FIVE TESTS EVERY GOOD STRATEGY MUST PASS (2024)

FIVE TESTS EVERY GOOD STRATEGY MUST PASS (1)

Evghenia Grozman

15 min read

Jun 6, 2019

Porter explains that the choices you make for your value proposition are practically resumed to three fundamental questions:

1. Which customers are you going to serve? Your value proposition can be aimed at serving one or more distinct group of customers or customer segments. So you need to ask yourself which customers are we serving, what end users, through what channels. After that you can choose what needs to serve and to figure out the relative price for your value proposition. Sometimes the essential problem to tackle first is to find a unique way for your business to serve your chosen customer segment profitably.

2. Which needs are you going to meet? In some cases, you can figure out and choose what need your value proposition will cover and then choose the particular customer segments (which in this case can be based on demographics or just be a common need customers share at a given time) and the relative price. The main questions you need to answer are — which needs you will cover, which products you’ll offer, which particular features and which services are you thinking about. So your strategy will revolve around your ability to meet the particular needs you have chosen for your value proposition configuration.

3. What relative price will provide acceptable value for customers and acceptable profitability for the company? And finally there are some instances when the relative price can be your primary choice, later followed by the customer segment and the needs. So here your choice revolves around what relative price you want to charge — a premium price or a discount? Your value proposition can target over-served and probably overpriced customers, whom you can serve by eliminating unnecessary costs and meeting the optimal level of their needs at a discount; or it can target the under-served and underpriced customers by offering higher value at a premium price.

You need to remember some critical points highlighted by J. Magretta.

First — companies rarely figure out every element of their value proposition from day one, they learn by doing it again and again.

Second — there isn’t a best value proposition, it can be the best at meeting a particular kind of need at a particular relative price.

Third — there are many possible configurations of a value proposition for an industry: serve all customers in the market but meeting only a specific need; serve a focused customer base but meeting more of these customers’ needs; deliver higher value at a premium price or be efficient and have a low relative price.

As a conclusion the first test of a strategy means choosing a different value proposition from your competitors. As M. Porter observes, if you serve the same customers, meet the same needs and sell at the same relative price, then you don’t have a strategy, you’re just competing to be the best. You do not want to be the same as everyone else in the industry, only slightly better for a period of time; what you want to accomplish — is being different and offering a unique kind of value through a specific value proposition.

The Second Test: A Tailored Value Chain

Your competitive advantage is an essential part of your strategy, and according to M. Porter the definition of a competitive advantage is the difference in relative price or relative costs that arises because of differences in the activities being performed. And the activities your company performs to deliver your value proposition represent your value chain. In order to have a competitive advantage your value chain must be different and specifically must be tailored to deliver your value proposition.

M. Porter warns that a value proposition that can be effectively delivered without having a tailored value chain will not build up a sustainable competitive advantage. And more than that Porter explains that even if you have a unique value proposition, it will not translate into a meaningful strategy unless you have also a different value chain or set of activities to deliver your unique value proposition. Only when the activities from your value chain are different from activities performed by your competition, your company will have a unique and valuable positioning in your industry.

So in order to have a good strategy and a sustainable competitive advantage first you need to choose to perform different activities from your competitors, and second of all you need to tailor those activities from your value chain to your value proposition.

For M. Porter the essence of strategic positioning means that a company will deliver a different kind of value to a different set of customers, and therefore your value chain’s activities can be supported by quite an extensive list of differences.

The diversity of value propositions reflects the diversity of customers and their needs, and they require various types of activity configurations, various types of value chains, each tailored for another kind of value proposition. M. Porter points to the fact that even if an industry produces a hom*ogenous product or value proposition, there are still many opportunities up and down the value chain for differentiation, to name just a few — differences in delivery, in disposal, in certification, in testing, in financing.

A unique and different value chain does not mean that every single activity in your value chain needs to be unique, but if you intend to have a robust strategy you need to design a great deal of tailoring, to have a competitive advantage you need to create and deliver a distinctive value proposition through a distinctive value chain, and to have a valuable strategic positioning in your industry you need to different activities than your competitors and at least perform the same activities in different ways.

Another crucially important thing to remember says J. Magretta, is the fact that only a value proposition that requires a tailored value chain to deliver it, can be a basis for your strategy, because if the same value chain can deliver different value propositions equally well, that these value propositions are not strategically relevant. And J. Magretta defines it as the first line of defense against your competitors.

The value proposition and the value chain represent two core dimensions of strategic choice, and they are linked in such a way that, your value proposition focused on the customer translates into your value chain focused on operations, while your strategy brings both sides together.

Your value proposition and value chain can even help you discover new strategic positions. You can discover a new strategic position through your value proposition — by looking for new ways to segment customers or to serve unmet needs; or through your value chain — by configuring a unique set of activities your company must perform, and therefore identifying your company’s strengths.

The Third Test: Trade-offs, Limits, Choosing What Not to Do

Strategy requires and thrives on choices, on limits and trade-offs.

