Thursday, May 31, 2007

Even if You Are The Tallest Dwarf, You Are Still Short

My first job out of college was working as Assistant to the President of a small retailer. One of my first tasks was to determine a broadcast advertising strategy for the company. I thought that would be fun—getting lots of free lunches and listening to advertising pitches. I soon found out that there was no such think as a free lunch—those sales pitches were quite painful to listen to, especially from the radio stations.

I figured it would be easy to find out which radio station was best. After all, there can be only one top-rated station per market, right? Wrong. Virtually every radio station claimed they were number one in the market…at least number one in something.

Each radio representative would pull out the big ratings book and show me the page where their station was number one in ratings. Sometimes, the qualifications around where they were number one were pretty narrow, like being #1 among nine-year-old girls at 7PM, or being #1 with 55-year-old men at 3 AM on Saturdays. I’m not sure how relevant any of these claims were, since I wasn’t trying to reach the small handful of 55-year-old men that for whatever reason were up and listening to the radio at 3AM on Saturday. But, as obscure as these references were, it still gave the radio sales representative the ability to boast, “We are number one.”

For the really, really bad radio stations that could not even do that, they would find a place in the ratings book where they were the “fastest growing.” Of course if you start at nearly nothing, any growth rate is mathematically near infinity.

In the end, I decided that none of the radio stations provided what I was looking for at a reasonable value, so I put all of my broadcast advertising dollars into television.

Moral of the story: You may be able to convince yourself that you are the tallest person in the room, but that doesn’t necessarily mean that you are tall. You may just be a short person surrounded by people who are even shorter. Even if you are the tallest dwarf, you are still short.

In the 1980s, General Electric made popular the strategic principle that if any of your divisions were not #1 or #2 in their market, they should be sold. There is strategic logic behind this principle. Market-leading businesses on average tend to be the most profitable and have the most defensible positions. By contrast, if you have a very small market share, your strategic options tend to be far more limited, and your likelihood of long-term success is very low.

Therefore strategists strived to make their businesses #1 or #2 in the market. However, instead of reaching this goal by growing to become a true market leader for a meaningful segment, many achieved this goal by cleverly redefining the size of their market so that nobody was larger. In other words, they did like those radio advertising executives mentioned above—they found obscure classifications that made them #1 and claimed victory, even if the victory had no strategic significance.

It’s easy to become number one by standing still and shrinking the number of firms that fit in your market definition. However, unless you do the hard work of growing yourself into the preeminent brand in the customer’s mind over all the current and potential competition, your leadership is not worth very much. Those radio advertising representatives mentioned above found ways to claim victory for themselves, but it was irrelevant to me. They all looked inferior to me compared to television advertising.

The tallest dwarf in the room can only claim victory as long as normal-sized or larger people do not enter the room. Eventually they will, and the advantage will vaporize. The goal to be number one only has strategic value if the definition of the marketplace has strategic significance.

Proper market definition and identification of the right competitors is critical to the success of any strategic plan. If you define the market too small, or if you ignore the wrong competitors, your strategy may become useless. There are three main reasons why such actions can lead to trouble:

1. It Can Create Complacency
2. It Can Cause You to Miss Out on Market Disruptions
3. It Can Cause You to Abandon Your Core Market too Quickly

These are discussed below.

Complacency. It’s easy to get overly confident if you have a large leadership position, because you figure that nobody in your narrowly defined market will ever catch up with you. Unfortunately, if business moves away from your market definition, you can still lose, even if you are #1.

For example, you might be the #1 manufacturer of fax machines, but if all of the document transfer business moves to e-mail, it doesn’t matter. By narrowly defining the market as “fax machines,” rather than “rapid movement of documents”, you can get complacent as being number one in your segment and fail to see that your segment may be shrinking as the preferred solution for moving documents. Being a seller of products nobody wants anymore is not a good strategic position, even if you are #1 in these products.

Sometimes, it takes a perceived “burning platform” to convince a company to jump off the current platform to build a new and better future. By always defining yourself in favorable position, you may be preventing your company from making the effort to truly see how vulnerable their position is. Without building a case for a need to change, many companies will not change. As a result, when the environment changes, they may be left out-of-sync and out of business.

Miss Market Disruptions. Virtually every revolutionary new innovation in an industry is introduced by a company from outside the industry. Mechanical adding machine companies did not invent calculators. Traditional soft drink companies did not invent sports drinks or create the bottled water craze. Traditional coffee manufacturers did not invent Starbucks. was not created by a book retailer. Encyclopaedia Brittanica missed the digital information revolution, even though it had a commanding #1 position in a portion of the physical information business.

Outsiders tend to invent market disruptions, because they do not feel bound by the narrow definitions of the current leaders. It is easy to define one’s self by what you do, rather than by the benefit the customer is looking for from what you do. This is what current market leaders tend to do. They say, “I publish encyclopedias” rather than “I provide information.” “I produce colas” rather than “I make refreshing non-alcoholic beverages.” “I sell ground coffee” rather than “I provide a coffee beverage experience.”

Major market disruption is created when someone finds a superior way to provide an old benefit by using a totally different process to get there. If you narrowly define yourself by your process (what I do) rather than by the benefit (what the customer is looking for), you will miss out on every market disruption. You will be the #1 mechanical adding machine manufacturer watching everyone switch to calculators, because they are a better solution. You will be the leading encyclopedia publisher watching people get their information off the internet, because it is a better solution.

If you define yourself by what you do, you will spend your time trying to do it incrementally better. However, becoming an incrementally better encyclopedia publisher does you no good if even the best encyclopedia is an inferior solution for information relative to the internet. Your best encyclopedia may make you the tallest among encyclopedias, but you are still a dwarf when compared to the internet. It is only when you open your eyes to see the world in terms of solutions that you will truly see how tall you really are.

If you define yourself by what you do, you will also tend to define your competition as people who do the same things you do. For example, if you see yourself as an encyclopedia publisher, you will tend to see your competition as others who also publish paper-based books filled with information. You will not even notice what is happening to information gathering in the digital space, because it is outside the scope of how you define your world.

By using a larger definition of the marketplace you may no longer be defined as #1, but you may also be opening yourself up to creating the next major market disruption. At the very least, the larger definition will allow you to see threats to your core business sooner, allowing more time to react.

Abandoning the Core Too Quickly. Companies are always looking for ways to build strategies that create significant growth. If you define your market too narrowly, you may not see much of an opportunity to grow within your industry. You may see the narrowly defined industry as not growing as a whole, and your ability to gain additional share unlikely, since you are already the market leader by a wide margin. This can cause a strategist to create strategies that take a company away from their current industry—which is seen as stagnant—and move to an entirely different industry, which is perceived to have much more growth potential.

Unfortunately, strategic moves into areas far removed from a company’s core competencies or strengths are highly risky. The new strategic space may have lots of growth potential, but if you have nothing unique to offer in that space, you may not benefit from that growth. The potential for failure is quite high.

By contrast, if the strategist had defined its business market more broadly, he or she may have seen much greater growth potential within the current space. As a result, the strategy would probably have been less risky and more likely to succeed. For example, the Coca-Cola Company used to define itself as essentially being in the cola beverage business. This made them very happy, because they had a commanding #1 global position in this space. Unfortunately, the growth in the overall cola business was slowing and their already high market share position in colas made it incrementally more difficult to gain additional share.

In order to continue their rapid growth, Coca-Cola started looking at potential strategies that would take them into risky areas outside of their strengths. Fortunately, instead of pursuing these strategies, they widened the definition of their core industry to be non-alcoholic beverages. When they did this, they were no longer #1 in their industry. However, it also opened up opportunities to get into a number of closely-related high-growth businesses, like bottled water (Aquafina) and sports drinks (PowerAde).

Most great strategies come from leveraging a strong market leadership position. However, not every method by which a company can define themselves as #1 is truly a strong market leadership position. You may be #1 in a category that is meaningless to potential customers. Therefore, proper market definition is critical to success in building strategies.

If you define your market too small, you run the risk of:

1. Becoming overconfident and complacent.
2. Missing the next major disruption that transforms your business
3. Looking for growth in risky areas well outside your strengths

Just because defining a business scope too small is bad does not mean that you should define it as large as one can. The goal is not to define your market as large as possible, but as meaningfully as possible. Defining your market as “all manufacturing” does you no good either, because there is no focus. The idea is to find the proper balance in business definition between being small enough to provide direction, but large enough so that you can encompass all of the potential threats and opportunities to your business.

Wednesday, May 30, 2007

Waffling on Research

Once a strategist was gazing at his breakfast and realized that a good strategic plan is something like a waffle. Those vertical and horizontal gridlines in a waffle form the foundational backbone of the waffle. Without them, the waffle would be thin, limp and lifeless. This grid pattern is what keeps the waffle firm and gives it substance.

This reminded the strategist of the foundational work of research in developing strategy. One could think of the vertical gridlines as research into consumer marketplace—how is the customer evolving; what are their unmet needs and desires. One could think of the horizontal gridlines as research into the external environment where the strategy must take root—trends in technology, government regulations, competition, and so on.

