Chicago Booth Review Podcast What Trader Joe’s Tells Us About Strategy

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Ram Shivakumar: The goal of strategy is not to be the best; it is to be unique. Unique in a way that is meaningful to that person or that organization's constituency, customers, suppliers, and so on.

Hal Weitzman: The US supermarket business is cutthroat, but Trader Joe's has been able to carve a distinct role. How has it done that, and what does it tell us about business strategy in a highly competitive market? Welcome to the Chicago Booth Review Podcast, where we bring you groundbreaking insights in a clear and straightforward way. I'm Hal Weitzman, and today I'm talking with Chicago Booth's Ram Shivakumar about strategy, game theory, and how Trader Joe's has thrived.

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Hal: Ram Shivakumar, welcome back to the Chicago Booth Review Podcast.

Ram: Thank you, Hal. My pleasure.

Hal: We're delighted to have you back. We had such fun last time talking about your approach to economics and storytelling and all that other good stuff that we wanted to have you back talk about the other thing that I know occupies a lot of your attention, which is thinking about strategy, competitive strategy, which is what you teach. Have you been teaching competitive strategy as long as you've been teaching economics?

Ram: Yes. 23 years.

Hal: The same period of time?

Ram: Yes.

Hal: Maybe we start with what is competitive strategy and what are the main questions that competitive strategy seeks to answer or address?

Ram: I think the word strategy means so many things, different things to different people. When I think of what I'm trying to convey, I'm going to say that what I want my students to be able to take away is big picture thinking and small picture thinking. The big and the small. I want people to have a familiarity with the first principles of strategy, which often borrow from other disciplines like economics, organizational sociology, and the behavioral sciences. I want people to be adaptive, which means they correct themselves. These are the three things that I think any student of strategy ought to learn.

The word "competitive" in Competitive Strategy, the title of the course that I teach at Booth, may have come from Michael Porter's book, Competitive Strategy. I think Porter was trying to convey this idea that strategy is not done in a vacuum. You are competing against other ideas and other people who are also trying to do their best, quite often trying to put you out of business. Strategy has to be competitive.

Hal: It responds to what other people are doing.

Ram: Exactly.

Hal: You talked about the first principles of strategy. Walk us through those first principles.

Ram: The goal of strategy is not to be the best; it is to be unique, unique in a way that is meaningful to that person or that organization's constituency, customers, suppliers, and so on. That would be one of the foundational principles of strategy.

Hal: Not to be the best, but to be--

Ram: Unique.

Hal: What does that mean?

Ram: One of the kind.

Hal: Correct. Just give us an example.

Ram: A very good example of that is illustrated through a case that I teach. Now, this course is usually taught using a case. I teach one case every week. The case is about a real company and its experiences over many, many years. There is this company that all of us are familiar with called Trader Joe's. I've been teaching the Trader Joe's case for many years. It is a fascinating company because it is actually very successful in a hyper-competitive market.

The grocery store market is hyper-competitive. You have the big companies like Krogers, you have the specialized companies like Whole Foods, you have many, many others, including Costco, Walmart, and so on, who have also entered the space in the last few decades. Somehow, Trader Joe's performs ahead of them, at least in terms of metrics like sales per square foot and so on. How does it do it? It offers a unique set of products and services to a small segment of customers.

I know, Hal, you've been into a Trader Joe's. The first thing that will strike you is that it is small as a store relative to many others. It has a limited selection. It doesn't do things like sales. It has the everyday low prices. It has products that you can't buy anywhere else because these have been procured from private label brands. Its entire operations is configured in a way that others cannot replicate it. It doesn't meet everybody's needs, but it meets the needs of a small segment.

In fact, this is my most favorite case because it illustrates what strategy is, is about being unique. They're not trying to beat Kroger in terms of size. They're not trying to beat, let's say, Whole Foods in terms of the size of net profits. What they're trying to do is to be unique to a set of constituents.

Hal: That was one of the first principles.

Ram: Yes. I think it's an application of that first idea that I spoke about. Strategy is about being unique.

Hal: What are some of the other first principles?

Ram: One of the things we teach is Porter's model. If you're not familiar with it, it is Porter's summary of what variables you pay attention to when you're trying to understand the market. It is used by everybody, like the back of the envelope calculation or assessment. I often couple that in the Trader Joe's case because when you look at groceries, no one is going to say, "I want to be in that business."

This is the point here again about strategy, that you don't mechanically apply anything, that what is true for 99 people may not be true for the 100th. That's why I say strategy is unique, about being unique. You are the only person who's capable of actually doing that because of your special advantages, your capabilities, your position, your knowledge.

