Wednesday, August 29, 2007

Plate Spinning

When I was a little boy, I used to enjoy watching the Ed Sullivan show on TV. Frequently on the show, he would have as one of his acts a “plate spinner.”

The plate spinner would have a number of long, thin wooden rods sticking straight up, all in a row. Starting at one end of the row, he would put a plate on top of the wooden rod and start spinning it until it was going fast enough to not fall off of the rod. Then he would move on to the next rod and get another plate spinning. He would continue this down the entire row of wooden rods.

Soon, the plates he began spinning earlier would slow down, start to wobble and almost fall off the wooden rod. The plate spinner would have to stop what he was doing and go back and very quickly get that plate spinning again. Eventually there would be so many spinning plates that the plate spinner would be frantically running from rod to rod trying to keep them all going.

Eventually, he would not be able to keep up with them all, and plates would start to fall and break. As a young boy, seeing someone breaking plates on TV seemed like fun.

In the business world, leaders are confronted with a great number of tasks and responsibilities. Often times, it can feel like being one of those plate spinners. You are frantically moving from crisis to crisis just trying to keep things from breaking. There appears to be no time for quiet reflection or strategic concerns. All the effort is used just to keep the plates spinning.

It doesn’t need to be that way. In this blog we will look at how to stop being a plate spinner and how to become a more effective long-term leader. Plates were originally made to hold scrumptious meals. Let’s stop spinning plates and use them to feast on the fruits of successful planning.

Back around the late 1980s, I read a book summary about how to be an effective manager. The author studied a number of executives who were noted for being effective leaders. He then wrote about the traits he saw in the effective leaders. I’ve forgotten the name of the book or the author and tried in vain to locate the book on the internet. If any of you know the name of the book, let me know.

What the author found was that there was no single way to be an effective leader, but rather several, although the methods did have something in common. As I’ve pondered what I read in the book summary so many years ago, I have modified the common principle of success to being “leveraged focus.” Using the analogy above (something the author did not do), when compared to plate spinning, the successful leader would not try to spin all of the plates by his/her self. Instead the leader would focus on only one of the plates. However, the leader would focus in such a way that the plate he was spinning would have an indirect impact on all of the other plates. His spinning of the one plate would leverage all of the other plates to keep them spinning without a need for the leader to focus on all of them.

The author mentioned several different types of “plates” to focus on and how they could leverage all of the others. I do not remember them all, but here are most of them:

1) Focus on People
2) Focus on Investment
3) Focus on Vision
4) Focus on Process

Each of these will now be described in greater detail.

1) Focus on People
This type of effective leader would focus on making sure that the right people were in the right part of the organization, pretty much to the exclusion of most other factors. This leader would get very involving in the hiring process for all executives, making sure to be part of the interviewing. This leader would spend a great deal of time making sure the skills of people matched their responsibilities and that there was a cultural fit.

The leverage works as follows: If you get great people properly aligned in the organization to take advantage of their strengths, and give them the right tools, they can do great things. In other words, if the “people focus” plate is spinning well, it will create an environment where great people on their own will find the right plates and spin them for you. Just get the right people in the right place and then get out of their way. By focusing on one plate, you get them all.

Dick Schulze, the founder of Best Buy is probably a good example of this type of leadership. He was always fond of saying “you win with people.”

2) Focus on Investment
This second type of effective leader would focus on making sure that the company was putting the resources behind the right projects. He or she would spend a lot of time focusing on capital investments—where and how the money is being spent. Returns on investment would be a key point of interest.

The leverage works as follows: If you can effectively control where the resources are placed in an organization, then you can effectively control what the organization does. In other words, you focus on determining which plates are the best ones to spin. Then you put enough resources behind those plates to ensure that they will keep on spinning without a need to constantly monitor them. The resources will get the work done, so you don’t need to be everywhere at once trying to spin the plates yourself.

3) Focus on Vision
This third type of effective leader spends a significant amount of his or her time on making sure the vision and mission is right. Then this type of leader spends most of the remaining time communicating the vision, to make sure that everybody understands it and is behind it.

The leverage works as follows: If you can get everyone focused in moving in the same direction, then you will end up moving the company in that direction. The details about which particular plates should be spun would occur naturally as people gravitate to the plates most in line with the vision and start spinning them. By focusing only on the direction, you can get all the proper action from others as a natural consequence.

Steve Jobs is probably a good example of this type of leader. He sets the tone for what Apple stands for, and because the people intimately know what he is looking for, they deliver.

4) Focus on Process
A lot of the failure in business comes from poor execution. Therefore, this fourth type of effective leader focuses a great deal of time on process—examining how things get done in the organization. This type of leader looks for ways to streamline a process, eliminate bottlenecks, and make handoffs more seamless. Process flow charts consume the interest of this leader.

The leverage works as follows: By focusing on the Process Plate, one is creating an environment where it is harder for things to fail. Therefore, one does not have to keep running from wobbly crisis plate to wobbly crisis plate, because the efficiencies of the process tend to make the plates keep spinning longer all on their own.

The point of all this is that leaders cannot do it all themselves. However, they still need to make sure that all the proper plates are spinning. So rather than be half-hearted at everything, pick a plate to really focus on. And then make sure that you leverage that effort so that the impact of that plate indirectly gets all the other proper plates to spin on their own. This then allows the leaders the freedom to be true leaders, rather than just frantic plate spinners.

Even though a lot of things have to go right in order for a business to be successful, that does not mean that leaders need to spend time on every little thing that has to go right. In fact, if a leader gets spread that thin, they will end up being effective at nothing. Instead, leaders need to focus more narrowly to ensure that one particular aspect gets done supremely well, be it the people factor, the process factor, the resource factor or the vision factor. Then, the trick is to make sure the effectiveness in that one area ripples out to all the other areas, so that the consequence of the narrow focus causes everything else to naturally fall in line and get done without the need for constant leader attention.

Of course there are always exceptions. Great companies like GE tend to be able to do multiple things right. Regarding people focus, GE has one of the best executive development programs around. Regarding process, they have gotten their arms around processes like six sigma. Regarding resource allocation, they were leaders in no longer investing in businesses that were not #1 or #2 in their field. The mix of the GE portfolio has changed greatly over time, as investments changed with the environment. Regarding vision, people quickly start to understand “the GE way.”

However, even here there has been focus. They didn’t try to institute or perfect all of this at once. Instead, they would tend to focus on only one of these four areas at a time to get it right and then just rotate to the next focus. It has been more sequential plate spinning rather than simultaneous plate spinning.

Monday, August 27, 2007

Successful Retail is about making PAR (part 2)

Many, many years ago, I did some consumer research to try to understand the difference between a Wal-Mart customer and a Target customer.

The people who loved Wal-Mart thought that Target customers were stupid, because:

1) Target shoppers are were paying too much (and that’s wasteful—which is a bad thing). They could get the stuff cheaper at Wal-Mart.

2) Target shoppers were seduced by all the frills and glamour, which at the end of the day is worthless, because the only thing you get to take home is the product.

At the same time, the people who shopped Target thought that the Wal-Mart shoppers were stupid, because:

1) The Wal-Mart shoppers were putting up with a dirty, undesirable shopping experience when they did not have to.

2) Don’t the People who shop at Wal-Mart realize that by going into those stores they are associating with the undesirable people of society, so by association they would be considered an undesirable person?

So in the end, both sides thought that they were the smart shopper and that the other shopper was stupid.

We tend to patronize those companies that reinforce the way we look at life. The Wal-Mart shopper tended to have a moral code which was against wastefulness. Many of them saw wastefulness as an indicator of being a bad parent, since money wasted at the store was less money they could spend on their family. Since Wal-Mart seemed to waste the least amount of money, that’s where these shoppers went.

Conversely, the Target shopper saw shopping as more than just a task to get a product as cheaply as possible. They also valued the shopping experience and how that experience would influence how others thought about them. Whereas the Wal-Mart shopper was more directed by an internal moral compass, the Target shopper was more influenced by external direction from the culture around them. Since the external culture thought more highly of Target, Target became the store of choice.

Therefore, when creating strategic direction for your brand, one must take into account how the customer integrates this purchase into their larger view of life and self worth. Otherwise, they will miss out on some of the key motivators of purchase and perhaps end up looking like the “stupid” choice for a large sector of people.

This is the second of two blogs looking at how to be successful as a retailer. Once you get past mastering the basics of retailing (right product, right price), there are three more areas one must master. We called it mastering PAR, because this acronym spells out the three areas:

1) Personality
2) Advocacy
3) Respect

In the last blog, we looked at personality. In this blog, we will look at Advocacy and Respect.

