#87 Strategy, Power, And The Flow Of Profits: A Narrow Definition of Strategy

(This is post number 2 of a series I’m doing on business strategy. My focus is the work of strategy guru Michael Porter via a book he cooperated on titled Understanding Michael Porter: The Essential Guide to Competition and Strategy by author Joan Magretta.)

Below are two selling experiences from my past.

SCENARIO #1: SELLING WITH MINIMUM POWER

My employer was Corning Electronics and my product line was commodity electronic components. This particular customer was a large manufacturer that consumed our stuff like peanuts. Huge volumes. 

Behind the purchasing agents desk was a large sign that read “Parts is Parts”. Translated that meant “I buy millions of pieces a month and there’s nothing special about yours but price." Along with that low price, of course, there were other implied requirements. If we shipped them something late, poorly packaged, or off spec we were out. He'd swap the business to one of my competitors that was waiting out in the lobby.

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So while I believed my product and service were worth a premium, outside forces kept my prices at rock bottom. 

He, the buyer, was in control.

SCENARIO #2: SELLING WITH MAXIMUM POWER

My employer was Powersoft Corporation and my product line was software development tools. (I described this market in detail in the prior post). This particular customer was a massive retailer with a big K in their name. Their IT department had chosen our tools for a project, and had already started development.

I was now circling back and getting the paperwork pushed through purchasing so we could get paid. I was on the phone with one of their buyers and he was demanding a discount. I told him if he wanted a better price he’d have to add a couple zeros to the size of his order. He told me how important their name was and the huge potential we had with them blah, blah, blah. Same shit I heard every time I spoke with a purchasing agent. So I listened but held firm. He got surprisingly angry and hung up on me - 3 or 4 times in a single afternoon. 

I got tired of playing games and sent an email to the development manager at his company. It said “please uninstall our software ASAP as we're unable to come to terms with your purchasing department”. 

My phone rang about two minutes later. It was the purchasing agents boss and boy was he nice. He had no problem paying the same price that everyone else paid that bought at that quantity. 

We, the supplier, were in control.

WHO'S IN CONTROL

Michael Porter draws a nice picture of the forces that determine who's in control in a given industry. He calls it Porter's Five Forces.

And here it is.

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Inside the circle are you and your competitors wrestling for business.

The blue boxes outside the circle are the other forces that influence your marketplace. They are…

the bargaining power of buyers
the bargaining power of suppliers
the threat of new entrants
the threat of substitute products or services

Porter claims that all markets have a fairly stable profitability level, and that the Five Forces determine who gets what share of that value.

So in my Corning example the buyer of our commodity electronics (the blue box on the right side of the diagram) carried huge bargaining power. While the other blue boxes were pretty weak- it was a mature market with few new entrants or substitutes and our suppliers had no special power over us. So, basically, a handful of competitors beat the hell out of each other on price. And our share of the loot - our profit potential - was low.

In my Powersoft example, once we established an early lead in the market, the bargaining power of buyers was low. And our suppliers were pretty much just making CD's and pretty boxes so they had no power over us. We did, however, have lots of challenges from new entrants and potential substitutes - our market was hot and startups were popping up all over the place. But our industry leading position helped us keep them at arms length. So our profit potential was high.

THE ROLE OF PROFIT IN STRATEGY

Porter wants you to draw the Five Forces diagram for your industry so you understand the power structure and see why the profits flow where they do.

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He then suggests you develop a strategy that allows you to earn a profit margin greater than your industry average. That seems kind of like “no shit” advice. But the point he’s trying to hammer home is that too many businesses lose site of profit as the goal. 

They get focused on top line growth or squeezing costs - but the bottom line never seems to improve. To be a real strategy, in Porter's eyes, your plan must lead to increased profit MARGINS. I repeat, increased profit MARGINS. You must consistently produce at a lower cost or sell at a higher price relative to your industry. And this difference must hit your bottom line. 

So let's assume you're a $10M company earning your industry standard 10%. If your goal is to grow to $20M in sales at the industry standard 10% - you don't need a strategy. All you're doing is trying to get a bigger piece of the pie at industry average profits. By Porters definition that ain't strategy.

On the other hand, let’s assume you’re that same $10M company earning your industry standard 10%. And let’s further assume that your goal is to maintain that $10M in sales while increasing your margin to 11%. In Porter’s eyes this plan WOULD qualify as a strategy because you’re seeking profits above your industry’s average.

I get the difference - Porter doesn’t want me to use the word strategy if I’m just increasing sales at industry standard margins. But that feels pretty academic to me. Why, in the trenches, do I care what label this guy thinks belongs on my plan.

So this whole Porter strategy thing is starting to feel like mental gymnastics. And I’m starting to doubt whether he has anything to offer my small business.

But I’m not giving up.

The guy’s considered a guru for some reason, so I’m going to give him the benefit of the doubt and keep tearing into his work.

THE MAP

(This site is all about building a Map that will help me do work and life better. So at the end of each post I check in to see if any changes / insights come to mind.)

If this strategy stuff does lead to adjustments I assume they’ll be in the IF sections ofmy Self and Work Maps. But there’s nothing to report today.

See you next time…

***NOTE: I've added a new section to the website titled SPEAKING. Here you'll find brief examples of my public speaking, and information on how to get hold of me if you're looking for a speaker.