Trade-offs are your friend

This is part of an ongoing series exploring the work of Michael Porter—the HBS professor widely seen as the father of modern strategy. It’s about how to use trade-offs to prevent competitors from copying you, and about how to know when you should (and shouldn’t) copy your competitors.

Enjoy!

One day, Herb Kelleher walked into his office and found a package from his customer service team. It was a bundle of angry letters from a customer with a note attached: “this one’s yours.”

Herb was the co-founder of Southwest Airlines, and the letters on his desk were from a frequent flier. They were not good. She hated almost every aspect of the experience: No assigned seats. No meals. No first class. She even hated the “casual atmosphere.”

The customer service team would normally just send a polite reply, but at this point, they were out of ideas. So they bumped it up to Herb.

He thought about it for a few moments, then simply wrote:

“Dear Mrs. Crabapple, We will miss you. Love, Herb.” [1]

What are trade-offs?

“The sign of a good strategy is that it makes some customers unhappy.”
— Michael Porter

In the last post, I wrote about why Porter urges businesses to “compete to be unique.” This post is about one of the main ways businesses can actually achieve uniqueness: by leveraging trade-offs.

But first, what are trade-offs? Trade-offs happen when getting more of one good thing means you get less of another. They occur in business, but you can find them everywhere.

For example:

Economy vs luxury - People like assigned seats and meal service, but Southwest is able to save money by not doing it. So luxury trades off with price.
Quality vs size - High quality music sounds great, but storing a lossless WAV file takes up a ton of space on hard drives, and downloads take forever.
Simplicity vs control - Substack’s simplicity is great for individual writers like me to run subscription newsletters, but not so great for big media businesses that may want API access, design customization, etc.
Force vs agility - There’s a species of finch on the Galápagos Islands that has a big, thick beak. It’s great at crushing shells to eat seeds and nuts, but bad at probing into tight spaces. Other species have thin beaks that can poke deep into tree bark to find insects for food, but aren’t strong enough to crush much of anything.
Risk vs reward - Investing in a startup is much riskier than buying a US government bond, but has the potential to generate much higher returns.

Each example above represents a fork in the road. There’s some constraint, often rooted in basic physics, that won’t let you have your cake and eat it too.

Porter outlines three main sources of trade-offs within businesses:

Product - If I want a big truck to haul timber, and you want a little car to park in a tight city street, the same product is not going to serve both of our needs.
Operations - The engineering process you need for creating cardiac pacemakers is going to be quite a bit tighter than the process you’d use for developing a podcast app. Safety trades off with speed, in this case.
Brand - Tiffany’s can’t offer discount jewelry without tarnishing their reputation as a high-end luxury brand.

Aside from these three sources of trade-offs, there’s one other big one: resources. Every dollar of cash (and every hour of focus!) can only be spent once.

Of course, this sucks. Nobody likes limits. So businesses often try to plow through trade-offs. And sometimes—rarely—they pull it off!

(For example, Japanese auto companies proved in the 80’s that much of the trade-off between “cost” and “defects” that Detroit took for granted was just a mirage, through their invention of lean manufacturing techniques.)

But most of the time, the company that attempts to eliminate a trade-off just ends up “straddling,” and gets the worst of both worlds.

Straddling example: Southwest vs Continental

In the early 90’s the CEO of Continental Airlines started to get pretty worried by how fast Southwest was growing. So he decided to launch “Continental Lite” — a new subsidiary that would copy as much of Southwest’s low-cost model as they could, right down to the flight attendants’ jokes. [2]

They charged lower fares, removed first class, served peanuts instead of meals, and focused on short, point-to-point routes. But they weren’t able to match the cost savings of Southwest, in part because they weren’t able to turn around their planes fast enough. Even after lots of tweaking and pressure from management, turn-arounds still took upwards of 30 minutes, compared with 15 minutes on Southwest. That might not seem like a big deal, but in a business where every idle minute costs huge sums, the difference was enormous.

So why, even after copying so much of Southwest’s model, couldn’t they match the 15-minute turn around? Case studies from Harvard Business School point towards one surprising factor: culture.

At Southwest, every employee learns to hustle, have fun, and help their teammates with tasks that may seem “beneath them.” Pilots might clean up peanut wrappers. Senior management might show up at a hangar at 3am to show solidarity with mechanics.

This culture was no accident. Instead, it was reinforced by a structure of interlocking policies all designed to foster this kind of teamwork. Everything from the way employees were hired (attitude trumps experience), trained (ropes courses, sketch comedies, etc), and compensated (profit sharing and stock options) worked to reinforce the ethos.

Meanwhile, at Continental, the relationship between management and labor was strained. Even if they were aware of the nuanced relationship between culture and performance, it would have been extremely challenging to copy, given their history. So they were stuck with a half-copy of the Southwest model.

The result? Continental lost hundreds of millions of dollars, and nearly went bankrupt. Within five years, Continental Lite was cancelled, and the CEO decided it was best to “explore other career opportunities.”

To copy, or not to copy

Turns out, copying is hard. And it’s even harder when the company you’re imitating has an intricate structure of activities that all make smart use of trade-offs to reinforce their value proposition, some of which may be at odds with the kind of value your organization is adapted to deliver.

That’s why even though Continental was able to copy most of Southwest’s system, they ultimately failed to generate the needed cost savings to be able to match Southwest’s prices. There were just too many subtle trade-offs that clashed with their current strategy.

You might be wondering: how could Continental’s CEO have known beforehand? What signs could he have seen? And, conversely, what signs might indicate situations where copying is a good idea?

For example, what emboldened Adobe’s CEO to make the switch to a subscription model? Why was Facebook willing to bet so much on copying Snapchat’s “stories” format? And why did the founder of Wal-Mart say “most everything I’ve done I copied from someone else”? [3]

The answer we get from Porter is that managers should copy tactics, not strategy, and only when the tactics clearly enhance the business you’re already in.

In the case of Facebook, the strategy was to increase sharing and “time spent in the app,” in order to increase ad impressions. So the “stories” format plugged almost perfectly into their overall system.

In the case of Adobe, the strategy was to be the industry standard toolset for creative fields. The subscription model enables them to deliver updates more continuously to users, and the recurring revenue model gives them a lot of additional cash and predictability that they can reinvest to make the tools even better.

In the case of Wal-Mart, the strategy was to be the best low-cost, general-purpose retailer. When they were getting started, retail was a super fragmented industry, so Sam Walton would visit retailers all over the country to find ideas to copy—but only if they fit the overall strategy.

In the case of Continental, the strategy was totally different from Southwest. Continental was a traditional full-service airline, and Southwest was a new breed of discount airline. So they weren’t just copying tactics, they essentially wanted to create two different companies within one corporate entity.

In theory you can save money by consolidating functions like HR, finance, and marketing, but as this example shows, things are more complicated than they seem. As it turned out, even Southwest’s HR function was incredibly tailored to support their overall strategy! This is because Southwest’s value chain at this point was extremely “dug in” — highly adapted to the strategy.

This leads us to a broader point about why copying strategy (rather than tactics) is so dangerous: it usually involves changes to the company’s culture. And you should be extremely wary of any plan that requires a culture change.

Perhaps one day our understanding of how culture functions will advance to the point that managers have more control over it, but for now it’s best to just remember:

“Culture eats strategy for breakfast.”
—Peter Drucker

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Footnotes

This story is from the 1996 book Nuts!, about lessons learned from Southwest’s success.
I found information on the misadventures of Continental Lite here, here, and here.
More on Sam Walton’s copying here