THE FRAMEWORK LAW: profit maximization
This is the fundamental prescription of classical economic theory, proposed for a little more than two centuries (1776) by Adam Smith and that, with some variations, has inspired several proposals to prescribe the behavior of economic agents, among them the most commonly called companies.
From this perspective, companies are conceived as a tiny agent whose behaviors are governed, at all times, places and circumstances, by the laws of the market and guided by the sole purpose of maximizing their profits.
That is the norm to ensure their survival. The breach of this commandment will make the one who violates it doomed to disappear. It will be replaced by others that do. Only those that fulfill them in the best way survive. It is the survival of the strongest in an open fight with his competitors. The focus of attention should be on the behavior of the competitors and the way to wage an endless war against them: perfect competition. All in pursuit of the same purpose and with the same weapons. A zero-sum game in which losses for some are gains for others.
Free competition between companies, in order to maximize their profits, also guarantees maximum welfare for consumers. Market forces are shaping behaviors and generating well-being, both for producers and consumers. It is as if an invisible hand is leading the economy on a path of permanent improvement. Thus, the general defense of personal and selfish interests is responsible for producing the general welfare. That invisible hand is free competition: maintaining the freedom of action of agents, eliminating any interference with the free play of the laws of the market. These forces will bring the economy to a state of equilibrium in which no one can improve its conditions without causing a detriment to others: all have achieved the maximization of their profits.It is a somewhat paradoxical world in which all agents have full freedom to do what they are condemned to do: act in defense of their own interests.
In this model of perfect competition, the generation of maximum welfare for producers and consumers is made possible thanks to the existence of a kind of superior force that determines the behavior of economic agents. Similar to Newton's model of physics, in which the universe is made up of a world of moving particles governed by the laws of nature, which reach a state of equilibrium. These movements, in turn, are shaped by a superior force, the force of gravity.
In the case of the economy, the economic agents are the particles, the laws of the market act as the laws of nature that govern the behavior of agents and free competition, the invisible hand, acts as the force of gravity.
THE ASSUMPTIONS OF THE MODEL.
To make this model viable, however, it is necessary to accept some assumptions that, for our purposes, the two most significant are:
First. The products offered in a given market are the same, or at least substitutable for each other. In the eyes of buyers, the only factor that differentiates them is their price.
Second. Both buyers and producers are rational beings who have all the information about the properties and availability of products, have free access to all of them and will always choose the cheapest as the one that maximizes their welfare.
With these two assumptions, the behavior of economic agents is determined. All buyers always purchase the products that are offered at the lowest price and all companies must offer their products at a price equal to or lower than that established in the market. Those who cannot offer it will not get customers to buy their products. The only way to survive is to concentrate on matching the price of the product to the level of the most efficient of the competitors.
This is the rule imposed by the laws of the market and that governs the behavior of companies. In turn, this behavior determines the performance of the company, that is, its level of profits, which are determined by the laws of the market. All companies obtain the level of profits imposed by the market. All must sell their product at a price equal to the cost of their last unit produced. That is the formula that leads them to maximize their profits. Make marginal cost equal to marginal revenue.
When costs are lower than those of competitors, it is possible to further reduce prices and thus achieve higher sales. In the event of being able to maintain the cost advantage, the market could be dominated. It is a virtuous circle that generates leadership in cost control. The drive for profits causes the company to seek a monopoly position in which it can free itself from the yoke of the laws of the market.
The free market economy dreams of perfect competition between producers, and producers, in turn, dream of monopoly, seeking to eliminate their competitors. Lowering costs is the only weapon available to outweigh competitors in endless war.
If the strategy of the company is understood as the choice of a way considered, in advance, as the most suitable to use the means to achieve certain ends, then in this model it would not be necessary. It wouldn't even be possible. There is no option to choose. All competitors obey the same prescription: the reduction of costs that supports the reduction of prices. This guarantees the maximization of profits. This implies seeking the highest productivity of all the resources used in the production and sale of the good or service. Since all these resources are acquired in their respective markets, all competitors can acquire them under the same quality and price conditions. Neither can achieve any distinguished advantage in acquiring his resources.
