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.

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