2) Advocacy
If one assumes that most stores in a particular sector sell about the same stuff at roughly the same prices, then what becomes the tie-breaker to get you to choose one over the other? Often, it has to do with which store is doing a better job of being an advocate for your way of life.

One way a store can be an advocate is by helping its core customers get more of what they want and less of what they don’t want. Most people do not want to wade through acres of stuff they are not interested in so they can find the stuff they are interested in. An advocate store will know its customer type well enough to pre-select only those products important to their customer. This can be a great time-saving service.

Walgreen’s recently found out from its customers that they would enjoy the experience more if the selection was reduced, so that is what they are doing. In the area of food, Trader Joe’s and Aldi have been successful by narrowing the choice to just what their customer is looking for. In fashion, specialty stores tend to do well if they focus on a particular type of fashion statement rather than trying to be too many things in the same store (such as the successful focus of American Eagle Outfitters versus the muddle of the Gap).

For additional selection options to become meaningful choice, it needs to be relevant to the customer’s way of life. Otherwise, it no longer represents choice, but only clutter. Advocates get rid of the clutter on behalf of their customers.

Another way to become an advocate is by reinforcing the fact that you endorse the lifestyle of your customers. These retailers seem themselves as more than just sellers of goods, but also as outfitters of a lifestyle. Whole Foods is about more than just product. It is trying to advance an entire way of healthy living. Hot Topic makes the Goth teen feel like their lifestyle is welcomed, understood and appreciated. Christian bookstores are not just selling books, but endorsing and supporting a particular spiritual lifestyle.

A third way to be an advocate is to be a fighter for your customers. It is sort of like being a concierge for your customer, looking for special ways to help out your customer. This could include anything from special ordering product to lobbying for the rights of the customer. It’s going that extra step to make the customer’s experience special.

Finally a store can be an advocate by supporting the same causes which are important to their customer. More than ever, customers want to patronize stores which direct some of their profits to help make the world a better place. If the causes which are important to the customer are also important to the store (and the store puts their money where their mouth is) the store will tend to be patronized more. This could include environmental causes, neighborhood causes, or helping those less fortunate.

3) Respect
Closely associated with advocacy is respect. Customers do not want to be taken for granted. They want to be appreciated for their patronage. About a week ago, MSNBC ran a web page asking people to write in about how to improve Wal-Mart. One of the biggest complaints was the long lines at the store. People felt that those long lines showed no respect for the customer’s time. If you do not respect a customer’s time, then they will shop at a place where they get the respect. One of the reasons for the success of Carmax is the fact that they do a better job than the competition in respecting the time of their customers.

Customers want stores that respect the choices their customers make. Don’t be patronizing or judgmental. Believe in what you are selling and be proud of it.

Finally, show respect for the customer beyond the store experience. The relationship shouldn’t end at the cash register. If you sell poor quality junk that breaks down shortly after purchase, you have not shown respect for your customer. Stand behind what you sell and make sure the post purchase satisfaction is just as important as the in-store satisfaction. Repeat business creates profits. If you let down the customer after the transaction, you might not get another transaction from them.

Customers have too many choices of where to spend their money. To get them to choose you, a retailer must go beyond just having the right goods at the right price. Instead, they must form deeper relationships which reinforce the lifestyles and moral codes of their customers. You must stand alongside your customer and become an advocate for the things most important to their way of life. In addition, you need to respect their time, their choices and their post-purchase experiences. Otherwise, you are seen as just a cold-hearted business. And it is difficult to excel high enough on the retailing basics in order to overcome this bad impression.

Sometimes, I think many retailers spend too much time defining themselves in terms of what they sell rather than who they serve. If a retailer were to focus more on pleasing a particular type of customer, they may find many more opportunities to profitably sell many more things which they would never dream of doing if they defined themselves by some narrow product category.

Friday, August 24, 2007

Successful Retail is about making PAR (part 1)

According to the Online Etymology Dictionary, the origins of the English word “par” comes from the Latin word par, meaning “equal” or “that which is equal.” In 1632, the word par in English still had this original meaning.

By 1767, the meaning of the word in English started to get modified. Par now was also used to mean “average or usual amount.” Its still similar, but not exactly the same meaning. Now, par was being limited to equality with normalcy.

The first reference to using par in reference to golf can be found in 1898. The idea here was that this was the normal amount of strokes it would take the average golfer to make the hole.

This golf usage then broke away from golf around 1947, when people started using the phrase, “that’s par for the course,” referring to that being normal behavior for someone.

Of course, nowadays professional golfers have gotten so skilled that to accommodate them golf courses have become ever more difficult to play in order to achieve “par.” As a result, par is no longer what a typical golfer achieves. Heck, even the great professionals of golf often have trouble achieving par these days.

So the meaning of par is morphing into more of an ideal state of performance, rather than an average performance. In other words, achieving par on the course makes one better than the masses. And so now, par is starting to imply that you are “unequal” and instead superior. So, in the span of less than 400 years, the term has moved from “equality” to “inequality.”

In retailing, it used to be that if you did well on the basics, you would be successful. The basics of retailing are to have the right items in stock at the right price with enough efficiencies so that your cost of doing business was less than your markup from wholesale.

However, just as golfers have gotten better over time, so have retailers. Similarly, just as golf courses have become more difficult, so has the playing field for retailing. As a result, merely being good at the basics of retailing is no longer enough to win. Mastering the basics of retailing is merely the minimum level needed to make the cut and survive to play another day. It does not ensure success.

To get to the higher performance of the newer, more stringent retail par, one must add to the mastery of basics additional skills. It is the only way to achieve the superiority required to be a winner.

What are the additional skills required to achieve this more stringent level of par? Well, I used the term “par”, because it is a useful acronym for the three skills one must add to basic retail mastery. Those three skills are:

1. Personality
2. Advocacy
3. Respect

In today’s blog, we will cover personality. In a subsequent blog, we will look at Advocacy and Respect.

1. Personality
When I first went to work for Best Buy in the late 1990s, I was given the results of some research that had been done a few years earlier. This research was asking consumers their opinions of various consumer electronics retailers. At that time, there were a large number of good-sized consumer electronics retailers in the US, including Circuit City, Best Buy, Highland, Silo, Fretter’s, and so on.

According to this research, most consumers saw these retailers as all pretty much the same. They felt they all had about the same variety of products at about the same price. There was very little to make anyone stand out from the crowd.

When asked to ascribe a personality to each of the retailers, most of the people surveyed drew a blank. The stores were viewed as so bland and similar, that they did not have any distinguishing characteristic on which to base a personality. The one exception was Best Buy. At the time, their advertising included a character dressed up in a costume to look like a giant Best Buy price tag. This character did some silly things interacting with customers which made Best Buy (the company) appear more human and more likeable.

As a result, Best Buy was the only retailer in the survey to get a meaningful number of positive personality responses. (Note: the survey comments showed that many respondents referred to the guy in the price tag as the reason for giving Best Buy the positive personality) So with everything else being relatively equal, Best Buy got an edge in “likeable personality” which became a sort of tie-breaker to shift business towards Best Buy.

I believe that this edge in personality was one of the key factors which started to shift the momentum towards Best Buy. Best Buy was able to take advantage of that momentum to build an even stronger business. Conversely, most of those other retailers (who were relatively competent at the basics, but had no positive personality) no longer exist.

Customers have a large number of choices of where to purchase products. All of these choices are fairly good at meeting the basics of retailing. The weak players have already been eliminated. To stand out from the crowd, a retailer needs to develop a positive personality which they can own to differentiate themselves from the crowd.

Target spent years refining its cheap chic personality. It’s the cool kid on the block when it comes to saving money, and people like hanging out with the cool kid. This has made Target very successful and helped it survive the shakeout when nearly all of the other discount store chains went away. At the teen level, American Eagle Outfitters has built a strong, positive personality which resonates with that age level. Whole Foods is another great retailer with a great personality.

Conversely, many of the retailers that are struggling today have poor or non-existent personalities. The Gap has tried to be too many things to too many people in too bland of a way. As a result, it really doesn’t have a strong, identifiable personality. And I’ve personally done some research on the personality attributes given to K Mart. Let me tell you, they describe the personality as being like a classless bum with bad breath (along with a lot of other negative attributes). This is the type of personality you do not want to be associated with (and their sales trends reflect this).

And this gets to the crux of the issue. People like to hang out with people who are similar to themselves or are like what they aspire to become. The same applies to the stores people want to hang out at.

