Friday, June 29, 2007

Bumpy Roads are Better

Yesterday, I spent most of the day in a car driving to Chicago for my daughter’s wedding. Fortunately, the roads had been recently repaved, so the ride was nice and smooth. However, I started thinking about what would happen if the road had been really bumpy.

Let’s assume for a moment that we were driving a truck full of items and we had to take these items a long distance on a very bumpy road. Before leaving on the journey, we had loaded the truck in a certain way, with boxes of cereal on the bottom and boxes of basketballs on the top. Once we get on the bumpy road, we can feel the truck bouncing up and down and shaking the entire trip.

At the end of that long and bumpy journey, we open up the back of the truck—and to our horror—we see a jumbled up mess. Some of the boxes of basketballs have shifted to the bottom and some of the boxes of cereal had bounced to the top.

Then, we say to ourselves, “If only we had been able to drive on a smooth road. Then nothing would have changed—everything in the back of the truck would be exactly where we put it at the beginning of the journey.”

Often times, companies can hold an opinion similar to that truck driver. We long for a smooth ride for our journey into the future. We view stability in a marketplace as a good thing. Stability tends to be more predictable. It is easier to do strategic planning in a stable environment. We feel like we have greater control of what is going on.

In reality, however, a smooth and stable ride can be a business person’s worst enemy. Usually, the key objective of strategic planning is to find a way to improve one’s position in the marketplace. This typically requires finding ways to gain market share.

It is extremely difficult to change one’s position and gain share in a very stable environment. To quote our truck driver, on a smooth road everything is in the same place at the end of the journey as it was when we started. Nothing moves. In business, this implies that in a stable environment, it is very difficult to attain a better position, because everyone in the marketplace tends to stay in the same position—nobody moves.

Instead, it is the bumpy and unstable ride which provides the greater opportunities to shift one’s position. In our story, the bumpy ride allowed boxes of basketballs, which had been on the top of the heap, to fall to the bottom while some boxes of cereal were able to make their way to the top. The same is true in business. Instability and change in the marketplace make it easier to shift one’s position from the bottom of the heap to the top.

As business people, it may be in our best interest to steer our business to the bumpy roads

The principle here is that changing environments can work to our favor, it we manage it well. Unstable environments have many advantages.

First, in unstable environments, customers are more willing to reconsider their purchasing behavior. We all tend to be creatures of habit. If nothing has changed in the marketplace, then there is little reason to even consider changing one’s habits. People will continue behaving as in the past (without even thinking about it). We just sort of go into autopilot and don’t alter our behavioral course.

However, if there is a lot of change going on, consumers can get jarred out of their habits. In turbulent air, we turn off the autopilot and put our hands back on the steering wheel. We pay more attention to what is going on and may alter our behavioral choices.

A simple example can be seen in the housing market. With the slowdown in people changing their residence, there is less reason to be concerned about home-related purchases. With this type of this stability in living arrangements, consumers just sort of drift through life without paying much attention to their home environment. Instead, other, more pressing issues of the day fill our mind. As a result, sales at retailers selling things related to the home, like Home Depot and Lowes, suffer.

However, when people have a major change in their lifestyle by moving into a new home, they take the time to reassess what they own and what they need. New needs arise, and sales at places like Home Depot go up. The change in residence increased one’s awareness of home needs and increased purchasing in that area.

Grocery shopping can be very habitual. People tend to shop the same store at the same time each week. These habits will rarely change from week to week, especially if there is stability in the marketplace. It is only when our environment changes that we get jarred out of that habitual pattern.

Perhaps a Wal-Mart supercenter opens up in the neighborhood, offering a new alternative to the conventional supermarket. Perhaps we get a huge promotion which changes our financial position. Maybe we are entertaining the boss for dinner at our house tonight. Any of these changes could get us out of our weekly rut and cause us to change where we shop or what we buy for groceries.

Therefore, change and instability can be our friend, particularly if we do not like our current position. Change causes people to stop their sleepwalking through life and pay attention—to rethink their habits. This is when people will be most receptive to paying attention to your marketing message. This is when they are most likely to switch their loyalty from someone else to you.

A second benefit from change is that it provides an opportunity to redefine the marketplace in your favor. In the grocery world, choices were often ruled by price. If you had the lowest prices, you tended to win. However, we are now entering a changing environment. There are scares of tainted food coming out of China (if it can kill our prized pets, what might it eventually do to us?). People are starting to worry more about the impact companies have on the environment. As baby boomers age, they are worrying more about health concerns. All of these changes can provide an opportunity to redefine how people think about food. Rather than stressing price, one can change the value priority to include more concern over health and safety.

Firms like Whole Foods are finding many converts who are changing their values regarding food and are willing to pay a little bit more to people who are selling food more in tune with these new values.

The benefit here is that if you are not the best at providing what consumers are looking for today, change may provide the opportunity to convince people to reconsider their values so that they prize more of what you are the best at providing.

Therefore, we should embrace change in the marketplace. It can be our friend in terms of increasing demand, increasing receptivity to our marketing, increasing shifting of share to our brand, and getting people to change their value priorities to more closely match our strengths.

If the market is stable, it can be in our best interest to take the initiative to create the instability on our own. Maybe we need to do something shocking, to wake people out of their autopilot and rethink their habits.

There’s a reason why the word “new” is so powerful. It makes what we currently do seem “old.” If we say we are “new”, it is more likely to break a habit than if we say we are “just like before.” And if we aren’t new, then maybe we can help convince people that their situation has changed, which should cause them to reassess their behavior—hopefully in your direction.

Although stability may appear to be a nice thing, it tends to freeze a marketplace and inhibit change. Strategy is about changing one’s situation for the better. That is easier when a market is in turmoil. Therefore, if there is change in the marketplace, use it to your advantage. Anticipate which direction the change will take the marketplace and then position yourself to be best suited for the change. If change is not occurring, try to create change on your own.

Bumpy rides can often lead to better end points, where your boxes shift to the top of the heap.

If you are a market leader, you may not like change, because you may have nowhere to go but down if things change. However, given enough time, change will occur, whether you like it or not. So you may as well prepare for it.

Wednesday, June 27, 2007

Every Intersection is Not a Crossroad

One time, a colleague and I were talking about how some companies do their strategic planning. Once a year, they bring together a large gathering of their executives for an offsite planning meeting. At the meeting, a big announcement is made that the company is “at a crossroad” in their strategy and that major changes are needed to get back on track or to choose a new direction.

It got me thinking. In the average city there may be 12 blocks to a mile. If you are able to maintain an average speed of 30 miles per hour, you will drive past an intersection about every 10 seconds.

You would think a driver was rather crazy if he stopped his car every ten seconds, got out of the car, and started telling everyone excitedly that he was at a major crossroad. Then, if he held a long business meeting to decide which direction to go every time he came to an intersection, you would really think he was mad. At that pace, it would take him all day to get across town.

So I turned to my friend and said, “When you’re driving across town, you will go past hundreds of intersections. You can’t call every one of them a major crossroads.”

Automobiles are like companies, driving towards their future. Intersections along the road are opportunities—opportunities for a company to change its strategic direction. Just because every intersection provides an opportunity to turn does not mean that you need to turn at every intersection. In most cases, a driver ignores the majority of the intersections and does not even consider them while driving, because he knows that they will not lead to his destination.

In the same way, every opportunity presented to a company does not require a rethinking of strategy. Most opportunities can be ignored. Instead of leading to someplace special, they will just take you on a detour that goes nowhere, while at the same time keeping you from reaching your intended strategic destination. These “opportunities” turn out to only be opportunities to get side-tracked, waste resources, and fail in achieving a lasting strategic success.

Often times, the most important aspect of a strategy is not what it tells you to do, but in defining the greater list of things you are not supposed to do. Knowing what you can ignore can free you to better focus on the few essentials needed for strategic success. The likelihood of success becomes much easier, because you can focus on only those things that help you reach your strategic destination. Using the driving analogy, let us say that your strategic destination is Paris. As you are driving along, you can ignore all of the roads that do not lead to Paris and only focus on the smaller subset of roads that moves in a direction towards Paris. As a result, you will get to Paris sooner and enjoy it longer.

Of course, just because you can ignore many of the intersections does not mean that you can ignore every intersection. If you stay on any single road long enough, eventually it will lead to a dead end. The same is true with strategy. It never runs exactly in a straight line. You may need to drive around a roadblock set up by your competition. You may need to make a small side trip to acquire new competencies for the journey ahead.

Therefore, ether extreme will get you in trouble. If you turn at every possible intersection, you will end up driving in circles and end up getting nowhere. At the same time, if you never turn, you will end up running out of road before you reach your destination.

Effective strategic planning has three elements:
1. A vision of an attainable position where you can win/prosper in the future.
2. A path showing the steps necessary to get from where you are today to the vision.
3. A feedback loop to ensure that you are going in the right direction once you start the journey down the path.