Within this gridwork of the waffle, one then looks for the “holes” where one can pour in the sweet syrup. The syrup represents a firm’s investment in a “hole” in the marketplace—an opportunity to serve an unmet need. Without the gridwork of the research, one cannot see the holes in the marketplace to fill.

In our last blog, we talked about the importance of preparatory work in developing a strategy. Effective strategic planning needs to be much more than just an annual off-site meeting at a resort. One needs time to do research prior to decision-making, in order to reduce risk and increase the likelihood of making wise decisions (for more information, see the blog “Strategy Takes A Holiday”).

As we can see in the story of the waffle, research is the backbone which makes it easier to find the opportunity “holes” and makes the strategy more “solid.”

The principle here is that strategy is a multi-step process based on the foundation of research. In the last blog, we discussed this on a theoretical level. In this blog we will illustrate this point with an example. The example we will use is the company Urban Outfitters.

Urban Outfitters is a retailer who builds stores around different lifestyles. It offers an eclectic mix of apparel, home goods and other items, centered around a way of life for a particular lifestyle segment. Its largest division is the Urban Outfitter brand, which serves the lifestyle needs of 18-30 year olds who are well-educated and live an urban-minded (almost Bohemian) lifestyle.

The second largest division is the Anthropologie brand, targeted towards serving the lifestyle of sophisticated and contemporary women aged 30 to 45. Anthropologie's target customers are, for the most part, focused on family, home and career, but do so in a more sophisticated fashion than many others.

After doing some research, Urban Outfitters learned that in the near future, these lifestyle segments will not be growing very rapidly. For example, they found that between 2000 and 2020, the 18-24 age segment will only grow 8.1% while the 25-44 segment will only grow 3.3%. As we discussed in an earlier blog (see “Dip Your Ladle in the Right Stew”), the best way to create a growing company is to sell growing product categories to growing segments. Since the core of Urban Outfitters is in a relatively low growth area (retailing to low growth customer segments), the firm would need to look elsewhere for growth.

One thing they found in their research was that the 45-54 age segment would be growing 35% between 2000 and 2020. Such a fact leads one to think that there may be some growth opportunities somewhere in that older segment. Therefore, Urban Outfitters decided to examine this age group in greater detail. What they discovered was the following:

1) This age group is developing a unique lifestyle, unlike the lifestyle of the younger segments and unlike the lifestyles of the previous generation of 45-54 year olds. This uniqueness is based on a combination of factors, including the fact that this is overall a much wealthier group of 45-54 year olds than in the past and the fact that these boomers are used to blazing new trails.

2) This lifestyle centers around the home. In fact, a large number of these consumers have more than one home.

3) They are interested in health & healthy living, nature & the environment, simple luxuries, and enriching experiences.

4) Nobody yet has developed a compelling retail brand offering an eclectic mix of products specifically designed to capture the mood of this emerging lifestyle.

Based on this knowledge gained through research, Urban Outfitters saw a “hole” in the marketplace—an opportunity that was not yet exploited. As a result, Urban Outfitters made the strategic decision to create a new brand to cater to this emerging lifestyle.

The research lead them to believe that the core elements of this lifestyle will revolve around a melding of an indoor life with an outdoor life. The core of the store will be an environment that evokes the feeling of being in a greenhouse. All of the senses will be stimulated. Key merchandise elements will include plants & flowers, flower pots, gardening tools, home furnishings, antiques, and food. The line between art and nature will be blurred. It will be information rich as well as inspiration rich.

The beauty of this strategic decision is that it not only found a growth opportunity in the marketplace that is underserved, but it found a segment which it can appeal to by taking advantage of the lifestyle-oriented strengths the company has mastered in its other brands. It is a great match of company and environment—a hole in the waffle perfectly designed to hold Urban Outfitter’s kind of syrup.

Of course the strategic process at Urban Outfitters is still not finished. Next comes the difficult task of bringing this idea out of concept stage into reality. Then, there is the tweaking of the concept in order to get all the details right before launching into growth mode.

However, without the basic foundation of research, this concept may have never been discovered, or it would not have been appealed to as successfully. Urban Outfitters might not have even devoted so much effort to find a new brand if they had not done the research to see the lack of growth in the core businesses. Therefore, skipping this step or research can be very problematic.

Strategy requires more than just meeting for a few days each year at some resort. It requires a number of elements including research into the external environment and one’s internal strengths and weaknesses. This research provides the foundation for a robust and strong strategy, just like the horizontal and vertical grids in a waffle provide its strength.

Although a good foundation is an essential element to a great home, it is only a small piece of the process. You are also going to need a vision of what kind of house you want to build on that foundation and method to add want walls, a roof, and so on to that foundation. I’ve known companies who are very good at gathering research data, but awful at the larger work of building and implementing a strategy.

The goal is not to see how much data one can gather, but to see how much knowledge and insight one can gain from the research. It is knowledge and insight which leads to great visions, not books and powerpont presentations full of numbers and charts. In fact, less, but more focused research may be far more valuable than reams of random data. The presentation deck to introduce the new concept at Urban Outfitters was based on research, but had only two charts in it. The bulk of the presentation was focused on the insights which came out of the research and how they can best be exploited.

Monday, May 28, 2007

Strategy Takes A Holiday

Over the years, I’ve organized a number of off-site strategy sessions for top management. They tend to go something like this. First, the CEO tells you what time he or she has available, which is never enough time. Then you scramble to find a resort that is available for that time.

Next, you start carving out time for expected activities. For example, the executives always want time for an inspirational speaker as well as time for a golf outing (and maybe some special dinner event).

Then, if you want to have any discussions and get any feedback from all the executives invited, even if you put them into groups and limit their presentations to about 20 minutes apiece, you pretty much have used up an entire day.

So when you subtract out all of these activities, whatever time that’s left can be used for strategic pursuits (which is never enough). After the meeting is over, everyone goes home, and most of the attendees do not think much about strategy until next year’s outing.

I’ve heard people say that they no longer believe in doing strategy, because they see no value in the process. When you probe a little deeper, I typically find out that these people equate “doing strategy” with the “process” of going to a resort for a strategic off-site session. They see these meetings as a waste of time, so they figure that doing strategy is a waste of time.

If the only strategic activity of a company is to have an annual outing at a resort, then I would agree that the “process” of strategy is flawed. As I tried to illustrate in the story, offsite meetings have a number of agendas which often have little to do directly with strategy. A few hours a year is not enough time to give strategy justice.

According to business strategists Gary Hamel and C.K. Prahalad, executives should spend about 30% of their time on strategic activities. In their research, they found that the typical executive spends only about 3% of his or her time on strategy. Without investing serious time in strategic thought throughout the year, strategy off-sites become little more than pep-rallies or worse, boondoggles.

Given that this is the Memorial Day holiday, I thought that it would be good to dispel the myth that good strategy is like going on an off-site holiday.

Good strategy involves much more than just showing up at a resort. There are six essential elements to a good strategic process. They are:

1) Research
2) Option Formation
3) Option Selection
4) Resource Allocation
5) Rallying the Troops
6) Monitoring the Process

These are discussed briefly below.

1) Research
Good strategy is rooted in facts. This is not to imply that all the facts need to be in before making a decision, since strategic decisions can often move a company into uncharted territory. However, strategy is more than just wild guesses. Certain things can be known through research, and that research should be done before making strategic decisions.

For example, consumer trends can be tracked in order to get a better idea of where consumer needs are heading. You can find out what consumers think about you—what are you known for? The more you know about the environment and the more you know about your strengths and weaknesses, the better you can determine how to best fit your company into that environment.

All of that takes research…something that cannot be done at a resort.

2) Option Formation
Before one can decide the proper strategic path, one needs to first come up with some strategic options. After all, it’s hard to make the right choice if you have nothing to choose from.

Developing strategic options requires brainstorming around the knowledge gained from the research. Although a limited amount of brainstorming can take place at a resort, I believe that a better list of options can come from dedicating a larger block of time than afforded at an off-site event.

3) Option Selection
Even if one had the time at an off-site event to develop options, there would most likely not be enough time to do that AND choose which option is correct. To know which option is the correct path to choose requires more than just having a list of options. It requires further analysis of these options. One needs to assess the risks, perhaps do a bit of financial modeling. One may need to ponder what unintended consequences may arise from a strategic decision (for more on this topic, see the blog “The Chisholm Trail”).

Hence, even if you want to choose an option at the off-site, someone needs to prepare in advance some assessment of the options—the pros and the cons of each, base on analysis.

4) Resource Allocation
Choosing an option is not enough. One needs some idea of how to make the vision a reality. This requires an understanding of how to allocate your resources—how to spend the company’s time, its talent and its money. In other words, there needs to be some discussion on what work needs to get done, who’s going to do it, and what do they have to work with to get it done.

