Uniqueness: Michael Porter's Key to Success in Business

Businesses compete against one another for the profit pool of their industries, and to achieve superior performance, they form strategies that ensure a competitive edge  . How do these strategies work, and how do we define superior performance?

First, the way you perceive performance. Business is not a zero-sum game or a form of warfare where only one prevails. The key actually lies in not competing directly. The key to competitive success—for businesses and nonprofits alike—is an organisation’s ability to create unique value. Porter’s prescription: aim to be unique, not the best. Creating value, not beating rivals, is at the heart of competition.

This blog will be the first Part of discussing how to analyse a business using Michael Porter's insights.

Battle to be Unique

How often have we heard, “May the best xyz win?” Way too many times. It makes sense to say it in competitive games like sports because it is a zero-sum game. However, it is a flawed way to look at it in terms of markets. Business competition is more complex, more open-ended and multi-dimensional. Within an industry, there can be multiple contests, not just one, based on which customers and needs are to be served.

Is Walmart’s presence dooming other retail stores? No, Target, Costco, etc., are still thriving. Did Apple conquer the whole market? Again, no. It is a remarkable business that controls most of the profit pools in the smartphone section, but that does not mean Samsung or OnePlus hasn’t thrived. 

Competition is more about focusing on meeting customer needs than on demolishing rivals. All of these succeeded in their niche because they did something different from their rivals. These businesses can sustain their profitability because no one can replicate them; they serve specific needs and wants that others don’t, which allows them to command higher prices.

Let's look at an industry that has failed to show this characteristic and has become a graveyard of businesses. Airline Industry.

Airlines have suffered from competition, which is the best problem. How often do we prefer an airline because of some service they provide or something they do? 90% of the time, it comes down to how cheap the business is. Let's take a relatable example: Air India is trying to capture the domestic market share of Indigo and cut prices. Because Indigo relies on its cost efficiency and its advantage is cost, they are forced to cut prices! And the investors take a hit because profitability takes a hit. 

Let's take another example that we all witnessed: the Telecom industry. Jio entered the market and broke the industry. The industry consolidated from fifteen to three players( one probably about to go bankrupt). This is because the most important thing for consumers is price. Who cares what I use as long as I get decent data speed?

This, says Porter, is competitive convergence. Over time, rivals begin to look alike as one difference after another erodes. Customers are left with nothing but price as the basis for their choices. This inevitable descent into price competition is the business equivalent of mutually assured destruction. And it’s not just the producers who suffer. Customers, suppliers, and employees often become collateral damage as rivals are squeezed for resources and forced to cut costs. When all else fails, and pressure on prices has destroyed an industry’s profitability, often the remedy is to limit competition through consolidation. Companies swallow each other up, thus reducing the number of rivals and allowing one or a few companies to dominate the market. And what happens when sectors consolidate? Innovation dies, and customers suffer.

One Upmanship is not an advantage.

Suppose you and I run a store selling pizzas for 500 rupees. We make the exact same food, and our profits are divided evenly. However, I decided to do something different. I introduce this new scheme: free fries with a pizza for the same price. I get more customers, but you one up my offer soon and include free Coke and fries. I can’t do much but match the offer. Ultimately, we ended up without differentiation but lost profits because of added costs. We dug our own graves because no one of us could back out of the offers and do the same thing but with less profits.

This is one Upmanship. If something can be replicated, it is not an advantage. One company’s attempt to be “the best” ended up raising the bar for everyone, which can only end in reduced profitability of the industry

Economies of Scale

Companies pursue economies of scale and scope believing that these will be decisive in determining competitive advantage and profitability. Of course, this thinking has at least a grain of truth, which is precisely what makes it so dangerous. There are economies of scale and advantages to being bigger in most businesses. However, it is not true that the biggest businesses make the most profits or are the most successful. It is just an easy goal to define, and that's it. Moreover, It is not actually an advantage. Economics of scale as an advantage is very relative to the size of your competitor. 

I never realized this until I read it, and now that I have, I can never unlearn it. Economies of scale are not an absolute advantage. It means nothing if the competitor is only 5% smaller than you, but it will mean everything if it's 90% smaller than you. 

Using it in Investing

Everyone wants to build a unique business. Obviously, who wouldn’t? But will everyone actually end up making one? I really doubt that. I started off making this website to be different: but will I actually become one? Let’s see.

As an investor, we are lucky because we get to witness thousands of businesses and choose which one is unique enough and worth investing. To put it in numbers, how does it help us invest in unique businesses, and how do we spot such a business?

Advantages of a unique business

1. High terminal value: A business that can prevent competitors from eating away its profits and customers will sustain its life longer than a usual business. It becomes increasingly difficult to compete against such a strong business, giving it a longer and higher terminal value, giving it a premium valuation. 
   

2. Stability: Being Unique means being predictable. When you are the only one in the industry, there are fewer variables to worry about. This translates to stable business operations, stable margins, stable and predictable earnings growth, and consistency. It also makes it easy to study the business, as the future isn't as uncertain as it might be for other businesses.  

3. Profits: The key advantage to being unique is being rewarded for it. Services and products which are unique and not replicable can be sold at a higher price and help the business get high margins and returns.

These are the key advantages of being a unique business. However, there will be many more, and I would love to hear more about them from you.

How do we spot a unique business?

A unique business should display the characteristics discussed above. We could manually study all the businesses, talk to fellow investors, analyse the industry, use the product, and maybe come to a conclusion about whether it is unique or not. By then, everyone would have probably found out, and the business would have run away.

A simple way to filter these businesses is to check their ROCE or Return on Capital Employed. In capitalism, competition should eat away the excess profit, and ROCE should revert to the cost of capital. However, if a business can fend off competition and maintain a high ROCE, it has a competitive advantage that can't be taken away that easily. Hence, ROCE becomes a very good starting point for studying such businesses and finding unique ones.

Until then, let me know if you found any unique businesses and how they ended up doing.