The Vision
Creating a vision that properly motivates your team to act properly has a lot to do with getting the right perspective on timing. If you have chosen a vision that is too far into the future, the people in your business may not know which path to take to get there, because they cannot find the link between where they are today and where the future vision is. For example, if you told the driver in our analogy that the ultimate destination is to go to the moon, he may have no idea how to get his automobile closer to the moon. Worse yet, he may think your goal is too outrageous and is impossible to achieve, so he stops listening to you and drives wherever he wants. Now, not only are you no closer to the moon, you no longer have a team.

Goals that your people cannot relate to because they are too far away or too different from what they understand fail to motivate. Instead, they may have the opposite effect of paralyzing the troops or leading them into chaos or defection.

Now it may be true that for your business, it is necessary to build a future that eventually takes you as far away from where you are today as the moon is distant from the earth. But, to make the vision real for the team that you want to take there, you may need to break it down into smaller chunks. For example, instead of just saying you are going to the moon, tell the team that the first goal is to get to Florida, where the Cape Canaveral space launching pad is located. Now this is something they can find on a roadmap and draw a path and a plan to get there.

Of course, there is a different problem if you break down the vision into too small of a block of time. If the timing around your vision is too short, you will not be able to build a suitable path. For example, let’s say that instead of telling people we are going to the moon, all you tell them is that the vision is to back the car out of the garage. This is something the team understands and can easily accomplish, so they rush out to the car and back it out of the garage. Then they get out of the car and come back to say, “We’ve accomplished our vision! We’ve reached our goal!” This is followed by a celebration.

Well, now you need to give them a new vision, so you tell them to get back into the automobile and back down the driveway to get to the street. So the team goes back to the car and gets to the end of the street and start to celebrate again. This is starting to sound like our earlier example, where the man sets his goal only a block away at a time, requiring a need to stop every ten seconds to set a new vision. At this pace, you will never get to the moon.

Worse yet, because the team has no idea of the larger vision, they will only prepare for the shorter vision. If all you think you are doing is backing a car out of the garage, you may just hop into the car quickly and do it, without bothering to even put on a coat or shoes. You certainly wouldn’t be thinking about packing a suitcase with spare clothing, bringing along snacks to eat, or checking to make sure the engine is in fine working order. However, if you knew that you were eventually driving 1000 miles to get to the space launching pad in Florida, you might prepare differently. Without proper preparation, you may never reach your goal.

Therefore, the ideal vision should describe a destination that is far enough away from today that people will adequately prepare for the journey (further away than just getting to the end of the driveway), but not so far away that they have no idea how to prepare for the journey (not as far as going to the moon).

The Migration Path
Once the vision is described, the task moves to designing the migration path to get there. Designing the migration path would be like getting a map and determining the best roads to take to get to Cape Canaveral in Florida. Just as the perfect vision requires getting the right balance in terms of timing (not too short, not too long), the perfect migration path needs to get the right balance in terms of detail (not too much, not too little).

The team should not spend years on trying to design the absolute perfect path to get from here to Cape Canaveral. That level of detail is impractical. After all, there may be detours along the way. Changes in weather may affect which route is the best. Unexpected road construction may occur. There may be unexpected problems with the automobile. All of these occurrences will create a need to alter your route, no matter how much time you spend perfecting it.

In the business world, you cannot entirely control your destiny. Therefore, acting as if you can and spending too much time designing perfection into your plan is a waste of time.
On the other hand, if you do not prepare at all, your vision will never be reached. You will be reacting to your environment, rather than helping to direct how the future evolves. If you do not try to help direct how the future evolves, your competition will, and I can assure you that they will try to form a future that advantages them over you.

Hence, you need a balance in your migration path—enough detail to show what big activities need to be accomplished to help control your destiny and reach your vision, but not so much detail that there is no room to flex with the inevitable change.

Feedback Loop
As you start implementing your plan, you need to monitor your progress through a feedback mechanism, in order to:

• Ensure that you are not unintentionally deviating from the vision and migration path; and

• Determine whether changes in the environment necessitate modifications to the vision and/or migration path.

The beauty of driving past a new intersection every ten seconds is not that you have to stop at every intersection. The beauty is that if you find out that you are off course a little bit, you are only ten seconds away from an opportunity to readjust your direction to get back on track. Each intersection should not be seen as a major crossroad requiring a new strategic initiative, but as an opportunity to adjust to stay on plan.

Strategic planning is about determining a destination for your business (a vision) and a means to get there (a migration path). If you find yourself frequently making major changes to your vision or migration path, then you have probably:

• Set your destination too close to where you are today (and thereby never make any meaningful forward progress); or

• Set your destination so far away or made your migration path so vague that the team members do not understand what to do to get there (and thereby get nowhere); or

• Not monitored your progress through a feedback loop often enough to see when current actions need to be adjusted to get back on track (before it is too late).

It’s okay to adjust the focus of the company every year based on where it is along the migration path, but if your business reinvents its overall strategic plan and migration path every year, then you really do not have a plan at all. You just have a series of unrelated tactics.

We might laugh at a person driving across town one block at a time, stopping every ten seconds at each intersection to replot his course. However, this is not that different from a company that only plans out one quarter at a time, stopping every three months to plot a new course.

In general, if your long-term destination is correct, most of the quarters along the way will be successful. However, if you only look out one quarter at a time, the cumulative direction of all of your quarters strung together rarely moves in a positive direction, and your business will “run out of gas” before reaching a more desirable future.

Monday, June 25, 2007

Gems on the Cutting Room Floor

Back during World War II, there was a shortage of rubber. Scientists in the United States were trying to quickly come up with a viable synthetic substitute. James Wright was one such scientist, working at one of GE’s laboratories under a government contract.

While working on the project, he accidentally dropped some boric acid into silicone oil. The combination produced a goo which had many rubber-like properties. When GE tried to get interest in this compound around the world, there were no takers, not even the US War Production Board. It was seen as no better than the synthetic rubbers already in use.

Well, at least the scientists had fun with it. They would roll it in a ball and bounce it, or stretch it flat and use it to lift a copy of a newspaper article. In 1949, Peter Hodgson, an unemployed ad man, was at a party where the scientists were playing with their invention. Hodgson saw potential in this failed experiment, so he borrowed $147 and bought the production rights from GE. He started producing the product under the name of “Silly Putty.” When he died in 1976, the success of Silly Putty caused Hodgson’s estate to be worth $140 million.

In the process of creating a strategy, one can go through a lot of ideas. Most of the ideas will be awful. A handful will be very good. Many ideas may be interesting, but really “off strategy.” In other words, they may have some business potential, but they do not fit the strategic direction of the company.

In the story above, the strategy was to help the war effort by designing a high quality synthetic rubber. Silly Putty, tried, but failed in that strategic effort. Since it was useless towards fulfilling the synthetic rubber strategy and well outside the core competencies of GE to be in the toy business, the silly putty idea was essentially thrown away.

Peter Hodgson was able to get the rights to the product from GE for practically nothing. He was basically allowed to sweep up a gem off the waste that GE had tossed onto the floor. Just because an idea does not fit one’s strategy does not mean that one should just toss it away. It may be a wonderful fit in someone else’s strategy.

The principle here is that good ideas have value, even if they have no real value to you with regards to your current strategy. If the idea is really, really fantastic, it may be worth your while to change your strategy. It can be a wiser move to abandon what you originally wanted to do and switch to building a strategy around that gem you threw away onto the floor. There is no harm in abandoning a path if a far better path comes along.

A second approach would be to diversify into continuing your current strategy as well as the new strategy. Although this can sometimes make sense, there is a risk that by trying to do two entirely different things, one can lose focus and end up doing neither well.

A third approach would be to “sell” the idea to someone else. This can often be a wise move, because the idea may be more valuable to someone else’s strategy than your own. There are a number of ways to sell an idea.

One can license the idea and get royalties. Once can invest in setting up someone else in the business and get a share of the profits. One can sell the idea for shares in the other company. Or one can just sell all rights for a fee. In general, I would think that the best way to sell the idea is one where you get a higher share of any upside potential.

After all, it was most likely going to end up on your cutting room floor with no value. Therefore, little is lost if you do not get much for the idea up-front. However, if you negotiate to get a piece of the action, either through royalties or shares in the company, then you can really rake in some easy profits.

This approach may also make more sense to a potential buyer, who may not have a lot of up-front money to pay you and who, at the time, has little to lose by giving you a piece of future action which may never occur.

One of the worst things to do is just hand it over for virtually nothing. GE got practically nothing out of the Silly Putty deal, even though their invention was worth hundreds of millions of dollars to Hodgson.

Xerox’s famous Palo Alto research facility came up with a whole slew of great inventions which others made millions off of while Xerox got practically nothing. If Xerox had gotten out of its core business and gotten into the full-time business of selling their great ideas at a fair price, they probably would have been better off.

Getting into the Venture Capital business full-time may not be right for you, but getting profit out of a great idea which does not fit your core strategy should always be considered. Perhaps you can set up some of your employees who discovered the idea into a separate company (for a share of the profits). Perhaps you can spend a little time figuring out who the idea might be most useful to and then spend a little time pitching it to them.

