Thursday, August 25, 2016

Strategic Planning Analogy #567: Water Between the Marbles

When I was in Junior High School, we did an interesting science experiment. The teacher took a beaker and filled it full of marbles. He asked the class if we thought the beaker was full. We all said "Yes."

Then the teacher poured water into the beaker over top the marbles. He poured quite a bit of water into the beaker before the water reached the top. Then he poured the water surrounding the marbles out into another beaker. The second beaker was about half full of water.

So the teacher then pointed to that original beaker with marbles up to the top and re-asked his first question: “Is this beaker full?”

This time we answered “No.”

Things can appear full even when they are not. It doesn’t matter what the container is or what you put into it. You can fill the container to the top and it still will not be full.

The problem is that little spaces form between the objects you put in the container. Each individual space may appear tiny, but when you add them up, all those spaces take up a lot of room. That’s why so much water could be put into a beaker that was supposedly “full” of marbles.

The same is true in business. A market may appear to be full, with large competitors appearing to take up all the available space. It looks like there is no room for anyone else.

However, if you stop looking at all the marbles (the big competitors) and start looking at the spaces, you will see that there is still a lot of room in that market. If you think strategically, you may still find a successful way to fill those open spaces.

The principle here is that even in highly mature markets there always seems to be room for niche products or niche companies. The reason is because large companies tend to be best at doing the large things (serving large customer segments, large product runs, large marketing programs, etc.). They are not well designed to go after those small spaces.

These large, mass companies are like those marbles. They take up all the space that marbles are capable of taking, but they leave gaps they cannot fill.

Because water can go into smaller spaces, they can fill in the places the marbles cannot get to. Smaller niche markets and niche companies are like that water, able to penetrate spaces difficult for the large companies to effectively reach.

McKinsey Article
I saw an example of this principle in an article put out this month by McKinsey and Co. The article was looking at the consumer packaged goods (CPG) industry. This is a very mature business. Consolidation has occurred and there are only a few large companies left trying to fill the CPG space.

To get an idea of how full the CPG space is, the article states that growth for these large CPG companies over the past four years averaged only about 0.3% per year. It looks like there is no more room for these large CPG companies to stuff any more marbles into the CPG market. They’ve already tapped pretty much all they can get, right?

So does that mean every other company should walk away? Not necessarily. In the story, we saw that even when the marbles “filled” the beaker to the top, there was still room for about a half a beaker full of water in that beaker. Similarly, the McKinsey article says that even though the big CPG companies have “filled” the CPG market, about half the CPG space is filled by niches not held by the big companies.

And here’s the more exciting news. While the big companies were averaging only 0.3% growth, the article says that midsize companies were growing at 3.8% and small CPG companies were growing at an astonishing 10.2%!  So even in so-called slow growing mature markets, you can grow and prosper if you know how to get into those small spaces.

So how do you take advantage of those small spaces? Well, simply put, you have to become less like a marble and more like water. Marbles are large and rigid. Water is fluid and flexible, able to seep into small places.

There are three ways to become more like water. They are discussed below:

1) Make your Company Successful At Being Small
Large companies tend to find it hard to do small things because their very bigness tends to get in the way. They have large overhead, lots of bureaucracy, rigid rules, and an infrastructure built to exploit big opportunities.

Smaller, more nimble companies, however, are less burdened with all this rigid structure and high cost. They can be built in such a way that they can make money on small opportunities outside the reach of the big ones.

Don’t try to gain success by imitating the big guys. Gain success by structuring your business model to do things they cannot do. Stop trying to be a rigid marble. Stay fluid and flexible.

2) Target Small Opportunities
Don’t look for the big opportunities. Big opportunities attract big competitors. The big competitors will crush you there. Instead, look for the small niches which fall below the big company’s radar.

Small niches can still be pretty profitable if you know what you’re doing and are designed to optimize in a niche environment. So don’t look at where the big marbles already exist. Look at the spaces between them. Find a small space rightly sized for you, but too small for the big guys.

3) Make Big Companies Better at Doing Small Things
If you are already a big company, the challenge is in finding a way to become better at doing small things. Technology can be helpful here. You can use technology to:
  • ·       Make small production runs more feasible;
  • ·       Make it easier to find and target smaller consumer segments;

You may also need to segregate your approaches to business depending on whether it is large or a niche. For example, large opportunities may get one level of service and support while niche opportunities get a different level of service and support. In other words, you may have both “marble” divisions and “water” divisions, which are run differently.