It is essential for your strategy to make choices regarding value proposition that can limit what a company will do, what in consequence offers the possibility to tailor the activities of the value chain in a way that best could deliver that value. Tailoring can be possible only if there are limits, because the limits offer the possibility to create a different value chain from that of your competitors who have chosen to offer a different type of value.

Trade-offs are also important for your strategy, and they represent the choice you make when you have two incompatible choices, and you can’t have it both ways, because they are inconsistent and compromise each other. As J. Magretta suggests, trade-offs hold a good strategy together, contributing to creation and sustainability of the competitive advantage, while the best strategies involve having multiple trade-offs, even at every step in the value chain. Trade-offs make strategy possible because they create the need for choice.

M. Porter highlights three main reasons why trade-offs may arise:

1. First case when you need to make trade-offs is when product features are incompatible. Such a product can best meet one set of needs but perform poorly when addressing other needs.

2. Second case refers to trade-offs in the value chain’s activities. As J. Magretta puts it the configuration of activities that best delivers one kind of value can’t equally well deliver another. An example would be a plant designed to produce small sized custom products won’t be efficient at producing large standard products. And one important thing to remember in this case is that trade-offs involving activities have economic consequences, and if activities are either overdesigned or under-designed their value will be destroyed.

3. Third case when trade-offs are necessary, arises when there are inconsistencies in image or reputation. These inconsistencies can confuse customers or even undermine the company’s credibility and reputation.

One popular trade-off is the trade-off between cost and quality. You can’t have quality at a low price. As J. Magretta suggests quality is free only when it means eliminating waste and defects. And there is one more instance when quality can be free — when innovations make the old trade-offs obsolete. Innovations such as new technologies or new management practices M. Porter explains, can result in both lower cost and improved performance, but only when such innovations are game changing for the entire industry, or when companies are not operating efficiently. All other instances related to obtaining a higher quality but maintaining the same cost are false trade-offs. In general M. Porter says — false trade-offs arise when organizations are not operationally effective and don’t perform adequately the generic non-strategy specific activities. Once companies achieve operational effectiveness, they have to make real trade-offs when they want to offer higher quality. Because in these cases adding quality means adding new product features, using better materials or offering a better or improved service, which definitely is not free.

M. Porter advises businesses that when managers want to focus on improving execution, best practices for generic non-strategic activities then eliminating trade-offs is a good thing. But when it comes to strategy, maintaining and sharpening trade-offs will only make your strategy better and more sustainable.

Trade-offs can also help keep your competitors away and harder for them to imitate your success. As J. Magretta explains that by their very nature, trade-offs are choices that make strategies sustainable because they are not easy to match or to neutralize. Where there aren’t trade-offs good ideas, product features, services, value chain activities can be copied easily, but with trade-offs in place the imitator trying to match your speed, or consistency or any other distinctive activity, will pay an economic penalty trying to match an activity tailored to your value proposition.

Another important thing to consider about trade-offs is that choices about what not to do are as important as choices of what to do. This means that deciding which needs will not be served, which products, features and services won’t be offered — are as important as deciding what you will actually offer. And after you decide what you will not do you need to stick to your decision. But as M. Porter warns the “more is better” psychology is hard to resist, because of the hope that an additional feature will increase sales and win customers while cost will be minimal, because the competition is doing it, because customers want it, and so you relax your trade-offs, you compete to be the best, you try to offer something for everyone and therefore undermine your unique strategy and your competitive advantage. Usually a company that has sustained over many years a competitive advantage it means the company didn’t abandon and defended its key trade-offs.

Businesses often don’t make trade-offs for fear of losing some customers, but it is quite unlikely that they will do a good job serving any customers and any needs and not choosing not to serve all customers and needs. By remaining unresponsive to some needs and making some customers unhappy and sticking to your trade-offs, companies can be responsive and offer great value to other chosen needs. Don’t offer customers everything they want if it’s not included in your value proposition, because some customers are not your customers, because you’ll have mediocre performance and you will blur your unique competitive advantage.

Fit: The Fourth Test of Strategy

The forth test for strategy is fit which M. Porter describes as how the activities in your value chain relate to one another. Fit means that the whole matters more than any individual part, and many things together create value. It is believed that competitive success can come from a single core competence or other thing your company does well, but M. Porter explains that good strategies don’t rely only on one thing, one choice, one core competence; they rather depend on making many interdependent choices, making series of choices and trade-offs regarding your value proposition and value chain, which will spur the creation of your competitive advantage and will make your strategy harder to imitate. Fit among activities only amplifies the competitive advantage and raises even higher the barriers to imitation, because the imitator needs to copy a set of interdependent activities, and they will have a hard time figuring out what exactly they have to match.

As J. Magretta puts it, fit means that the value or cost of one activity is affected by the way other activities are performed, and M. Porter identifies three common types of fit that can overlap:

1. Basic consistency is the first kind of fit. Basic consistency means that each activity in the value chain is aligned with the company’s value proposition and contributes incrementally to its dominant themes. If activities are inconsistent, they will cancel each other out.