Sometimes you can have your cake and eat it too. Let’s suppose for a minute that Silly Putty had also been a great synthetic rubber. Just because that would fit the strategy and make lots of money for GE, it does not stop them from also selling the idea as a toy to someone else. Why not use it internally for your purposes and still sell it to others for different purposes. You may have many great areas in your business that could be redeployed elsewhere.

HEB supermarkets in Texas was so good at deploying technology in their stores that they set up a separate profit center to consult with other retailers in how to use technology. They figured that so many people were asking to tour their operations, they may as well charge for the privilege.

Ideas can have great value, even if they are not useful in helping your strategy. Their worth may be more valuable in the hands of others. It may be worthwhile to spend a little time to see if you can get these ideas into a place where they can be more valuable (and share in that value, especially for a piece of the upside). Even ideas that are useful to you may also be useful to others, so that you can get your return on that idea twice. It sure beats just throwing the idea away.

Of course, this type of discussion implies that your company spends lots of time coming up with ideas. Unfortunately, I know a lot of places that see strategy very narrowly in terms of “more, cheaper.” In other words strategy doesn’t get much further than setting targets to get more (sales, earnings, production, etc.) while spending less (cutting budgets). If that’s your version of strategy, then this blog has little application to you.

Saturday, June 23, 2007

Early Bird

Back in the late 1990s a phenomenon was sweeping through US protestant churches. Some churches were changing the style of worship music. Instead of singing traditional hymns backed by a large organ, they went to singing contemporary praise songs backed by a “praise band,” with electric guitars and drums. Choirs were replaced with song leaders and soloists.

This change in music seemed to strike a chord (pun intended) with a good number of people. The early churches which adopted this change in music started growing in membership very quickly. Many became “mega-churches”, with congregations of several thousand.

People in religious circles started to take notice. “Experts” in church growth started writing about it and, when consulting with churches that wanted to grow, advised them that they needed to ditch the hymns and go with praise songs.

At first, the advice seemed to work. Those churches that were early adopters of this new worship format saw similar types of rapid growth. However, after awhile, the later adopting churches which changed their format more recently were not seeing a similar type of growth. Instead, they were seeing the opposite—more people were leaving than coming.

It’s the same strategy as before. It’s still working for the early adopter churches. Why isn’t it working for the later adopters?

The early adopting churches of contemporary worship were providing something new and different to worshippers. Since only a small minority of churches were doing it at first, the people who wanted to worship this way had to flock to the few places that were offering it. This caused the membership in these early adopter churches to swell in size.

The later adopters were facing a different problem. First of all, many of the people at these churches were there because they did not desire a contemporary worship service. If they had really wanted contemporary worship that badly, they would have switched to worshipping at one of the early adopter churches.

Second, by switching over to contemporary worship late in the game, these churches were not really offering anything new that wasn’t already available. Those that preferred contemporary worship would already be worshipping at one of the early adopter churches of contemporary worship. There would be no reason for them to switch to the late adopter church.

Finally, the early adopter churches had attracted some of the best musicians of contemporary worship in the neighborhood. They had been at it for awhile and were pretty good at it. The later adopters were still adjusting to the change and were in most cases not as polished as what the early adopters had become by this time. So the later adopters would appear at first to not be as good at contemporary worship as those more established in the format.

Therefore, many of the ones who were in the later adopting churches who did not want the contemporary worship left those churches and few who preferred contemporary worship came to take their place.

Businesses can fall into the same pattern. Early adopters get a competitive advantage by getting into a new strategic trend while it is still relatively unique. Businesses who enter into the same strategy at a later date do not achieve anywhere near the same benefit as the early adaptors, even though it is the same strategy which worked for the early adaptors.

As they say, the early bird gets the worm.

The principle here is the principle of early adoption. In general, early adopters of a strategy get more benefits out of the strategy than later adopters. There are three reasons for this:

1. Negotiating Benefits
2. Differentiating Benefits
3. Perpetuating Benefits

This picture helps illustrate these benefits. These are explained below.

1) Negotiating Benefits
In the business world, when you have something new and different to offer, it is often difficult to get that first big customer. Nobody wants to be the first one to put their reputation on the line in case the new idea doesn’t pan out. However, once you land that first big customer and you can prove success, others will quickly fall in line around your product.

Since getting that first big account is so important, one is often willing to bend over backwards to get that business. You may offer that first customer a lot more than what the following customers get. This could include things like:

a) A lower price
b) More on hands help from the seller
c) More promotional dollars
d) Exclusivity for a period of time
e) Perhaps even a piece of equity in the company

The early adopter is in a much more powerful position when negotiating the deal. They can ask for and typically get more than if they wait, because the early adopter has to power to make or break a new concept or product.

I remember back when Sears introduced the Discover card. At first, no other retailer wanted to honor the card. It looked like it was going to be a dismal failure. Eventually, however, the Dayton Hudson company (now Target Corp.) decided to honor the Discover Card at its department stores and discount stores. Once Dayton Hudson signed up, others soon fell in line and started to honor the card. I would imagine that Dayton Hudson got a pretty good deal when they signed up to honor the card. It was most likely a better deal than what the followers got.

Best Buy discovered Netflix long before it was a popular brand. Best Buy approached Netflix with an offer to help make it a success. Of course, Best Buy was in a more powerful position than Netflix. Assistance by Best Buy could be the difference between Netflix succeeding or failing. So Best Buy negotiated a sweet offer and helped to make Netflix the powerful brand it is today. I highly doubt that those who came along later to help sell Netflix got as good a deal as Best Buy.

The point is that if you think a new idea or concept is going to take off, it is better to get in early, because that is when you have the most negotiating power to get a better slice of the new business.

2) Differentiating Benefits
As we saw with the churches, the ones who were early adopters created differentiation in the marketplace. They were offering something new and different. This gave people a reason to switch to the early adopters. By the time the late adopters got around to the change, it was not longer differentiating. It was just like others in the marketplace, providing little reason to switch to them.

You can see that with Best Buy and its Geek Squad. Best Buy was the first major retailer to provide great service on high technology. This gave them a competitive edge for a time…a reason to go to Best Buy over the competition. It was so successful that others eventually felt the need to copy the idea, such as Circuit City with Firedog and Staples with “Easy Tech” service. However, by coming in later, they were not offering anything new or differentiating. They were just playing catch up (and I’ll bet Best Buy picked off the best service people by being first, so that they will have a hard time catching up in quality of the service).

When you are the first to offer something that is truly new and desirable, one can often (for a time) charge a premium price and still grow market share. By the time the late adopters get into the game, it is more competitive. The premium price goes away through price wars. In the end, most everyone ends up with a similar offering, but the early adopter got more profits out of it during the time when it was a differentiating strategy rather than a “me too” strategy. So if you are all going to end up offering the service eventually, it pays to get in when there are still differentiation benefits (for market share and profit margin).

3) Perpetuating Benefits
If you are an early adopter, you get to reap the benefits of early negotiation and early differentiation. These help give you an advantage versus competition, who did not get the additional profitability and market share like the early adopter. These additional benefits can be plowed back into the business to make it even stronger than before (making it ever harder for competitors to catch up).

In addition, when others come along with the next big new thing, they will probably first go to the one who has the reputation for being an early adopter. You get to be first in line to get all those advantages again, which can further strengthen your position in the marketplace.

As a result, early adopters get into a perpetuating virtuous cycle, where they keep increasing their advantage relative to competition.

Eventually all great new things eventually become the norm—the radical becomes tomorrow’s traditional. If you wait until they are the new tradition before jumping in, you miss out on all of the advantages gained by the early adopter. If the transition is going to happen anyway, one may as well get in early.

Getting in early does not mean jumping into every half-baked scheme which comes along. Most new ideas are bad ideas. Be choosy. Just don’t wait until it is already a proven success before jumping in. Take calculated risks.

Wednesday, June 20, 2007


I love to stare at maps. I find them fascinating. If you stare at them long enough, you start seeing some interesting things. For example, we think of Minneapolis/St. Paul as a very cold and northerly location. However, when you look at the same latitude as Minneapolis in Europe, you end up in the south of France, a place we do not usually think of as cold and northerly. Yet, the fact is that Minneapolis is about the same distance from the North Pole at Southern France.

Detroit, Chicago and Boston are also thought of as being relatively cold and northerly. Yet they are about as close to the equator as places like Rome, Italy and Barcelona, Spain in the heart of the Mediterranean Sea. Not exactly the same climate zone, even though the same latitude.

And what about our friend London, England? Well, if you take the same latitude as London and come over to North America, you end up on the north shore of Ontario, Canada in James Bay, about 1,100 miles north of Toronto. Sure, London can get cold, but nothing like James Bay.

So if someone tells you to pack your bags for a vacation, and the only thing they tell you is the latitude of your destination, you really don’t know very much. You have no idea what clothes are appropriate to bring.