Given all of the politics and sensitivities related to these issues, these might not be the types of issues which work well in a large, public discussion. With strategy comes power…and some will see their power grow while others do not. Some hard choices need to be made, since there are typically not enough resources to go around. It may be better to do this type of decision-making in a more private, one-on-one environment, than in a large gathering at a resort.

5) Rallying the Troops
Once the first four topics have been covered, the fifth task is to communicate the vision to the organization and rally the troops around supporting the decision. Off-sites are actually rather good settings for this type of activity. You can control the environment at an off-site and get people focused on the vision without a lot of distraction. There are opportunities to motivate people to action through razzle-dazzle and powerful presentations.

Of course, if you skip the first four steps (which require substantial time prior to the event), there isn’t much to rally people behind.

6) Monitoring Progress
Once a strategy is set in motion, the task is still not over. One needs to monitor progress to ensure that:

a) Tasks are getting done properly, timely and within budget.
b) Tasks are leading to the proper outcome. If not, then what modifications are needed to get the strategy back on track?

Neither of these two points can be done at the off-site meeting. They can only be done later, after the strategy is set in motion.

Strategic off-site sessions at a resort may be a useful (but not the most critical or most necessary) element in a larger strategic process. Without the entire process, however, these off-sites can become little more than “corporate vacations.” Leave the vacations to your personal time, such as the Memorial Day weekend.

Sometimes today, about the most sophisticated a strategic discussion gets is whether or not to sell out to privatization using money from a hedge fund. That type of discussion certainly does not require time at a resort. And I’m pretty sure the hedge fund won’t want you to spend a lot of money on time at resorts, either.

Thursday, May 24, 2007

Reducing the Risk

I used to work for a company which did a miserable job of managing the 401K savings accounts of its employees.

Every year the company went through the same ritual. First, they would tell the employees how poorly the money had been invested over the past year. It was always a return well below the average return which the rest of the market received.

Then they would announce that because of the horrible return, the company was changing to a different investment firm to manage the 401K account. The new 401 K managers were chosen based on having one of the highest returns over the past year (far higher than the returns the company received with the prior money managers).

Of course, after having such a banner year in the prior year, the new money managers would have a slump the following year (the year we switched our money to them). So after a year of suffering through their slump, they’d repeat the process all over again and hire yet another new management firm for the 401k. We were perpetually one year too late in benefiting from the good year of an investment company.

A major reason for doing strategy is to improve one’s risk. The idea is that if one takes time to think and plan strategically, it should decrease the risk of encountering problems (because you are better prepared and aware of potential pitfalls in advance) and increase the likelihood of success (by discovering high potential options). When dealing with risk, one needs to grasp the big picture.

The people who were deciding who should manage the 401 K accounts in the story above seemed to be missing the big picture. They would choose the financial managers based on a very short time horizon—typically looking at a track record of only a year or two. And then they would only keep the management firm for a year or two.

Investments tend to be cyclical, with high years and low years. Over the long haul, some investors are able to do better than average, but even the good investors can occasionally have a bad year or two. Similarly, poor investors can sometimes have a rare good year if they are lucky. If you only look at a short track record, and only keep an investment firm for a short period of time, you are more likely to:

1) Choose a poor investor who just finished a rare lucky year; and
2) Not get the full benefit of a good investor, because you may have only stayed with them during their rare unlucky year.

Had the company taken a broader view and either looked at a longer historical track record, or stayed with the current manager over a longer period, they could have mitigated the risk of low performance by smoothing out the occasional lows with the more frequent highs.

Strategists need to take a longer or broader view to improve their risk profile as well.

There are four key principles to understand when using strategic planning to improve your risk profile:

1) Risk = Reward
2) Risk is Minimized When Bundled at Same Time
3) Risk is Minimized When Stabilized Over Time
4) Risk is Minimized With Pruning

These are discussed in detail below.

1) Risk = Reward
The first thing to keep in mind is that the roll of strategy is not to eliminate risk. As the old saying goes, “Risk = Reward.” If you want to achieve outstanding rewards, you have to take some calculated risks. The goal of strategy is not to eliminate risk, but manage risk.

The only way to totally eliminate risk is to stay with the certainty of the status quo and make no investments. Unfortunately, this lack of risk leads to the absolute certainty that your company will die when the status quo eventually gets replaced by the next big thing.

To truly grow and have above average returns, one must make investments into unproven territory. If you wait until all the facts are known, others will invest before you and reap the rewards of the fast mover. By waiting until an industry is mature and well-defined, you will perpetually suffer from the mediocre returns inherent in mature businesses.

The role of strategic planning is to help your ventures into the unknown become less risky, by increasing what you know. First, strategic environmental analyses can help you understand how the marketplace is evolving. By knowing how the marketplace is evolving, you can better understand which new ventures are most in tune with that environment.

Second, by examining opportunities strategically, it is easier to understand which new ventures are inherently the least risky. Finally, by having a strategic plan which helps you build up core competencies, you can better determine which opportunities fit the strengths you have been developing. The more strengths you have that fit the needs of the new opportunity, the better you will be able to succeed in that venture, regardless of its inherent riskiness.

2) Risk is Minimized When Bundled at Same Time
If you put all of your eggs in one basket, your total risk is the same as the risk of the individual project. However, if you invest in a handful of new ventures, your total risk is less than the risks of the individual projects. When doing a bundle of ventures at the same time, the likelihood increases that you will find a winner within the bundle. Provided you get out of the losers soon enough and properly feed the winners, the likelihood of total success goes up significantly over the long haul.

Remember, the goal is not to make every individual investment a winner. The goal is to properly manage both the good and the bad in a manner that best optimizes the performance of the total corporation. Strategic planning can help you manage this ever-evolving portfolio.

3) Risk is Minimized When Stabilized Over Time
As we saw in the story about the 401K managers, if you keep changing management all the time, one increases the likelihood of have a string of bad performance. The same can be true in managing your strategy. Changing one’s strategic direction too often usually serves to hurt performance.

If you change your strategy for a given business investment too often, it can alienate your customers. They can become confused about what your brand stands for. If you are wishy-washy about what you stand for and keep changing your approach, the customers will be wishy-washy about their loyalty to you. Different strategies may require different competencies, which makes it difficult to develop any expertise. How can customers believe you are an expert, if you keep changing your expertise?

Sometimes, different strategies appeal to different customers. For example, if some customers prefer an everyday low price strategy. Others prefer a more promotional pricing environment. If you switch from one pricing strategy to the other, you could end up alienating your current customers and not pull in the other type of customers who prefer your new pricing position.

In retailing, I know from experience that every time one significantly changes the sales floor, there is an initial negative reaction from the confusion it causes. Constant change will turn of the retail customer.

It is a shame that the average tenure for a CMO is now under two years and that advertising agency changes have become such a frequent event. These changes make it hard to create the continuity which leads to strength and clarity with the customer.

Sometimes, the best action with a business is to do nothing and just let it build momentum from having a stable strategic platform.

4) Risk is Minimized With Pruning
Just as a grape vine can only produce the optimal number of grapes if it is regularly pruned, companies can only produce optimal results if the portfolio is regularly pruned. Yes, stability is important for an individual investment, but for the portfolio, it is often beneficial to add and subtract investments on a regular basis. Some firms are great at start-ups but not at running mature businesses. For these firms, it may make sense to prune out businesses when they reach maturity. Similarly, some businesses are great at turnarounds, but cannot add much value to an already successful investment. These firms may need to prune out businesses once they have successfully turned them around. By sticking to what one does best, one minimizes the risk of staying in businesses that no longer fit one’s strengths.

In addition, not all investments in the bundle will succeed. It is important to know when it is time to pull the plug on the losers.

Risk is an inherent part of creating business success. By utilizing strategic analyses and by understanding your strategic strengths, you can increase the chance of success within these risks.

If the only thing you add to an investment is money, then you do not provide very much to ensuring the success of the investment. However, if you add to that strategic insights and strategic synergies, risk goes down and likelihood of success goes up.

Tuesday, May 22, 2007

Dip Your Ladle in the Right Stew

Once upon a time there was a man who fancied himself to be a bit of a gourmet. He enjoyed making his dinner time as pleasurable as possible.

His kitchen was well stocked with all of the latest gourmet cooking gadgets. The only thing he was missing was good ladle for dishing up stew. He had a vision in his mind of what the perfect ladle should be. It should be sturdy enough to hold a full portion at a time. The handle should be designed for perfect balance. The bowl of the ladle needs to be shaped so that it is easy to get the stew out of the stew pot and easy to pour the contents into the stew bowl.

This gentleman could not find any ladle in the market which pleased him, so he commissioned a craftsman to produce a special one-of-a-kind ladle meeting his strict qualifications. After several attempts, the craftsman finally produced a ladle meeting the needs of the gourmet.

The gourmet couldn’t wait to try out his new ladle. He went straight home, ladled out a perfect portion of stew, and effortlessly poured it into his soup bowl. Then he tasted the stew. He suddenly got very ill and had to spit out what he had partaken.

As it turns out, he had waited so long for his ladle that his stew had gone rancid. It was unfit for human consumption.

