Choices in Strategy

Issue 42

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Good Morning,

Hope you and your families are safe. This is the 4th post of the strategy series. So far, we have covered three concepts in strategy:

  1. Law of competitive exclusion — Over the long-term, out of multiple companies competing for the same market need, only one will survive.

  2. The litmus test of good strategy — The opposite of a good strategy shouldn’t look stupid.

  3. The paradox of strategy — To succeed, you have to commit to a singular strategy. Committing to a singular strategy increases the risk of failure, which means either you will have large gains or large losses.

These three concepts are the building blocks of strategy as we will see in this and future posts.

Life is all about choices

In this post, we are going to discuss the generic choices available for anyone building their product or business strategy. You can pick any product/idea available to you, and if you apply the framework we are going to discuss, you might land with a much better strategy.

It’s much easier to understand strategy from a consumer point of view, i.e. positioning in their minds. A firm can position itself in three ways in a consumer’s mind: low cost, differentiation, and focus. A firm has to choose between the three to start with. Michael Porter wrote about this in his book, Competitive Strategy.

Low cost

Also known as ‘cost leadership’ in strategy circles, low cost is a strong positioning in consumers’ minds. Think airlines, hotels, smartphones — when it comes to mass consumers, low-cost options always win in terms of market share.

There are multiple ways to measure market share. Let’s take US airlines as an example. Southwest Airlines Co. (NYSE: LUV) has grown from a tiny airline with three planes serving three Texas cities in 1971 to one that serves almost 100 destinations across the U.S., flying 4,000 flights a day. 1 Their strategy is to cut costs across the value chain and then pass these savings to customers in terms of affordable ticket prices.

The company's low-cost business model has booked 45+ consecutive years of profitability. This is quite impressive considering the volatile airline industry, One could look at domestic revenue passenger miles, a measure of demand. Southwest Airlines had 18% of the domestic revenue passenger miles market share for July 2017 to June 2018. This falls just behind the market share leader, American Airlines (AAL) with 18.1%.

Here is a graph displaying Southwest Airlines performance over the last 15 years (revenue in $B)

It should be noted that even though low cost attracts the most number of consumers, it isn’t the most profitable option. Let’s take a look at the smartphone OS market — Android vs iOS.

Android is an open-source operating system that any smartphone manufacturer can use. iOS is closed source and only available on Apple devices. Because Android smartphones are cost-effective, Android owns 85% of the smartphone market as per IDC, whereas iOS owns the rest 15%. So Android looks far ahead of iOS. But here is the puzzle: despite lower iOS devices, Apple's App Store generated 80% more revenue than Google Play with a third as many installs in the first half of 2019. How does that happen?

Apple and Google both charge a 30% commission on revenues earned by apps in their stores. App Store generates more revenue because revenue per device on iOS is higher than Android — 10.2 x higher, to be precise. A higher revenue per device is because Apple sells iPhones at a premium price and hence captures the segment with the highest spending power. 

How do firms create cost leadership? By making choices across the value chain, leads to lower costs. Southwest does it by 2

  • Using secondary airports reduces the cost of landing there

  • Using only one aircraft type reduces training for pilots, skills required of mechanics and spare parts bank required to remain operational

  • An intelligently put together schedule, with short turnaround times and routes that maximize the airtime of every aircraft in the fleet

  • Short, in-demand routes operating at a high frequency

Low-cost strategy passes the litmus test because the opposite option, i.e. building premium products isn’t stupid, as shown by Apple. If you are able to create cost leadership, you also survive the law of competitive exclusion.

One last thing to note is that cost leadership doesn't mean offering the lowest prices. Companies can create cost leadership while offering prices the same as competitors, thereby earning higher margins. These margins get re-invested into the business, thereby creating a source of competitive advantage.

Does the product you are working on fall in this category?

Differentiation

Differentiation in product/offering is another way to position a firm. By creating a differentiated product, we can create a unique remembrance and position in the user’s mind. It requires making choices different from existing products out there. Let’s take the example of smartphones.

Smartphones have created differentiation by focussing more on improving one or more aspects like camera, battery, speed, graphics, etc. Gamers prefer smartphones with better speed, performance, and graphics like Samsung Galaxy S21 Ultra Smartphone. It has a QHD+ display, an octa-core 5nm chip, and up to 16GB of RAM. Influencers prefer smartphones with a better camera, whereas travelers prefer the one with better battery life.

