Michael Porter is considered to be the founder of modern business strategy. He is one of Harvard Business School's most famous professors and originated the ideas of the "five forces" of industry analysis, the value chain and competitive advantage.
Porter is essential reading for business managers, and he is also highly informative for investors who want to know as much as possible about business management. After all, if you don't understand how a business is run and managed, and what makes one business successful and another fail, it is difficult to pick the best investments.
What's the value proposition?
Porter has done a great deal of work on the idea of the value proposition -- what a company offers to its customers and how it interacts with its customers before, during and after the transaction.
According to Porter, a distinctive value proposition answers three questions. First, management must know which customers they are going to serve. Then they need to decide which customer needs are they going to meet. And finally, there needs to be thought given to the price at which customers will think the product offers value and provide acceptable profitability for the company.
The underlying theme of all these points is the idea that a company must decide which customer segment it is going to target and then stick with what it knows. Trying to branch out into different sectors and industries can not only be costly for a company, but it can damage the reputation with existing customers and let competitors gain an edge.
Many businesses fail in this regard. Managers can become blind in the race for growth, trying to serve more customers and develop more features, offering as much as possible in order to increase sales. Unfortunately, this can leave companies "stuck in the middle" as they are outflanked on each side, by cost leaders on one side, which are just good enough but convince customers they are the better option on price. And on the other side are differentiators, who are able to offer customers a better, possibly more attractive proposition because they focus on what they know best.
A unique proposition
Above all, companies have to be sure that they offer a unique value proposition to rivals. If they are offering the same service, to the same customers, at the same price they "don't have a strategy," according to Porter.
This advice can be very useful in the investment world. The most successful companies of all time, such as Amazon (AMZN) and Apple (AAPL), offer a unique value proposition. Amazon virtually revolutionized the e-commerce sector and Apple revolutionized the cell phone market. You can also make a strong argument that companies such as Coca-Cola and Kraft Heinz also offer a unique proposition (although both companies are currently seeing their competitive advantages eroded buy lower cost competitors).
Investing is an art, not a science, and there will never be a precise formula for finding companies that have the greatest long-term potential. However, focusing on businesses that have a strong proposition will narrow down the range of opportunities. I have always tried to avoid companies that chase growth at all costs because this strategy can lead businesses astray, and they ultimately may end up alienating their core customer base as they chase other markets where they have little experience.
A great example of a company that focuses on its core value proposition and does not try to do anything else is Berkshire's See's Candies. This business is still relatively small compared candy giants such as Mars, but it has stayed that way because it knows there is value in having a unique product.
As I said, there is no set template for finding companies with the most convincing value propositions, but including some of Porter's ideas in your investment analysis will help you find these businesses.
Disclosure: The author owns shares in Berkshire Hathaway.
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