Sometimes we can get so fixated on perfecting a small portion of what is in front of us that we miss the bigger picture. In our story, the gourmand was so fixated on getting the proper ladle that he failed to take care of the stew. In the end, the stew is the prize…it is what you eat. The ladle should only be a means to the end. Having a perfect ladle does one no good if the stew is inedible.

In the strategic process, one can become fixated on perfecting that strategy—getting all of the nuances correct and so on. You may end up with an excellent approach that will win in the marketplace and give you all sorts of market share growth. When you put it into practice, it may even work as brilliantly as you designed it. You could end up winning in the market place even more than planned.

However, if the prize you have won is as rotten as the stew of our gourmand, then you really haven’t won much. Having a good, well-functioning strategic ladle is fine. But spend some time making sure you are dipping it in a place that will deliver tasty results.

According to Harvard professor and strategic planning guru Michael Porter, the first principle of strategy is to choose a profitable industry. The logic is quite simple. Some industries have higher profit margins than others. If you create a strategy to win in an industry without much profitability, you haven’t won much. Yes, you can congratulate yourself on being a winner, but the prize is not worth the effort.

If you are going to go to all of the cost and effort of creating and executing a strategy, one may as well target an industry where there is money to be made. Otherwise, you can be like the man in the story who had the ideal ladle, but no edible stew to dip it in. I’d rather have a mediocre ladle dipped into a rich pot of stew than the perfect ladle dipped into an empty pot.

The point of doing strategy is to help one make better choices. Within some limits, you can choose what industry you will participate in. Don’t assume that you are permanently stuck within the industry you currently operate. Look at GE. Over the years, it has continually reinvented itself from being in basic manufacturing to high tech manufacturing to financial services to entertainment. As industries matured and became less profitable, GE moved to places where the total profitability potential was higher. In a psychological milestone, GE just got out of the plastics business, one of few remaining reminders of strategies past.

In the retail sector, the Limited is getting out of the lower profit apparel retailing business and concentrating on lingerie and personal beauty care items, because this is a richer industrial sector in which to play. The margins on “bottles of goo” are far higher than the margins these days in apparel. As long as you are selling something, why not choose to sell the items with the inherent and naturally higher margins, provided you have a strategy to win in retail?

Because it takes time to make these types of transformations, you have to develop your strategy far enough in advance to provide time for a smooth transition. You need to look out more than just a year or two. These are the types of transformations that typically do not come out of an annual budgeting process. You have to think bigger.

Some recent research has made the imperative to do this even stronger. This past week, the McKinsey consultants announced the results of a major study looking at how companies grow. They studied over 200 companies across the globe. The idea was to determine what the key differences were between the companies with consistently high growth over the years versus companies experiencing much lower growth.

What they discovered was very interesting. Yes, having great strategies which allow a company to gain market share are useful in creating growth. However, a company’s ability to gain or lose market share only accounted for only about 20% of the difference in the growth performance of companies.

Instead, a much greater contributor to growth was the choice of the subindustries and product categories which a company chose to operate in. Based on these results, McKinsey concluded that “executives should identify and allocate resources to fast-growing segments in which a company has the capabilities and resources to compete successfully.”

Well, this pretty much takes us back full circle to what Michael Porter said. If you want lots of profits, enter profitable industries. Or to paraphrase McKinsey, if you want lots of growth, enter high-growth industries. Gee, it doesn’t sound as special when you put it that bluntly. But it’s the truth.

How do you find industries with high profits? Industries with high profits tend to have high barriers to entry, making it harder for new firms to enter and start a price war for market share. Michael Porter likes to point to trucking as one such industry. It is relatively easy to get into the trucking business, therefore supply and demand pressures cause low bidders to suck the profitability out of the industry.

Traditionally, the pharmaceutical industry has had much fatter profit margins, because it is such a difficult business to enter from scratch. Of course, the irony here is that once you’ve identified these high profit industries which have high barriers to entry, it may be difficult to find a way to enter them. That is why time is needed to develop a strategy.

Without taking time to develop strategies, one is typically stuck just making incremental improvements to the status quo. If you want to make significantly better returns or achieve significantly higher growth, it typically requires transforming your portfolio to businesses with inherently more profit or more growth. This transformation will not occur on its own. It requires long-term strategic planning.

There’s an old saying which goes something like this: “I have good news and bad news. The good news is that I won the Wal-Mart account and will now be one of their suppliers. The bad news is that I won the Wal-Mart account and will now be one of their suppliers.”

Be careful what you wish for. You just might get it, and then later choke on it like bad stew.

Monday, May 21, 2007

Watch, Don't Listen

I used to work for a company that gave its executives free access to all of the health care resources of the Mayo Clinic executive program. It was a great benefit. They would test you for all sorts of potential medical problems with a very thorough examination (maybe a little too thorough in some areas, if you know what I mean). Then the doctors would take the time to explain all the results to you in great detail.

One time, the doctors were concerned that I was starting to put on a bit too much weight, so they wanted me to spend time talking to one of their nutritionists/dieticians. This dietician started talking to me about all sorts of subjects, like exercise, food choices, meal portions and the like, but I could hardly hear a word she was saying. I was too fixated on noticing the fact that this woman was significantly more overweight than I was. I had difficulty taking her words seriously, when the results of her own behavior were staring me in the face.

In the story above, it was hard for me to take the advice of this dietician seriously, because it was apparent by looking at her that she was failing in heeding her own advice. I figured that this type of thing is what she did for a living, so she would be more motivated than anyone else to follow through. Being more aware of the health risks, she should have more motivation to lose weight. Being an advocate for slimness, you would think that she should be more motivated to be slim than most people. Being smarter about the topic, you would think she would be more successful at finding what works.

Yet she was fatter than I was. And I’m not all that motivated to be slim. So if she couldn’t follow her own advice with her added motivation, what chance did I have? I couldn’t hear her words, because her actions were speaking too loudly.

In our last blog (see “Stop Listening to Me”), we talked about the dangers inherent in listening to our customers too much. What they say can be too limiting and not take into account everything necessary to create great strategy. Worse yet, customers may not be telling us what they truly believe, based on a desire to please or a bias caused by the interview itself.

If there are problems in asking and listening to our customers, then how can we get their input? As in the story of the dietician, we can learn a lot by observing behavior. It’s much harder for our everyday actions to lie. The cumulative impact of everyday behavioral decisions by the dietician were plain to see.

The principle here is to learn through observation rather then intervention. It is less about surveys and more about anthropology. We are to be more like Dian Fossey and her study of the Gorillas in the Mist or Jane Goodall and her study of the Apes. They learned by observing their objects in their natural environment.

There are two worlds where you can observe your consumer, the physical world and the internet world. We will look at each of them.

1) Observations in the Internet World
Rather than using the internet to directly connect to the consumer, you can use the internet to observe what people are saying in general to each other. There are enough people saying enough things online that you can find out what people are thinking on a wide variety of topics.

Now you still have to be a little bit wary of biases out there, particularly if you are pulling data from advertising-supported sites or blogs with a very strong bias in a particular direction. To please their advertisers or fellow extremists, these sites could mis-represent general sentiments. However, a lot of what is out there is just regular people saying what is on their mind. Tapping into this can be a relatively inexpensive way to learn what people truly think—about your company and about how they live their lives.

There are a number of companies out there who can help in this task. A partial listing would include BuzzMetrics, owned by AC Nielsen, Cymfony, owned by TNS, and Dow Jones’ Factiva. They can help you pick up on trends very quickly by aggregating all of the noise on the internet and distill what the key trends are.

The beauty of these types of observations is that you get results relatively quickly and they tend to have fewer biases than traditional consumer research. The problem is that the web chatter tends not to be equally distributed amongst all demographic groups. If your particular target is not well represented in chatter, this is more limited in scope.

2) Observations in the Real World
Sometimes, the best information can come from just watching people live their ordinary lives. For example, if you are marketing to teens, you can learn a lot by just observing teens doing what they do in the places they congregate, such as shopping malls or basketball courts.

Often times, if your observations take place in locations which tend to catch onto trends more quickly (or tend to be places where trends originate), you can learn about trends in their infancy and take advantage of them before the competition. This is particularly useful in categories where there is a strong fashion element, although useful in many other areas as well. The practitioners give it the fancy name of being “Cool Hunters.”

Back when I lived in Minneapolis, I would sometimes go to the Mall of America (one of the largest malls in the world) and just watch the people—what they were wearing and which store bags they were carrying. I would make a note of which store shopping bags I was seeing more of and which I was seeing less of. Then, later, when the monthly retail sales reports came out from all the retailers, I would compare national sales results to my mall observations. Normally, the more bags I saw in the mall, the better the official sale results.

Retailers have been known to follow people around in the store, to see what path they used to get through the store, where they stopped to look at something and so on.
Consumer product companies are famous for observing people over long periods of time to see how they actually interact with their products. They take photos of the inside of the refrigerator, or ask customers to take photos periodically of what they are doing or a whole host of other things. The idea is that once people get over the initial thought of being observed, they will eventually go back to their normal routines. Seeing this “real” behavior gives great insights into what can make or break your success. The practitioners like to give this the fancy name of “Ethnography.”

