Tuesday, 22th of September 2002
Source: HBS Working Knowledge

Location, Location, Location: Strategy in Europe
HBSWK Pub. Date: Jun 3, 2002

European companies often believe that their business landscape puts them at a competitive disadvantage. Not so, as long as smart strategy is their priority, says Christian Ketels, principal associate of Harvard Business School's Institute for Strategy and Competitiveness.

by Sarah Jane Johnston, HBS Working Knowledge

What are the forces that shape business strategy in Europe? And why should we care about understanding them? Christian Ketels, of Harvard Business School's Institute for Strategy and Competitiveness, answered those questions in a new article, "Why the European Context Matters," in the summer 2002 issue of European Business Forum magazine. Ketels is principal associate at the Institute, a center dedicated to the study of competitiveness among companies, cities, regions and nations, which is led by University Professor Michael E. Porter. Recently, Ketels explained the European side of the story in an email interview with HBS Working Knowledge's Sarah Jane Johnston.

Sarah Jane Johnston: What conditions in Europe most often influence strategy making at the company level, in your view? How should European companies think about crafting better strategies for themselves?

Christian Ketels: European companies face an environment that is shaped significantly by their location. Using Michael Porter's "Diamond" framework 1, the Global Competitiveness Report Survey gives insights into Europe's business environment relative to the U.S. In the area of factor conditions, Europe is strong in the basic elements of education and infrastructure, but weaker in more specialized and sophisticated elements like research institutions and financial markets. The context for firm strategy and rivalry in Europe is shaped by openness to international trade, but also by less intense local competition. Demand conditions are in general on a par with the U.S., but feature local or regional pockets of very sophisticated demand. Finally, despite being home to some vibrant local clusters with strong traditions, in terms of related and supporting industries Europe provides, in general, poorer conditions for clusters than the U.S.

What makes these companies (and others like them) stand out is that they adhere to the general principles of strategy, and leverage the unique characteristics of their European location. - Christian Ketels -


Cutting across all these dimensions is the high degree of heterogeneity between individual European markets. This heterogeneity has two main effects: First, industry structures are more heterogeneous across European countries than across the United States-hence success is often more a function of understanding local idiosyncrasies rather than mastering the generic dynamics of an industry. Second, market demand is more heterogeneous and serving the European market from one central location is more cumbersome-hence production structures are often more decentralized and less well equipped to exploit economies of scale. The European integration process and, more recently, the launch of the Euro are reducing some of this heterogeneity while leaving other areas of the national European "diamonds" untouched.

European companies have often thought about the heterogeneity they face as a competitive disadvantage. While it is true that smaller national markets tend to increase cost levels, most of these additional burdens will evaporate with increasing European market integration. European companies will need to aggressively pursue these new opportunities for efficiency increases. But to stand out, they need to turn that heterogeneity into a strength by mobilizing the uniqueness of their European home locations as central pillars of their strategies.

Question:Which companies in Europe are standouts, in your opinion, for their superior strategic decisions? Why?

Answer: The criteria that distinguish successful companies from their peers are no different in Europe than they are in any other location: The final arbiter of success is financial performance, measured against their industry average. And performance is driven by strategies that make consistent choices on which customers to target, which value to deliver, and which activities to perform.

A good example is BMW, the German car manufacturer. BMW has a clear focus on the high-quality, sportive segment of the market, and its financial performance has consistently outperformed many of its European and global competitors. The choices BMW has made about customers, brand and product value, and activities in R&D, manufacturing, distribution, and marketing are consistent and reinforcing. And they have been made in an environment featuring a strong supply of engineers, sophisticated demand from critical drivers on the German autobahn, and an intensely competitive neighborhood with companies like DaimlerChrysler, Porsche, and Audi. BMW's success has not been determined by its location, but the location has enabled and pushed the company to choose a path to success that others find very hard to copy.

Another example is IRIZAR, the Spanish manufacturer of coaches. IRIZAR has a clear focus on individually designed, high quality coaches; is one of the financially most successful companies in the industry; and has won a number of business awards. IRIZAR's strategic positioning choices leverage the manufacturing base at its Basque location to aim for the high-quality segment. IRIZAR invests heavily in its employees and has adopted a flat management structure with decision power devolved to shop-floor teams. This management approach is consistent with the company's focus on individually designed solutions.

What makes these companies (and others like them) stand out is that they adhere to the general principles of strategy and leverage the unique characteristics of their European location. Their strategies take advantage of the intimate knowledge of and interaction with local suppliers, customers, competitors, and other related institutions that rivals in other locations do not have access to. The unique access cannot be copied easily and thus helps to secure the sustainability of their success.

Question: In your view, U.S. companies often fall into the "trap" of imitating the leader in an industry; and you write that with global integration of markets European companies could squander their strategic advantages. Could you give an example of a U.S. industry where this trap has taken hold? And in the context of European economic integration, is the trap avoidable?

Answer: The trap of imitating industry best practice instead of developing unique strategy is a common phenomenon, with the U.S. airline industry being a particular dramatic example. With the notable exception of Southwest Airlines, the major competitors in this industry are hardly distinguishable in terms of the customers they target, the value they offer, and the activities they perform. The consequences of this "competitive convergence" towards one positioning, as Michael Porter calls it, are obvious: The industry itself is a national benchmark for low profitability.

Europe used to be, in many industries, somewhat sheltered from the forces that drive competitive convergence. National markets were sufficiently different to require differences in positioning, and pressure on top managers to adopt the formula of more successful competitors tended to be less intense. With further integration of European markets and heightened exposure of company behavior to performance scrutiny, this will change. The effects of this change, however, are ambiguous and will depend on the decisions European business leaders take.

In one scenario, European companies will let the increasing homogeneity of their home market dictate that they become more like their U.S. peers. With the burden of more heterogeneity taken away, they will be able to improve efficiency to cut into whatever productivity gaps exist. But they will essentially compete on the terms that were defined in the U.S. market, increasing competitive pressure and reducing industry attractiveness. In the other scenario, European companies improve efficiency but choose strategic positions in the market that build on the remaining unique characteristics of their home locations and thus differ from the positions taken by their U.S. rivals. They will compete on different terms, offering not lower prices but increasing choice, adding more dimensions to the competition and increasing industry attractiveness.

The reality will likely end up somewhere between these extremes, but it is important for European managers that this reality can, to a large extent, be shaped by their own decisions about strategy.

Question: You write, "As markets become global, understanding the role of location may matter more than ever." Many Europeans are experiencing a powerful identity crisis under globalization. What unique characteristics in European business environments will endure in the face of global market change?

Answer: Clearly the globalization "angst" found in some European quarters is driven by more than just economic trends. But the economic trend of increasing homogeneity might reinforce the sense of a disappearing identity. However, unique elements of the European business environment, such as often-sophisticated local demand, regional clusters with long traditions, and strong institutions for collaboration, are likely to endure. And, if European managers play their cards right, these unique elements can give rise to unique European companies, successfully competing on world markets with differentiated strategies.

The pessimistic assessment of globalization as the large "homogenizer" is driven by a one-dimensional view of what characterizes a location. A location is more than just a cost level with a corresponding productivity. Using the diamond framework, it is possible to see the many dimensions in which locations can be different. Some of these differences can be ranked as more or less productive, but many others create heterogeneity on different dimensions. And similar to business environments, company strategies can be different without being better or worse.

A loss of identity occurs when political and business leaders fall for the false promise of "the one" optimal business environment and company strategy. The opportunities for other choices are there, and Europe has a good chance of shaping them to its advantage.

Christian H. M. Ketels is a principal associate at the Institute for Strategy and Competitiveness