The personality of the store reflects upon the people who patronize the store. If the store is cool, then my being there makes me appear more cool. If the store is considered wise and caring about the environment, then my shopping there will make me appear more wise and caring of the environment. If the store is considered rebellious, then I am more rebellious if I shop there.

The idea is that people prefer stores whose personality reflects their own personality.

We make a statement with our choices of where to spend our money. We want our peers to think better of us (and we want to think better of ourselves) based on these statements. The personality of the store impacts those statements. As mentioned in a previous blog, the personality of the name on the shopping bag you carry in public reflects on you and changes behavior as well (see "Pride of Bag").

Finally, if a store has a positive personality, it tends to create greater store loyalty. If you are seen as just a bland store selling what everyone else sells at about the same price, there is little reason for the customer to remain loyal. It is easier to walk away from a lifeless store than it is to walk away from a store that seems alive—like a friend—because it has a personality. There is more of an emotion bond when there is a personality. That bond helps keep people more emotionally attached to your store.

In today’s world of retailing, the stakes are very high. Practically all the retailers who are left are pretty good at mastering the basics of retailing. Just being good at the basics is not enough. If you are a retailer, you have to elevate your game to a higher level in order to create the kind of superiority which makes one stand out and become a winner. That requires a mastery of PAR (personality, advocacy, and respect).

Regarding personality, the creation of a strong, positive personality for your store will give you an edge. People prefer shopping stores which have a personality which reflects well upon their own personality. The old saying is that you put your money where your mouth is. It is also true that you put your money where your personality is. Personalities also increase store loyalty, since emotional bonds are harder to break than rational ones.

One of the great things about personalities is that there are a variety of personalities to choose from. This variety allows you to choose a personality not already taken in the marketplace, so that you can stand out and be unique. This can be a lot easier than if there was only one desirable personality and you had to continually fight everyone else to gain temporary superiority in that same area (which, by the way, is a good reason not to pick the same personality as the leader when choosing your personality).

Monday, August 20, 2007

Building & Tearing Down Walls

In order to earn money while in college, I spent some time doing heavy labor. One time we had to tear down a sturdy brick wall inside of a building. The only tool we had was an incredibly large and incredibly heavy sledge hammer.

We took turns whacking at the wall with the sledge hammer. You would whack at the wall until you were exhausted, and then hand the hammer to the next guy. He would do the same, and so on. Eventually, the sledge hammer would get back to you and it would be your turn again to whack away at the wall. I have never been so exhausted and sore in my life as I was after that day was over. And after all that effort, we only made a small hole in the wall.

Another time, I was on a team helping to build a wall, although I did not get to have any of the fun part. My job was to haul the cement in buckets to the site where the wall was being built. The cement was outdoors. The wall was being built on the interior of the second story of a building. So I had to spend all day carrying these buckets up flights of stairs. Let me tell you, wet cement is very heavy. By the end of the day, I thought my arms and legs would never stop being in pain.

So the next time someone says that something is as solid as a brick wall, trust me—those walls are very solid.

Strategy is like a journey. It is the art of finding a way to get from where we are today to where we want to be tomorrow. In business strategy, we tend to focus on creating the path we want to take. This is good, since blazing new trails can lead to great reward. However, as any trailblazer knows, after you do the hard work of creating a path where none existed before, others will start walking down that path you worked so hard at.

You may have invented a great new retail concept only to see someone else copy it and build out a successful chain faster than you. You may have worked hard to invent a new kind of drug and then see others make similar copycat formulations.

Studies have shown that being a “fast-follower” can be a very profitable way to go. For years, Coca Cola was successful by watching others experiment in the beverage space and then quickly copying what appeared to be catching on. Because Coke had superior distribution channels, it would win the battle. RC Cola invented cola in cans, diet cola, flavored cola, and so on. Coca Cola let RC do all the hard work of blazing the trails, and then swooped in to take all the profits.

Microsoft used a similar philosophy over the years. It would watch for developments in their space, like Netscape, and then be a strong fast follower with their own products, like MSN. The idea is to let someone else spend all the money and take all the risks on innovation, but out battle them on who ends up getting all the market share for that innovation.

So if you are an innovator, you need to do more than just focus on blazing the trail. You also need to spend some time building some walls. You need to build impediments to others so that they cannot just waltz down the path you built. As mentioned in the story, it is very difficult to tear down walls. It will slow down the competition as they try to chase you.

Yes, building walls can be difficult as well, but the effort can often produce great benefits by slowing down others who would want a piece of the fortune you are designing.

The principle here is to incorporate into your strategy a comprehensive approach which not only makes it easier for yourself to get to the prize, but also makes it harder for others to do the same. We’ve touched on the need to concern one’s self with the competition in other blogs (see “Bombs Start Wars” and “If You Can Open the Door, So Can Others”). This time the focus is on designing ways to keep the competition from getting the upper hand in the race for market leadership.

Here are some ways to build those walls that will help your cause by not allowing others to catch up.

1) Speed to Capacity
It is usually not enough to just be good. In most cases, one also has to be fast. Speed is necessary, because of limited capacity, be it capacity in the supply chain or capacity in the mind of the customer. Take retailing, for example. If you have a great new retail concept, one cannot afford to be slow in rolling out the concept to multiple locations. Potential competitors may visit your store and copy it faster than you can roll it out yourself. There tends to be a relatively fixed capacity of how many stores a market will hold. The more you let a competitor build stores in a market, the less capacity there is for you.

Let’s say that a market can hold three stores. You build a single store in the market, thinking that will be very profitable. But what if the competition builds two stores in the market? Now, you may be locked into an inferior position in the marketplace. What if you own one city, but the competitor surrounds you by owning the rest of the state? Eventually, they will win the war of attrition. A similar situation occurs in packaged goods where the rush is to soak up the limited shelf capacity in the stores. If you own all of the shelf space, it is hard for others to attack you.

The customer’s mind has limited capacity as well. The first one to penetrate the mind as owning a position will get the credit for that position, whether they invented it or not. Everyone else will be seen as an impostor. Therefore, it is important to act quickly in order to be the first to claim the position in the mind of the customer.

Once you own the capacity in the field and the capacity in the mind, you have erected a difficult wall for others to tear down. The sooner you ramp up, the stronger your wall will be. Get out of test mode as quickly as possible and ramp up to outpace the competition in the growth mode.

2) Exclusivity
Competition has a tougher time attacking you and taking away your progress if you have created exclusivity for yourself. Maybe you can create exclusivity for yourself in obtaining some key manufacturing resources, like specialized computer chips. Perhaps you can create exclusive arrangements for yourself with key retailers. If you can create a strong, exclusive network with all of the other major players in the supply chain, then you force the competition to utilize an inferior network. When you “lock up” an exclusive arrangement, you have turned an open door into a locked wall. Exclusivity can be a huge wall.

3) Loyalty
The more you can lock in a customer to be loyal to you, the harder it is for a competitor to take them away. Loyalty programs which reward customers for increasing their business with you make it harder for them to leave, because they have to abandon not only you, but the rewards they were getting. The higher the wall you can build around “switching costs” the less likely a customer will switch to someone else.

4) One-Upmanship
If you can always stay one step ahead of the competition, then you are forcing the competition to always be one step behind. The Japanese automakers have been doing this to the Detroit automakers for years. Just when the Detroit firms think they have caught up the Japanese on some factor, like quality, the Japanese firms up the ante by moving on to the next improvement, like fuel efficiency or luxury.

The worst thing to do is to stay in the same place. If you don’t keep raising the bar for success, someone else will pass you by and create a new level of superiority. Reinvest some of the profits from being ahead into innovations that will make it even harder for others to catch you. This creates a situation so that when competition thinks they’ve finally torn down your wall, they will be disgusted to learn that behind that wall they just eliminated you built yet another wall for them to tear down.

Take time from your busy trail-blazing schedule to ponder ideas that can keep you one step ahead of the competition. For more on this, see the blog “Genius Sleep.”

Sometimes, we can get so caught up in trying to move forward with our own company’s agenda that we forget to consider the ways in which competition can benefit from our strategy as much or more than we can. Unless we incorporate wall-building into our strategic process, we may be blazing trails which others use to get greater success than we do. Incorporate ways to increase your speed, suck up capacity, create exclusivity, increase loyalty, and stay a step ahead.

If you are not very good at building walls, then perhaps you should not have a strategy that is overly dependent upon innovation. Instead, you may want to become the fast follower by focusing on ways to tear down walls.

Saturday, August 18, 2007

X-Ray the Balance Sheet

Imagine that you were asked to judge a beauty pageant. However, after you accepted, you were told that you would not be able to see any of the women in the pageant. Instead, all you would be able to see were X-rays of their skeletons.

