Producing sustainable competitive advantage
Would have you begin by selecting the right industries. After all, “not all industries offer equal opportunity for sustained profitability, and the inherent profitability of its industry is one essential ingredient in determining the profitability of a firm. ”1 According to Michael Porter’s now famous framework, the five fundamental competitive forces that determine the ability of firms in an industry to earn above-normal returns are “the entry of new competitors, the threat of substitutes, the bargaining power of buyers, the bargaining power of suppliers, and the rivalry among existing competitors. ”2 You should find industries with barriers to entry, low supplier and buyer bargaining power, few ready substitutes, and a limited threat of new entrants to compete away economic returns. Within such industries, other conventional analyses would urge you to select firms with the largest market share, which can realize the cost benefits of economies of scale. In short you would probably look to industries in which patent protection of important product or service technology could be achieved and select the dominant firms in those industries.
You would have been very successful in selecting the five top performing firms from 1972 to 1992 if you took this conventional wisdom and turned it on its head. The top five stocks, and their percentage returns, were (in reverse order): Plenum Publishing (with a return of 15,689%), Circuit City (a video and appliance retailer; 16,410%), Tyson Foods (a poultry producer; 18,118%), Wal-Mart (a discount chain; 19,807%), and Southwest Airlines (21,775%). 3 Yet during this period, these industries (retailing, airlines, publishing, and food processing) were characterized by massive competition and horrendous losses, widespread bankruptcy, virtually no barriers to entry (for airlines after 1978), little unique or proprietary technology, and many substitute products or services. And in 1972, none of these firms was (and some still are not) the market-share leader, enjoying economies of scale or moving down the learning curve. *Adapted from Jeffrey Pfeffer, Competitive Advantage through People, Harvard Business School Press, Boston, 1994. 95 96 Academy of Management Executive What these five successful firms tend to have in common is that for their sustained advantage, they rely not on technology, patents, or strategic position, but on how they manage their workforce.
The point here is not to throw out conventional strategic analysis based on industrial economics but simply to note that the source of competitive advantage has always shifted over time. What these five successful firms tend to have in common is that for their sustained advantage, they rely not on technology, patents, or strategic position, but on how they manage their workforce. The Importance of the Workforce and How It is Managed As other sources of competitive success have become less important, what remains as a crucial, differentiating factor is the organization, its employees, and how they work.
Consider, for instance, Southwest Airlines, whose stock had the best return from 1972 to 1992. It certainly did not achieve that success from economies of scale. In 1992, Southwest had revenues of $1. 31 billion and a mere 2. 6% of the U. S. passenger market. 4 People Express, by contrast, achieved $1 billion in revenues after only 3 years of operation, not the almost 20 it took Southwest. Southwest exists not because of regulated or protected markets but in spite of them. “During the first three years of its history, no Southwest planes were flown. ”5 Southwest waged a battle for its very existence with competitors who sought to keep it from flying at all and, failing that, made sure it did not fly out of the newly constructed Dallas-Fort Worth international airport. Instead, it was restricted to operating out of the close-in Love Field, and thus was born its first advertising slogan, “Make Love, Not War. ” Southwest became the “love” airline out of necessity, not choice. In 1978, competitors sought to bar flights from Love Field to anywhere outside Texas. The compromise Southwest wrangled permitted it to fly from Love to the four states contiguous to Texas. 6 Its competitive strategy of short-haul, point-topoint flights to close-in airports (it now flies into Chicago’s Midway and Houston’s Hobby airports) was more a product of its need to adapt to what it was being permitted to do than a conscious, planned move—although, in retrospect, the strategy has succeeded brilliantly.
Nor has Southwest succeeded because it has had more access November to lower-cost capital—indeed, it is one of the least leveraged airlines in the United States. Southwest’s planes, Boeing 737s, are obviously available to all its competitors. It isn’t a member of any of the big computerized reservation systems; it uses no unique process technology and sells essentially a commodity product—low-cost, low-frills airline service at prices its competitors have difficulty matching. Much of its cost advantage comes from its very productive, very motivated, and by the way, unionized workforce. Compared to the U. S. airline industry, according to 1991 statistics, Southwest has fewer employees per aircraft (79 versus 131), flies more passengers per employee (2,318 versus 848), and has more available seat miles per employee (1,891,082 versus 1,339,995).
7 It turns around some 80% of its flights in 15 minutes or less, while other airlines on average need 45 minutes, giving it an enormous productivity advantage in terms of equipment utilization. 8 It also provides an exceptional level of passenger service. Southwest has won the airlines’ so-called triple crown (best ontime performance, fewest lost bags, and fewest passenger complaints—in the same month) nine times. No competitor has achieved that even once. 9 What is important to recognize is why success, such as that achieved at Southwest, can be sustained and cannot readily be imitated by competitors. There are two fundamental reasons.
First, the success that comes from managing people effectively is often not as visible or transparent as to its source. We can see a computerized information system, a particular semiconductor, a numerically controlled machine tool. The culture and practices that enable Southwest to achieve its success are less obvious. Even when they are described, as they have been in numerous newspaper articles and even a segment on “60 Minutes,” they are difficult to really understand. Culture, how people are managed, and the effects of this on their behavior and skills are sometimes seen as the “soft” side of business, occasionally dismissed.
Even when they are not dismissed, it is often hard to comprehend the dynamics of a particular company and how it operates because the way people are managed often fits together in a system. It is easy to copy one thing but much more difficult to copy numerous things. This is because the change needs to be more comprehensive and also because the ability to understand the system of management practices is hindered by its very extensiveness. Thus, for example, Nordstrom, the department store chain, has enjoyed substantial success both in customer service and in sales and profitability 2005
Pfeffer growth over the years. Nordstrom compensates its employees in part with commissions. Not surprisingly, many of its competitors, after finally acknowledging Nordstrom’s success, and the fact that it was attributable to the behavior of its employees, instituted commission systems. By itself, changing the compensation system did not fully capture what Nordstrom had done, nor did it provide many benefits to the competition. Indeed, in some cases, changing the compensation system produced employee grievances and attempts to unionize when the new system was viewed as unfair or arbitrary.
Thirteen Practices for Managing People Contrary to some academic writing and to popular belief, there is little evidence that effective management practices are 1) particularly faddish (although their implementation may well be), 2) difficult to understand or to comprehend why they work, or 3) necessarily contingent on an organization’s particular competitive strategy. There are interrelated practices—I enumerate 13, but the exact number and how they are defined are somewhat arbitrary—that seem to characterize companies that are effective in achieving competitive success through how they manage people.
The following policies and practices emerge from extensive reading of both the popular and academic literature, talking to numerous people in firms in a variety of industries, and the application of some simple common sense. The particular way of subdividing the terrain is less important than considering the entire landscape, so the reader should realize that the division into categories is somewhat arbitrary. The themes, however, recur repeatedly in studies of organizations. It is important to recognize that the practices are interrelated—it is difficult to do one thing by itself with much positive result.
Employment Security Security of employment signals a long-standing commitment by the organization to its workforce. Norms of reciprocity tend to guarantee that this commitment is repaid. However, conversely, an employer that signals through word and deed that its employees are dispensable is not likely to generate much loyalty, commitment, or willingness to expend extra effort for the organization’s benefit. New United Motor Manufacturing (NUMMI), the Toyota-GM joint venture in California, guaranteed workers’ jobs as part of the formal labor contract in return for a reduction in the number of job.