Fullness is a relative term. When you try to fill a space with large objects, there will still be lots of spaces where the large objects cannot penetrate. In the business world, you can have a successful strategy by targeting those niche spaces between the large firms. The trick is to design your business to succeed at niches (small, fluid, nimble) and to choose the niches which fall below the radar of the large companies. Large companies can also do a better job of going after some of these niches if they segregate these niche opportunities within their company and treat them differently.

There is no such thing a single right strategy which makes all the other strategies wrong. The right strategy for a marble is different than the right strategy for water. Both can work. The secret is finding the strategy where you have an advantage. The question for you should not be “What is the right strategy?” but rather “What is the right strategy for me?”

Sunday, August 21, 2016

Strategic Planning Analogy #566: Regimented Plans

Way back when I was getting my MBA, the accepted rules for success in marketing went like this:

1.     Get an MBA in marketing from a top-tier business school.
2.     Immediately go work a few years for Proctor & Gamble (P&G).

The idea was that if you had a top tier MBA and P&G experience on your resume, you could go and do almost anything in marketing. Your long term career was set for life.

There was a woman in my class which took these rules to heart. She made them her life plan. She was currently getting her MBA like me from a top tier school. Then her plans were to immediately go to work for P&G.

As you can imagine, she was very excited when the P&G recruiters came to campus. Actually, she was a little bit too excited. For years, this next step had been a part of her life plan and she could hardly contain her excitement and nervousness.

A short time after the P&G visit to campus, I noticed that I hadn’t seen that woman around campus recently. I asked someone what had happened to her. I was told that she had suffered a nervous breakdown and would probably not be returning.

I guess her experience with P&G had not gone as planned and she took it a little hard.

Strategic planners tend to like plans. The idea is that if you have the right business plan, and follow it to the letter, your company will have success for a long time. This is similar to the thinking of that student. Follow the plan (top-tier MBA, experience at P&G) and your career will have success for a long time.

The problem this woman had was that she apparently did not get the job at P&G. Her plan could no longer be completed as designed. Since she did not have a back-up plan, she lost her composure and had a nervous breakdown. In the end, she didn’t get the MBA or the P&G job and probably ended up with a career far less desirable than the one she had planned for.

The potential for this type of negative outcome can also confront strategic planners and their plans for their business. Their plan may be meticulous and well thought out, but for some reason, not all the pieces come together as planned (for any number of reasons—controllable or uncontrollable). If you are too emotionally attached to the original details or have no backup if something goes wrong, things can get pretty messy for the business. Instead of getting even a portion of the success dreamed of, you end up with nothing.

The principle here is that the goal of planning is not to make perfect plans. We live in an imperfect world. When a perfect plan encounters an imperfect world, the plan is usually the first to crack. Setbacks are not a rare occurrence…they are the norm. Therefore, if your entire future is predicated on everything going exactly as planned, you’re in trouble. You have nothing to look forward to, except perhaps a nervous breakdown.

Well, if the main job of planners is not to create perfect plans, what is their role? The role of the strategist is to:

Facilitate the process which causes the long term future of the company to be better than what would naturally occur if a company only focused on opportunism or fixing the immediate concerns.

The goal is not perfect plans, but a better future. Companies tend to get fixated on attending to the immediate crisis of the day. By being held captive to today’s pressures, little time is left for long-term concerns. I refer to this as the Tyranny of the Immediate.

The strategist’s role is to create more balance between the near-term and the long-term. By getting more long-term thinking into the daily decision-making process, the future will arrive in better shape than what would otherwise occur.

Yes, this process usually includes making plans. But the plans are merely tools to help create the real objective of a better future. And because the future is messy, the plans will be a little messy, too.

Problem #1: Placing Tactics Over Goals
The problem with focusing on executing the perfect plan is that tactics can mistakenly become more important than the objectives. We can become so focused on doing each step of the plan exactly as conceived, that we end up failing to recognize that there may be other, better ways to obtain the larger objective.

My fellow student was so focused on the tactic of getting the job at P&G that she forgot about the greater goal of having a great career in marketing. When the tactic failed, she gave up. In reality, there are many paths to a great career in marketing. She should have focused on the larger picture and found another way to achieve the greater goal.