THE STRATEGY AS A GENERIC PRESCRIPTION
Each competitor would then have to find the best way to combine resources, and to use different production technologies in order to improve the productivity of the resources, and thus reduce their costs. Of course, if all producers can know the particular ways of acting of the competitors, there will be no way to differentiate themselves. Free access to all information not only eliminates learning costs, but also eliminates the possibilities of differentiating production and sales processes.
There is no possibility of having a strategy, since the conduct of the company is imposed by the laws of the market. All competitors are subject to the dictates of a generic prescription.
But if there was no free access to all the information, then each competitor could identify their particular way of achieving the greatest efficiency in their operations. It is therefore necessary to recognize the existence of some process or factor or actor within the company responsible for achieving cost leadership. An element responsible for using resources in the most efficient way and obtaining the highest productivity with them.
It will be necessary to look for those responsible for choosing the best ways to obtain the highest productivity in the use of the resources used in these processes.
THE LACK OF COMPLETE INFORMATION. UNCERTAINTY
It will have to go from the scenario of the certainty imposed by the laws of the market, the maximization of profits and the irrelevance of strategies, to the real world of uncertainty, the permanent improvement of the productivity of resources and the urgent need for strategies to achieve it.
When the reality is recognized that human beings have discretion when making their choices, and that they make decisions based on their different purposes, conditions, beliefs and personal values, then the decision about the purchase of goods or services becomes uncertain.. The certainty for the producer disappears that his product will always be bought when it is offered at a lower price than that of competitors.
The cheapest could be rejected for multiple reasons. Some buyer might argue that:
Being within the reach of many buyers, its acquisition does not generate any distinction.
Another might think that low price is synonymous with poor quality.
A third party could choose a more expensive product, because acquiring the cheapest requires travel that is costly and takes time.
And others, perhaps the most numerous, might consider that, although they know that there are other products that are better and that they would prefer to buy, their purchasing power does not allow them to acquire them: they must settle for buying the cheapest.
Each buyer perceives and defines the product in a different way, depending on the judgment they make about its attributes. Clients especially value certain characteristics and some of them give the greatest relevance: the one that offers the solution of the need that they most want to satisfy with the product. That particular characteristic, which the client considers as the one that brings the greatest value, is the one that definitively influences their purchase decision.
The price is judged in relation to the attributes of the product and especially the one that is most appreciated. Many times you choose to purchase the product that meets that expectation without regard to price considerations.
Only when you have at your disposal several products that meet that special condition, you could choose to buy the one with the lowest price. The products are then defined by the customer and her decision to buy them will always be uncertain. If in the previous model all products were similar and their price was the only differentiating factor, now all products and buyers are different and there is no known feature of the product that ensures its sale.
Rather than a complex web of market forces that apparently shape a company's strategy, only one of them really shapes it: customer discretion over their decision to buy. It is the customer, representing market forces, who decides on the fate of the company.
He embodies the forces of the market, compares the benefits of the product with those of the competitors in terms of quality, prices, convenience, after-sales services, etc., and chooses the one that meets his expectations in the best way. This is the decision that materializes a sale and the one that generates the income that makes the company viable. The buyer's discretion over his decision to buy renders all efforts to influence that decision uncertain.
THE IMPERIOUS NEED FOR STRATEGY
These conditions of uncertainty impose the obligation to define, in advance, the attributes of the product that are expected to be recognized by a certain group of customers as determinants of their decision to buy. The choice of the distinctive characteristics of the product with which it aspires to captivate the customers of a market segment, is the choice of the way to compete. If the strategy is understood as the statement of the way chosen in advance, as the best possible, to achieve a certain purpose, then the choice of the attributes that differentiate the product is the strategy with which the entrepreneur chooses to compete for the favor of clients; it is the choice of your competitive strategy.