There’s a reason why you can have so many different climate zones at the same latitude. Climate is determined by more than one’s distance from the equator. Not only do you have to consider latitude, but you also have to consider altitude. And, more importantly, one has to take into account climate changers like ocean currents. Northern Europe is kept warm due to the Atlantic Meridonal Overturning Current, otherwise known as the Atlantic Conveyor.

The Atlantic Conveyor works to warm Northern Europe in two ways. First, it brings warm water from the Gulf of Mexico to Northern Europe. Second, it promotes “chimneys” in the ocean which push the coldest water straight down to the ocean bottom so that the warmer water stays closer to the surface. These factors are estimated to account for 10 to 15 degrees Fahrenheit of additional warmth for Northern Europe. The difference between 50 degrees Fahrenheit and 75 degrees is certainly enough to change your wardrobe.

In Southern Europe, Mediterranean Sea currents help keep coastal areas warm. Northerly winds off the Mediterranean even help to keep Germany warmer than it would otherwise be.

What makes this so deceptive is that all the warmth-providing activity is taking place below the surface. You cannot really see it with the naked eye. It is happening deep in the oceans and seas, and requires thousands of miles of territory in order to measure the full impact.

The latitude is something that is easy to measure. You can quickly look up any city in an atlas and get its latitude (or even faster on the internet). The impact of complex ocean currents gets a bit more complicated.

This same principle can hold true in the business world. We like to make strategic decisions based on facts. In this day and age, it is easy to get overloaded with a lot of facts. All of these facts can lull us into a sense of confidence about our decision-making. However, if you just look at the surface facts, you can come to some wrong conclusions, just like you can come to the wrong conclusions about climate from just looking at latitudes.

To get a complete picture of a market, one needs to find those undercurrents which are not immediately discernable on the surface, yet have a major impact on customer behavior. A business climate can be as complex as a weather climate. Your chances of bringing the right baggage for the job will require looking for those hidden factors which influence behavior.

The principle here is that just because two groups of customers may share vary similar demographic characteristics, it does not necessarily mean that they will react the same way to your strategy.

Think of DNA, a measurable trait. A human and a chimpanzee have nearly identical DNA, yet I think that if you marketed to chimpanzees the same way as you do to humans, you would not get the same results. The same is true on other measurable traits.

We can see this in a demographic factor like ethnicity. Just because someone is a Hispanic in the United States does not mean that they behave the same way or can be appealed to in the same way. Some of these differences are due to factors thousands of miles away, just like the impact of the Gulf of Mexico on England’s climate. For example, if a Hispanic immigrated to the US from Puerto Rico, they will have different characteristics from a Hispanic originally from Mexico, because the Hispanics bring a bit of their culture of origin with them to the US.

Another major impact is time. A third generation Hispanic in the US is typically not very different from mainstream Americans, whereas a first generation Hispanic acts very differently. One has to dig a little deeper below the surface to segregate Hispanics by generation in the US.

If one looks globally at a factor like household income, one can see vastly different standards of living, even though the amount of money earned is about the same. “Middle Class” behavior often has only a tangential relationship to income, just like temperature is only tangentially related to latitude.

I remember over a decade ago when Marsh Supermarkets, out of Indianapolis, Indiana decided to build a large supermarket in India. The “facts” seemed to show a rising percentage of households in India with incomes large enough to afford the benefits of supermarket shopping. Based on facts like this, they built a store in India. It was an utter disaster.

What Marsh discovered was that the due to a different labor market than in the US, the people in India who could afford to shop at supermarkets could also afford cheap labor to do their grocery shopping for them. These shoppers preferred to patronize the small independent shops, because these shopkeepers were their friends and were more in tune with the culture of these hired hands. Hence, the culture of the hired hands was more important than the affluence of the family who hired them when it came to choosing where to purchase groceries. I guess that even though Indianapolis starts with the word “India,” that does not make you an expert on the nuances of Indian culture.

Recently, the Wall Street Journal wrote an article on the fact that Disney has finally decided to no longer go it alone when entering cultures different from the US. They are forming partnerships with local companies who know the undercurrents of the local culture. In India, Disney formed a partnership with Yash Raj Films, a local family-oriented film company in the Bollywood tradition.

To quote the Wall Street Journal,
“Disney's traditional approach was largely to force-feed its U.S. products from its Burbank, Calif., headquarters. The company ultimately concluded the cookie-cutter approach wouldn't work, and now it is going country by country, with a particular focus on five hot markets: India, China, Russia, Latin America and South Korea. ‘We're building Disney from scratch,’ in countries such as India, said Mr. Iger, citing the company's founder and namesake: Just ‘as Walt did in the U.S. over 50 years ago.’"

Surface statistics, like latitude or demographics, only tell part of the story and can lead to wrong strategic conclusions. Often, underlying currents of culture and history can have a greater impact than the surface statistics. It pays to dig a little deeper under the surface (or find people who are already intimate with these undercurrents).

Just knowing the distance from the equator can be very misleading about climate if you do not differentiate between miles north versus miles south. The Northern Hemisphere has opposite seasons from the Southern Hemisphere. Now that would really throw off your ability to pack the right clothing.

Monday, June 18, 2007

The Same, Yet Better

Sometimes I feel sorry for the American automakers. In their advertising, they always seem to find a need to tell the audience something to the effect that, “We are just like Honda and Toyota, only better.”

Of course, a statement like than brings up a number of questions:

1) The more you keep telling me that Toyota and Honda are the ideal benchmark for comparison, the more you are convincing me that they are the gold standard. Aren’t you then implying that the foreign car is the one I should really be desiring instead of the American car?

2) If you are just like them, how can you be better than them?

3) If Honda and Toyota are the ones you are trying to imitate, how can a copy become better than the original? At best, shouldn’t you only be able to achieve parity? And if you are trying to catch up with them, won’t you always be a step behind?

4) If you are better than them, then why do you have to sell your cars at a discount to a Honda or Toyota?

Apparently, I’m not the only one who has trouble with this logic, since Toyota just keeps getting stronger.

It’s sort of like a child on the playground saying, “I’m just as tall as the tall kids, only taller.” First, if you were really that tall, wouldn’t you be one of the “tall kids”? Second, if you are just like them, then how can you be taller?

The point of most strategies is to find a way to gain market share. For your product or service to gain market share, someone else’s product has to lose market share. As a result, strategies tend to target the place where the most market share lies—with the market leader.

That is why American automobile brands tend to target Toyota and Honda—because that is where the market share is. The problem is not that others have the market share you want. The problem is in how you go after that share.

It is safe to assume that the market leaders got there for a reason. Therefore, many believe that if they can take that reason away from the leaders and attach that same reason to their brand, then they will become the leader. Hence the strategy of “I’m just like the leader, only better.”

The problem, as we have seen, is that it is difficult to win with that type of logic. Saying that “I’m just like the leader, only better” is not very convincing. That type of logic points the consumer to your competitor as the standard for what is good. Instead, it is better to discount the standard set by the leader by setting a different standard for what is good, and claim that for yourself.

The principle here is the principle of comparison. To win market share, one must convince the customer that, when compared to the competition, you are superior in some meaningful way. As we have seen, it is difficult to create a sense of superiority for yourself if you use as your benchmark the factor which made the current leader successful. All you are doing is playing into their strength.

Over the years, I have learned two important facts:



These are explained below.

1) Before you can convince someone that you are superior to the competition, you must first convince them you are different from the competition.
Claiming to be the same, but better is a hard sell, because it is impossible to be viewed as better if you are perceived as merely the same. This is especially true if another brand has already achieved ownership to that attribute in the minds of the customer.

To be better, one needs to be different. There is a specific order here. First you have to prove you are not the same—that you are different. Then, and only then, can you prove that the thing which makes you different is the thing that makes you better. This can be very convincing.

This is how Dawn won the dishwashing liquid war. Before Dawn, the standard upon which one rated a dishwashing liquid was on how clean it made the dishes. Dawn came to market by ignoring this. First, it claimed to have unique superiority in fighting grease. Since nobody else was making that claim, and since Dawn was pretty good at fighting grease, it won that argument. Then, Dawn tried to prove that grease fighting is the most important attribute for choosing a dishwashing liquid. It won enough people with that argument to win the entire dishwashing war.

2) The best way to convince someone you are different is to emphasize a different set of attributes.
It is hard to prove a difference to the competition if you are picking on the competition’s strength. First, there is less room to create a differential, since they are already good at it. Second, the consumers will always give the leader the benefit of the doubt on the attributes which gave them the leadership position.

Therefore, if you want to prove you are different, it is better to pick a new, unclaimed territory. Dawn did that with grease fighting.

Going back to the automobile industry, Chrysler was an also-ran in the truck business. Looking at the leaders (Ford and Chevy), Chrysler saw that they were trying to win with a rational appeal. They were emphasizing rational facts, like how much weight you could put in the truck bed, how much it could tow, how long they last, etc. Rather than try to compete in this rational space, Chrysler went for something entirely different—an emotional appeal.