The real significance can be making observations related to problem solving. Through observations, one can see the types of problems people have, the innovative ways they try to solve them, and the level of success they have had in solving them. I have talked to many executives in the consumer products industry who have told me of all sorts of ways in which their products are used that are not at all as the company intended them to be used. When you see problems where customers are having difficulties, this could lead to the development of new solutions.

Although strategies should never be totally developed based solely on consumer insight, it is an important element. And often, the best way to get that insight is not by asking the consumer directly, but by observing them in their natural course of activity, be that activity on the internet or activity in the physical world. Good strategists are often pretty good anthropologists.

There’s an old saying, “Do as I say, not as I do.” Well, in my case, I would rather pay more attention to the “do” than to the “say.”

Sunday, May 20, 2007

Stop Listening to Me

Auto executive Bob Lutz likes to talk about the disasters one creates when designing cars based on consumer research. Regarding the Ford Thunderbird, he said,

“Ford ruined the Thunderbird by taking [consumer survey] responses too seriously. The original Thunderbird was a sleek, zippy, tightly designed two-seater. Ford asked T-bird customers what they’d like more of: Would they like, say, a little extra room? They would. How about a back seat? You bet. So Ford introduced an “improved” four-seater (and later a four-door). The restyled car was no longer the sleek sportster that had first attracted drivers. It’s mystique paled, and what had been a unique addition to Ford’s line was now just another car.”

The larger, more boring Thunderbird sold poorly enough that it had to be retired.

When at Chrysler, Lutz saw this problem again. In the 1980s, the Chrysler sub-compacts were not selling as well as the Ford Escort. Chrysler asked the customers what the problem was. In Lutz’s words:

“By a vast majority, respondents said they would like the car much better if it were just a little bigger—say four inches longer on its wheelbase. Now, anyone even passingly familiar with the US auto market knows that most people buy subcompacts because that’s all they can afford, not because they have some warped desire to sit with their knees up around their chest. Thus, when asked what they’d like changed about their cars, it’s axiomatic that subcompact owners would like them bigger.”

According to Lutz, the Chrysler executives were so fixated on giving the customer what they wanted, that they embarked on a $170 million campaign to find a way to make their sub-compacts four inches longer and still sell them at the same low price. It never occurred to these executives that Chrysler already had popular cars that were four inches longer for which people were willing to pay a higher price. Eventually, Lutz had to put his foot down and stop the nonsense.

And then, there was the Edsel, one of the biggest design disasters in automotive history. Oh, by the way, it was also one of the most consumer-researched designs in automotive history. Consumers were given choices of many different types of designs on each part of the car. Then Ford took the winners of each part and put it all together. When all of the “consumer chosen” parts were assembled, the total design was a mess that consumers rejected.

We live in a Web 2.0 world. Because the Web 2.0 provides unprecedented opportunities for two-way dialogue, companies are rushing to get consumer interaction—even moreso than in the heyday of Bob Lutz. It is not uncommon these days for companies to have their advertising designed by consumers or even have their products designed by consumers.

In fact, based on what companies are doing, you might conclude that the need for strategy in a Web 2.0 world is being made obsolete. Why develop strategies, when all you have to do is whatever the customer says?

Although it can be insightful to learn what customers are thinking, the examples in the auto industry above point out that if you put too much power in the hands of the customers, it can actually destroy your business.

Just because we have new web tools to better interact with customers does not mean that customers have suddenly gotten any smarter or more insightful. They still say some silly things that could get us into serious trouble. All these new tools merely do is make it easier to fall into the trap of listening too closely to our customer to our own demise.

The principle here is that strategies should incorporate many issues which transcend the interests or opinions of customers. If you limit strategy to merely the level of consumer interaction, we can end up making some self-destructive decisions.

The weaknesses of relying too much on consumer input can be summarized as follows:

1) Consumers Don’t Care If Your Business Survives
2) Consumers Can Only Interact Incrementally
3) Consumers are More Interested in Being Polite than in Being Honest

Each of these will now be discussed in greater detail.

1) Consumers Don’t Care If Your Business Survives
One of the chief goals of strategy is to provide a path to long-term prosperity (or at the very least a path to cash out of the business well). Consumers do not typically care about these things. They don’t worry about whether investors (shareholders, banks, hedge funds, etc.) get a return on their investment or whether the employees have prosperous careers. They just want what’s in it for them. And if they are honest, that means they want it all, they want it now, and they don’t want to pay for it.

Very few businesses can develop a sustainable business model around those qualifications. And guess what…in most cases, the customer doesn’t care if you business is sustainable. There are usually enough options that they will just go somewhere else to make their demands.

So if you single-mindedly try to please the customer by giving them whatever they want, and ignore your other stakeholders, you will typically end up with an unsustainable business model.

2) Consumers Can Only Interact Incrementally
Even if customers did care about the long-term viability of your business, they do not have the proper perspective to make long-term decisions. They do not know what is technologically possible. They have full-time jobs and concerns of the immediate. Consumers do not spend 40 hours a week thinking about the potential for where your brand and where it could go in the future.

As a result, consumers can only react incrementally to what is in front of them today. In the case of autos, they may be able to tell you to make them a little bigger or put in more cup holders, but they cannot help invent the future of personal transportation. Nobody was clamoring for a minivan before it was invented. They only clamored for it after a business put it on the market.

Most great business ideas are transformational—upsetting current conventions by providing something completely different than what was in the marketplace. These came out of the minds of visionary business people, not consumers. Nobody asked for the transformational coffee phenomenon of Starbucks, but now they are everywhere.

At Sony, they are proud to say that nobody ever asked for any of those great transformational inventions they have given us over the years. Instead, Sony’s great inventions came out of a deep understanding of consumer behavior (perhaps knowing people better than they know themselves) and a deep understanding of technological possibilities (for which consumers are unaware).

Incrementally, a consumer can suggest a new coffee variation for Starbucks or a new feature for a Sony computer, but beyond that, they are typically not much help. And if your company stays at only the incremental level in its thinking, your company will be passed by from other firms who are thinking transformationally, and who end up taking your customers with them (even though the customers did not ask for the transformation).

3) Consumers are More Interested in Being Polite than in Being Honest
When consumers are asked their opinions, they want to be helpful, but certain biases tend to creep into their responses to cause distortions. For example, there is a bias for consumers to say they will buy your product in your survey at a given price even if they would not, because they want to please you and encourage you. People don’t want to appear to be cheapskates, so they will tell you they are more willing to part with their money for something than they would in reality.

To quote an article in the May 18, 2007 Wall Street Journal, “The moment you ask someone for their opinion I have created a bias because of the natural human instinct to please.” Bob Lutz puts it more bluntly when he says “consumers often lie—albeit for the noblest of reasons.” Lutz’s point is that we tend to give very rational answers when being surveyed, because that is the “responsible” thing to do. Unfortunately, our true behavior is more likely to be driven by emotions.

So even if the consumer has our best long-term interest at heart and thinks about transformational issues, they may still give us answers that do not reflect their true intentions.

Although consumers can tell us a lot of things, they cannot tell us what our strategy should be. If we let too much consumer commentary affect our strategic decisions, we will most likely miss the mark and allow others to take our business away, because these firms give the consumers what they really want, rather than what they say they want.

Web 2.0 technology is a great tool, just as a hammer is a great tool. But to build your strategic house, you need more than a single tool; you need the entire tool belt.

Thursday, May 17, 2007

The Chisholm Trail

One summer, I drove the back roads through central Oklahoma. Quite a few of the cities along the way had museums dedicated to the Chisholm Trail. I visited several of these museums.

The Chisholm Trail was the path that cowboys used to move cattle from the south of Texas to Abilene, Kansas, back in the late 1800s. In Abilene, the cattle were placed on trains, where they were shipped back east for food. At its peak, nearly a million head of cattle took the Chisholm Trail to Abilene in a single year. As many as 5,000 cowboys a day would get their payday at the end of the trail.

With all of the books and movies and songs about the Chisholm Trail, you’d think that this phenomenon went on for decades and that cowboys made a lifetime career out of moving cattle up the trail. However, after going through several Chisholm Trail museums, I heard over and over again that it was a short-lived phenomenon. In fact, the original Chisholm Trail to Abilene was really only a major factor for four years—from 1868 to 1872.

The problem was that those same train tracks which made it possible to get the cattle to population centers of the east, were also the same train tracks which brought people from the east who wanted to settle in Kansas. These new settlers started up ranches, which they surrounded with barbwire fences, making it hard to get the cattle into Abilene. Then the new settlers started to complain that the Texas cattle were bringing diseases to their ranch livestock and that the rowdy cowboys were a bad influence on the community.

This started a phenomenon of pushing the trail further west every few years to an even more remote outpost, in order to get around the settlers who kept building further west. Eventually, the process ended completely when a rail line was built all the way to south Texas.