For example, I know of a retailer that wanted to enter the Nevada market. The tactic in the plan was to purchase a retailer who already had a presence in Nevada. Unfortunately, another retailer ended up purchasing this company. If you only focused on the tactic, you would now walk away defeated, like the woman missing out on getting into P&G.

But here’s what happened. As it turns out, the retailer who bought the company had already started retail development in Nevada on their own. They no longer needed this. So the company that lost out on buying the firm purchased the development in progress from the company that did purchase the firm. In the end the strategic objective was met with a different tactic. They didn’t give up; they merely found another way to achieve the greater goal.

Plans are not to be written in stone, unable to be altered. There needs to be room for flexibility to adapt to the changing situation.

Problem #2: Mistaking Opportunism for Flexibility
So let’s say you get over the idea of creating perfect plans and decide to become more flexible. You can still run into problems if you get too flexible. Too much flexibility results in abandoning planning and just chasing the latest hot opportunity. The problem with chasing opportunistic fads is that if you bring no strategic advantage to the opportunity, you will end up failing.

It doesn’t matter how “hot” the opportunity is. In the end, the market will consolidate, leaving most of the participants as losers. If you do not bring a competitive advantage to the space, you will lose. 

Look at the smartphone industry. It was a very hot space. Lots of firms jumped into the space. Only Apple and Samsung made any money. Everyone else lost. Building social media platforms was also a hot space. Lots of people opportunistically jumped into the space. But when you get past a few firms, like Facebook and Linkedin, you see that most of the people who jumped in lost.

Being flexible is not the same thing as being opportunistic. Being flexible means being willing to alter tactics to achieve a previously chosen strategic goal. Opportunism, by contrast, is just chasing whatever is hot at the moment. If you have no strategic advantage in that space, you are just pouring money at the problem. Money is relatively easy to get, so a lot of people will be pouring money into the hot space just like you. In the end, you are just pouring money down the drain, because you have not brought any strategic justification for winning in the space against all of the others chasing the same hot opportunity.

The better approach is to first build strategic superiority by focusing efforts on improving expertise in a particular area. Then, when an opportunity pops up which matches your point of superiority, you jump in. Now you’ve moved from mere opportunism to exploiting strategic advantage in a place where you can win.

Apple won in smartphones because they brought a lot more than mere money. Apple had a great brand image in that space, they knew how to source the product, they knew how to design a more appealing product, they had distribution in place, they had the right connections with content providers, they knew how to build a closed system to surround the product, and so on.

If Apple had gone after another hot space, like craft beers, I doubt they would have had as much success, because it was not as good of a strategic fit.

You will never have superior strategic fit if you don’t plan for it. So planning is still essential. You need a plan that builds a reason you can win. Flexibility does not negate that chore. But never forget that the reason you build a way to win is so that you can eventually win. The path to get there may not be as straight a line as you want, and there may be detours along the way. Don’t give up when the detours come along. Just pick yourself up, adjust, and continue towards the greater goal that you have planned for.  

Strategy is not about building perfect plans. The world is too messy for perfect plans to survive fully intact. Setbacks will occur. Don’t let the setbacks create a nervous breakdown. Instead be prepared for flexibility on the way to your ultimate goal. But don’t let a desire for flexibility result in the complete abandonment of planning to be replaced by opportunism. Opportunism only works when you already have a plan in place for how you can create strategic superiority in that space. Without the prior planning to create a winning advantage, you will lose, no matter how “hot” the opportunity appears.

It’s easy to fall into the trap of focusing on building and executing the perfect plan rather than focusing on building the better future. After all, it’s easier to show off your contribution and easier to measure your progress on getting something done when “checking off the tactics on your list” becomes the goal. But don’t confuse getting tactics done as the same as moving your company into a better future. It’s a bit more complicated than that.

Friday, August 19, 2016

The Fall of Strategic Planning

I was recently reading a posting on the Strategic Planning Society group’s site on Linkedin. It was titled “Forget strategy, innovation has replaced it!” The point Bernhard Schmidt was making was that strategy has lost its relevance in business and has been replaced by innovation.