The competitive strategy, then, is the choice of the value proposition that is made to a group of customers through product differentiation and the most productive ways of using resources to ensure that the product has those attributes.
It is the definition of the way in which it is intended to influence the purchase decision by customers in favor of a certain product. Differentiate the product, in such a way that it maximizes the value perceived by the customer when acquiring it. It is no longer the blind and inescapable slavery in the reduction of costs and prices, but the freedom to use innovation and creativity to differentiate the product, both in the way it is produced and how it reaches customers. The only competitive strategy is product differentiation. When there is no product attribute that is considered by customers as a special value, then the low price should be used as the differentiating factor. We return to the assumption that when the customer is faced with similar products, the customer will always buy the cheapest product
Whatever the attributes chosen to differentiate the product, the competitive strategy is materialized through the results of the interrelation between the production and marketing processes carried out in the company. With these processes, the value proposition is built and therefore, the competitive strategy.
If the value proposition is based, for example, on low prices, then the management of the production and sales processes should be oriented towards obtaining the highest productivity of resources to achieve the lowest cost that makes the competitive strategy based on low prices. If the value proposition is based on facilitating access to the product, then the distribution process must ensure the availability of the product in the places that its customers frequent. If you choose to offer it by virtual means, as has become the custom, potential customers should be informed about the existence of the option to make their purchases online, and ensure the simplicity and effectiveness of the navigation process in the web portal that offers it.
THE COMPETITIVE ADVANTAGE IS NOT DISCOVERED. IT IS CREATED
The multiple activities and resources with which these production and sales processes are carried out are the only means that the company's management has to elaborate and deliver a product with the attributes with which it hopes to fulfill the promise made to customers. in the value proposition.
Therefore, the way to conduct these processes is what allows
building the company's competitive advantage. The strategic management process, in charge of coordinating the production and sales processes, is ultimately responsible for coordinating the processes that materialize the competitive strategy.
Those responsible for coordinating these processes must choose those ways that they consider to be the best to use the resources that the materialization of the value proposition demands. The competitive advantage is built with the strategies that guide the multiple activities and operations that intervene in the production and commercialization processes. In particular, the way in which these processes are coordinated and innovated to generate synergies and productivity gains in the use of resources.
Strategic management is responsible for competing for the clients' favor. It is the results of this strategic management that come under the scrutiny of potential buyers. Even competitive strategy is nothing more than a hypothesis, a theory, which reflects the belief of the company management about the attributes of the product that make it valuable and attractive and about the most effective and efficient ways to produce them. This hypothesis cannot be static; it must permanently adapt to changing customer circumstances and the new possibilities offered by technologies. Competitive strategy only becomes sustainable when strategic management develops ways of permanently introducing improvements and innovations.
The performance of the company depends on the ability of its strategic management to adapt its value proposition to the changing expectations of its customers. That is the condition imposed by the inescapable presence of uncertainty.
This moves from the condition of certainty that the price of the product always meets the expectations of potential buyers, to the trial of novel and creative ways to add features to the product that meet the changing demands of customers. It also goes from the world of slavery to the task of reducing prices and costs, to the world of uncertainty, creativity and innovations in which new value proposals emerge at every moment.
The conduct of the company is not dictated by the laws of the market, nor is it condemned to the sole and endless task of reducing costs to ensure lower prices. This conduct is freely chosen by those responsible for strategic management.
They choose the ways to advance and innovate the processes that give life to the value proposition that they themselves have chosen. Neither the performance of the company, its profits, is determined by the price imposed by competitors. The ability of those responsible for strategic management to introduce innovations to the value proposition and to obtain the highest productivity from the resources with which it materializes, is responsible for this performance. This is not reduced to the maximization of profits but to obtaining remuneration from customers that allow achieving a satisfactory profitability on all the resources used to materialize and renew the competitive strategy.
The laws of the market do not determine the behavior and performance of companies. They determine the threats and opportunities in the environment. The innovative strategies of companies are responsible for overcoming the former and taking advantage of the latter. These strategies are responsible for the performance of the company.
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