Hal: You referred to Porter's framework there. Just walk us through that until we can understand what the criteria are.

Ram: Porter has actually contributed some of the foundational ideas in strategy. I spoke about strategy is about being unique. Let me speak about something else that Porter did in his book called Competitive Strategy. This book was written in 1980. In this book, he lays out in plain English, in words, how one should assess an industry, a market. What he says is that you should look to see the power of these forces and how these forces shape you if you are a player in this industry.

He speaks about the bargaining power of buyers. Very intuitively, if buyers have substantial bargaining power, it's going to be much harder for you to make a profit. Imagine, for example, you're selling to a single buyer, what in economics we call a monopsony. That single buyer is exercising substantial power on you. They can dictate what price you are going to sell your product at. The bargaining power of buyers.

The bargaining power of suppliers. Imagine, once again, only a single firm supplying you that product. It has substantial power. Lots of competition; that's the third variable. If you have lots of competition, you remember the model that I spoke about, B, C, and P, P goes lower. P gets closer to C, which means you're not going to be able to make a profit. Porter speaks about these forces and how they shape the profitability of an industry.

When you think about the grocery store industry, which I just spoke about with Trader Joe's, if you apply Porter's model, you will see very quickly that the grocery store industry is a very tough place to make money, and yet a company like Trader Joe's has excelled. This is reminding us that Porter's model has to be used with caution, with care. That's where I speak again about the art and craft of strategy, that you have to know what the model is saying in the context.

Hal: Does that mean sometimes you ignore the rules or you ignore the frameworks and just go with what you feel makes you different?

Ram: The art of strategy is to know when you ignore some rules. You can't ignore them all the time. I don't know if I'll call them rules, but principles. You have to know how to apply them collectively. The balance of forces, which way are they likely to move things?

Hal: It's interesting because it makes me think that the other competitors to Trader Joe's you talked about, the big giant supermarkets that are not distinct in the products that they're offering necessarily, although some are, but let's say they're just distinct on the fact that they're cheap or they have masses number of products available, they're not being as distinct as Trader Joe's is. How do they fit into your model?

Ram: Great question. In fact, this is one of the things we discuss in the Trader Joe's case. If you look at, for example, a Kroger, a Kroger operates large stores, wide selection, and very thin margins. One might well ask, with such thin margins, how are they making money? We call that asset turnover. In other words, what's happening is that the products on the shelves are being shipped out very, veyy quickly. What a Kroger's, for example, would do, the best example of this is a company that has products that are literally shipped to the customer every 24 hours, very fast turnover. That's their model.

The Whole Foods model, you might call it the premium model, is they have a selection of highly curated products that are within quotes, high quality, that are pitched to the high willingness to pay customer. Their turnover will not be as high as a Kroger, but they're getting the margins. They have higher operating costs because their stores are bigger, they are more luxurious, and hence their operating costs are much higher. That's the way they justify it.

What you're seeing in these three companies that I've just spoken about, Trader Joe's, Kroger, and Whole Foods, is three different models for competing in the same industry, three different sets of strategies. Each works. Now there are many others who fail. They don't have anything distinctive. This is how these three companies survive and prosper in groceries.

Hal: It's interesting because a cynic would say, what business school professor does is they look at the company that's already succeeded, and then after the fact, they try to explain why it succeeded, but they don't look at all the supermarkets that were distinct, that had unusual products, had a particular market, and didn't succeed for whatever reason, and analyze those.

Ram: Now that's a legitimate criticism. I would say that in many ways what we're doing is storytelling again. We are storytelling. We are looking at exemplars, companies that have prospered, and we are trying to reverse engineer what they did and did well. Will that work for a company today going forward? I don't know. That's what makes strategy hard. That's why I think that intellectually strategy is actually an easy discipline to master.

I could tell you the rules of strategy or the ideas or principles or frameworks of strategy in a way that even a high school graduate could understand, but even the most experienced business person will struggle to take those sets of ideas and make it work, create and start a business, and have it prosper. I think there's a huge gap between theory and practice.

Hal: You could say it's all history, but you're only looking at the positive cases. I'm only able to tell you why the Union Army beat the Confederacy, but not why any other army lost.

Ram: I spend half the time in my classes talking about companies that fail. We do the same thing here as well. We are looking backwards, and we are saying, "Here are some of the reasons that this company failed." Can I spot a company in real time and say that this company is about to fail? I don't know. I would say that there's a huge gap between one's understanding or one's explanation for things and one's ability to predict things. That's for sure. Perhaps that's why the people who are the most successful CEOs are not professors.