Chrysler designed its trucks to look sexy in a testosterone sort of way. They were made to look like the big rigs—the semis. They even put an engine in them built by the company that makes semi engines. They made you feel like you were driving something special—that you were a big man on the road like a semi driver. The commercials emphasized the bragging rights to having a manly machine rather than to any rational features. This strategic approach boosted their market share more than anything else they had ever done in the truck space.

In the retail space, I remember when Wal-Mart was just starting to expand out of their southern US base. As they were moving east to the Carolinas, they were going to meet up with the local chain, called Rose’s. Rose’s decided that Wal-Mart was a leader based on certain things, so before Wal-Mart got to the Carolinas, Roses had converted its stores to look as much like a Wal-Mart as possible. They painted their stores with the same color scheme, put up signs that looked like Wal-Mart, displayed merchandise like Wal-Mart, and so on.

Unfortunately, when Wal-Mart came to town, people saw that one thing Rose’s could not copy was how low Wal-Mart’s prices were. Since it imitated everything else, Rose’s was seen as having no distinctive advantage—it was just a higher priced version of Wal-Mart. Rose’s soon disappeared as a company.

By contrast, Shopko tried a distinctively different tactic. While Wal-Mart was winning the battle of low everyday prices, Shopko decided to win the battle of having the best advertising deals—a high/low approach to pricing. It provided a distinct alternative in the marketplace. Shopko is still in existence today, more than 20 years after Wal-Mart entered their territory.

Before you can convince someone you are superior, you must first convince them you are different. Difference is easier to obtain if you emphasize attributes other than the ones already claimed by the leader.

Just because you want to gain market share does not mean it all has to come from the leader. Sometimes just creating clarity around something different will allow you to gain a disproportionate share of the people who don’t like the leader and are just looking for a rationale to pick someone else. And that could be enough market share to become very successful.

Saturday, June 16, 2007

Mighty Canoes

From the late 1700s into the early 1800s, one of the most strategic locations in North America was the Straights of Mackinac. Located between the Upper and Lower Peninsulas of Michigan, this narrow waterway connects two of the great lakes—Lake Michigan and Lake Huron. It is also not very far from the mouth of Lake Superior. Whoever controlled the Straights of Mackinac controlled the lucrative fur trade, which brought great wealth to whomever was in charge.

To ensure control of the straights, a fort was built on Mackinac Island, located just to the east of the straights. For a time, the British controlled the fort, but after the American Revolutionary war of 1776, it was given to the Americans. The key feature of the fort was the wall of cannons on the south side. These cannons were strong and powerful—able to shoot cannon balls long distances towards attacking war ships, which would by necessity need to approach from the south.

This defensive wall of cannons gave the Americans so much confidence that there did not appear to be a great need to fortify the fort with many soldiers. Only about 60 were deemed necessary. After all, the ships would be blasted away by the cannons before reaching shore, so hand to hand combat seemed remote.

When the War of 1812 was declared, the British saw this as their opportunity to retake Fort Mackinac and regain control of the fur trade. Enlisting the help of their Native Indian allies and some of the fur trappers, the British used mostly canoes to quietly paddle their way to the north side of the island in the middle of the night. They dragged a small cannon onto shore and up the hill towards the fort.

At daybreak, the British fired a single warning shot from the cannon, awakening the American soldiers. The Americans found themselves in quite a predicament. First, their defensive cannons were on the wrong side of the fort. Second, even if they could quickly move them to the other side, they would be worthless, because the cannons were designed to shoot far out into the water, not down the side of the hill. Third, the Americans were well outnumbered by the British, the Indians and the trappers.

As a result, the American commander Porter Hanks surrendered the island to the British without firing a single shot.

Be it armies or businesses, we all tend to fortify our defenses at the point where we believe we are most vulnerable to attack. In the case of the Straights of Mackinac, if an army of warships were to come, they would most likely come up through Lake Huron from the more populated areas to the south. Hence, the fort was built to defend that type of an attack. Thinking like an army, they assumed their primary enemy would be an army just like them—someone who would use warships.

Indians and trappers, however, do not have war ships. They use canoes. As the Indians and trappers were gathering in the region to join up with the British preparing for the attack, they did not appear to be a threat. Indians and trappers canoed through the area all the time. They were not soldiers.

Although a warship cannot attack Mackinac Island from the north, canoes can. Because the Americans were only prepared for a conventional attack by like-minded soldiers, they were unprepared for a northerly attack from what appeared to be harmless canoes. Instead, they turned out to be mighty canoes.

This same problem often happens in business. Our best laid strategic defenses turn out to be worthless because they prepare us for the wrong type of war.

The problem here is that we tend to look in the wrong direction when it comes time to create a strategic defense. The problem is twofold:

1) Looking Backward Rather Than Forward
2) Looking Inward Rather than Outward

Each of these will be looked at separately and then shown how they worked together to hinder a recent battle in the business world.

1) Looking Backward Rather than Forward
There is a tendency to believe that the next strategic battle will be fought in a similar manner to the battles of the past. The expectation is that relatively similar weapons will be used and that relatively similar tactics will be used. Therefore, when preparing a defense, there is a tendency to prepare to do a better job against what we have seen in the past. In other words, our preparation makes us ready to win a war that is already over.

History is shown that each new major war is fought with a different type of weapon and a completely different set of tactics. These render defenses prepared for fighting wars the old way obsolete and relatively useless.

For example, after World War I, France spent a considerable amount of time and money preparing a strong defense against any future attack by Germany. It was designed under the assumption that Germany would attack the second time the same way they did the first time—with slow, protracted, stationary battles. France was confident that if Germany tried the WWI tactics again, they would fail against the French defense. However, in WWII, Germany used a new mobile “blitzkrieg” approach for which the French were not prepared. The French defense proved to be worthless.

The Americans at Fort Mackinac expected a warship attack, because that was the traditional approach of the past. They were not prepared for a new type of war using canoes.

Rather than looking backwards in time to find our inspiration for strategic defenses, we need to look forward and anticipate how the next battle might look, and how it will be different from past battles. That is why a key component of strategic planning involves spending time trying to envision potential future scenarios, to answer questions, like:

A. What the future environment will be like?
B. How consumer needs and desires will evolve?
C. What non-tradition opportunities and threats could crop up which better fit the future environment?
D. What will it take to win in that future world?

One thing we probably count on is the fact that what worked in the past will not work in the future. Therefore, we need to prepare ourselves for new types of battles with new types of tools. Just as the Americans at Mackinac should not have rested in the confidence that the big cannons would always protect them, businesses should not rest in the fact that the tools which worked for them in the past will always for them in the future.

2) Looking Inward Rather than Outward
The American soldiers made the mistake of thinking that their enemy would be a lot like them—professional soldiers trained to fight traditional battles. Instead, they got Indians and fur trappers. Businesses do the same thing in thinking that our enemies will be similar to us.

If you are the cola leader, like Coke, you may see the enemy as another cola, like Pepsi cola and prepare to win the cola wars. Instead, the new enemy is sports drinks, fortified beverages, energy drinks and the like. Pepsi caught on to seeing the potential new enemy as being a non-cola sooner than Coke and has reaped the benefits.

In many cases, the most potent enemy does not look like us at all. Rather than looking inward at our own narrowly defined industry to find enemies, we need to look outside our industry. Strategic thinking can help us find the new enemies lurking outside our traditional industry, ready to gobble up our market share.

Newspapers Vs. the Internet
For most of the second half of the 20th century, newspapers in the United States had a virtual monopoly in their home market. They were strong; they were powerful. They were confident that nobody was going to be able to start up a new newspaper that would cause any serious damage to their near-monopoly. Owing the local newspaper was like owning the big cannon, ready to take on anyone who wanted to build a rival newspaper.

Then, at the end of the 20th century, the internet started to get used by people other than scientists and researchers. To the powerful newspapers, the internet looked like little canoes going by—no big threat. After all, we’re in the newspaper business. The internet is not a newspaper…not even close. Who would ever place an ad on something like that?

Eventually, the internet became a very viable information source. It used new tactics that were foreign to the newspapers:

1) Fresh news available 24 hours a day.
2) Ability to interact with the news and other readers of the news real-time, using Web 2.0 technology
3) Customize the news so that you only get the news you wanted
4) Combine news from multiple sources
5) Make the news available for free

These young internet upstarts did not act like newspaper people. What’s the matter with them.

Well, now the newspapers are fighting for their lives against the digital world. Because they looked backwards to the past (this is how the news had been done and will always be done) and they looked inward at the newspaper industry (instead of looking outside for threats), they caught on to what was happening too late. The mighty canoes of the internet are winning the war.

A good strategic defense needs to be based on looking forward (at what the new tactics for success will be) and outward (at players who are not a part of your traditional industry). Strategic planning is a process which helps one look forward and outward.