2. The second type of fit occurs when activities complement or reinforce each other, and Zara is a good example of reinforced activities. J. Magretta explains that Zara’s high-traffic store locations and the large number of collections reinforce each other. The high-visibility locations help Zara with its goal of turning over all of a store’s merchandise every two weeks, and large display windows are drawing customers in.

3. Substitution is the third type of fit. Substitution means performing one activity offers the possibility to eliminate another. The example given by J. Magretta includes Zara again — Zara’s prominent store locations and the rapid turnover of its collections make traditional advertising unnecessary.

J. Magretta warns that basic consistency can be identified more easily by competitors, but if the strategy relies on more complex fit, it gets harder for competitors to know exactly what they try to copy, because it’s one thing to copy a particular sales approach and quite another to copy a whole system of interlinked activities. Complex fit lowers the odds that your strategy could be copied, because it would be organizationally challenging for competitors to integrate decisions across departments and functions.

Fit even has a say in the outsourcing dilemma. M. Porter says that instead of trying to determine which activities are core, better ask: Which activities are generic and which are tailored? Generic activities suggests Porter — those that cannot be meaningfully tailored to a company’s position — can be safely outsourced to more efficient external suppliers. But outsourcing is quite risky for activities that can be tailored to strategy. And he gives a convincing argument — if there are fewer elements that remain in the company’s value chain, than there are fewer opportunities to use and benefit from tailoring, trade-offs, and fit. Porter claims that outsourcing can not only limit the opportunities for uniqueness and fit in the company’s strategy but also push an entire industry into greater hom*ogenization.

Strong fit offers not only a superior strategy but also a superior execution, by making easier to spot, address and improve one flawed activity, that due to fit, affects overall performance, therefore making the companies stronger and deterring imitation.

Continuity: Final Test Of Strategy

The fifth and final test of strategy is continuity over time.

Usually fingers are pointed towards slow changing companies, but M. Porter highlights an equal mistake, companies that are changing too much. He also points out that having a strategy with limits and trade-offs, doesn’t affect your ability to change, actually it can facilitate the right kind of innovation. Over time continuity offers to all internal and external partners of a company a deeper understanding of the value the company is offering to them, and how they can contribute to strengthening this value.

J. Magretta offers some beautiful descriptions for continuity’s importance:

· Continuity reinforces a company’s identity — it builds a company’s brand, its reputation, and its customer relationships. Customers will never mistake what these companies stand for, what needs they can and cannot meet, they understand the core value proposition and the major trade-offs. A good strategy, consistently maintained over time through repeated interactions with customers, is what gives power to a brand.

· Continuity helps suppliers, channels, and other outside parties to contribute to a company’s competitive advantage. The longer outside parties work with a company, the better they understand its goals and methods. The benefits can flow both ways. Continuity of strategy allows companies to attract employees who fit the company’s strategy and fosters relationships with distribution channels.

· Continuity fosters improvements in individual activities and fit across activities; it allows an organization to build unique capabilities and skills tailored to its strategy. Consistent pursuit of a strategy over time allows a company to develop various strategy-specific assets, including its culture, hard to match. Continuity increases the odds that people throughout the organization will understand the company’s strategy and how they can contribute to it, they are more likely to make decisions that reinforce and extend the strategy.

It usually takes years, not months, to successfully implement a new strategy, because strategy is inherently complex and involves different complex activities like: understanding your customers; creating real value for them; establishing links between your organization and its suppliers and its partners; identifying hundreds of activities you must perform, and aligning them with your value proposition and with each other; engaging and aligning hundreds of individuals who need to do the work. And when companies have frequent shifts in their strategies, they pay a high price for it. These frequent shifts and changes require: dismantling and unlearning the old ways of doing things; reconfiguring new activities; realigning entire systems; reeducating customers and value chain partners, which means heavy reinvestments in brand and image. M. Porter highlights that probabilities of getting each activity right can explain why frequent shifts in strategy will be a significant drag on performance, while some activities, practices, skills, or attitudes could never be recreated through the new strategy.

Continuity of strategy does not mean your company should stand still, because while the core value proposition should be stable, you should innovate the ways you deliver it. If you are successful you don’t need to reinvent yourself only your methods and ways of creating more value.

Taking into consideration the uncertainty of the business environment, you could wonder how your company can maintain the continuity over time. It could be explained as J. Magretta suggests, by the fact that great strategies are rarely, if ever, built on a particularly detailed or concrete prediction of the future. She actually thinks that your company requires only a very broad understanding of which customers and what needs are going to be relatively stable for the next five or ten years. Strategy in her opinion is some sort of bet on the fact that your chosen customers and their needs will endure at least in the near future and that your trade-offs and choices of your value propositions, value chain and chosen price will still be relevant to them. In that sense, as Magretta suggests — some value propositions turn out to be more robust than others. Are you ready to make your bet?

RESOURCES:

1. Understanding Michael Porter by Joan Magretta