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Hal: If you're enjoying this podcast, there's another University of Chicago Podcast Network show that you should check out. It's called Not Another Politics Podcast. Not Another Politics Podcast provides a fresh perspective on the biggest political stories, not through opinions and anecdotes, but through rigorous scholarship, massive datasets, and a deep knowledge of theory. If you want to understand the political science behind the political headlines, then listen to Not Another Politics Podcast, part of the University of Chicago Podcast Network.

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Hal: Ram Shivakumar, in the first half, we talked about your approach to competitive strategy and spent a lot of time talking about Trader Joe's, so let's move on to about game theory. I know game theory is really important for strategy. What are the key lessons that we need to know about game theory?

Ram: The first thing is that game theory is the science of strategy. What I often try to teach is exactly what I teach in economics, first principles. Like in economics, I emphasize the language of game theory, terms, concepts, ideas that game theorists use. That is, in itself, something worth learning.

Then one gets exposed to games, classical games or what we call canonical games, games such as the prisoner's dilemma, which everyone is familiar with or most people are familiar with. I speak about the lessons of that game. I illustrate that game in a business context of two companies trying to decide whether they should set a high price or a low price, where the outcome to each player depends on the choices that each player has made.

We very quickly discover that each company has a dominant strategy to choose a low price. To use a term from game theory, we have a unique Nash equilibrium. The Nash equilibrium is not necessarily good for either player. That's one of the important lessons of prisoner's dilemma, that when everyone relentlessly pursues their narrow self-interest, they're all collectively worse off. This is a very important point in business and another context. Many, many interactions in our real world leads us to prisoner's dilemma. That's one game.

Hal: You mean companies get caught in price-cutting, undercutting each other type dynamic?

Ram: Yes, companies get caught in it. Countries can get caught in it. Industries can get caught in it. Prisoner's dilemma may, in the end, be worse for everybody. That's an important lesson from a game like game theory.

Hal: Just to push on that, so you say to the students, you should be aware that you're getting pulled into a game that has a-

Ram: I should add that-

Hal: -negative outcome?

Ram: -what I do in my class is I expose students to many types of games. One is the most famous game is the prisoner's dilemma. We have something called the battle of the sexes. That's the name given to this interaction between two players. The lesson of that game is different. The battle of the sexes game is a game in which the players have difficulty coordinating.

You may have heard that story. This is the way the game is illustrated. A husband and a wife are deciding where to go in the evening after dinner in the era before smartphones. The wife is guessing, "Should I go to the bullfight or the opera?" The husband is guessing, "Do I go to the bullfight or the opera?"

The wife would like to go to the opera and for the husband to come to the opera. The husband would like to go to the bullfight and have the wife go to the bullfight, but that doesn't often happen. There's a coordination problem. It's quite possible that the worst of all outcomes can happen, which is where the husband is going to the opera and the wife is going to the bullfight. I illustrate games like this.

Then the third most famous game in game theory, the first being prisoner's dilemma, the second being battle of the sexes. The third one is the stag hunt, which is a game that originates in, I guess, an example or a discussion from Jean-Jacques Rousseau from centuries ago, in which he spoke about the failures that happen when people don't trust each other.

In his game, the players can decide, the two players, am I going to hunt stag or am I going to hunt rabbit? Catching a stag requires cooperation. Catching a rabbit does not. When both players hunt stag, they're both better off. If they hunt rabbit, they get something, but not as much as catching a stag. Think of what they get as subsistence living.

The stag hunt, we have two Nash equilibrium. Both are possible. Which one is more likely? That depends. The stag hunt game raises this possibility that in periods where there's lack of trust, people go off and hunt rabbit because they don't want to be caught hunting stag when the other person is hunting rabbit because that's the worst of all outcomes.

These games teach students to appreciate that the context in which we find ourselves in varies considerably. It isn't always easy to recognize the game that we are playing as a prisoner's dilemma game. I think students enjoy this because this is a much more concrete-- think of it as a much more of a closed problem, albeit many, many games, so many, many problems as opposed to what you encounter in a case which is like what's happening out here.

Hal: I want to make time to talk about AI briefly. How is AI changing strategy?

Ram: Let me speak about the use of generative AI, and let me speak about it in the context of teaching first, and then very briefly about the practice of strategy. I think we're probably still only in the first inning or second inning in terms of learning how to use this generative AI in the classroom. I have been using generative AI in executive education for the last, let's say, a year and a half or two years.