This is a good issue to bring up. However, I think that point of view just touches the surface of the problem. I wanted to reply with a longer, more nuanced answer to why strategic planning has gone out of favor, but my response was too long to fit into the comments section. Therefore, I am putting my response here.

This is what I tried to put into the comments section:

Here’s my brief take on the decline of Strategic Planning:

1) When strategic planning was at its peak, companies saw many options for their firms and they wanted to learn which option was the best for the company’s long term future in terms of profits, market share and stability. As a result, strategic planning tended to focus on marketing (i.e., positioning) and business models. This was highly valued, so strategic planning was held in high esteem.

2) Then the CMO (Chief Marketing Officer) position was created. This robbed the strategist of one of their most powerful tools—strategic positioning—because that function was given to the CMO. Unfortunately, most CMOs were so preoccupied with near-term advertising that positioning rarely got the attention it deserved from CMOs. As a result, the idea of strategic positioning faded away.

3) Without the marketing foundation, strategic planning became principally a financial function—a bunch of scorekeepers (did you make your numbers). Since there was little foundation behind the numbers (why the numbers should be hit), the scorekeepers turned into complainers (you didn’t hit your number). Who needs that?

4) Worst of all, the objectives of business changed. First, modern companies don’t care so much about traditional measures of success. Business model profitability and customer satisfaction became optional or of far less importance. After all, nearly all of a modern company’s value comes at two points in time—when it gets initial investment money and when it cashes in (goes public or sells out). This limits strategy to how to:

a)     Make the best investment pitches to VCs; and
b)     How to cash out.

So strategy looks more like an episode of Flip This House. You don’t need fancy strategic planners for that.

5) This leads to the second change in objectives. Almost nobody seems to care about the long term as much as in earlier days. Why worry about the long term when you are going to flip the company near term? And since few people stay at a company over 2 years, the employees have no vested interest in long-term health. The founders get their wealth up front when the firm cashes out, so the outer years are less meaningful to them. Few shareholders care about long term either. Without a concern for the long-term, there is little regard for long-term strategy experts.

6) So it gets down to innovation. I interviewed for a strategy position at one firm that planned to go public soon. They said that they would get a higher IPO price if they could show innovative new ideas in the pipeline, so they were looking for someone to help fill the pipeline with a little innovation. This would make great copy to put into the S-1 document filed with the SEC when going public. Hence, innovation was more about boosting the near-term cash out value than the long-term viability of the firm. So in this case, strategy was reduced to little more than a public relations function.

So the issue is a lot bigger than just strategy losing out to innovation. Strategic Planners have been robbed of some of their most powerful tools (like strategic marketing) and companies no longer seem to want to buy what strategic planners used to sell (long term profitability and stability).

So what can marketers do? There are two approaches.

First, strategists can reassert themselves by re-introducing companies to the value that traditional strategic planning can provide. This starts with getting management to see the value in what strategic planning offers. The most compelling argument is that current valuations are based on future expectations. So if you want a high value today, you need a plan which shows a better future tomorrow.

The next step is to grab back your power base. Seize back the strategic positioning role. Downplay the scorekeeper role. Get involved in business model discussions. Put companies on the right path. Place yourself in the middle of company decisions where there are long-term implications. Be the “strategy whisperer” who never lets the CEO forget about the strategic implications embedded in day-to-day decisions.

The second approach would be to adapt strategic planning to be vital to the new reality. This would include things like:

a)     Make scorekeeping a more valuable function by doing a better job of linking numbers to strategic initiatives and helping teams make their numbers.
b)     Do a better job of helping companies get VC funding and to cash in.
c)     Become a public relations expert. Show you can master the strategic language that gets more money from VCs and when cashing in.
d)     Show that you can be fast and provide insights today rather than waiting for a year-long planning cycle to occur.
e)     Show that there can be a more strategic approach to innovation than just “trying a bunch of stuff hoping something will work.” I looked at this in more detail in my prior blog.

Finally, show everyone how including a consideration of long-term implications when making short-term decisions leads to better short-term decisions. This gets at the heart of the issue facing most leaders.

It is true that traditional strategic planning has gone out of favor and that innovation is the “flavor of the day.” To regain relevancy, strategic planners need to either:

a)     Re-educate management as to the value traditional planning can bring; or
b)     Adapt strategic planning to be a more vital element in the new management priorities.