Well, there’s a few things you can tell about beauty from looking at the X-rays. For example, you can check the spine for good posture. In addition, beauty pageant winners tend to be tall and have high cheek bones. You can check for those on the X-rays as well.

However, there are many things the X-rays cannot tell you, such as skin tone and the amount of fat on the contestant. Even more important, X-rays cannot tell you if the contestant has a winsome personality, poise, or a winning smile. You cannot hear them speak or see them walk. It is all of these subtleties which create a true pageant winner.

So the X-rays may be able to eliminate obvious losers, but by themselves are inadequate to determine who the best winner should be. At some point, you have to just narrow the choices and guess.

A lot of business strategy these days revolves around buying and selling companies. In many ways, these courtings between buyers and sellers are a lot like beauty pageants. This has been especially true lately with all of the activity by private equity funds, hedge funds, and the like. These funds look at thousands of companies to find who they want to crown as that beauty they then try to purchase.

How do many of these firms find the time to look at so many different companies? In part, it is done by narrowing the focus to published financials. They pour over hundreds of thousands of numbers, looking for patterns that could lead to easy profits.

Finding the right takeover target just by looking at financials is similar to trying to determine who should win a beauty pageant by only looking at their X-rays. Sure, a balance sheet can tell you how strong an underlying business structure is, just as an examination of a skeleton can tell you how well a person is structured. But true beauty is more than just structure.

The subtleties of a smile, a personality and a walk can overcome a slightly less than perfect skeleton. Similarly, if a balance sheet is examined without looking at the subtleties of the business, you can miss a lot of the features which can truly make a company great (or truly ugly).

The principle here is the risk of an over-reliance on numbers. Over the last year, I have had the opportunity to interact with some of those private equity funds and hedge funds. They all seem to have some of those quantitative geniuses in their organizations—people who are experts at dealing with numbers. It is scary how smart some of these people are, at least when it comes to looking at financials.

When they look at a set of numbers, they can see all sorts of business issues, just like a medical expert can see all sorts of things when looking at an X-Ray. Unfortunately, to many of these quantitative experts, the numbers are really nothing more than abstract concepts. They really do not understand the subtleties behind how the numbers are created. They can see a bad gross margin, but have no idea how to turn it into a good gross margin.

Because they look at so many different kinds of businesses, they often become experts in none of them. It’s all just a bunch of numbers and the trick is to find a combination of numbers which can be easily tweaked for profit, regardless of the industry.

After these firms get done looking at the numbers, some of them then go to management to get “comfort” with all of the subtleties behind the numbers. To me, this is a lot like asking a sleazy used car salesman to give you comfort that his promises about the car he is trying to sell you are true. There is a reason why my wife always takes a used car she is considering purchasing to an auto mechanic she has known and trusted for years. This mechanic has pointed out things the used car dealer was trying to hide, saving my wife from making several mistakes.

Why go to all the trouble to do your numerical homework and then drop the ball on the other aspects of success? This is like getting your act together on how to haggle over price on the used car without knowing whether the engine is in good shape.

In the beginning of the current rush to private equity, knowing just the numbers may have been enough. However, times have changed. There are many more firms bidding up the price and it has gotten a lot harder to find cheap money with which to do a deal. The margin for error has gotten less favorable. It is riskier. Now you cannot “manufacture” enough profits just through clever financials. You also have to “earn” them through superior execution of a sound operating plan.

There are many firms out there that “get it,” including firms like Cerberus. Cerberus employs a lot of operational experts full-time, people who in the past have been successful CEOs of large companies, or bring other types of operational expertise. This allows Cerberus to see beyond just the X-ray of the balance sheet and get to know the full personality of the beauty they are courting.

A similar problem exists in the firms which build those massive mathematical models for stock trading, typically referred to as quant funds. The reasoning was that if you churned through enough numbers quickly enough, you could beat the system. However, as the Wall Street Journal pointed out last Tuesday, these funds have done poorly in the volatility in the market of recent weeks.

According to the WSJ column Ahead of the Tape, the quant funds were playing with some of the same math as the private equity and LBO firms. This doubled the riskiness of what was going on, so that when the credit crunch squeezed the LBO gang, it also busted the math of the quant funds. What the columnist found particularly amazing was that the quant funds were so focused on just the numbers, that they missed the whole concept of how their fate was tied to the LBO boom, something easily seen by those with their heads out of the spreadsheets.

To quote Ahead of the Tape columnist Scott Patterson, “Many quant fund managers now seem to think that their models will start working again soon enough. But if the models proved flawed this time, who’s to say they won’t be proved flawed again?”

Understanding numbers is critical to success in forming business strategy, particularly as it relates to buying and selling companies. However, if one only looks at numbers, one can be deceived about what is going on behind the numbers. A more balanced approach is needed which looks into the subtleties of success. Just as beauty queens are more than just a good skeleton, great strategic deals need to rely on more than just number manipulation.

Mergers typically do not fail because the number gathering was flawed. It isn’t because of a glitch in a formula on a spreadsheet. Instead, mergers typically fail due to people issues, cultural integration issues or an insufficient understanding of the nuances of business acquired. It is the very things that are hard to place on a spreadsheet which can make or break the deal. Why don’t we spend as much time on these other issues as we do on the number gathering?

Wednesday, August 15, 2007

Better Than Last Year

What would you think of a CEO if he said the following:

“Last year, our product defects killed 20,000 people. This year, our product defects killed only 10,000 people. I cut the deaths related to our defective product design in half. That’s a tremendous improvement! I should get a huge bonus for that. In fact, I should have a parade given in my honor.”

Now, what would you think of this CEO if you also knew this:

The reduction in deaths had nothing to do with improving the product design. Instead the reduction in the death count was due to the fact that so many people had heard of the deaths related to the defects in the prior year that the number of purchases of the product this year was also cut in half.

Businesses tend to exist in a world that likes to measure progress versus the prior year. The general logic is that if your performance this year is better than last year, then you have done a very good job and should be rewarded for it.

In the story above, the CEO chose as his measurement the number of deaths related to product defects. Since this year’s results were better than the prior year (i.e., he cut the deaths in half), he felt he deserved a big reward.

However, there were a couple of flaws in his logic. First of all, he assumed that 20,000 deaths last year was an acceptable standard, and that any improvement on that standard was an added bonus. In reality, any deaths caused by defective product design should be considered intolerable. The goal should not have been “achieve less than the 20,000 deaths last year.” Instead, the goal should have been “no deaths from defective design.”

Second, he wanted to be rewarded for beating last year’s performance on this measure, even though the means by which he achieved it was ruining the company. This CEO did not try to eliminate the defect in the design. Instead, deaths were dropping because many people became aware that the defect still existed and therefore stopped purchasing the product. This CEO was ruining the brand image, ruining sales, and ultimately ruining the long-term viability of the business. Yet he wanted to be rewarded for it.

Obviously, just trying to beat last year—by any means possible—is not always worthy of being rewarded.


The principle here is to understand the risks involved in rewarding behavior impacting the future based on looking at looking at the past. Past performance is not always the best benchmark for grading future performance. Some of the key factors to consider are the following:

1) Was the achievement of the past at acceptable minimum levels of performance?
2) Is this the appropriate benchmark to measure?
3) Can we achieve success in the future by merely doing the same things better, or do we need to do something different?
4) Is this a time when taking a step backward is called for?
5) Can the goal be met by doing the wrong things?

These points are discussed in more detail below:

1) Was the achievement of the past at acceptable minimum levels of performance?
As we saw in the story above, the CEO assumed that 20,000 deaths due to a defective design was an acceptable benchmark to improve upon. In reality, the acceptable minimum level of deaths due to defective design should have been zero. Anything less than zero should have been punished, even if it were a great improvement over the prior year.

Now you may not have done anything which killed people, but what if you were “killing” a company’s return on investment? What if your division had been losing money for 5 years straight or providing a sub-standard return on investment for 8 years? At some point, just saying “Well at least I lost less money than the prior year” does not suffice. At some point, the minimum standard needs to be set significantly higher than the past. At those times, providing an adequate return on investment needs to be demanded at a minimum, even if past behavior has been well below that standard. And if you cannot do it, we will have to find someone else who can.

For more on this topic, see my prior blog “We Suck Less is Not a Strategy.”

2) Is this the appropriate benchmark to measure?
Not all measurements criteria are created equal. Some are more appropriate at this point in your business’ life cycle than others. For example, at the beginning of a lifecycle, getting recognition and acceptance in the marketplace may be more important than profits. During the growth phase, growth in sales, market share or capacity may be the best measure. In maturity, profit margins may be the best measure of success. In decline, reduction in expenses may be a better measure.