Many things can immediately look like great ideas. Take, for example, the Chisholm Trail. At the time, cattle in the north and east cost over $40 a head. Cattle in Texas could be had for only $4 a head. Even though you needed to spend a bit of money to get the cattle to the north and east, you could still make a fortune on Texas cattle if you could find a way to get them to the population centers in a reasonable manner. This made the Chisholm Trail to the Abilene train depot look like a “no brainer.”

Unfortunately, those trains—which the cattle-drivers and cowboys saw as their means to a fortune—were also the means to their demise. The good news was that the trains sent the cattle east. The bad news was that the trains sent civilization west. The civilization pushing west would try to abolish the cattle drives, making them take ever longer and less profitable paths to get the job done. Eventually, those trains did the entire transportation directly from the south of Texas, making cattle-drivers and cowboys obsolete.

The same phenomenon often happens in business. Someone will come up with a new idea or new technology which immediately looks great. People will latch onto the new idea or technology thinking it will provide a lifetime of great profits. Unfortunately, over time people find out that these “good” ideas also come with some “bad” consequences. Many times, the bad can eventually outweigh the good, causing disastrous results instead of prosperous results over the long haul.

This is the principle of “unintended consequences.” The idea is that we can often see the initial consequences of an action, which look great, such as the positive consequence for cattle-drivers of getting cattle to the Abilene train station. However, we often stop our examination with the initial consequence and do not look for the secondary and tertiary consequences. Many times, the secondary and tertiary consequences are not as favorable (like trains bringing back settlers, or trains eventually making the whole journey without cattle-drivers).

When the initial intended consequences are combined with all of the unintended consequences, what started out as a great idea may turn out to be a bad idea. Therefore, when building a strategy, always take time to fully test out its viability by looking for all of the possible unintended consequences which could arise out of your strategy.

Unintended consequences tend to come from one of three sources:

1) Your Competition
2) Your Customers
3) Yourself

We will look at each of these in detail.

1) Unintended Consequences From Your Competition
In an earlier blog (see “Bombs Start Wars”), we talked about the concept that if you come up with a strategy which starts taking significant market share away from competition, do not expect the competition to stand still. Instead, expect them to react in a manner to regain their market share. Depending upon the unintended consequences of how they react, your market share gains could be very short-lived and in fact you may end up in a worse situation than you were before.

The easiest example would be a strategy to lower prices in order to gain market share. At first, it sounds great. I lower prices. I gain market share from the higher-priced competition. I make more money.

Unfortunately, the competition may respond by resetting their prices below your new prices. This could start a nasty price war in which everyone eventually ends up with about the same share they had at the beginning, but far fewer profits, because the prices they charge are so much lower.

Another example would be if you go after taking share from a competitor’s most profitable product, and they respond with the unintended consequence of going after your most profitable product. You might gain a little more profit from your new venture, but not enough to make up for the losses on your formerly most profitable product.

Never assume that competition will stand still. Always factor in unintended consequences from the competition when you have a strategy which will hurt them.

2) Unintended Consequences From Your Consumers
Consumers are very crafty about finding ways to get the best value for their money. Sometimes, your initial actions, which you think will lead to getting more consumer money have the unintended consequence of leading to getting less of their money.

For example, let us assume that you are a retailer known for having consistently low everyday prices. You then decide that you can get some incremental business (and profits) by holding an occasional sale. At first, this works great. But then come the unintended consequences: eventually your consumers figure out that if they wait for a sale, they can get a better deal. So your everyday business goes down and your sale business goes up. In the end, you have about the same amount of business you had before, except that a greater proportion of it comes at the lower margin sale price. So in the end, all you have done is lower the amount of gross margin made at the cash register (due to selling more at the lower sales margin) while increasing your cost by adding the costs of running the sales. You are worse off than before.

Another example: gas stations thought they were providing a great service by allowing customers to pay for their gas right at the pump with a credit card. The hope was that customers would love the convenience and flock to the station (and they might buy a little bit more gas at each fill-up if they were buying it on credit). First came the unintended consequence that practically every competitor put in the same convenience, causing it to no longer be a unique differential to cause people to switch to you. The second unintended consequence came when customers who paid at the pump no longer came into the store to buy the high margin snacks and convenience items. So now, the gas stations were selling perhaps a little bit more of the low margin gas, but were selling less of the high margin convenience items. I’m not sure that provided a good return on the investment in those new gas pumps.

3) Unintended Consequences From Yourself
Sometimes we can be our own worst enemy and cause our own unintended consequences. For example, what we do favorably with one part of our product mix could hurt other parts of our product mix. This has happened to consumer electronics retailers, who in the desire to increase sales dramatically dropped the prices on their electronics products. When the prices dropped to so low, it made the extended warranties much less valuable. The extended warranties were providing most of the profits. Now the retailers are scrambling to find a replacement for the extended warranty profits.

Sometimes a company can destroy its own image. For example, if your firm is has a successful high-end fashion image and you think you can get some incremental profits by reaching out to a broader audience, you may end up destroying that image. The elite fashion taste-makers may no longer find your brand appealing, because it has lost its exclusivity. It may now be seen as to “common” to them, and the tastemakers could abandon you for a different brand. And when the tastemakers abandon you, the other eventually will as well and you will be left with nothing. The unintentional consequence of trying to appeal to a broader audience could leave you appealing to no audience.

Almost every strategic action causes a change in the marketplace. Some of those changes are easily predictable. Others may be less obvious. The less obvious consequences of your change may be the most important ones. Try to discover these potential unintended consequences before embarking on your strategy. Otherwise, you may end up with undesirable, unintended results.

There are always unknowns when blazing a new trail, be it the Chisholm Trail or a new strategic trail. Just because you cannot predict all of the potential outcomes should not deter you from blazing the new trail. If you wait until everything is known, then it is often too late. However, one should never blaze a new trail blindly. Prepare yourself for unintended consequences in advance.

Wednesday, May 16, 2007

Play it Backwards

Back in 1969, the world went wild trying to unravel one of the biggest hoaxes in pop culture history. A number of people started playing the music of the Beatles backwards. They also started looking at the Beatles album covers backwards in the mirror. When they did so, there appeared to be clues indicating that bass player Paul McCartney was dead.

Many of these hidden messages in the music and hidden symbols on the album covers could only be detected if you looked at them backwards. Although the Beatles deny the existence of such a hoax, there seemed to be far too many clues to make this completely random.

Strategies are based upon choosing a position in the marketplace. The position stands as a guidepost, pointing the direction in which the company is to move. It should describe the manner in which the company is going to win in the marketplace, and why certain consumer segments should prefer it.

When choosing a position, it should not only be able to tell you the right things to do. It should also tell you what are the wrong things to do, things which are inconsistent with your strategy.

Unfortunately, many companies develop mission statements and other such strategic documents that are nothing more than platitudes. They talk of noble goals, such as making money, or being a leader, or of enriching lives, but they are worthless at providing any sort of strategic direction.

One way to tell if your positioning is truly strategic or merely a platitude is to play it backwards, similar to what people did to the Beatles music. For example, if your statement says that your mission is to make money, play it backwards and the reverse would say that your mission is to lose money. Since people rarely go into business to lose money, this is not really a viable option. Therefore, if the opposite is not viable, then the original is just a platitude.

The same could be said about mission statements around “being a leader” or “enriching lives.” Playing it backwards, it does not seem to be viable to have a position of “being a loser” or “hurting lives.” Thus, these are platitudes as well.

If all you hear when you play your statement backwards are non-viable options, then your mission is just a meaningless platitude. And if that is the case, then maybe there is a hidden message in your statement about your pending death as well.

The principle here revolves around making choices and trade-offs. Rarely is a company strong enough to be all things to all people. And even if you were strong enough to be all things to all people, the consumers may still reject you because they favor being served by specialists, rather than generalists.

Therefore, companies need to make trade-offs—emphasizing certain benefits while deemphasizing others. For example, Wal-Mart has a position which revolves around providing the lowest prices. To succeed in providing the lowest possible prices, Wal-Mart has to make some trade offs. For example, Wal-Mart is not known for its service. If Wal-Mart added too much service, it could no longer afford to provide its low prices.

Harvard Professor and strategic expert Michael Porter says that one of the most important tasks of strategy is to determine which trade-offs you are going to make so that you can stand out and win in a particular direction.

If your position is based on a clear understanding of your trade-offs, then it will provide clear direction on what you are to do. When you play it backwards, you can tell that it is not just a platitude. For example, if you play backwards the Wal-Mart strategy, it would say that you are not going to win based on low prices. Is that a viable strategy? Of course it is. There are many companies that succeed by making a different set of trade-offs in order to win based on service, or convenience, or quality, etc.

Unfortunately, the trap of thinking in terms of platitudes rather than trade-offs is very common. So common, in fact, that it is often made fun of in Dilbert cartoons. In his book, The Dilbert Principle, Scott Adams defines the mission statement as “a long, awkward sentence that demonstrates management’s inability to think clearly.” Two of his parodies showing how useless a platitude-rich vision statement can be are as follows:

• “We enhance stockholder value through strategic business initiatives by empowered employees working in new team paradigms.”

