Michael Porter - Fundamentals of Strategy

Fundamentals of strategy:

A successful strategy is established on two bases; the first of which is a deep  understanding of the business situation through internal analysis, that is related to the company’s capacities and assets, and external analysis, that is focused on the environment where the company works. A framework through which internal and external insights are classified is SWOT; that is STRENGTHS, WEAKNESSES, OPPORTUNITIES and THREATS. The second basis of a successful strategy is a clear mission and vision that defines the company’s business, and sets forth its goals, objectives, and criteria to measure its performance.

Michael Porter describes a model that Improves industry performance; low-cost and differentiation, which allows a company to produce the same goods as its competitors at lower costs, and differentiation is the advantage that a company’s products have, and that allows it to be sold at a higher price.

Importance of strategy assessment and judgment 

Strategy assessment and judgment can be made only when the decision maker fully understands the industry and the business position. Failure to come up with an accurate judgment of the business position simply leads to poor performance because strategic decisions need to be based on accurate information.

Performance success and shortfalls

Common reasons of poor financial performance are three; first, sales that are too low to cover costs; second, too high product or fixed cost; failure to come up with effective plan that takes into account the proper staging of actions.

The profit equation:

  We can understand fro; Fig.1 that if FC (fixed costs) are higher than unit sales multiplied by unit margin, then the profit is negative.

  We can also understand fro; Fig.1 that unit sales = market size* market share, and that unit margin = selling price – cost of goods sales.

Unit sales: market share:

There are three factors that govern demand: the market’s need or demand, the economic conditions and competition. (see Fig.2).

Unit sales: market share:

If market size remains stable and a company’s market share drops, then unit sales will drop and profitability will be affected. Common causes of drop of market share are the appearance of a new product, a competitor’s upgraded product, a change in the company’s marketing, low production or a rival’s change of marketing policy. To meet this challenge, that is the drop of the market share, it is essential to understand both the customer and competition.

Unit sales: forecasting sales for a product:

Accurate forecasting sales is essential for business success. It saves the company from such pitfalls as stock outs, which is running out of stock and incapability to meet demand, and having unsold inventory, which means having a surplus of stock.

Accurate forecast can be based on the drivers of the market size * market share part of the profit equation.

Unit margin:

Unit margin is (SP-GOGS), it is the difference between the selling price and the cost of goods sold.