Friday, September 14, 2007

Filling the Gap

It’s odd the phrases one remembers from their youth. When I was in high school, I had a friend whose father loved to spend his time in the great outdoors. Not only did he love to be in the outdoor wilderness, but he loved to read stories about full-time outdoorsmen from the past.

In one of these books, the author had a little saying to help in making decisions about which path to take in the woods, particularly when coming to a challenging spot, like a swamp, a canyon or a raging river. His saying went like this:

“Don’t go under what you can go over, and don’t go over what you can go around.”

In other words, when coming across challenging terrain, it is safer to find some sort of bridge over the danger than to walk into the danger. However, it is safer still to avoid the dangerous terrain altogether.

It’s odd how I can remember this little saying, but have trouble remembering birthdays, anniversaries and phone numbers.

In strategic planning, we often have some ambitious goals. These could include goals about hitting particular sales targets, profit targets or stock price targets. Many times, it may appear highly doubtful that one can reach these goals by continuing on the path one is currently on.

For whatever reason, the goal appears to require a higher level of performance than the current strategy provides. For example, let’s assume that I am a US-based retailer who has set an ambitious sales goal. Afterwards, I do the math and it appears that even if I completely saturate the entire US with my stores, they will not provide enough sales to meet my goal. There is a gap between the potential available with my current strategy and my desired goal.

This gap is similar to the dangerous terrain mentioned in the story. I am on one side of the danger, and my goal is on the other side. How do I reach my goal? What do I do to fill the gap?

Just as in the story, I have three options: go under, go over, or go around. To go under would be to plow ahead straight into the danger with the current strategy and see if I can find ways to squeeze more out of it than I currently know of. To go over would be to build a bridge to the future by diversifying into additional sources of revenues and earnings. To go around would be to avoid the challenge in front of me and settle for whatever I can attain without taking on the additional risk of plowing ahead or building a bridge.

For the outdoorsman, the goal was risk avoidance, so he tried to avoid treacherous terrain as much as possible. In the business world, we realize that if you avoid all risks and challenges, there is a good chance that we will produce unacceptable results. Some level of risk and challenge must be undertaken in order to reach the ambitious goals on the other side. There is some truth in the statement “No risk, no reward.” However, it is also true that risk can sometimes lead to failure.

So what should a business do to get to the other side? We will look at each of the three options separately to learn when each is appropriate.

Option #1: Go Under
There is a school of thought which believes that businesses often under-estimate the potential of their current strategy. These people would advise going down into the treacherous territory and continuing your core strategy. Although today you may not see how you can get enough potential out of the current strategy, these experts believe that often, over time new opportunities will develop which expand your potential without the need for radical strategic change.

Hence, the terrain may not be as treacherous as you thought. You may be able to make it through to the other side and achieve the ambitious goals without a significant deviation from what you are currently doing. For example, chains like McDonald’s and Starbucks have reached points in the past where they sensed they were reaching total saturation and could no longer rely on their core strategy to fuel their growth ambitions. However, over time, they discovered they could build far more units than they thought without saturating the market.

There are many reasons why there may be more long term potential than one originally thinks. For example, if you have created a relatively new innovation, the current acceptance level for the innovation may currently only be among early adopters. It is fairly easy to quickly saturate the early adopter segment. However, over time your innovation may move from the early adopters to the mainstream customer segment. This would create far more potential than what is available today.

Similarly, new technology often starts out as being relatively expensive and limited in its uses. However, over time the price of the product typically goes down and the number of uses for the product typically go up. Lower prices and greater uses increase the potential for the product far beyond its original potential. Take microwave ovens. At first they were seen as expensive luxuries for the rich with limited usefulness. However, once prices came down and the supermarkets provided products specifically designed for the microwave, the consumption of microwaves skyrocketed. Now, many homes have several units.

When the UNIVAC mainframe computer was first invented, the company hired a consultant to help them determine what the potential market size was for computers. Back in 1950, the experts determined that the number of computers in use by the year 2000 would be 1000 computers, which works out to be about 20 new customers per year. The “experts” failed to take into account lowered prices and expanded uses for the product.

This does not mean that one can merrily go into the treacherous territory and magically come out on the other side. It takes effort to move a product from early adopter to mainstream. It takes work to get the costs lower. It takes effort to find the additional uses for the product. The core product may need tweaking in order to squeeze more potential out of it.

And, of course, sometimes it really is true that there is not a lot of potential for your core business. Maybe a new innovation will make your product or service obsolete. Or perhaps there is potential for the business, but your competition does a better job of capturing that potential. This could leave you stuck out in the middle of that swamp or raging river without enough energy to get to the other side. The swamp could suck you in or the river wash you away.

Therefore, it is wise to rethink the potential of the core business to determine if there is more long-term potential than what is currently visible. But don’t blindly go into the swamp just hoping that “something will turn up.”

Option #2: Go Over
If one cannot easily get to the other side with the core business, it may be necessary to keep evolving your business in order to find paths to long-term growth and prosperity. One may need to add new businesses to the portfolio and get rid of old businesses. GE is considered one of the most successful businesses over the last century. They have stayed successful over time in part because they have continually modified their portfolio. They have diversified into newer, growing industries and exited stagnant businesses. Nokia has done the same.

These new businesses can get you in on the ground floor of amazing growth potential which can be far greater than what is available out of the current core business. These are the bridges that can help you get to the other side without trudging through the swamps or raging waters of a more mature business.

Sometimes the best way to avoid company obsolescence is to diversify into the businesses which are making your current business obsolete.

Of course, diversification also has its risks. Just as it is often the case that we underestimate the potential of our current business, studies have shown that companies frequently overestimate the potential of new businesses (and underestimate how difficult it will be to master the new business).

Option #3: Go Around
Sometimes the risks of going under and going over seem too high. At that time, you may want to avoid all of the risk by selling out to someone else (take the money and run).

Ambitious goals tend not to get achieved on their own. Hard work and prudent risk-taking are required. Sometimes the best path is to look for ways to expand the potential of the core. Sometimes the best path is to diversify away from the core. Often, it is wise to do a little of both (hedge your bets). However, the worst thing to do is create ambitious goals and then have no real path to get there. This will only create disappointment. The best way to find the right path for yourself is to further scrutinize your core assumptions to ensure that you are not overly pessimistic about the core business potential or overly optimistic about the ease of diversification.

A recent study looked at the characteristics of successful companies versus non-successful companies. The non-successful companies tended to be at the extremes, either doing no diversification or in doing too much diversification, particularly into areas far removed from the core. The most successful companies tended to mildly diversify, and usually into areas somewhat close to the core.

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