Of course, traditional internet players cannot sit back and think they’ve won the war any more than the newspapers before them. New threats, new tactics, new players will show up to threaten them as well. For example, will mobile phones change the rules so that the money is made at the carrier level instead of at the content level? Will users take over the content and leave out the internet content players? And so on…

Thursday, June 14, 2007

Cutting Your Way to Prosperity? (part 3)

Once there was a farmer who thought he had come up with the secret formula for living the good life. When he was young, this farmer had noticed how so many other farmers were struggling to make ends meet. Not wanting to live that way, this young farmer’s goal was to live well by farming differently.

Therefore, the young farmer spent time investigating what other farmer’s were doing, to find out why they were having trouble making ends meet. After a thorough analysis, he came to his conclusion: Farmer’s do not live well, because they foolishly waste their money. He saw many ways in which farmers were wasting their money:

1) They would let portions of their land lay fallow each year rather than plant something they could make money off of.

2) They put all kinds of money into fertilization and irrigation. Why spend all that money on something Mother Nature supplies for free? (rainwater and fertile soil)

3) They would waste money buying expensive seeds when they could just get seeds for free off of part of the prior year’s crop.

So the young farmer put his plan into action. He planted his entire land every year. He would use “free” seeds from what was produced in last year’s crop. He cut way back on irrigation and fertilization, relying on the “free” resources of Mother Nature.

At first, this plan seemed to work quite well. The money he saved on irrigation, fertilization, and seeds was used to live the good life—a nice home, nice car, luxury lifestyle. He was proud that he had “beaten the system” and could live well on the farm. Over time, however, the plan seemed less successful—every year the fields supplied less and less produce. Eventually, it got so bad that eventually the farmer had to declare bankruptcy.

The farmer in the story failed because he had a tragic flaw in his logic. He assumed that the farmland would continue to produce at peak performance forever without replenishing the soil. Yes, Mother Nature may have gotten him started out with good soil, but if you do not replenish the soil through fertilizer, irrigation, and letting it lay fallow, it will eventually become depleted—unable to produce crops. Weak crops do not produce the kinds of seeds which create healthy crops the following year—and are nowhere near as effective as specially grown hybrid seeds.

The farmer’s success was an illusion. What he thought was high profits from current operations was actually stealing the profits from future crops by failing to reinvest in the soil. These were not extra profits—they were the costs of doing business which he was refusing to pay. By not paying the price of reinvestment into the soil, he was destroying his own future.

Does it sound silly that a farmer would not be smart enough to take care of his soil? Well, I’ve seen otherwise smart business people destroy their future by not reinvesting in their businesses. Yes, it is wise to not be extravagant in your business spending. Keeping costs low can be a good thing, especially during the tough times. But a continual effort to starve a business of investment, even during the good times, can cause a business to have the same fate as this farmer.

This is the third and final blog in a series on the pitfalls of cost-cutting. In the first blog, “part 1”, we looked at how some cuts are really not cuts at all, but are rather just shifting of costs from one location in the company to another. In “part 2” we looked at the problems that can occur when cost-cutting is done without being connected to strategy. In this third blog, we will look at what happens when extreme cost-cutting becomes the norm, even in good times.

Extreme cost-cutting means not reinvesting into the future cash flow streams of the company and instead taking the money out as today’s extra profits. It may make you look like a genius today, but in the long run it depletes the business of what it needs to produce future profits. Businesses are like soil, they need to be replenished.

The temptation to take the money out rather than reinvest seems greater today, with top executives spending ever less time in their position. If the leaders only expect to be hold the position for a couple of years, why worry so much about the long term? In the world of marketing, the average CMO lasts less than two years in a job. Often times, as in the recent case at Macy’s, the rapid change in CMOs is a result of a conflict between near-term sales promotion and long-term brand building. The CMOs trying to invest in the long-term strength of the brand are losing favor to leaders trying to take the profits out now.

There are three main reasons why reinvestment is crucial to long-term success:

1) Things Wear Out
2) Customers are Fickle
3) Technology Improves

These are discussed below.

1) Things Wear Out
Cutting back on repairs and maintenance may work for a short period of time, but eventually, lack of repairs and maintenance will cause thinks to break down. There is an old Fram auto parts advertising campaign where a mechanic would say “Pay me now or pay me later.” The implication was that you could spend a few dollars now on a Fram oil filter or put it off until your engine breaks down and then pay hundreds and hundreds of dollars on engine repair.

This principle may seem obvious for equipment and machinery. However, other things can also wear out if money is not put into them. For example, in retailing, shopping centers and entire neighborhoods can wear out and become tired. It may become necessary to spend the money to move a store a few miles to a more vibrant neighborhood, even though the store itself may still be in relatively good condition.

Strategies themselves can wear out overtime and become less relevant in a changing environment. With the current movement to green environmentalism, an old formerly successful strategy viewed now as environmentally wasteful could severely damage a company. It is better to invest time and money in strategic thinking on a continual basis to stay in front of these changes, rather than waiting until it is too late to efficiently react.

2) Customers Are Fickle
Even if everything in your business is in fine working order, it does not mean that there is no need to reinvest. Customers are fickle. Loyalty is weak. Just being in fine working order may not be enough if competition is investing in the latest and the newest gizmos and gadgets. Shiny new things from the competition can catch the eye of your consumers and make you look dull and drab by comparison, even if there is nothing inherently wrong or broken in your process.

The goal is not to be serviceable. The goal is to be superior (in some way versus competition). Superiority is a relative term. Today’s exciting superiority can fall behind competition if they invest at a faster rate than you do.

3) Technology Improves
Even if your investment is in fine working order, that does not ensure top performance. For example, you may have the absolute best computer operating system available in the 1980s (which is when you purchased it) and you may have kept it in fine working order all these years. However, there have been so many technological advances since the 1980s that you would be woefully uncompetitive in the marketplace versus significantly more efficient competitors who are using the power of more up-to-date computer technology.

It could even be more subtle than this. In retailing, one could have perfectly serviceable cash registers which do a good job of scanning the price tag and letting the customer pay you. However, modern cash registers (which are now called Point of Sale computer terminals), can do so much more—capture customer data, process credit cards faster, allow more sophisticated pricing programs, suggest add-on selling opportunities, handle customer loyalty programs, and so on. By not investing in the new terminals, one is missing out on opportunities and falling behind those that do make those investments.

Continual aggressive cost cutting may be seen by some as being efficient, but it does not necessarily mean that you are effective. By not reinvesting in your business on a regular basis, you can deplete it of its ability to produce revenue in the future.

The biggest problem with chronic underinvestment is that by the time one can see the problem, it is often too late to fix it. The soil of the business is too depleted. Too much time and money would be needed to bring it back to life. And you don’t have the money, because you took it out in extra profits. And without new income coming in, you do not have the time to wait until the soil is brought back to life.

Tuesday, June 12, 2007

Cutting Your Way to Prosperity? (part 2)

One of my favorite comic strips of all time was Pogo, by the late Walt Kelly. In one of his comic strips, Albert the Alligator was running as fast as he could through the swamp. Pogo the ‘possum was desparately trying to keep up with the pace. While they were still running, Pogo asked Albert where he was going. Albert answered something to the effect that he didn’t really have a particular destination in mind. In response, Pogo replied, “If you don’t know where you are going, then why are you running so fast to get there?”

This story is not that dissimilar to what happened to Alice in Wonderland. Alice was confused, so she asked the Cheshire cat which way she should go. The Cheshire cat asked Alice where she was trying to get to. Alice said that she didn’t know. In response, the Cheshire cat said that if you don’t know where you are going, then it really doesn’t matter which path you take.

Strategic planning is all about finding the right destination for your business and the right path (journey) to get you to your destination. Both are necessary ingredients to success. A goal without a means to get there is worthless. Similarly, tactics which lead nowhere are also worthless.

Sometimes, we can fall into the trap that captured both Albert the Alligator and Alice in Wonderland—disconnecting the journey from the destination. Albert was so intent on making progress on the path that he failed to take the time to choose a destination. A lot of activity and movement was enough to make him happy. And as Pogo pointed out, if the journey has no purpose, striving to do it faster or more efficiently does little, if any good.

Alice had a similar problem. She was so intent on leaving her current situation that she failed to take time to determine a better location. She was seeking guidance on which path to take to move away from a position she did not like. And as the wise cat responded, if you have not planned your destination, then it really doesn’t matter what you do or where you go.

Although it may seem silly to think that a business would be as foolish as Albert or Alice, it does happen. During the dot com boom, people were saying that choosing a destination is obsolete. All you need to do is race like Albert to get to the next “killer application” before someone else. Some of those dot com “geniuses” don’t look so smart anymore.

Another time when leaders are tempted to disconnect action from destination is during tough times. When tough times hit, there is pressure to make a lot of cuts in order to make it through until good times return. These cuts can be across the board, regardless of any strategic concern. Like Alice they are looking at avoiding the current bad situation rather than seeking out a better situation. The analogy I hear often goes something like this:

“I don’t have time to worry about fancy things like strategy and positioning. My patient is dying. I’ll worry about that luxury later. Right now I have to focus on stopping the bleeding.” And, of course, stopping the bleeding means stopping the flow of red ink by cutting costs as much as one can (and without thought as to how it will impact the strategy). However, if you do not know what is wrong with the patient and how to cure the underlying problem, stopping the bleeding will not ultimately solve the problem.