• “We will produce the highest quality products, using empowered team dynamics in a new Total Quality paradigm until we become the industry leader.”

After reading those statements, could you tell anyone…
…What field of business the firm is operating in?
…What solution is being provided?
…How that solution is superior to other alternatives
and why some people would prefer it?
…What trade-offs are being made to win with this solution?

You cannot be motivated to act in a certain manner unless you first understand what you are supposed to be doing (and via trade-offs, know what you aren’t supposed to be emphasizing).

Fortune magazine once did a parody of bad vision statements by providing a universal multiple choice vision statement. It went as follows:

a)Premier; leading; preeminent; world class; growing
b)Innovative; cost-effective; focused; diversified; high quality
c)Products; services; products and services
d)Serve the global marketplace; create shareholder value; fulfill our covenants with our stakeholder; delight our customers
e)Information solutions; business solutions; consumer-solutions; financial-solutions

Platitudes do not provide direction. They say you want to lead, but they don’t show the way. Platitudes do not inspire. Platitudes don’t tell people how to make trade-offs. Platitudes do not tell you how to differentiate yourself from other firms who have the same platitudes.

A better fill-in-the-blanks option would be as follows:

When it comes to solving the problem of ____________, I will win by owning the solution which places the highest priority on _______________, and I will make the appropriate trade-offs to remain a leader in this direction in the mind of the consumer who wants to make similar trade-offs to solve this problem.

A couple of retail examples could be as follows:

When it comes to the problem of feeding my family, I will win by owning the solution which places the highest priority on fresh, organic and healthy foods, and I will make the appropriate trade-offs to remain a leader in this direction in the mind of the consumer who wants to make similar trade-offs to solve this problem. (Could this describe someone like Whole Foods?)

When it comes to solving the problem of being appropriately dressed for work, I will win by owning the solution which places the highest priority on quality classic tailoring which lasts beyond one fashion season, and I will make the appropriate trade-offs to remain a leader in this direction in the mind of the consumer who wants to make similar trade-offs to solve this problem. (Could this describe a portion of what Talbots is trying to do?)

When it comes to solving the problem of providing my family with the everyday necessities of life, I will win by owning the solution which places the highest priority on paying the lowest prices in a one-stop shopping environment, and I will make the appropriate trade-offs to remain a leader in this direction in the mind of the consumer who wants to make similar trade-offs to solve this problem. (Could this describe a Wal-Mart Supercenter?)

Now aren’t these statements more practical than a set of platititudes?

For a strategy to be useful, it must provide direction. Platitudes do not provide direction. The way to tell if you have a platitude is to play it backwards. If it doesn’t make sense in reverse, then it is a platitude. Good strategies show the trade-offs one is willing to make in order to win in a particular direction. When you play that backwards, what you see are other ways to make a different set of trade-offs.

Not everyone wants to make the same set of trade-offs to solve a problem. Therefore, when you are choosing the trade-offs for your firm, you are not only making choices about what you are providing, but also who you are providing them to. When making trade-offs, you are going to make some people unhappy with what you are doing. But as long as there are enough people who want to make the same trade-offs as you do, that’s okay.

Monday, May 14, 2007

Psst...It's a Secret

Once upon a time, there was a businessman who made a lot of money. He was afraid that one of his nearby competitors would steal his money, so he buried the money in a hole on his business property and did not tell anyone where it was hidden.

The wealthy man thought that he was very clever. “Those competitors will never get the better of me now,” he said. “If I ever run into a little bit of trouble, I can just dip into my underground treasure. There’s enough hidden treasure to keep this company strong for generations. My children will never have to worry.”

Unfortunately, shortly after burying the treasure, the wealthy man died in an automobile accident. His children were not yet wise enough to run the business without him. When times of trouble came, they did not have any extra money to use because they did not know about the buried treasure or where it might be hidden.

As a result, the business eventually fell into bankruptcy. The children sold the business, at a huge loss, to one of the neighboring competitors, a person that the wealthy father hated, and one of the people he thought might steal his money (which was why he buried it in the first place).

After this competitor took over the business, he decided to renovate the property. He brought in some earthmoving equipment to build a new foundation. While digging, the equipment found the buried treasure. So, in the end nothing turned out like the wealthy man had planned. His business did not last for generations, and his competitor “stole” his money anyway.

Sometimes, if we keep something too much of a secret, it can lead to ruin. Money is only useful for its ability to purchase something of value. If the money is never ever used, it has no real usefulness or value. The children of the wealthy man owned a great deal of money. Technically, they were wealthy people. However, because they were unaware of their wealth and unaware of how to tap into that wealth, it did them no good. Instead of living in wealth, they had a lifestyle of poverty.

Had their father been less secretive about his money, the children could have tapped into that money and put it to good use in saving the business. Instead, because they didn’t know what they had, they gave away the wealth to the competition.

Sometimes, businesses treat their strategy similar to how that wealthy businessman treated his treasure. They hide their strategy so the competition cannot get hold of it. Because they are afraid of it getting in the wrong hands, they don’t let it get into anyone’s hands. They don’t ever talk about it around employees or customers. It is protected as a highly valuable secret, buried away somewhere in a company vault.

The problem is that if nobody is aware of the strategy or how to tap into the value behind the strategy, it is as useful to the company as that buried treasure was to those children. For a strategy to have any value, it has to be used out in the marketplace. Just as those children couldn’t spend money they were unaware of, employees cannot implement and reap the benefits of a strategy they are unaware of. Customers cannot prefer your business if you hide from them the reasons why they should prefer it.

In the end, if you bury your strategy, you have taken the power of it away from your employees and the benefit of it away from your customers. As a result, that competition you were trying to keep the information from will end up winning anyway, because the strategy was never effectively used against them.

The principle here is that strategies are most useful when they are widely discussed. Keeping them a secret robs them of their value. There are four key points related to this principle:

1) It’s Okay For Your Competition To Know Your Strategy
2) Employees And Customers Need To Hear The Strategy Often
3) Although Strategies Should Be Open To Public, Tactics Should Be Kept Private
4) If Your Strategy Is Nothing But Platitudes, Then Forget Point 1 Through 3 And Go Build A Real Strategy.

We will talk about these points in the context of the “Fast Fashion” strategy used by a handful of apparel retailers like H&M, Zara, and Forever 21.

1) It’s Okay For Your Competition To Know Your Strategy
A CEO once said to me, “You know how every once in awhile we somehow get access to ‘secret’ documents from other companies? Well, you can pretty much assume that those other companies are also getting some ‘secret’ documents of ours.”

The point is that in today’s digital age, it is fairly easy for some items to get into the wrong hands. It is almost impossible to hide everything. Therefore, unless you completely hide your strategy from everyone, including employees and customers, some of it will leak out, either through vendors or disgruntled customers, or former employees who start working for the competition. Therefore secrecy really is not an option, because it cannot be held secret.

To paraphrase a former boss of mine, “We should just mail our strategy to all of our competitors so that we can get rid of the suspense and get on with the business of executing the strategy.” The reason he could be that nonchalant about the strategy is that he knew that if your strategy is strong enough, it doesn’t matter if the competition knows what it is.

A strong strategy takes advantage of the unique position and strengths of your organization and builds an integrated approach so strong that even if the competition knew what your strategy was, they couldn’t copy it because it would take them years to figure out all of the intricacies behind it. Besides, because their starting position and their strengths are different than yours, they are not starting form a place which even makes the strategy most appropriate (or perhaps even achievable for them). By the time they could catch up to where you are today, you will already firmly own the position in the mind of the customer and have improved upon the model.

In fact, if a competitor knows your strategy and fears your power, they might respond by choosing an alternative strategy which is compatible and complementary to your strategy in order to avoid direct confrontation. That is a win-win for both companies.

As I mentioned in a prior blog, former Green Bay Packer Coach Vince Lombardi used to say that a team should execute its strategy so well, that even if the opposing team knows in advance every one of your plays, they could not stop it (see "Keep an Eye on the Ball").

In the case of the Fast Fashion strategy, the apparel retailers which use this strategy are successful because they have reinvented the supply in a new way, so that they have a constant supply of new, spot on fashionable goods comparable to the big designer labels at inexpensive prices. Rather than having about 5 new seasons a year, these retailers have 10 or more new seasons a year. Customers love it because there is always something new, current and exciting in the store and the prices are a great value. The retailers love it because customers come in more frequently to see the newness and they are more likely to pay full price, because the customers know the goods won’t be around very long before being replaced on the racks with something else.

It is okay that other retailers know this strategy, because just knowing the strategy does not benefit the competition. They do not know the secrets behind how to reinvent the entire supply chain to make it work. Even if they did, it would take them years to put it into place. And it would be so disruptive in the interim that their business would suffer short term. In addition, it might not be compatible with their other strategic goals to match this strategy. For example, if the competition is known for carrying the authentic designer labels, adapting this strategy could cause those labels to no longer sell to them, which might destroy decades of image building.

