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.

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