Understanding Porter - Joan Magretta

Interesting insights:

“The essence of strategy,” Porter often says, “is choosing what not to do.”

Avoid head on competition by developing niches - there is a place for everyone if only they focus on the right customer segment eg. McDonald’s is a winner in fast food, specifically fast burgers. But In-N-Out Burger thrives on slow burgers. Its customers are happy to wait ten minutes or more (an eternity by McDonald’s stopwatch) to get nonprocessed, fresh burgers cooked to order on homemade buns. 

Either be number 1 or number 2 in your industry, or get out. That ultimatum was made famous by former GE CEO Jack Welch, but it is just one version of what is arguably the most influential form of competition to be the best. For investors, it may well make sense to invest only in the top 2 or 3 leaders in a segment

Economies of scale are often exhausted once an industry leader captures 10% market share (don't know if there are enough examples out there to prove this). It is a bit counter-intuitive that size does not imply scale economies, may be size is a necessary but not sufficient condition for scale economies. Eg. GM vs BMW, GM went into bankruptcy while BMW, small by industry standards, has a history of superior returns. Over the past decade (2000–2009), its average return on invested capital was 50 percent higher than the industry average. In the Indian context, Leyland vs Eicher Motors could provide similar basis

Industry structure is surprisingly sticky, i.e High RoIC industries remain that way for a long time.Despite the prevailing sense that business changes with incredible rapidity, Porter discovered that industry structure—once an industry passes beyond its emerging, prestructure phase—tends to be quite stable over time. New products come and go. New technologies come and go. Things change all the time. But structural change—and therefore change in the average profitability of an industry—usually takes a long time.Not sure if this is applicable to technology companies which are rapidly evolving eg. twitter etc.

Doctors and airline pilots as suppliers have historically exercised tremendous bargaining power because their skills have been both essential and in short supply. China produces 95 percent of the world’s supply of neodymium, a rare earth metal needed by Toyota and other automakers for electric motors. Neodymium prices quadrupled in just one year (2010), as the Chinese restricted supply. Toyota is working hard to develop a new motor that will end its dependence on rare earth metals. Guar production in Rajasthan for usage in fracking may exhibit similar characteristics

The ability to command a higher price is the essence of differentiation, a term Porter uses in this somewhat idiosyncratic way.

Typically, the culture of low cost permeates the entire company, as it does with companies as diverse as Vanguard (financial services), IKEA (home furnishings), Teva (generic drugs), Walmart (discount retailing), and Nucor (steel manufacture). You can look at the executive dining room and judge the cost structure of several companies!

Investment implications: Invest in industries which have above average RoICs and within industries, invest in companies with above average industry RoIC

Low cost differentiators: Charles Schwab created a new category known as discount brokerage—around a different value chain. Not all customers want advice, so why should they have to pay for it? Take away all the activities needed to give advice, focus instead on executing trades, and you can create a different kind of value: low-cost trades that make stock ownership accessible to a wider customer base. Matching the value chain—the activities performed inside the company—to the customer’s definition of value was a new way of thinking just twenty-five years ago. Today it has become conventional wisdom. Zerodha in India is a pioneer in doing this - leveraging technology to provide low cost broking.

 Substitution:Natural cork stoppers contaminating the natural frangrance produced by wine bottles created an opportunity for plastics makers such as Nomacorc to step into the breech. Nomacorc’s value chain made it relatively easy for it to undertake research into the chemistry of wine taint, and to solve the problem.  By 2009, Nomacorc’s automated North Carolina factory was churning out close to 160 million plastic stoppers a month, and synthetic corks had captured 20 percent of the market

Niches:For 30 years, Edward Jones focused on customers defined not by how much money they have, but on their attitude toward investing. Jones serves conservative investors who delegate financial decisions to a trusted advisor

Trust is built through personal, face-to-face relationships. To that end, Jones invests in conveniently located offices, and lots of them—in small towns, suburbs, and strip malls. Each office has just one financial advisor, a model unique in the industry. Jones prefers to hire from outside the industry, looking for advisors with both community and entrepreneurial spirit. It spends heavily on training new hires in its conservative product line (mostly blue-chip investments) and its buy-and-hold philosophy

It lays out what Edward Jones does not do: It doesn’t serve high rollers and day traders. It doesn’t sell derivatives, commodities, or penny stocks. It doesn’t offer online trading because that “encourages rash decision making.” It tells prospective clients it wants investors, not gamblers. Trade-offs like these are never easy. 

Oblique competition:The Enterprise value proposition is based on a simple insight: renting a car meets different needs at different times. Hertz and its followers in the industry built their business around travelers, people away from home on business or on vacation. Enterprise recognized that a sizeable minority of rentals, roughly 40 to 45 percent, occur in the renter’s home city. If your car is stolen, for example, or damaged in an accident, you’ll need a rental. In such cases, your insurance company might cover the cost, usually with contractual limits on the price it will pay. About a third of Enterprise’s revenues come from insurers. Other occasions prompt home-city rentals as well—for example, when a car has a mechanical failure or when a child is home from school on vacation. In all of these uses, home-city car renters tend to be more price sensitive than business or vacation travelers.

Enterprise crafted a unique value proposition to meet these needs: reasonably priced, convenient, home-city rentals. Compared with Hertz and Avis, Enterprise has chosen to serve a different need at a different relative price. It is not that Enterprise is the best car rental company. Nor is the market it serves inherently better. But starting with the specific need it serves, Enterprise has made a different choice about the value proposition triangle. Enterprise’s customer base would confound traditional market segmentation by demographic characteristics.

Key learings:

- Best measure of superior long term returns is RoIC

- Competitive advantage means a company can sustain higher relative prices or lower relative costs