The proper approach depends on your current situation, although a blend of both is probably required.

There is no value in being “the strategy person” if nobody is looking for a strategy person. So job #1 is to come up with a strategy to make being the strategy person a valuable title to have.

Wednesday, July 20, 2016

Strategy Planning Analogy #565: Not Enough Monkeys

There’s an old saying (originally attributed to Thomas Henry Huxley) that goes roughly like this: “If you get enough monkeys sitting at enough keyboards, one of them, by random chance will write the next Shakespearian play.” While that may be theoretically true, there’s a problem with that logic.

The problem is with the word “enough.” In order to get random tapping on a keyboards to come out as a coherent Shakespearian play, you need a lot of monkeys sitting at a lot of keyboards.

How many? I would guess at least a million times more monkeys than exist on the entire planet sitting at more chairs and with more keyboards than exist on the planet.

So, while the statement may be theoretically true, from a practical matter it is worthless.

The big word in strategy today is “innovation.” People want strategies which make them leaders in innovation. And if that’s what people want, you can rest assured that countless numbers of consultants will come out of the woodwork saying they have a way to make you a leader in innovation.

A lot of these consultants have a theory similar to the story about the monkeys. They say that if you have enough experiments taking place, one of them will turn out to be a big hit. That’s like saying if you have enough monkeys, you can write a great play.

The problem is that many of these consultants don’t get very specific about how many experiments is “enough.” The reason they don’t get very specific is because they don’t want you to know your real odds for success. Like the story with the monkeys, the only way to guarantee that you will have a successful innovation is by doing a lot of experiments. And by a lot, I mean more experiments than you could possibly ever do over several lifetimes.

Look at the social media space. How many truly successful bone fide outstanding and hugely profitable innovations have there been in social media? 20? 50? 100? 1,000? Even if you are generous and say there have been a thousand big innovations, compare that to how many people on the planet have been experimenting around the world in this space.

There’s probably at least tens of millions of people world-wide who have tried on average dozens of experiments in the social media space. That would put us at about 1 in 500,000 being a hit. And I think that’s a very generous number. Do you think you can do 500,000 experiments in order to guarantee a winner?

So, while this type of response to innovation is theoretically possible, it is worthless on a practical level.

The principle here is the difference between randomness and purposefulness. Randomness is about producing large quantities and hoping you beat the odds. Purposefulness is about focusing on ways to intentionally improve your odds in a meaningful way. Randomness is about repeating a lot of fast failures (and I do mean “a lot”). Purposefulness is about focusing on places where failure is less likely to occur.

Here are some characteristics of purposeful innovation:

#1: Purposeful innovation plays off your strengths
Even if you do beat the odds and by chance stumble upon a great innovative idea, you still don’t have a hit on your hands. You still have to develop it, bring it to market, and win versus others with similar ideas. The odds of random success at all five levels (ideation, development, operations, distribution and marketing) is really not in your favor.

As I alluded to in an earlier blog, even if you have a one in a million idea, there can be more than a million experiments in that space, so you have to fight to win against others with almost the same idea. The idea alone is not enough.

So if you want to succeed, you need to play to your strengths. Look for innovation only in places where you have competitive advantages in all of these areas. This means that you need to shut off innovation wherever your differentiating advantages do not apply.

This will narrow the innovation scope very quickly. But it will also increase your success very quickly.

Another option is to take away resources from random innovation and apply them to building competitive advantages. The more advantages you have, the better your odds of creating an innovative hit that will win.

I remember touring the area in Austin Texas where a lot of innovation start-ups were located. They all looked about the same to me. None of them were building differentiation capabilities. They were all just pulling all-nighters to get lines of code written. How do you expect to beat the odds if you are not doing anything meaningfully superior?

#2: Purposeful innovation looks for superior solutions to real problems
A lot of innovation focuses on applying the coolest new technologies in a spectacular way. These may be the types of innovations that make other engineers jealous of what you’re working on, but that doesn’t mean the rest of the world will care.

Consumers are looking for superior solutions to existing problems at reasonable prices. You need to ask yourself these questions:
  1.  Once the coolness wears off (and it will, sooner than you think), is there any real substance to your innovation?
  2. Is this just a short-lived fad?
  3. What existing problem does my innovation solve? Does it solve the problem better than current options? It is superior enough to be worth the price you need to charge? Is it superior enough to overcome the barriers to switching from current solutions and networks?
  4. Will consumers intuitively get what you’re trying to offer or will it be confusing and hard to explain? (Hint: If it takes more than a sentence or two to explain the superiority of your innovation, it probably won’t catch on.)