We should also understand that, unlike hardware products, differentiation in software is harder to build in terms of features. The cost of building software isn’t as high as hardware products, so competitors catch up quickly. We have look for ways that are harder to copy to create sustainable differentiation for software, and we will discuss that later in this post.

Focus

Focus is where things get interesting. Focus is building a product for a niche/unique TG. Focus can offer both cost and differentiation advantages. Coca-Cola Company introducing ‘diet cola’ to serve the niche market consisting of diabetic patients is an example of differentiation focus.

Cost focus is establishing cost leadership in a niche segment. Local fruits and vegetable markets in remote areas are an example here. Because the food is grown locally, there is less wastage and transportation cost. So they become the most cost-effective option for these local markets.

Another thing to note is that you can also charge premium prices when you create a product for a niche because the TG doesn’t have many competing options. Porsche AG is the largest and most traditional Sports Car manufacturer and the most profitable automotive manufacturer in the world (differentiation coupled with premium pricing).

To summarise, this is how it looks. Think of the companies that fit in different quadrants.

Internet economy

The same set of generic choices can be applied to Internet companies. But we have to be cautious of two additional factors while making the choices: cost-to-copy and rate of change in customer expectations.

Cost-to-copy — Creating a hardware product requires years of R&D investment, creating custom production lines, and a distribution channel. Creating a software product is relatively easier for anyone. Since building software is a commodity nowadays, the advantage has to come from somewhere else. In order to win, it’s not just important to create a differentiated product, but also harder to copy in the Internet era.

An example is streaming platforms. Netflix started out as a DVD rental company and launched the streaming platform in 2007. Over the years as the technology improved and the adoption of streaming platforms improved, other players in the entertainment industry started looking to build their own streaming platforms. In 2012, Netflix made an exclusive deal with Disney. Thereafter, Netflix started making its own content and launched shows like House of Cards, Stranger Things, etc. By the time Disney launched its own streaming platform Disney Plus in 2019, Netflix had its own library of original content.

Had Netflix not made exclusive deals or its original content, it would have been easier for competitors to copy it and gain an advantage. Survival in business is a game of adding continuous hard-to-copy elements.

We can see other examples beyond Netflix. Aggregated user base (all the large B2C internet companies), supply base (Shopify entrepreneurs), network effects (Facebook friends graph), data intelligence (google search algorithms), proprietary content (Netflix), etc. are some of the hard-to-copy advantages of other internet companies.

D(UX)/Dt — User experience is a moving target for any industry, more so for software. The companies nowadays consistently ship quality features that move customer expectations and experience up. The ones that persistently do so accrue advantage over time. “Accrue” is the key here, since the advantage isn’t visible in months and quarters, but in years and decades.

Because of the higher rate of change for customer expectations, product-market fit also changes continuously. A product that consumers love today will be hated soon if it fails to evolve. Think Orkut or Skype.

So how should you ensure that you are in the game consistently? One is by keeping a close watch on industry and consumer trends. The other is by improving the velocity of software development in your org.

Even if building software is a commodity, building quality software consistently isn’t. It takes years for companies to build a robust process and pipeline that improves the velocity of software development. Many have tried and failed. Where does the shipping velocity help? Offering a feature quickly to your customers retain them on the platform. As soon as a competitor launches features, customer expectations move up. Instagram launching stories after Snapchat was a strong move as it retained its customers on the platform. Instagram Stories became a massive success. Just two months after its launch, it had 100 million daily active users, a number that doubled to 200 million by April 2017 and 250 million by June 2017, figures that dwarfed Snapchat’s 166 million daily active users.3

A very good book around this is Phoenix Project by Gene Kim. It discusses software deploy (release) frequencies of different companies. A typical enterprise releases software only once every nine months. In contrast, Amazon, for example, releases software updates thousands of times per day due to its well-constructed process. 

I will end this post with a quote from Michael Porter — “Strategy is about making choices, trade-offs; it's about deliberately choosing to be different.”


For any feedback, you can write me directly at deepak@growth-catalyst.in. To receive regular posts, subscribe here

1

https://www.investopedia.com/articles/markets/021216/analyzing-southwest-airlines-market-share-luv.asp

2

https://simpleflying.com/southwest-lcc-model/

3

https://www.wired.com/story/copycat-how-facebook-tried-to-squash-snapchat/