When a competitor earns a higher margin, the usual reaction is a cost programme across the board: a percentage cut for every department. It is simple to announce and almost always wrong, because it cuts the activities that create advantage as much as those that destroy it.

Break the margin into activities

Porter's value chain splits a business into the activities that deliver a product to the customer: inbound materials, operations, outbound logistics, marketing and sales, service, and the support functions around them. Measuring the cost of each activity per unit sold, for you and for your best competitor, shows where the margin gap actually comes from.

The value chain of the company, cost per 100 of revenue: ours against the best competitor. The margin on the right is what the activities leave. Illustrative comparison.
Cost of each activity per 100 of revenue, against the best competitor. The 7-point margin gap comes mostly from operations, while the competitor spends more on marketing and service. Illustrative comparison.

The company earns a 17% margin against the competitor's 24%. Five of the seven points come from operations, three from materials and two from overheads. But the company spends less than the competitor on marketing and on service, the two activities customers see. An across-the-board cut would widen the gap where the competitor differentiates and barely touch the real problem.

Four decisions for each activity

  1. Fix the activities where you are structurally more expensive for no customer benefit, here operations.
  2. Invest where customers pay for the difference, even if it raises cost.
  3. Outsource activities where a specialist has scale you will never reach.
  4. Combine activities with a partner or an acquisition when shared scale creates the synergy.
BS

Bartor S.

Founder

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