It does no good to hit a target, if it is the wrong target to be aiming at. For example, if you focus too much on profit margins too early in a lifecycle, you may permanently stunt the long-term growth potential for future profits. If you focus too much on growth in the mature phase, you may be destroying value by making poor investment choices at a time when there is not enough growth to support them. Just look at the problems Wal-Mart is having trying to remain a high growth company. They finally decided to curtail some of their expansion plans, because there was not enough market growth potential to support it. For more on this subject, see my blog “Management by Growing.”

In general, the best criteria to measure success are the ones most closely tied to your current strategic objectives. In other words, are you closer to your strategic goal than you were last year? Every year, you may have different near-term strategic objectives. Therefore, you may need to change your measurement tool annually as well. What you want to get better at is achieving your strategy. If that is not something that gets measured, then there is a good chance it will not be achieved, as people instead do whatever it takes to meet the measured goal for the year.

3) Can we achieve success in the future by merely doing the same things better, or do we need to do something different?
If changes in the marketplace are making what you do no longer competitive, or worse yet, obsolete, then just doing it better than last year may not be good enough. Measuring success as making analog camera film more efficiently in a world of digital photography may not be the best goal.

If you are a small hardware store, and a big Home Depot or Lowes decided to build across the street, perhaps this is a good time to reassess what you are doing. Perhaps doing what you did before—only a little better than last year—may no longer be appropriate. It may be time to try something different.

In our little story above, the CEO was trying to be more efficient at building a defective product, instead of focusing on fixing the defect. He needed a new product design, not a more efficient way to kill his customers.

Maybe this is the year for reengineering rather than just improving on status quo. And sometimes when you reengineer, you take a short step backwards during the changeover, which leads to our next point.

4) Is this a time when taking a step backward is called for?
Sometimes you have to take a step back in order to leap forward later. Ramping up R&D or investing more in technology might temporarily cause profits to dip from the prior year. However, it may be the only way to insure greater long-term success. If you continue to under-invest every year in your core business in order to squeeze out an incremental profit, you may eventually choke the business and kill off your future cash flow stream. For more on this topic, see my series on “Cutting Yourself to Prosperity?” Part 1, Part 2 and Part 3.

5) Can the goal be met by doing the wrong things?
Yes, it is true that if you want to change behavior, you should measure that behavior. However, improper measurement might cause them to change their behavior to the worse. In our little story above, the CEO was measured on reducing the killings related to defective design. But rather than improving the design, he achieved the goal by cutting sales in half.

You can improve sales by destroying profit margins. You can improve profit margins (at least for a little while) by cheapening your offering. You can increase market share through acquisitions for which you pay so much that it never provides an adequate return on investment. Therefore, when setting targets, make sure that there are some controls on the methods used to achieve the target, so that bad practices are not rewarded.

Although we like to pat ourselves on the back and congratulate ourselves whenever we improve on last year’s performance, often times just “beating last year” is simply unacceptable. Perhaps last year was a bad benchmark (e.g., influenced by hurricane Katrina). Perhaps we chose the wrong measure to improve on. Perhaps we achieved the goal in the wrong way. Rather than always looking backwards, we need to set goals more with the future in mind.

Goals need to be set well in advance. It does no good to wait until near the end of the year to pick what you want to be measured on for that year. After all, you can always find at least something on which you improved over the prior year.

Sunday, August 12, 2007

Mow Your Yard

Vicki Wozniak, of Edgewater Park, New Jersey, decided to let her suburban yard go “natural.” Rather than having a yard of neatly trimmed grass, it is overgrown with wildflowers. She put a small pond on the 1/8 acre lot and let the bushes go untrimmed.

Vicki claims she is building a beautiful natural habitat for birds, butterflies and other creatures. She has gone so far as to get her yard certified as a backyard habitat by the National Wildlife Federation. She even has a sign in her yard to prove it. She is proud of what she it doing to help the environment.

The township and the neighbors don’t quite see it that way. They see it as a dangerous health hazard due to the mosquitoes breeding on the property. In addition, it just doesn’t look like a normal suburban yard. It’s just not the way things are supposed to be done.

She has been summoned to court to make her yard conform to normal standards of neatness. She has been notified by the city that: “Your property has become blight to your neighborhood, with its overgrown landscaping, bushes and weeds…There is accumulated debris and is in an unsafe condition.”

So much for the green revolution—all is well and good as long as it is not in your neighborhood.

Just as residential communities have standards for the way things are supposed to be done, so does the business community. Residential communities want yards to be clean, neat and efficient. Business communities want companies to have clean, neat and efficient operations, portfolios and balance sheets.

If a resident doesn’t follow the rules, the government steps in and mandates changes, which can go as far as mowing down your habitat and then giving you the bill. If a company gets outside the realm of efficiency, investors will step in and mandate changes. If the management refuses to comply, they can lose their jobs.

Sometimes, it comes from activist investors. Sometimes it comes from hostile takeovers. Other times it can come from hedge funds or private equity funds, or maybe a nervous board of directors. Whatever the source, they come in and demand that you “clean up your act.” If you do, THEY reap the rewards of neat and efficient operations, portfolios, and balance sheets. If you do not, they find someone who will.

Now Vicki Wozniak believed that she had good and legitimate reasons for what she was doing. These reasons did not convince the township.

Business leaders could also believe that there are legitimate reasons for their “untidy” businesses. For example, they might think that a balance sheet “overrun” with cash is good, because it creates the stability needed to focus long-term and take appropriate risks. Or they might like having an “untrimmed” portfolio of businesses because they believe the diversity protects them from problems in any single sector. Or perhaps they like having a looser style of operations, because it fosters more creativity.

Regardless of the reasons, others will see it as inefficiencies and swoop in to take control. They will strip out the cash (and give some to themselves). They will clean up the portfolio (and pocket some of the benefits). They will make the business run leaner (and pocket some of the benefits).

Of course, there may be something even more insidious going on here.

The insidious principle here is that if a company fails to do comprehensive strategic planning on the inside, pressure will come from outsiders who do their own comprehensive strategic planning. And you may not like the way the outsiders plan your business. Therefore, it is better to do it yourself.

Companies would rarely admit to abdicating or ignoring strategy. However, what goes for strategy might not be comprehensive enough. Strategy needs to be more that just slapping higher performance targets on doing pretty much what we’ve always done. Just saying “get 20% more profits out of your division” may not be enough. Perhaps the company should not even own that division. Perhaps the division should be repositioning itself in a new direction which would temporarily lower its profits.

Every so often, one needs a zero-based strategy session to question the status quo and ask some tough questions:

1) Do we have the right portfolio of businesses (is it properly trimmed)? Should some portions be jettisoned? Do we need to acquire new businesses to optimize the portfolio? Will we unlock additional value to the firm if we spin some divisions out (in whole or in part)?

2) Is our balance sheet properly trimmed? Is there too much cash in the company? Are we leveraging our debt to the right levels? Is our dividend policy appropriate? Should we be buying back stock?

3) Are our businesses being run as efficiently as they could be? Are we using best-in-class principles? Are we missing opportunities to get more profits out of the investment?

4) Are we focusing our businesses on the right opportunities? Are they adapting to the changing environment? Does the product mix have dead weight in it that should be discontinued?

5) Does the division have a path to win? If it cannot win in its space, can we move it to a space where it can win? If it cannot win, then why are we bothering with it?

There are many groups out there who are looking at all sorts of firms all the time and are asking these types of questions for each firm. In essence, they are doing comprehensive strategic planning for your business without your knowledge or consent. If they think that their strategy is better than yours, they will swoop in and take drastic action.

Therefore, you cannot just rely on small, incremental planning. You cannot afford to get a little lax or sloppy. You cannot afford to ignore the bigger picture of how to radically reconfigure your company to maximize its returns. You cannot afford to ignore the balance sheet as part of your strategic plan. Even if you have the endorsement of the board (just like Vicki had the endorsement of the Wildlife Federation), it may not be enough.

I suspect that if Vicki had only devoted a small portion of her yard to the green revolution, she could have gotten away with it. Similarly, if a company truly believes that some alleged “inefficiencies” are good for the business, they could probably get away with it if most of the business appears neat and efficient.

However, Vicki got too far out of the norm. So now she might end up losing it all. Similarly, if a company gets too far out of the norm, the leaders could end up losing control of the company.

These outsiders, if they take control, might get too radical in their corporate surgery. In their quest for the greatest efficiency (and their greed to put as much in their personal pocket as possible), they may swing the pendulum too far in the other direction. The company could get saddled with so much debt, and have so little flexibility to take risks, that it could go bankrupt. To continue the analogy, they may cut the grass so short that it burns out and dies.

