specialty/commodity continuum.  The basic idea behind this curve is that companies with a clear commodity or specialty strategy will be more profitable than those that flounder in between the two.  One of the reasons why the five forces exert such power on profitable strategies is that they tend to force companies away from the extremes of this curve and into the middle, where profit is minimized.  As an example, consider a situation where customers can choose substitute products.  The customers’ desire is inevitably to maximize value by getting better products, better service and lower prices.  Where the customer has less choice, the real-world trade-off between these can be forced into the customers’ decision-making processes (“Do I buy the expensive, better product or the cheaper, worse product?”).  Customers who have more choices can demand that these compromises not be made – which inevitable drives a company into the middle of the curve, where profit is lower.  The only force that usually does not show its main effect on the saddle curve is the power of suppliers.  When that force comes into play, the profit of the company is affected because profit can be the result of forcing suppliers to move towards the center of the curve.

Where do you see your company on this curve?  How do the five forces affect your position on the curve, and your strategies for positioning in your markets?  If you would like a straightforward, no-nonsense process for working these ideas into your strategic planning, consider attending our two-day simplified strategic planning seminar soon!

Why Wal-Mart is not invincible

After a couple of years of news stories trumpeting the success of Wal-Mart (again), sales at Wal-Mart stores showed a decline last year. Why? There are two very different reasons. The first is economic, the second is competitive. The economic reason is that all shoppers shift spending downward when they see themselves affected by an economic downturn. This means people who shop at higher-end stores when times are good may stay pinching pennies by making the same purchases at a commodity store like Wal-Mart when things get tight. The competitive reason is that some of Wal-Mart's closest competitors - notably the dollar stores like Family Dollar and Dollar Tree - have started to close the gap on some of the weaknesses that caused customers to shift away from them and towards Wal-Mart. The first shift isn't really big news - commodity players always fare better when the economy is doing badly, and worse when things brighten up. But the second shift should be worrying to the folks at Wal-Mart. The commodity game, unlike a specialty strategy, allows only one winner. Any change that reduces volume for the lead player makes it that much more likely that an upstart will be able to remove the commodity crown from the top dog. Wal-Mart has undertaken some big expenses in the past few years that their smaller competitors have not - notably advertising and opening/closing stores. These are both strategic moves, and properly done may lead to higher profit at Wal-Mart - BUT improperly done, these moves may just be another chink in Wal-Mart's armor.
While I'm not a big fan of commodity strategies in general, so much has been made of Wal-Mart's management approach that I will find future developments in this market space very interesting to watch.
Here is a question for you in your strategic planning: Are YOU staying on top of your game? Are you considering pursuit of strategic moves that may create chinks in your armor? And how are you preparing yourself for a better 2011 and beyond?

Strategic Planning: The "disappearing middle" of the job market

A common question in strategic planning revolves around the strong profitability of clear, focused specialty and commodity strategies. Apparently, this is becoming a factor in the labor market, as well.
An article in The Lookout on Yahoo notes that there is a "disappearing middle" in the job market. This trend - growth in lower-tier unskilled jobs and upper-tier skilled jobs, looks suspiciously like the "saddle curve" we use to explain the profit impact of pursuing specialty and commodity strategies. Is is possible that the labor market is now coming to reflect the same specialty and commodity tendencies we have observed in other markets? An interesting question is: why has this tendency not been apparent in the past? Strategically, you should ask yourself: is my company employing specialty employees or commodity employees - and how does that fit with our strategic planning?

Strategic Planning: Why Wal-Mart is a bad place to buy books

A recent article on Yahoo Finance got me thinking about a fascinating strategic planning question: why is Wal-Mart is a great place to buy some things (such as video game consoles) and a terrible place to buy books?

Wal-Mart wants to turn over its merchandise quickly, and prices hot items (like the Nintendo Wii) to sell quickly. When it comes to books, there is a serious problem in this. Wal-Mart has been having a price war with Amazon over best-selling titles. Fortunately for Amazon, Wal-Mart has to do this, because Wal-Mart would never win a value war with Amazon. Amazon has invested huge amounts in having millions of titles available - arguably, a better selection of books than any other source on the planet. Wal-Mart - true to their commodity strategy - only wants to sell huge quantities of the best-selling books. This means that Wal-Mart, at best, might carry one thousand titles, compared to Amazon's millions. This brings us to the classic reason to buy - or not buy - from Wal-Mart. Want a cheap price on a New York Times bestseller? Wal-Mart will probably have it, and they will try to price it less than Amazon. This is still a challenge, since Wal-Mart is still largely a bricks-and-mortar operation, but their advanced distribution and purchasing power enables them to give Amazon a run for it's money.

But let's look at the flip side: Want any one of a million titles - say, a book about fossil hunting in Florida? Wal-Mart will never carry such a title, because the turnover rate would be too poor. In fact, there are thousands of books in a typical Borders or Barnes and Noble that Wal-Mart wouldn't want to carry because they don't have the volume demand that, say, the latest Twilight book would have. This approach might make little difference to readers who only buy a book or two to take to the beach in the summer - which is a valid, addressable market that Wal-Mart already caters to - but it makes buying books at Wal-Mart about the same as buying clothing at a convenience store. Sure, you might find what you are looking for, but you'll waste a lot less time going to a specialty retailer whose strategy is centered on giving you the selection you want. This is true whether you are talking about online sales or bricks-and-mortar sales: selection is both a cost and a consumer preference in the book market (and arguably, the fashion market and many others).

Wal-Mart can succeed by sacrificing the preference for selection because price is also a strong preference. For retailers like Amazon, however, the strategy of leaning into Wal-Mart's weakness (product selection) will always garner a sizeable chunk of market share. The challenge for even more specialty-oriented stores (small, independent booksellers, for example) is to provide other values that Amazon (or Waldenbooks) won't, such as personal service, focused selection, ambiance, and browsing configurations.

I'd go a step beyond this and say that people who buy books at Wal-Mart are also doing society a disservice, because civilization suffers when economic resources are diverted only to cultural production that sells in mass quantities, but that's a somewhat elitist viewpoint. Still, a culture that only supports best-sellers isn't just bland, it is systematically likely to sink to the lowest common denominator in literature. Call me a snob, but I'd prefer not to build a civilization on Harlequin romances.

How about your business? Are you like a Wal-Mart, an Amazon, or a small independent bookstore? How do you create value for your customers? Does your strategic planning give you the ability to out-serve your biggest competitors in a huge portion of your market?