Increase the overall Strategic Market Position for your business unit or company and you will increase your ability to achieve higher profitability and growth, and unlock hidden value. On the other hand, organizations that fail to recognize and act on their Strategic Market Position may be at risk. First, however, you must know what Strategic Market Position is and how to use it. This author, who has written the book on SMP, describes what it is and how to use it.
Faced with the challenge of achieving continued growth and higher levels of profit, executives may have a nagging suspicion that the secret to sustained higher performance and value may be hiding somewhere on the competitive landscape just waiting to be discovered. Most often, however, the problem is not a shortage of information and ideas, as business leaders are typically barraged by a wealth of information on markets, customers, competitors and new business opportunities. The challenge is identifying the exact information and ideas that can lead to higher shareholder value.
High performing, value-creating companies have learned how to tie together the principles of customer preference, producer economics, and corporate finance so that they understand where and how expanded operations and increased market share pay off – and don’t pay off – for their business. In short, they have learned how to find strategic value and capture it by achieving an effective Strategic Market Position, or SMP.
When it comes to operating a successful business, conventional wisdom holds that bigger is better. However, insisting on being number 1 or number 2 in your market – without first having a very clear understanding of what definition of market share really drives profitability – can take some very interesting opportunities off the table. Organizations that fail to recognize and act on their Strategic Market Position may be at risk because their definition of market share often does not correlate with company returns, profitability, and strategic growth potential.
In addition to defining market share precisely and accurately, understanding the impact of different approaches to penetrating and growing market share in chosen segments is critical. By deploying investments in carefully selected segments, where (among other things) they are potentially poorly served by the strong players, companies can position themselves in their industries strategically and allocate more assets in fewer, carefully selected ways. As a result, these companies can achieve much higher market shares in their chosen segments.
Creating value through strategic market positioning
The key to uncovering one’s true SMP in an industry lies in assessing which dimensions of scale or market share contribute to increased profitability and value. There are endless ways to segment a market, but very few provide the right basis for strategic decision-making. Successful companies understand where growth will build competitive strength and profitability and where it will not. They put more of their eggs in fewer, carefully chosen baskets.
SMP is a tool for decision-making shared by management functions throughout an organization that can be applied to a broad range of situations. Examples include prioritizing sales or development efforts, finding new and profitable markets, improving and/or shedding low-growth or low-margin businesses, and identifying acquisition opportunities. In sum, SMP can be summarized in the following three-step action plan. Although plans will vary depending according to a company’s specific circumstances, a typical plan would include these three major activities:
- Be creative and cast a broad net. To maximize the chances of identifying successful strategies, think beyond the current business offerings. Evaluate other businesses that share the same customers or leverage the same technologies. Consider service as well as product offerings. Identify the range of organic or acquisition initiatives that could be used to pursue potential growth strategies.
- Apply the SMP test. Identify the growth strategies that have the greatest potential to increase the company’s weighted average relative market share, as measured across all strategic segments impacted by the strategy. This will identify strategies that have the potential to improve the company’s overall position on the most important drivers of profitability.Apply the SMP test quantitatively to specific initiatives to see whether market share, appropriately defined, increases or decreases.
- Apply the value-creation test. “Strategic value” is defined as the net present value of cash flows from higher revenues, lower costs, and lower capital requirements that will accrue from the growth opportunity and the existing business being run together versus separately.
If the strategic segmentation and value creation tests have both been performed correctly, the most attractive options should come out on top using both methods.
Case Example: Oil and Gas Exploration and Production
To explain how SMP works in greater detail, consider the example of an industry that is a key component of the Canadian economy: the energy industry. How would you apply the logic of SMP in the context of oil and gas exploration and production? Backing up a step further, would you?
Conceivably, some people would argue that you would not. They would argue that the main growth driver in the oil and gas exploration and production industry is your success rate in avoiding dry holes (through luck or otherwise), and that the discipline of SMP therefore does not apply.