Therefore, it is better if the insiders do their homework and ensure that their “yards” never get so overgrown that they draw the interests of these parties. Never get yourself into a position where outsiders are doing more sophisticated strategic thinking and modeling of your company than you are. MOW YOUR YARD.

We live in sophisticated times, when outsiders can scrutinize companies from afar and swoop in if they think they have a better strategy. Top notch, sophisticated, comprehensive strategic planning—which is willing to look well beyond the status quo—needs to be done internally so that the company benefits, rather than some outsiders. Beat them at their own game by keeping yourself so efficient that they have no incentive to come after you.

These outsiders are doing all of this analysis over hundreds of companies. You only need to do it for only one company. Surely you can find enough time to do that.

Wednesday, August 8, 2007

Full Circle

One of the most important satirical novels of the 20th century was Animal Farm, by George Orwell. In this story, the animals on the farm were sick and tired of the harsh and inhumane treatment they received at the hands of humans. Finally, they took matters into their own hands started a revolution—kicking all the humans off the farm.

At first, everything after the revolution was wonderful. All the animals felt equal and appreciated. The noble cause of the revolution was put to song. To ensure that the animals on the farm would never again suffer as badly as they did under the humans, they enacted the Seven Commandments:

1) Whatever goes upon two legs is an enemy.
2) Whatever goes upon four legs, or has wings, is a friend.
3) No animal shall wear clothes.
4) No animal shall sleep in a bed.
5) No animal shall drink alcohol.
6) No animal shall kill another animal.
7) All animals are created equal.

For the animals not smart enough to remember all of the commandments, they were shortened to one chant: Four Legs Good, Two Legs Bad.

Over time, Napoleon the pig started gaining more power. The more power he gained, the crueler and more dictator-like he became. Slowly, Napoleon started changing the seven commandments in order to justify his dictatorial behavior and the fact that he was letting the pigs ignore the rules. The commandments started to read as follows:

No animal shall kill another animal without cause.
No animal shall sleep in a bed with sheets.
No animal shall drink alcohol to excess.

Over time, most of the older animals who remembered the great cause behind the revolution die off. Squealer the pig, one of the last of the original group, assumes power and continues the cruel and harsh dictatorship from the pigs which began under Napoleon. Squealer even taught himself to walk upright on two legs and began to wear clothes.

Squealer changed the chant to: Four Legs Good, Two Legs Better. Then he changed the Seven Commandments to a single commandment: All animals are created equal, but some are created more equal than others.

The pigs decided to invite the neighboring human farmers over to show off how productive the farm was (due the harsh treatment of the non-pigs). As the other animals watched the dinner proceedings through the window, they realize with horror that they can no longer tell the pigs’ faces from the human ones.

New businesses often take off and become successful because they have done something “revolutionary.” It may be a revolutionary way to deliver a product so that the price is dropped significantly below what it could be purchased for previously, like what discount stores did to department stores. It may be a revolutionary approach to service that pleases the customer far more than what they had before. It could be a revolutionary way of treating the employees, which creates unusually high morale and productivity, such as what was done at Costco. It could be a revolutionary process which produces never-before seen levels of quality.

It could also be a special way in which the company bonds with the community, going above and beyond the call of duty to give back to the local community. It could be a devotion to particular causes, like sourcing locally, being environmentally friendly, not testing on animals, and so on.

Whatever the source of the revolutionary concept, the new twist on the way things are done can often result in success. Success can change the attitude of companies.

In the Animal Farm story, the revolution started for a noble cause—to eliminate cruel treatment of animals at the hands of the humans. At first, this creates great joy among the animals, who are willing to make sacrifices for the greater good. Eventually, the noble cause is forgotten, and the pigs become just as cruel to the animals as the humans had been. In the end, the animals cannot distinguish between the humans and the pigs.

This same thing can happen when revolutionary companies get large and successful. The idealistic leader is eventually replaced with a “professional manager,” schooled in the old ways. When tough times come (and they always do), instead of sticking to the cause of the revolution, they begin to cut corners. Those unbelievably low prices start to become closer to what others charge. The revolutionary service becomes less revolutionary. Employees are treated less like partners in a revolution and more like costs which need to be contained.

Eventually, there are very few people left in the organization who remember the humble beginnings of the revolution. Now, all that the management sees is a large company.

Before you know it, the customers have a difficult time seeing differences between this formerly revolutionary company and all the old, large companies it used to be taking share away from. The pigs look just like the humans. The customers stop patronizing the company and move on to the next revolutionary company. And thus, everything has gone full circle, from revolution to normalcy to stagnation…and then the cycle begins again with another company’s revolution.

It is very difficult to keep from falling into the trap of going full circle, of losing your reason for success due to losing the spirit of the revolution. The revolution will not stay alive on its own. Natural forces will tend to push a company more towards normalcy. A company must proactively put into place mechanisms to keep the revolution alive.

Look at Apple. Apple started out as a very revolutionary company, doing things differently from others. These revolutionary differences were the driving force behind the success Apple was having. When Steve Jobs left Apple, the revolution faded, and so did the fate of Apple. Steve Jobs had to come back and start the revolution all over again. Now Apple is back to designing revolutionary products under a revolutionary philosophy and selling them in a revolutionary way. The success is back, bigger than ever.

A similar situation happened at Gateway Computer. Ted Waitt started the company in an Iowa farmhouse in 1985. His rural Midwestern culture and personality (which was not like traditional businessmen) helped to create a revolution in the computer business. Eventually, the success caused the company to become quite large. Ted felt that his style of leadership and approach to business was no longer appropriate for such a large firm.

As a result, in 1998 he moved the company from South Dakota to California, where all the other big technology companies tended to be. At around the same time, he hired a bunch of “professional managers” to run the place, people schooled in the traditional way of running large companies. In 2000, Ted Waitt completely backed away from active management and left the “professionals” in charge. Between the move to California and the professional managers, the revolution at Gateway died…and so did the prosperity of the company.

Not very long later, Ted had to call off his retirement and come back to manage the business again. He fired the professional managers and tried to resurrect the old culture via TV commercials. Unfortunately, by then it was too late. The revolution was dead and could not be brought back to life. Regarding the professional managers, Ted said, “They were really nice people, but they didn’t seem to do anything,” at least not anything in the hands-on manner that Ted was used to.

The situation at Whole Foods may soon be approaching the loss of the revolution. The recent revelation about outbursts of CEO John Mackey on internet stock message boards is forcing the board to have to reign in Mackey a bit and make the company more “professional.” The old homey, down-home natural approach to the stores is starting to be replaced with glitz and glamour. At some of the newer stores you find things like fancy restaurants, fancy day spas with personal shoppers to purchase your goods while you get a massage, fancy cooking schools, and so on. The potential loss of the revolution could lead to big trouble down the road.
This is why strong vision statements and attention to culture are such an important part of strategy. They help to keep the revolution alive—the differentiation which made the company great in the first place. This may ultimately be more important to long term success than any other part of the strategic process.

When designing a strategic planning process, it is important to proactively work to retain some of the revolutionary heritage which created the initial success. Otherwise, when the leaders and other revolutionaries retire, the revolution will die. Then you will just be another big company, and indistinguishable from everyone else. You lose your competitive edge and are replaced by the next revolutionary company.

Wal-Mart has succeeded for so long because the revolutionary culture surrounding low cost/low price started by Sam Walton has been so ingrained in the culture that the revolution has survived more than a decade after his death. Recent cracks in that success stem in part from a new culture of paranoia filtering through the company as well as a desire to be a little more upscale (walking away from the strong foundation).

Tuesday, August 7, 2007

A Divine Right to Perpetual Success

Back in the 1980’s, Donald Katz wrote a book about the history of the Sears retail company. The book was titled The Big Store. In this book, Mr. Katz went into great detail about all of the successes and failures Sears has had throughout the years.

Katz tells a story in the book about one of the low points, when Sears was losing customers and having financial difficulties. A group of Sears executives got together to try to diagnose the problem and find a solution. One of the executives exclaimed that he knew what the problem was. I lost my copy of this book a long time ago, so I cannot quote it exactly, but what that executive said went something like this:

“The problem is that people have forgotten that we are Sears. If we can just remind them that we are Sears, then they will come back and shop us again. Sears represents Americana. Sears is a part of our American heritage. If people could just remember how great Sears is, they would come back.”

Apparently, to this executive, the problem with Sears was the stupidity of the customers. These customers had forgotten that Sears is a successful brand who deserved their patronage simply because it was Sears. People had forgotten that Americans are supposed to shop Sears because that is what Americans do.