So the place to start is by finding where customers are complaining the loudest about the stress points in their lives. Then, you focus on looking for better ways eliminate these stress points. This means putting solution solving ahead of just looking at what the latest technology can do.

#3: Purposeful innovation avoids imitation
Facebook has been very successful. But that doesn’t mean that a copycat of Facebook will also be successful. That innovation has already been done. That market has already been captured.

Even if your innovative imitation of Facebook is a little bit better, it still won’t win. The network effect will keep people from switching for only minor improvements.

Almost by definition, true innovation is not a close copy of what already exists. It is doing something different. The blue ocean approach says it is easier to succeed in places where there is no established market/solution than one which has already been staked out by a host of competitors.

Imitation may be a sign of flattery, but it usually is not a path to success, especially when you need to get people to switch networks.

Great innovations can often lead to success. Unfortunately, most experiments in innovation will be failures. The odds of randomly stumbling into innovation success are about as likely as having a monkey randomly write a play on a keyboard. Rather than rushing off to do as many experiments as possible, it is wiser to take a moment first to determine a strategic focus for your efforts. Narrow the scope to improve the odds. This is purposeful innovation. Purposeful innovation narrows the scope by: 1) Looking in places that take advantage of competitive strengths; 2) Looking in places where you can provide a superior solution to current problems consumers are complaining about; 3) Not looking to imitate what’s basically already out there.

Good fishermen know that you are more likely to catch fish if you fish in locations where there are more fish to be caught. They don’t just randomly fish anywhere. They go where the odds are better. Innovators should do the same thing.

Tuesday, July 5, 2016

Strategy Planning Analogy #564: The Attack of Gravity

I have a skateboard park near my home where lots of young boys like to hang out. The primary attraction at the skateboard park is a giant U-shaped surface. The idea is to start at the top of one end of the “U” and skate down & back up the other side of the “U”.

It sounds easy enough, but these boys have a tendency to fall off their skateboards. As it turns out, the location the skateboards prefer is not on top of the “U” but at the bottom. That’s where all the skateboards congregate after the boys fall off of them.

They are victims of the law of gravity. The boys try to fight it, but the skateboards willingly give in to the gravitational pull to the bottom of the “U”. But then again, if skateboarding were easy, there wouldn’t be any challenge to the sport.

Lately, it seems like retailers have become more like skateboards. They all want to fall down to the bottom of the “U”. In this case, it is the gravity of pricing which is pulling them down. All the retailers seem to want to be on or near the bottom of the range of prices.

In the past, retail pricing was more like when a boy is guiding the skateboard, trying to defy gravity and get as high in the air as possible. Similarly, retail management in the past would guide the stores on paths towards pricing as high as they could get away with. But now it is more like when the boy falls off the skateboard. The retail pricing falls to the bottom like an unmanned skateboard.

And there the stores lay, all clustered at the bottom of the pricing range. And although that may be good for the consumer, that’s not a good thing for the retailers.

If you want people to prefer your offering, then you have to give them a reason to prefer you. There needs to be something in your offering that makes it special enough to cause people to see a justifiable reason to prefer it over the alternatives. That won’t happen if every option looks the same. Similarity makes all the options undistinguishable from each other. There is no reason to prefer one over the other when you cannot distinguish one from the other. Therefore, a key aspect of strategy is to find one’s point of preferred differentiation.

The problem is that business gravity tends to pull everyone down into an indistinguishable sameness. As soon as one firm finds a positive differentiation, everyone copies it. They chase each other on prices until everyone is at the bottom. They all get stuck in a heap at the bottom of the “U” looking about the same.

To fight the business gravity, firms need to apply the principles of differentiation. We will look at three of these principles.

#1: A Difference Needs to be Meaningful
Marginal differences do not motivate behavior. Consumers are creatures of habit. If you want to change their habits, you have to make your differentiation large enough to grab their attention and overcome the resistance to change.