Alternatively, they might argue that global scale and a strong balance sheet are the most important contributors to success. The investments needed to compete in the oil and gas exploration and production are huge, and the uncertainties and challenges that exist in this business are equally enormous. As a result – the argument might go – it’s extremely important for a company in this industry to be large enough to be able to absorb capital expenditures on the order of billions of dollars. In addition, since most of the reserves in locations that are easy to mine have already started to dry up, companies now have to go to geographically and geopolitically difficult places from which to extract oil and natural gas. Given the risky and challenging nature of this business, they might conclude, the ability to be able to leverage global scale is the key driver of success.
This might be the conventional wisdom, and if so, it would not be totally wrong. Global scale is important, for example. But when the industry is seen through the lens of SMP, global scale turns out not to be the most important value driver. In fact, economies of production – and therefore profitability and shareholder value — are driven by a much more local factor: scale within a drilling basin. Why? To state it simply, the company that has a large-scale operation within a specific region will develop greater expertise in understanding the geology of the region, be able to develop better, more cost-effective local infrastructure, and be in a position to gain a competitive advantage in delivering the product once it has been taken out of the ground.
That being said, vertical integration is no longer an important factor in the industry. (These factors do change, over time.) There was a time when all of the major oil and gas companies were completely integrated — from exploration and production all the way through to refining, distribution, and retailing. But it has become increasingly obvious that with efficient trading operations, and the efficient market for transfer of product between one part of the value chain and another, producers don’t need to be fully integrated in order to be highly successful. Conversely, if you are still fully integrated, that isn’t going to create a big advantage for you, versus companies that are focused on one part of the value chain or another.
To ground this general analysis in specifics, we can compare two real-life companies: Anadarko Petroleum Corporation and Phillips Petroleum Company. Anadarko is a particularly timely example given its recent strategic move to acquire Kerr-McGee and Western Gas Resources. In order to better understand the rationale for this deal, we will look at the historic context for what strategies have worked in this market.
First, a quick snapshot of the two companies: Founded in 1959 and headquartered in Houston, Anadarko is one of the world’s largest independent oil and gas exploration and production companies, with about 80 percent of its reserves located in the U.S. in 1996 (primarily mid-continent in Kansas, Oklahoma, and Texas). Beginning in the mid 1990s, Anadarko undertook significant exploration of some strategic international locations, and particularly in Algeria’s Sahara Desert. The company began international production in May 1998.
Phillips Petroleum Company – older, bigger, and better known — was founded in 1917 with headquarters in Oklahoma. Its main production areas are more widely dispersed across the globe than Anadarko’s: in the U.S., U.K., Norway, Canada, Nigeria, and off the coast of China. In 1996 – the year of our comparison — only about 30 percent of Phillips’ crude oil was produced in the US.
Phillips production in 1996 was 234,000 barrels per day of oil/natural gas liquids (NGL), and 1,527 million cubic feet per day of natural gas. Anadarko, meanwhile, averaged only about 28,000 barrels per day of oil and NGL and 451 million cubic feet per day of natural gas. Phillips is substantially larger and much stronger than Anadarko in terms of market share in their relevant global markets. In production, Phillips has about 1.1 percent of global market share (in the markets where they play), where Anadarko has less than 0.2 percent.
To understand SMP, we need to consider a different definition of “market share”: the one previously highlighted in our energy-industry Value Map, which is the scale of the two companies’ operations in their respective drilling basins. While Phillips has concentrated its operations in some regions, they have not focused their resources on any particular basin. As a result, the company is pretty well spread out over a number of geographic markets, and has a low market share in each of them.
In contrast, Anadarko has focused its efforts in Kansas and Oklahoma, and has established a very strong market position in those regions. Its concentration in Kansas has given it an advantage in terms of better information, larger operational scale and stronger position in negotiating with suppliers. Therefore, Anadarko’s overall strategic market position (weighted average of the market shares in each of the geographic regions) is actually stronger than that of Phillips.