2) Employees and Customers Need to Hear this Strategy Often
For the Fast Fashion strategy to work, everyone in the company needs to be working in the same direction. There is no room for time lost due to misdirected activity. This is not a strategy that works in a vacuum. Everyone in the organization needs to know the strategic priorities around supply chain speed in order to pull it off. If the strategy is totally hidden, to protect it from the competition, how can the employees be rallied together around the principles and priorities of the strategy?

The same is true for the customers. If they are unaware that you are rapidly moving the inventory in and out, they will not frequent you more often. They will wait for a clearance sale and be disappointed when none of the goods they wanted made it to clearance. This will disrupt the sales side of the equation, causing the operational side to no longer be successful. The supply side reinvention only works when customers change to fast fashion buying patterns. The customers need to know the strategy in order to appropriately change their behavior to make the entire integrated strategy work.

3) Although Strategies Should Be Open To Public, Tactics Should Be Kept Private
It’s one thing for people to know that you have a Fast Fashion strategy. It is quite another thing for people to know the tactics behind how you reinvent the supply chain to not only be faster, but also less expensive. The Fast Fashion retailers all carefully guard their trade secrets around these tactics.

Even though tactics tend to appear as lesser and more mundane when compared to the broad strategy, in reality these little tactics are the crown jewels which need protection, not the strategy. As the old saying goes, the devil is in the details. Protect your tactical details and you protect your strategy from being mimicked. Coke spends a fortune telling everyone why they should love their product, but they never give away the tactics behind the secret recipe and how it is made.

4) If Your Strategy Is Nothing But Platitudes, Then Forget Point 1 Through 3 And Go Build A Real Strategy
If your strategy is a variation on some useless platitudes like “We strive to be leaders” or “We want to make a lot of money” or “We want to be a great company” then it really doesn’t matter who knows it. It doesn’t tell employees what to do or how to prioritize when making decisions. It doesn’t tell customers why they should prefer you. And it is irrelevant to competition. Heck, it is irrelevant in general. Get rid of it and form a real strategy (this topic requires it own blog).

It’s okay to let everyone know your strategy. In fact, it is impossible to successfully implement a strategy if employees and customers do not know what it is. And if the strategy is a good one, it really won’t matter very much if the competition knows it as well. Just make sure to hide the tactics.

I’ve seen places where companies not only keep employees in the dark about their strategy, but about almost everything. The employee is not the enemy. Remember, the only thing that grows well in the dark are mushrooms.

Thursday, May 10, 2007

It’s Better to Consistent Than To Be Accurate

Awhile back I was working on a project with one of the world’s largest investment banking firms. My task was to create a model to predict the detailed monthly financials of a retail chain going out about 5 years into the future.

My team created a very complex model which taxed the extremes of the capability of an excel spreadsheet. This model was so complex, and involved the interplay between so many different inputs, that the output in any given month fluctuated around a bit.

These little fluctuations bothered the people at the investment bank. They wanted nice, smooth progressions in the numbers over time. Therefore, they scrapped the huge, complex (but fairly accurate) model and built a simplistic little ditty based on extrapolating a couple of metrics. It didn’t exactly tie to all of our detailed assumptions, but all the numbers moved in smooth progressions over time and it roughly matched the macro trends of the complex model.

What these investment bankers told us was that it was better to be consistent than to be accurate. So the simple little model won out over the complex one.

Businesses are made up of hundreds of thousands of little tasks which come together to create the financial outcomes. In addition, there are probably just as many activities in the external environment which also impact one’s financials. Depending on how all of these activities come together, one will get different results.

Trying to model all of these events and accurately guess how they will play out in the future is an extremely difficult task. It is easy to get lost in the minutiae and lose site of the big picture.

The task of strategy is not to accurately predict all of the events of the future in great detail. The task of strategy is to provide enough insight into the future so that whatever decisions you have to make “today” will have enough futuristic context so that you can properly choose a path that will improve your condition over time. Additional details do not always cause additional insight. Sometimes, they just cloud the issue and make it more difficult to see the big picture (for more on this topic, see the blog “Too Many Clocks”).

Therefore, instead of using up valuable time in building extremely complex (but potentially more accurate) models, that time could be better spent in understanding the strategic implications of the big picture (which can be derived with a simpler model) and developing the right strategic alternatives.

Strategists are in the business of selling—selling visions, selling ideas and selling alternatives. For example, if you cannot sell a vision of the future, then you cannot get consensus on what to do to improve yourself in the future. Facts are a key element in the selling process, but it is not the only element. Beyond a certain point, additional facts do not increase your persuasive abilities. Other issues also come into play. That is why it can be more important to be consistent than to be accurate. In particular, there are three principles which cause this statement to be true.

1) The Principle of Focus
2) The Principle of Credibility
3) The Principle of Large Numbers

These are discussed in more detail below.

1) The Principle of Focus
It is difficult enough trying to reach strategic decisions when people are focused on the right issues. It is virtually impossible if people are focused on the wrong thing. In selling a vision of the future, what you want is to have people focused on the key assumptions which would cause you to reach a different conclusion, depending on how you think the assumption would turn out.

For example, if you were trying to create a strategy in the health care industry, you might come to a different conclusion depending upon your assumptions around how active the government will be in managing health care in the future. Therefore, discussions around expectations of government involvement in health care management would be very important in developing your strategy.

If you produce data which looked like the data that came from the complex model I referred to earlier, your added accuracy would cause your numbers to have little wiggles in them over time. Your audience could get fixated on the wiggles and start asking questions about all the nuances in you model which caused the wiggles. Then your conversation would be side-tracked into all sorts of minutiae. The big issues, like how much the government will get involved in health care, could get squeezed out of the discussion.

Models are only representations of assumptions. Their goal is to help roughly quantify the direction and magnitude of the impact of an assumption on your business model. That way, you can see the impact of the assumption on your business and then make decisions which optimize under that assumption’s scenario. If your model is so complex that it clouds the impact of the assumptions, then the model is no longer useful in helping you make decisions. Rather than focusing your audience on the key assumptions, it gets them focused on “wiggles.”

In general, most key assumptions revolve around how you think an issue will trend—for example, will it get stronger, weaker, or stay the same over time. Since we tend to think of these assumptions in terms of smooth trends, then the model is more effective in helping us understand these assumptions if it also reflects consistently smooth trends. Again, the goal is not accuracy, but usefulness in making decisions. Consistently smooth trends help keep us focused on the assumptions and their general impact. That is typically enough information to make the right decision for today.

2) The Principle of Credibility
One’s ability to be effective at selling is directly related to one’s level of credibility. If your audience believes you have credibility, then you can be more effective in selling your visions, ideas and alternatives. Conversely, if you have no credibility, it doesn’t matter what you say or do, because nobody will take you seriously.

We are conditioned to believe that life tends to move rather consistently through time. If we think of our assumptions in consistent terms (e.g., things getting gradually better or gradually worse over time), we would also expect their impact to be consistent over time on the model. If your model does not have this type of consistency, it makes people question the accuracy of the model. Complex models with wiggles in them are difficult for people to understand. If the model is so complex that they cannot assess its accuracy themselves, they are less at ease and have to trust even more in your credibility. But if the wiggles cause them to think that there must be something wrong with the model, because “it doesn’t look right,” then you have lost your credibility.

It is better for your credibility to be a little less accurate in your modeling and create models with smooth consistency over time, so that the model appears more “believable” to your audience. As long as the simpler model does not distort the facts enough to come to the wrong conclusion, the simpler model will be a more effective selling tool.

3) The Principle of Large Numbers
The law of large numbers says that it is often easier to forecast an aggregate outcome of many factors than to forecast the all of the individual outcomes of every factor. This is true because there is often more variability in the outcomes of the individual components than in the outcome of total integrated unit. When you aggregate many parts together, the variabilities of the individual parts tend to offset one another. Because the offset, they reduce the variability of the whole.

For example, if you were a retailer trying to forecast your gross margin, it may be easier to forecast the aggregate gross margin for the entire company than to forecast the gross margin on every single item you might sell and then add all of the items up. This is because the variability on the gross margin for each individual item sold is much higher than the variability over time in the aggregate for the entire company.

Therefore, building a simple model that creates smooth consistent trends on a few key aggregate outcomes might actually end up being more accurate than a model which tries to forecast all of the individual components. Hence, by concentrating on consistency over accuracy, you might end up with better consistency AND better accuracy.

Effective strategy building requires effective salesmanship. Better salesmanship (and hence better strategy) usually comes from simple models that are easy to comprehend and follow smooth trends. That is why it is more important to be consistent than to be accurate.

One of the problems we can often run into is trying to make too many decisions too soon. Frequently, some of the more tactical issues are better handled when delayed until closer to the time when the tactic must be implemented. By keeping strategic models relatively simple, it keeps discussions on the strategic level (where more lead time is needed) rather than getting into the tactics too soon.