When I was in the grocery business, the general rule was that if you wanted to get people to shift based on price, then your average prices would need to be at least 7% lower than the competition. Otherwise, the price differential is not enough to succeed. You don’t look different enough to create preference on price.

The problem is that in commodity retailing, pretty much all retailers are now within about 7% of each other on price. Wal-Mart’s original popularity was based on the fact that their prices were significantly lower than the prevailing “normal” prices. That caused people to shift to them in droves.

Now, Wal-Mart prices are considered to be the “normal” price. Their prices are no longer seen as abnormally lower than the marketplace. They are the marketplace price…no big deal. They set the market norm which others come pretty close to matching. No wonder Wal-Mart has stagnated. Their level of difference in their prices is no longer meaningful. When your level of differentiation is no longer meaningful, it is no longer a point of strategic differentiation.

#2: Successful Differences tend to be on the Fringe, Not the Core
Such a phenomenon is typical for the core attributes in almost any industry. Because the core attributes are so critical to success, competition won’t let you get a meaningful differentiating advantage there. They will copy the market leader on core attributes to nullify any advantage.

In retailing, the core attributes tend to be product and price. Unless you are a niche retailer, the products and prices between retailers today are not all that different. As a result, it is difficult to create meaningful differentiation at the core. Therefore, if you want to create differentiation, you have to look to the fringe.

And that’s what commodity retailers are doing. Wal-Mart has been investing in improving its service levels and store décor. Even Aldi, a leader in no-frills, low cost retailing, has started a program to upgrade its store décor. After all, if your prices are not that much lower than anyone else, why should customers put up with your low service and bad décor? The trade-off isn’t worth it when the price differential shrinks. So now you can no longer just be the best low price store; you have to be the low price store with the best fringe offering.

So the irony is this: although the core is the reason for consuming an offering, it is the fringe where differentiation tends to be most effective, since it is easier to create differentiation at the fringe than at the core.

#3: Successful Differences tend to be Difficult to Copy
But just as the core can be copied, eventually so can the fringe. So the trick is to try to find the types of differentiations which are the most difficult to copy. This is done by making bold trade-offs.
The trick is to get extremely good in one fringe area (i.e., create a huge differential) by foregoing much investment in other fringe areas. It’s like putting your eggs in one basket.

For example, the core in the airline business is getting a passenger safely to their destination on time. Most airlines are pretty similar with respect to these core features. So to create differentiation, you have to go to the fringe. Southwest Airlines focused on the fringe aspects most popular with pleasure travel and pretty much ignored the fringe directed at business travel. As a result, they are not the most popular business travel airlines, but they have meaningful differentiation that attracts the pleasure traveler.

Had Southwest tried to be equally strong in all fringe areas, they would not have stood out on any fringe area. The beauty of only focusing in one area of fringe is that it allows you to make bold changes to your business model. You can cut out the aspects of the business model where you do not focus so that you can alter your business to be even better at providing the fringe being focused on. This is the idea of making trade-offs.

For example, Southwest Airlines eliminated the hub & spoke approach to scheduling. Although that may not have made business travelers happy, it freed up resources to make it easier for Southwest to win with the pleasure traveler. The beauty is that it is difficult for airlines who did not give up hub and spoke to match Southwest on the fringe which matters to Southwest, because the others did not make the trade-offs necessary to create ability to outdo Southwest in the areas where Southwest chose to differentiate.

So the secret to differentiation is this: pick an area of differentiation which is inherent to the unique way you operate your business model, so much so that those using a more conventional business model cannot match you. Create trade-offs in both the way you operate and the fringe you offer, which make imitation difficult. By working the two in tandem (internal operation and external fringe offering), you can distance yourself from the norm and create meaningful differentiation.

There is a natural tendency in business for companies to chase the same approaches to the core. Like gravity, they are pulled to the same place. By all looking and acting the same, there is little opportunity to create differentiation. And without meaningful differentiation, there is no reason for a customer to prefer your offering over the alternatives. To get around this, firms need to:
  • Consider how to create differentiation in an aspect of the fringe;
  • Create trade-offs in the business model which allow one to get so good at offering the chosen fringe that others with a more conventional business model cannot effectively copy you. 

This is not just a problem for retailers and airlines. All businesses can fall victim to their industry’s gravity and become indistinguishable from the competition. Differentiation at the fringe is important for all businesses to consider.