This stronger market position is evident in shareholder returns from investing in Phillips versus investing in Anadarko. If we look at performance over the 1996 – 2001 period, we can see in Figure 1 that total shareholder returns on investing in Anadarko were approximately 5 percent higher than investing in the S&P 500 Oil and Gas Index; whereas, the returns from investing in Phillips were actually about 6 percent lower than if one were to invest in the S&P index.
Again, you can see how “thinking SMP” increases your chances of success in a highly competitive context. For the most part, oil and gas exploration companies have to bid on drilling rights. How do they determine those bids? Well, one approach – which appears to be the one favored by Phillips and other industry giants – is simply to assign a net present value to anticipated reserves in the ground, and bid based on that NPV assumption. Under this approach, you bid for drilling rights in auctions all over the world, and hope to win your fair share of them. The alternative – which appears to be the approach employed by Anadarko – is to bid more aggressively in basins where you already have a strong position, and less aggressively (if at all) outside of those basins.
While the SMP framework is critical for evaluating organic growth strategies such as bidding on drilling right, it is equally applicable when considering growth through acquisitions. This is evident from Anadarko’s recently completed acquisitions of competitors Kerr-McGee and Western Gas Resources in August 2006. Kerr-McGee has properties in the deepwater Gulf of Mexico and in Colorado and Utah. Western Gas Resources’ has assets in the Powder River Basin. The stated strategic basis for these transactions is not merely to create a larger player but to strengthen the combined company’s market presence within specific basins, namely in the Gulf and the Western U.S.
In reference to the transactions, Anadarko’s CEO, Jim Hackett illustrated the importance of growing within strategic market segments when he stated, “The core assets being acquired strongly complement Anadarko’s existing properties, providing scale and focus needed to deliver more robust, predictable and efficient growth. Kerr-McGee’s outstanding deepwater holdings and skill sets will elevate Anadarko into the top echelon of deepwater operators. Similarly, Kerr-McGee’s long-lived natural gas resource plays in Colorado and Utah, along with Western Gas Resources’ in Wyoming, will combine with Anadarko’s assets to make us one of the largest producers in several of the most prolific basins in the Rockies. Together these acquisitions create a more focused portfolio, which will ensure our ability to deliver very competitive growth rates and returns.”
Only time will tell if these acquisitions create economic value for Anadarko’s shareholders. However, it is clear that it was not Anadarko’s intent just to become bigger. It did not acquire businesses with assets in far flung locations. It was a strategic choice to bring together a trio of businesses with significant overlap in targeted basins, increasing the combined company’s share within strategic market segments, with the intent to create shareholder value.
Strategic market positioning (SMP) is a proven and highly effective tool for creating value. It is founded on the assumption that not all growth is good – in fact, that some growth actually destroys value. SMP helps companies identify the difference and respond accordingly. My goal with this example is to give you some preliminary insight into the core principles of SMP:
1) Every business can be thought of as one or more strategic segments, defined such that increased scale or market share in any segment will, other things being equal, always create the potential for higher profitability and competitive advantage. The boundaries for these strategic segments are determined by how different dimensions of scale or share impact economics for providers and benefits to customers (the Value Map). Strategic segments are often different than accepted market definitions and boundaries.
2) If you know the boundaries of the strategic segments you are competing in and can see the “game board” for your industry, you are in a great position to:
- find new business that enables you to build up a strong strategic market position (SMP) in segments where you do not face overwhelming competitors
- know when it makes sense to “deemphasize” parts of your business that are not contributing to strong strategic market positions and profitability
- communicate the logic of your growth strategy to senior management and investors
3) If you increase the overall SMP for your business unit or company, you will increase your ability to achieve higher profitability and growth, and unlock the hidden value of your business.
The author wishes to thank Rob Maeder of L.E.K. Consulting for his assistance in preparing this article.