Many of our students in our executive education programs don't have a whole lot of experience using either Copilot or ChatGPT or Claude or Perplexity or anything. What I do is I give them a structured problem. I tell them, "I want you to come up with a set of ideas, a new business idea in, say, the food industry. I'm going to give you one hour to discuss this. Here's what I want by way of presentation in five minutes. I want you to not present a PowerPoint, but talk about what you learned from your research."

Generative AI, think of it as a companion, as the machine, a machine that is not flawless, a machine that may be biased because of its exposure to the training data, a machine that may be a little too eager to please you, so you have to keep prompting it and pushing it to give you a more precise answer, but a machine that is improving each day.

Ethan Mollick at Wharton writes about the evolution of ChatGPT and the like. In his most recent column, he speaks about the amazing advances of ChatGPT, especially the reasoner model that ChatGPT has put out. I actually believe that not just the teaching of strategy, but even the practice of strategy is going to change quite a bit over the next few years.

Hal: As you say, one of the challenges is that at least ChatGPT, the regular model, always agrees with you. It's built to say that your ideas are fantastic. Yes, you should open a trader arms. Wonderful idea.

Ram: That's exactly why you have to push it. You have to keep asking it questions. You can say things like, "I disagree with you. Tell me something else differently. Tell me why this idea might fail." It's actually pretty good at that. It's getting better at it. I think one of the things I've learned is that ChatGPT or Gemini can tell you some things you never thought about. I'm not saying everything it says are things that are new to you, but you can get a real education and you can think of it as a companion tool.

By the way, Hal, one of the things I learned in the classroom is that humans are learning from each other alongside the machine. It's people talking to each other about what to ask the machine, the machine coming back, and the humans collectively interacting and challenging the machine. I have no doubt that this is going to accelerate both the process of coming up with a strategy and the quality of strategy. Not that everything is going to result in grand revenues and profits, but there's going to be an improvement in the process by which we discover things.

Hal: Ram, for people who are listening and thinking, "I want to be more strategic in life and in business," what are some key lessons you want to leave us with?

Ram: There's this quote attributed to Eisenhower. "Plans are nothing, planning is everything." That seems a little cryptic, but I guess what he's trying to say is that the process of planning is what is important. That what one shouldn't do is follow the plan in rigid detail. That's a very important lesson. The process of planning makes us all better, but we are not wedded religiously to the plan. That would be one of the lessons I convey.

The second lesson I'll convey, and this is actually for me a personal lesson, is that opportunism may be the best strategy. There's so many things embedded there, which means that you have to be ready to depart from your plan. You have to be ready to accept that what you thought was true was not true.

When I look back on my life, the most rewarding things, the most valuable things that ever happened to me happened accidentally. It didn't happen because I went looking for it. It came to me when I was not looking for it. Whether by design or not, I acted. That is something that dawned on me when I turned 50, that this is actually one of the golden rules of strategy. Be opportunistic.

Lesson number three is something I learned from an anthropologist. His name is John Shook. He said something in the context of a case that I use in my class on NUMI, New United Motor Manufacturing. He said, "It's easier to act yourself into a new way of thinking than to think yourself into a new way of acting." I actually found that quite profound. You have to do things. That's how change happens. It doesn't happen because you start thinking about it.

Let me give you lesson number four, something that's attributable to someone from ancient Greece. No person crosses the same river twice for the person is not the same and the river is not the same. You can't apply strategy in a rigid way. Let me end with a quote which I read in a Warren Buffett annual letter, which is a little funny and still deep. He says, "It's only when the tide goes out, do you know who is swimming naked." It's actually a profound idea on risk, risk management, learning who has got character, who's going to be your ally in times of trouble. These are some of the lessons I share with my students.

Hal: Ram Shivakumar, always fun to talk to you and to hear your ideas. This time, thank you for walking us through your thoughts on competitive strategy.

Ram: Thank you, Hal.

Hal: Thank you.

Ram: Wonderful to be here.

Hal: Thanks for coming on the podcast. That's it for this episode of the Chicago Booth Review Podcast, part of the University of Chicago Podcast Network. For more research, analysis, and insights, visit our website at chicagobooth.edu/review. When you're there, sign up for our weekly newsletter so you never miss the latest in business-focused academic research. This episode was produced by Josh Stunkel. If you enjoyed it, please subscribe, and please do leave us a five-star review. Until next time, I'm Hal Weitzman. Thanks for listening.

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