Double clicking on differentiation
Most leaders we have talked to over the past few months sense a paradigm shift arising from the health and economic crisis derived from COVID. Changing customer behaviors, combined with the doors closing of many key competitors, have led many to pause and reflect on their business aspirations.
At this moment, some leaders are fighting to save their companies while others find themselves in blue oceans and are in the early stages of extending position or even exploring new markets. These are complicated decisions and we believe it is important, now more than ever, to anchor to the fundamental principles of competitive strategy.
In his foundational works Michael Porter lays out a few key mental models for business leaders to consider when shaping strategy. At the core of his work is the idea of striving to be unique.
To Porter, uniqueness is reflected in a few distinct competitive advantages:
- Cost leadership
- Differentiation
- Focus
The aim of each of these strategies is to extract more value than competition. In mature markets, this is usually reflected through better return on invested capital (ROIC).
For cost leadership, the advantage is primarily driven by the cost structure of a firm’s value chain. Meaning, the firm produces a product of similar quality for less cost than competitors. Higher ROIC is typically driven through low margins and high turnover. But it is critical to understand there is typically only ONE cost leader in a given market. For players in large markets, the competition for this position is fierce.
Differentiation is the strategy that we most often hear described by our clients. To Porter, this means offering a unique product or service at a premium cost to the customer. With a differentiation strategy, companies achieve a better ROIC through higher margins and moderate to low capital turnover. The premium comes from a unique value proposition.
A focus strategy, at a high-level, is segmenting a market and implementing a strategy centered on cost leadership, differentiation, or combination of both.
Outside of vary narrow market segments, Porter warns against pursuing multiple strategies at once. Cost leadership and differentiation involve focusing on distinct areas. Cost Leadership requires a ruthless focus on process. While differentiation is rooted in customer understanding, research and development, and innovation. As many of us know, these activities are on different sides of the spectrum and do not align. Pursuing them in parallel inhibits an organizations ability to succeed.
While there is much to be written about cost leadership and focus, we find understanding differentiation is of the highest interest to most clients.
When we discuss strategy, often times the key differentiator is described as “being the best.”
To Porter, competing to be the best is the most common error in all of strategy. Creating value for customers, and not beating rivals, is the heart of competition. Business competition is not war or sports. Winning is not zero sum. In the vast majority of markets, there is simply no such thing as ‘the best’ and competing on this premise can lead to confusion.
Only by competing to be unique can an organization achieve sustained superior performance.
But where to begin?
Leverage a Core Strength
Many of the best differentiation strategies are centered on a core strength that has been developed over years of business. For example, Amazon has centered its strategy on superior customer experience since its launch in the late 1990s. From the beginning, founder Jeff Bezos focused on building capabilities around ‘customer obsession.’ In the early days this involved calling customers for feedback directly and manually taking orders himself. This process eventually evolved and led to unique offerings like endless shelf space, a more streamlined purchasing experience with one-click buying, best in class distribution with Amazon Prime, and streamline cloud computing with AWS. By compounding capabilities around customer obsession, Amazon has differentiated itself as one of the most customer centric companies in the world, and its service offerings align to the strategy. While its overarching ROIC is below industry benchmarks, its continual innovation, growth trajectory, and consistently high NPS confirm the effectiveness of the strategy.
Aim the Core Strength at a Customer Need
While centering a differentiation strategy around a core strength is table stakes, aiming it at an unfilled customer need increases the odds of success. Zoom is a great recent example of this strategy flourishing. Video chat has a long history. Products like Skype, Blue Jeans, and WebEx have been around for a while and had a major head start on Zoom.
Many of these products were popular and successful. ‘Skype’ even became a verb in popular nomenclature, similar to ‘google’ as a proxy for search.
But Zoom founder Eric Yuan noticed an emerging market opportunity. Yuan was formerly an engineering manager at Cisco WebEx and understood a key customer problem that was yet to be solved by WebEx: friction.
Yuan’s technical expertise combined with increased talent pipeline (engineering resources in China) built technical strength and Zoom aimed this strength at the core customer problem.
One of the key things you notice when using Zoom is the simplicity.
There is no need to download an app or other service to enter a meeting, it works seamlessly across devices, it is intuitive enough for kids and grandparents to onboard quickly, and this is all supported by technical reliability. The lack of friction in the customer experience has created a powerful network effect and made Zoom a core piece of the work/life infrastructure for teachers, CEOs, and families during the COVID stay at home orders. Zoom is still maturing as a public company and time will tell if the differentiation strategy is enduring, but it is off to a strong start.
Execute a Differentiation Strategy by Building Brand
Most leaders understand why centering a differentiation strategy on specific strengths and pointing them at existing customer problems makes sense, but after the analysis, they struggle to figure out how to execute.
NYU Business School Marketing Professor Scott Galloway explains brand as a function of promise and performance. While it may seem simple, focusing on these core components can go a long way to bringing a differentiation strategy to light.
Let’s start with promise. A strong promise comes down to understanding customer problems and telling a compelling story that helps them imagine a future where the problem doesn’t exist. Performance is a simply the follow through. Does the interaction fulfill the promise? Performance is rooted in quality. This comes from customer feedback, research and development, and innovation.
Nike is masterful at balancing promise and performance. From the early days of the company, Nike positioned itself as the preferred gear choice of professional athletes. They have delivered on that promise by being the running shoe choice of countless Olympic medal winners, NBA champions, and athletes in every other major sport. Nike invests heavily in storytelling to customers and regularly collaborates with athletes to test, innovate, and improve the performance of it’s gear. This combination is at the root of making Nike one of the most differentiated brands in the world.
Establish a Rigorous Process for Differentiating
The core components of building a differentiation strategy with a strength at the center, aiming that strength at a specific market opportunity, and ensuring messaging and quality are aligned, is a simple framework to help leaders think about sculpting the strategy.
But the success of the strategy largely depends on the accuracy of the insights that underly key decisions.
We find that many times organizations rely too much on the intuition of leaders in this process.
Often times, strengths are defined by the most senior person in the organization, while market research and brand development are outsourced to third-party organizations. Relying on the intuition of leaders and other experts can be a great way to get started, but this should only be the beginning.
The best organizations have a repeatable framework to define what is true in the market, and then shape strategy around reality. This means assessing strengths against competitors, accurately understanding the customers, and executing the necessary brand building activities required.
If organizations ignore this work and do not root strategy in reality, it makes it increasingly challenging to win by differentiation.
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