Contrast this to the response to a blog called Brand Autopsy by John Moore. On March 21, 2007 John posed the question: If Sears went out of business tomorrow, would anybody care? Some of the responses were as follows:

“Miss Sears? I can't remember the last time I was in one of their stores. Sears was a regular stop for my parents while I was growing up in the 60's.”

“Going to Sears is like a trip to the museum. You get to experience the past permanently.”

“I gave up on Sears years ago.”

“Did anyone miss Roebuck all that much?”

The Sears executive in the story assumed that for some reason Sears deserved perpetual success. It was as if there had been a decree from heaven that people were supposed to always love Sears. If people stopped loving Sears, it was because they forgot that Sears had a divine right to always be successful. If people would only remember that Sears is a successful brand, then it would be successful again.

This executive made the fatal mistake of taking success for granted. He assumed that once a brand attains success, that success cannot be taken away—once successful, always successful.

Unfortunately, brands have to win their loyalty every day. Past victories do not ensure future victories. When developing strategies, do not take success for granted. Do not take your customers for granted. Future strategies need to incorporate tactics designed to continually make the brand relevant and desirable.

The second fatal mistake this executive made was to blame any failure on the customer, rather than the business or the executives. Remember, the customer is the one with the money. If they don’t like you, they will spend the money elsewhere. It is your responsibility to get them to spend it with you. If they spend it elsewhere, you have to take the blame. If you take the approach to failure as “My strategy was perfect, it was the customer who was flawed,” then you are doomed to repeat that failure.

The principle here is that reputations are perishable. Just because you have a great reputation today does not mean that you will have a great reputation tomorrow. There are several ways that one can lose a great reputation:

1) You stop doing the things which gave you the great reputation in the first place, like great service or great prices.

2) The marketplace changes and customers start valuing something different. If you do not change with the times, your prior benefits can become less desirable or even obsolete.

3) A scandal or crisis causes people to lose faith in you.

4) You are providing the same level of benefits as before, which used to be the best available. But now someone has found a way to do the same thing better than you.

Because reputations are perishable, one can never take them for granted. Every strategy needs to deal with the question of how to ensure that customers continue to love you, in spite of all the changes in the environment. If you assume that customers will love you pretty much regardless of what you do, then your strategy can fall into the trap of “customer exploitation.”

Of course, you would never refer to a strategy as being rooted in customer exploitation, but many strategies end up being that way. Here’s how the process tends to go.

If you assume customers as a given, then your focus shifts to profits. The strategic question then becomes: How can you squeeze a little bit more profitability out of those customers? The answer tends to be through a combination of small modifications: raising prices, cutting service, cutting quality, etc. The subtle thinking in the back of the mind is that customers love us, so they will put up with a small about of these reductions to the overall value of the offering. In fact, we can even come up with a fancy name for it, called “brand premium.” In other words, our brand is so strong, that we can charge a premium. Or to say it another way, if the brand is strong enough, we can exploit our customers more.

Yes, there is some truth to the power of a brand. But that power can evaporate if we exploit the customer too much. Back in the 1960s and 1970s, Schlitz was one of the top selling beers in the United States. Even as late as 1976, it was the #2 brand in the country. But the Schlitz company started taking its success and its customers for granted. Instead of worrying about its customers, it looked for ways to squeeze more profits out of what they assumed to be a guaranteed perpetual flow of business forever.

To improve profitability, Schlitz found a less expensive way to make beer. Unfortunately, this process had the negative side effect of making the beer taste less desirable. Although people had loved the Schlitz brand in the past, they did not care for the inferior taste of the new beer made with the cheaper process. The love was lost. They abandoned the beer in droves. Today, Schlitz is a minor factor in the industry, made in small quantities by Pabst.

So what do I think was the principle factor behind the decline of the Sears brand? Back at the height of the Sears success (in the 1950s and 1960s), the US had Fair Trade laws. These laws made it illegal for a retailer to sell a product below the retail price suggested by the manufacturer of the product. If you were a retailer selling name brand products, you could never really get a price advantage over the competition. By law, you were constrained to price parity.

This is where the genius of Sears came in. Sears developed its own lines of products under its own brand names, like Kenmore and Craftsman. They positioned them to be every bit as good as the brand name products. However, because Sears owned the brands, it could charge whatever price it wanted. It was not restricted by the Fair Trade laws. Therefore, it priced its brands to always be below the fair trade price on the equivalent brand named goods.

In essence, Sears was the Wal-Mart of the 1950s and 1960s. It owned the reputation for “always low prices.” The laws of the United States almost guaranteed that Sears would be lowest priced alternative.

However, the Fair Trade laws started being abolished in the late 1960s/early 1970s. Suddenly, Sears was no longer guaranteed to have the lowest prices. Department Stores and Big-box specialty stores could now underprice the Sears private label with the often more desirable brand names. In fact, the repeal of the Fair Trade laws helped spur the rapid growth of discount department stores, like K Mart and Wal-Mart.

The reason people had loved Sears (lowest prices) vaporized. Sears was no longer the “Wal-Mart” of their time. Now Wal-Mart was the Wal-Mart of their time. Because Sears did not understand why people used to love them, they had no idea why people stopped loving them when the environment changed.

When Sears lost its original reason for success, it needed to do one of two things with its strategy. Either it needed reinvent itself so that it could hold onto its lowest price reputation (in other words, morph into a discount store like Wal-Mart), or find a new position as desirable as the old one (which they have never found).

It is not the customer’s fault that Sears is not doing well. The customer did not forget what made Sears great. Sears failed to understand the impact that Fair Trade laws had on their success, and so it misread the impact when those laws were lifted. The Sears strategy never found a new reason for customers to love them, because the company was apparently not aware that it even needed a new reason for people to love them. They thought “Americana” was enough. Sadly, it was not.

There is no such thing as a perpetual divine right to success. Customers love you for a reason. Things can change, causing that reason to no longer apply. Therefore, strategic processes must always have at their core a reassessment to ensure that the company continues to have a desirable and winnable position in the hearts of their customers. Otherwise, you can take the customer for granted and increase your exploitation of them until they eventually leave.

During this same time period (the 1960s/70s), Kresge could see what was going on in the environment and morphed itself from being a variety store chain (S.S. Kresge) into being the leading discount store chain (K Mart). Sears could have done the same. It is their own fault that they did not.

Monday, August 6, 2007

Reason Vs. Rationale

This story, and its many variations, have occurred countless times over many generations. It goes something like this.

A boy named Timmy finds a cute little stray dog. Timmy falls in love with the little dog. He coaxes it to follow him home. When Timmy gets home, he tries to convince his skeptical mother to let him keep the little dog.

“But Mom, raising a dog will teach me responsibility. Don’t you think it’s a good idea for me to learn responsibility at a young age?”

“But Mom, I’ll train this dog to be a great watchdog. You don’t want any burglars to come into our house and steal our prized possessions, do you? With this dog, you can rest easy, knowing that you are safe from unwanted intruders.”

“But Mom, in case our house catches on fire at night, this dog will wake us up and make sure we get to safety. He could end up saving our lives.”

Eventually the mother gives in, but only after Timmy promises to take care of the dog by feeding him, taking him for walks, and bathing him.

Well, over time, the Timmy’s promises regarding the dog fall by the wayside. He no longer wants to feed him and walk him all of the time (Guess who ends up with the chore—you guessed it—“Mom”). The dog never becomes a watchdog and the dog would sleep through a fire. And the dog is always filthy.

However, Timmy got what he really wanted: a canine companion who provides unconditional love.

In the story of Timmy and the dog, there are two types reasons given for why the Timmy wants the dog. The first is an emotional reason—Timmy wants a canine companion who provides unconditional love. The second is a rational reason—the dog teaches responsibility, the dog will protect the family, the dog might even save the lives of the family.

Timmy doesn’t really care at all about the rational reasons. They do not motivate his desire for a dog at all. All he cares about is the emotional reason—his emotional bonding with the dog as his canine companion.

Yet, without all of those rational reasons, there is a good chance that his mother would not have let him have the dog in the first place. So, from that perspective, the rational reasons are important to Timmy as a means to get the emotional desire satisfied.

In the business world, we try to sell products or services to customers. Sometimes, we may try to sell the product or service with just an emotional appeal. Sometimes we use just a rational appeal. In reality, it is often best to use a dual appeal: an emotional appeal (you’ll really love this dog and this dog will love you) and a rational appeal (it teaches responsibility and protects the family). Each serves a different purpose in the process.