This blog is the second in a series on avoiding pitfalls when in a cost-cutting mode. In the prior blog (see “Cutting Your Way to Prosperity (part 1)”), we looked at the pitfall of when cuts are really not cuts, but rather just a shifting of costs from one location to another. In today’s blog, we are looking at what happens when cost cutting is done without concern for its impact on reaching a strategic destination.

Three principles should be considered when making cuts to ensure that it doesn’t get disconnected from strategy:

1) Prioritization
2) Process
3) Preemption

These are covered in more detail below.

1) Prioritization
Across the board cuts can not only cut the fat in your business, but also the meat. I recall two discount store chains that cut their merchandise buying across the board. Unfortunately, not all merchandise sells at the same rate. Fast turning items like health & beauty care, household chemicals or candy sell through much faster than clothing. In one store, the only thing consumable item left in stock after inventory cuts was 2001 flushes, so that’s what an entire aisle was filled with. In another store, I saw more than three aisles filled with just one item—red licorice rope. I doubt if this left a good impression on the customer who was looking for the items which used to be on those shelves. Sometimes, you have to cut things differently, due to their different characteristics.

Rather than cut everything equally, one needs to make priorities. In general, areas that are most near and dear to one’s competitive advantage need to be cut the least. You’ve worked hard to build that reputation. Don’t give it all away at the first sign of panic.

Areas that are least crucial to your strategy should take the brunt of the cuts. Of course, this assumes that:

A. The people doing the cutting understand the strategic priorities of the company and what is most crucial to success; and
B. They understand how various cuts might impact the ability to continue down the path to one’s strategic goal.

Before making a cut, first ask yourself:

- Will there be a noticeable difference to my customers, enough to turn them away?

- Will this cut change the nature of who I am, to the point that I have inadvertently changed my strategy without knowing it? For example, if your historical strategy hinges on being known for superior service, and you cut the life out of your people providing the service, then you have really changed your strategy to no longer be about service.

2) Process
It takes a certain amount of input (people, money, equipment) to get a job done in a particular way. If you cut back on one or more of these inputs and do not change the expectations of the way a process gets done, you may be courting disaster by guaranteeing failure, since the same process cannot be done with the lower input. Decisions about cuts in inputs should not be divorced from decisions about the process creating the outputs.

Two types of process decisions can be made. First one can look at the various tradeoffs involved in cutting the inputs. For example, it you need to cut back on your service one can choose a tradeoff between speed and quality—either keep the quality and make it take longer to get the service, or keep the speed, but lower the quality. Depending on your strategy, one tradeoff may be better than the other. Hence, you alter your process based on which tradeoff you want to make. Making such a tradeoff is usually better than cutting back both quality and speed.

The second type of process decision may be to change the process to best fit the cut in inputs. For example, let’s say that the advertising budget gets cut. Since the original process cannot be achieved on the lower budget, maybe it’s time to do things differently, like maybe switch from TV advertising to radio, or move from mass-oriented advertising to just advertising to a narrow niche…or cluster fewer ad dollars into less frequent, but bigger bursts, instead of dribbling it evenly throughout the year.

Again, it is easier to know how to alter the process if you know your strategic direction, because it will help direct which alternative processes are most in tune with your strategic direction and destination.

Sometimes tough times are caused more by our own lack of strategic direction than by any outside forces. To quote from Pogo again, you may be in a situation where, “We have met the enemy, and he is us.” If your strategy is weak, you are more vulnerable to competitive onslaughts and economic downturns. Conversely, if your strategy is strong, you may be able to weather an economic downturn without much difficulty. You may not even have to cut much at all, because the strength of your strategy will carry you through.

The plummet in prices on digital TVs is hurting all the consumer electronics retailers with weak positions. Circuit City has been furiously trying to cut costs. Tweeter this week filed chapter 11. Best Buy, however, is still going strong due to its years of building a strong strategic position.

In other words, the best way to deal with price cuts is to avoid them completely by creating such a strong strategy that you are less vulnerable to downturns. This would be preempting cuts via strategic forethought.

During tough times or economic downturns, there can be a tendency to forget strategy and just rush to cut costs. Spending a little time first thinking about strategic implications can make cost cutting far more productive, and may even eliminate the need to make the cuts in the first place.

The best time to prepare for the tough times is when you are still in the good times. During the good times, you have the luxury of time to figure out your strategy and what is really critical to its success (the destination and the path). As a result, instead of acting irrationally or emotionally in panic when the bad times come, you can calmly go back to what you learned in the good times and do what makes sense both near term and long term.

Monday, June 11, 2007

Cutting Your Way to Prosperity? (part 1)

A long time ago, I was in charge of creating the advertising media budget for a retail company. I turned in what I thought was a reasonable budget.

A couple of weeks after I turned in my budget, I got a call from the budget department. They said that when the budgets of all the departments were rolled up, the expenses were too high. They asked me if it would be okay for them to cut the advertising budget by 25%.

I said, “Before I answer that, let me ask you a question. If the advertising budget is cut by 25%, are you planning on cutting sales by any amount?”

They replied, “No, the sales budget would stay the same.”

In response, I said, “Well in that case, why don’t you make advertising $0? Obviously, you do not think that advertising has any impact on sales, so I suppose we shouldn’t do any advertising at all.”

One of the hardest times to execute a strategy is when times get tough, such as in an economic downturn. To get through the tough times, there is often a need to cut expenses deeper than normal. There can be many problems if the cutting is done improperly. This is the first of a series of blogs on some of the pitfalls to avoid when cutting costs.

The first pitfall to avoid is in ignoring the interconnectivity of cost reduction decisions. If you cut costs in one area, it can make that area look good. However, due to interconnectivity, the impact of that reduction impacts other parts of the business. It may cause damage to other parts of your business which are worse than the benefits gained in the inital cuts, causing you to actually lose ground in your quest for profitability.

You may end up congratulating someone for their cuts, even though it is ruining the profit structure elsewhere. Take, for example, the story above. One could look like a hero for cutting advertising by 25%. It might cause the people in the advertising department to get a big bonus. However, if the reduction in advertising causes sales to drop too far, then you have rewarded people for destroying value.

In most cases, it is illogical to believe that one can just cut 25% of advertising and expect it to not impact sales at all. The overriding purpose for practically all advertising is to influence people to buy more from you. Advertising and sales are interconnected. To budget a huge drop in advertising without any drop in sales is to either admit that you are incompetent in your advertising or admit that your sales budget is an unrealistic lie.

The principle of interconnectivity needs to be considered when implementing cost reduction programs. There are three main areas where interconnectivity can hurt you:

1) Vertical Connections
2) Horizontal Connections
3) Customer Connections

These are discussed more fully below:

1) Vertical Connections
An income statement has many lines on it. If you focus on just one line on the income statement, you can achieve huge cuts on that particular line. However, it may just serve to move those costs up or down the income statement to a different line. The lines on an income statement are interconnected.

For example, let’s say one is focused on cutting a department’s payroll expenses. There are many ways to achieve this. For example, one can outsource work which used to be done internally to an outside third party. The payroll line goes down, but the outside services line goes up. It may even go up faster than payroll goes down.

Another way to reduce payroll is to increase the use of temporary services. The work didn’t go away…it just went to a different line item. If the focus is on cutting headcount, it may result in increased overtime for the remaining workers.

If the focus is on cutting capital investments, there may be an increase in repairs and maintenance in order to keep the old capital running. Or if the repairs and maintenance are cut too far, as appears to have been the case at some BP refineries, you may end up with serious disasters of entire businesses going out of commission for a long period of time. That raises costs on all sorts of other lines.

The moral of the story: When looking at a department’s cost cutting efforts, do not focus too narrowly. Look at the impacts that a cut on one line could do the increasing a different line on that department’s income statement. Cuts on one line rarely fall 100% to the bottom line. Some of it leaks back to other lines. Capture the leakage in your estimates.

2) Horizontal Connections
Vertical connections tend to be easier to address, because the income statement can be contained within a single department. For example, if you tell the legal department to reduce their total costs, then they do not gain much when shifting internal legal personnel costs to outside legal counsel. Since they have responsibility for both lines, they do not shift their total expense much in shifting the burden from one line on their income statement to the other. Hence, there is not much incentive for making the shift.

The more difficult problem is when the connectivity is horizontal—between departments. If one can improve their department’s expenses by pushing costs to another department, it can make that department manager look good, because his or her area has permanently reduced their costs. Even though the total company expenses did not go down, the department that shift costs to another department can get undeservingly rewarded.

Let’s look at how this might play out in a retail company. The merchants might be able to lower their cost on the good they buy by requiring less of the vendors. They could ask the vendor to stop doing certain tasks in return for a lower price. Those tasks could include:

A) No longer having the vendor put price tags on the goods.
B) No longer having the vendor sort the goods by store before shipping them.
C) Shipping the goods all at once, rather than holding onto the inventory and shipping it in more manageable quantities.

While this takes costs off the merchandiser’s books, it adds a ton of costs to the retailer’s distribution center, because now they have to do what the vendor used to do. They have to do the sorting and the tagging. At the same time, the warehouse gets clogged with extra goods, making processing at the distribution center less efficient.

Now the distribution center may want to escape some of this problem by shifting the burden to the stores. They could send the goods to the stores untagged. They could clog the stores with more inventory than they need. So now, someone at the stores has to do more work than before.

Moral of the story: Don’t just accept a department giving a commitment that they will reduce their costs. Ask them how they are cutting their costs, so that you can determine if their method of cutting is just shifting the burden to another department.

3) Customer Connections
Some cuts in cost are noticeable to the potential customers. If your cost cuts make your firm less desirable to customers, they could end up going somewhere else. It does little good to cut costs if it results in alienating customers and eliminating sales. Long after the tough times are over, customers will remember how you treated them in the tough times and may not come back when the times are good.

Using a retail example again, one can cut labor in the stores in a way that:

1) Makes the store visually less desirable, because there is less cleaning and straightening up.
2) Make the checkout lines longer due to fewer people operating the cash registers.
3) Create more out-of-stocks, because there are fewer people restocking shelves.

These outcomes can cause customers to no longer want to shop your store. The drop in sales could be greater than the drop in costs.

Moral of the story: Don’t forget the customer perspective when cutting costs. Do the reductions in expenses exceed their impact on reducing sales?

Just because one has a “successful” cost cutting plan put in place does not necessarily mean that total costs really went down all that much or that profitability of the entire company is better off. To really have success in tough times, one needs to check the interconnectivity of cost cutting actions, to make sure that costs were not merely shifted up and down a department’s income statement, or shifted to another department, or caused customers to stop patronizing your business.

I am not trying to imply that cost cutting is bad or unnecessary. Cost cutting is often necessary and good. We just cannot go around blindly believing that all cuts are good cuts. The next blog will address some of these issues around deciding what are good cuts.

Saturday, June 9, 2007

Sometimes, It’s Not Nice to Share

I’ve worked at several companies who have had a portfolio of retail businesses and decided to centralize most of the overhead of the divisions into corporate shared services. Although each company handled it slightly differently, they tended to follow a pattern something like this:

First, someone would get the notion that if you combine division level overhead to a corporate location, the company is better off. They make a case that:

A) The quality of expertise should go up due to specialization; and
B) Costs should go down due to eliminating duplication and through economies of scale.

They win the argument, so a corporate shared services area is set up. The people running these new shared services areas get fancy new titles and increases in their salaries. To justify their position, they create a bureaucracy to interact with the divisions. The bureaucracy, of course, requires additional people to do the interacting.

Not long thereafter, the divisions make three complaints about the shared services:

1) It takes longer to get anything done.
2) More time is wasted in meetings.
3) The quality of the output from the service is not as good as before.
4) It costs a lot more money.

The complaints are investigated and found to be true in many cases. As a result, the shared service programs are scaled back significantly or eliminated altogether. Then things return pretty much back to where they were before shared services, with the divisions running much more independently.

Strategies often involve the building of a portfolio of businesses. Within such a strategy, it is common to build at least part of the portfolio via acquisitions. To help justify the high purchase prices for acquisitions, savings are factored into the financial model for the various economies of scale which are expected from combining the new business with the rest of the portfolio.

Unfortunately, it is commonly the case that after the acquisition occurs, the savings from combining the businesses turn out to be far less than what was put into the business plan. As a result, it soon becomes apparent that too much was paid for the acquisition. Now the acquiring company is faced with the reality of having of destroyed shareholder value, because they paid more for the company than they will get back in earnings/savings.

The problem is that combining certain overhead functions turns out to be counterproductive. As we saw in the story above, shared services in many cases can increase costs while reducing quality. It turns out that the number of areas which make sense to combine are far fewer than one would at first think.

Although we tell our children that “It is nice to share,” in the business world, it often makes more economic sense “not to share.” Therefore, when developing strategies, be careful not to rely too heavily on sharing of overhead to justify your tactics.

What we are really talking about here are synergies. If we overestimate synergies, we can end up with a seriously flawed strategy—maybe flawed enough to destroy a company. In order to ensure that your strategy does not come de-railed by poor assumptions on synergies, three principles should be kept in mind.

1) Resource Vs. Outsource
2) Distinctive Vs. Distractive
3) Frozen Vs. Flexible

These three principles are discussed below.

1) Resource Vs. Outsource
Often times, aggressive synergistic models are based on an assumption that divisions will outsource a number of functions to corporate. Complete outsourcing is rarely cost effective because the division gives up too much control in a complete outsource. The divisions lose control over their destiny. It is difficult enough to execute a strategy when you control your functions. If you have outsourced your functions, then it can be like fighting two wars—one against the outside marketplace and an internal war with the shared service group.

Corporate may mean well, but when the entire function is outsourced, the division tends to get stuck with too much bureaucracy, too many costs, too much wasted time, and a product not always well suited to the unique needs of the division. Divisions tend to need functional people within the division to fight for what is right for the division.

Many times, one size does not fit all. A company in the incubator stage has different needs from a rapidly growing business or a mature business. Some divisions can afford more service than others. To put them through the same process would be like telling all women that they should be wearing a size 6 dress.

Rather than “outsourcing,” one should be looking at “resourcing.” There are many resources within the portfolio which can be shared between divisions. For example, one can share access to channels of distribution, knowledge about certain customer groups, patents, vendors, sales reps, intellectual property, employees, and so on.

For example, I have a friend who used to work at 3M. He says 3M often paid a premium to acquire a company just to get access to a patent which they knew could be valuable if spread across a few of their divisions. The deals worked based on the sharing value of the patent resource rather than imaginary synergies from outsourcing.

Resourcing does not require divisions to give up control of functions. Instead, it is a means to empower a division’s function to be better off than it was before. Whereas outsourcing is primarily taking away something from a division, resourcing is primarily giving something to a division. It is like sharing gifts at Christmas.

When looking at acquisitions, one is more likely to have success in reaping benefits if the benefits are based on understanding the value of specific resources which can be shared within the portfolio, rather than difficult-to-achieve synergies through generic centralization of complete functions through outsourcing.

2) Distinctive Vs. Distractive
Certain functions are core to the success of a business. They help provide the distinctiveness which ensures strategic success at the point of implementation. In retailing, one such core function is Advertising/Marketing. Marketing is how one communicates the strategy to the customer. Advertising decisions at most retailers tend to require input from many parts of the division under very short time-frames. It is a valuable tactical tool. To lose control of advertising would be to lose control of a key determinant of strategic and operational success.

Yet, on more than one occasion, I have seen marketing/advertising outsourced from a division into a corporate shared service program. Taking away a core function from a division can make them “average” at the point where they need to be “distinctive.” We have already talked about how outsourcing can lower productivity. In certain core areas, outsourcing can also make it nearly impossible to stay on-strategy.

By contrast, some functions tend to be business distractions. For example, issuing payroll checks rarely provides competitive distinction. It is just a distraction which needs to get done. If you can take away these distractions and centralize them, the division can focus on the more critical factors.

Core strategic functions which provide distinction need to be out in the field with the division on the front lines. Functions which provide no competitive leverage (distractions) can be placed at corporate. Different businesses may have different points of distinction and distration, so one needs to examine this on a case to case basis.

3) Frozen Vs. Flexible
One of the problems with too much integration of division functions with corporate is that portfolios are not frozen. New divisions are added over time, and old divisions are divested over time. If one tries to squeeze out too many synergies by tight intertangling of the divisions with each other and corporate, it becomes more difficult to maintain flexibility when it is time to divest one of the pieces. There is value to maintaining some of that flexibility. That value can be destroyed if synergies are attempted beyond the two points already mentioned.

Instead of tight intertangling, one can get some of the same benefits with standardization. For example, if every division uses basically the same standard software systems (on non-core processes) and the same standard language to talk about business, it is easy to share resources back and forth without having to be intertangled, because standardization breaks down the barriers to working together. Yet at the same time, it makes it easier to unfreeze the portfolio and divest of pieces, because they are not so intertwined.

Making too aggressive an assumption on synergies can cause one to make the wrong strategic decisions. Subjecting divisions to overly aggressive outsourcing to corporate can end up counterproductive. To be safe, only take into account synergies regarding:

1) Resource Sharing
2) Non-Distinctive Functions
3) Those that still allow flexibility in adding to or subtracting from the portfolio.

Often, the problem with synergies is that they do not really exist in the first place. Not all business combinations make sense. Instead of 1+1=3, one can end up with 1+1=0.5. You cannot always blame the people executing the strategy when synergies to not live up to plans. Sometimes, the original design of the plan is wrong.