The principle here is understanding the difference between reason and rationale. Reason refers to the true reason why you desire the product or service. It is usually emotionally based. Examples include the following. If I owned this product or service….

…I would feel more manly (or more feminine, depending on gender)
…I would be more popular with the opposite sex
…I would feel more secure (safer, more protected, less at risk)
…I would have more fun
…I would eliminate stress in my life
…I would gain more stature (have more bragging rights) with my peer group
…I would feel better about myself

In Timmy’s case the reason was unconditional love. Reasons such as these tend to be the principle drivers which create the desire to want to make that purchase. However, reason alone is often not enough to clinch the deal and make the sale. That’s where rationale comes in. This is how we justify our seemingly irrational desires and make them appear to be the sensible thing to do. Sometimes we need this justification just to get that rational part of our own mind to give in to the emotional side which already wants to do the deal.

Sometimes, as in the case of Timmy, there are others who have a say in the decision (like Mom), and since they do not experience the same emotional attachment, they must be convinced more through the logical rationale. Other times, we have to justify the expenditure to a skeptical spouse before we are allowed to make the purchase. Sometimes, the rationale is most important after the purchase, so that we can explain to others why our purchase was not wasteful extravagance, but rather the wise thing to do. After all, we might not mind looking stupid to ourselves if we get our emotions satisfied, but we don’t want to look stupid to our friends.

This does not just apply to children and dogs. Perhaps you can recall an episode of The Simpsons, where Homer really wants to buy a big truck. It’s all about his emotional desire to own a big truck. His wife Marge needs extra convincing to get her to agree to the purchase. So Homer pulls out the rationale: “If we put a plow on the front, I can make money plowing people’s driveways. This truck doesn’t cost any money. It will pay for itself through the income from plowing.” The rationale cinched the deal.

What about beer? On the one hand we subliminally sell that message that if you drink this beer all the beautiful women will love you. This is the reason to get you to choose this beer. But then comes the rationale: less filling, wins taste tests, low in carbs, won’t slow you down.

There are a lot of sexy looking new washers and dryers out there in hot colors and slick designs. They also look all “high tech” for those who are lured by that sort of thing. Their looks cry out to your emotions to “purchase me.” Yet, to appeal to your rational side, they also claim to use less water and less electricity. Why, you are a wise protector of the environment if you purchase these sexy looking machines. Never mind the fact that they often don’t clean as well as the old machines and that much of the money you save in water and electricity is sucked up into the premium price you pay for the machines. As long as the rationale makes you look good, and you get the sexy machines you desire, all is good.

And then there is life insurance—a product very few have a natural desire to want to load up on. Therefore, the insurance agents need to conjure up emotional desire for you—the desire to feel secure, to eliminate stress in your life fretting about the future. Then they pile on the rational guilt—good, sensible people provide for their loved ones in case the unthinkable happens. You’re a good sensible person, aren’t you?

When developing a strategic position for your product or service, one needs to consider developing a position which can tap into both the emotional yearnings (the reason) as well as provide justifications for why it is the wise thing to do (the rationale). The more you can tap into both in your singular position (without creating confusion), the greater the likelihood that you will succeed.

To do so, one side usually has to be the dominant overt message, while the other is more subliminal, in the background. Sometimes the reason is the dominant message. Sometimes the rationale is the dominant message. But both are there.

Right now, off the top of your head, can you tell me what the reasons are and what the rationales are for what you sell?

Positioning is the process of placing the image your product or service into the mind of the customer in a way that will cause you to win. Since our minds are both rational and emotional, winning usually requires creating advantage in both the rational and emotional aspects of our thinking. You may want to sell the manliness of owning a truck, but you’d better have that snow plow equivalent in there somewhere, too. What’s your version of the snow plow?

I wonder what Timmy would have told his mother if, instead of desiring a little dog, he wanted to bring home an elephant. I’m sure, if he wanted it badly enough, he would have come up with all sorts of rationale for why that would be a wise move.

Sunday, August 5, 2007

Strategy Without Powerpoint

I know of a college where the student newspaper would not put out a regular issue on April Fools Day. Instead, they would put out a phony paper making a satire of the regular paper.

One year, the lead story in the satirical April Fool’s edition focused on a supposed plan to tear down one of the newest and most prestigious buildings on campus (something they would never consider in reality). Next to the article was a large photo with the caption: ARTIST’S CONCEPTION OF WHAT THE CAMPUS WOULD LOOK LIKE WITHOUT THE BUILDING.

So what did the photo look like? It was a photo of the campus just as it always was. The building in question was still there, as prominent as ever, in the center of the photo. The only difference was that the “artist” had drawn a big “X” over the building. That “X” was supposed to help me visualize a campus without that building.

Businesses use a lot of presentations. Some are beautiful Powerpoint presentations, full of eye-catching photos and slick looking charts. They are often a real work of art. This can be particularly true at strategic planning meetings. In fact, I’ve been at strategic planning meetings where almost the entire meeting is a series of slick Powerpoint presentations.

The problem with these works of art is that you are at the mercy of the artist who made them. As in the story above, if the artist is bad, you get no real insight into what is going on. The “artist’s conception” of your strategy may not provide any more of a clue of what is going on than putting an “X” on a building shows you how the campus will do without the building.

Worse yet, if the artist has something to hide, he or she can use presentations to distort the truth.

The principle here is the idea of making strategic planning a dialogue rather than a monologue. If the strategic planning meeting is primarily just a presentation, then you have a monologue. The presenter (usually the head of the division whose plan you are evaluating) has nearly complete control over how the meeting goes. Almost everything is one directional—information from the presenter to the audience.

Monologues have a small, but useful purpose in strategic planning, particularly at either end of the process. However, if they constitute the majority of the process, then one could be asking for trouble.

In the very beginning, a presentation on issues relevant to strategy can be useful. This would include a compilation of the internal and external environment in which the division/brand/company competes. It becomes an efficient way to do a “data-dump” of all the information that could impact strategy formulation, concerning issues like:

a) What is the competition up to?
b) What are the key consumer trends one needs to be aware of?
c) What is expected to occur regarding industry issues, government regulation, new technology, or whatever else in the environment that could impact strategy?
d) What is going on within the company which could help or hinder particular strategic options? Where are the strengths and weaknesses?

In addition, at the end, after the strategy has been determined, presentations can be an efficient way to get all of the employees focused on the strategic task which lies ahead of them. It serves as a rallying point…a way to motivate.

However, in the middle of the process, slick presentations can be detrimental to the task at hand. There are many stakeholders in a strategy—the corporation, the division, the people who must execute or finance the vision, the strategy professionals, and so on. All need a voice in the process. This is best done through dialogue.

Think of strategy formulation as being similar to interviewing someone for a job. What would you think of an executive who brought someone in for an interview and just sat back while the prospective job applicant presented a Powerpoint of why you should hire him or her? You probably wouldn’t think much of that executive.

In job interviews, one usually doesn’t just allow the applicant to have a monologue and control the meeting. You don’t just take them at face value. Instead, you ask a lot of tough questions of the applicant to see what their made of. You build a dialogue to learn about the character of the applicant. You challenge them to see just how capable they are.

That’s how good strategy is formulated. You ask tough questions to determine if the strategy truly can stand up to the realities of the harsh marketplace. You examine the character of the ones who will have to execute the strategy, to see if they have what it takes to pull it off.

As mentioned in prior blogs, good strategic dialogue will help you create the proper position for your firm within the environment. It will help find the best way to pursue the strategy for maximum impact. And it will help you discover the tricks to optimize the productivity along the way.

There’s give and take; the throwing out of good ideas and bad. There’s the devil’s advocate. There’s the dreaming of “what ifs” and the scrutiny to see if the “ifs” can become realities.

This cannot be done via slick Powerpoint presentations. Last week, I suggested trying strategy without numbers (see “Strategy Without Numbers”). This week I’m suggesting trying to hold a strategy session where presentations are outlawed and see what happens.

Great strategies typically come out of great dialogue. Dialogue is stifled if all you have is an environment of well-rehearsed presentations. Charts and graphs and numbers have their place, but at the heart of strategy are creative ideas. These ideas are creating a new reality which does not yet exist—in reality, in graphs, or in numbers. It is a future waiting to be built. To make sure you have sound ideas, one needs the rigor which comes from the pressure-testing of active dialogue. Strategic planning professionals are useful in helping make the dialogue as productive as possible.

They say a picture is worth a thousand words. Sometimes I think we shortchange ourselves if we avoid pondering and discussing those “thousand words.” Taking the shortcut by substituting a picture may be faster, but perhaps not as useful.