Tuesday, October 30, 2007

Don’t Forget the Taxman

On the front page of one of last week’s editions of the Wall Street Journal (October 23, 2007), there was a story about the tax strategy of Wal-Mart. According to the article, back in May of 2001 Wal-Mart Stores, Inc. sent out a call to the big accounting firms to find creative ways to cut their state tax bills.

Ernst & Young LLP aggressively went after the business. They put together a 37-page proposal outlining 27 potential tax strategies. Ernst & Young characterized the proposal as “a very aggressive strategy with considerable risk.” Indeed, many of these proposals skated along the edge of the law, and many states have since closed some of these loopholes.

But in the end, records show that Wal-Mart’s effective tax rate at the state level tends to be about half the average state corporate tax rate. So they are winning the war against the tax-man.

Wal-Mart is not the only aggressive tax avoider. According to the Wall Street Journal article, “Publicly traded companies reduced their federal income taxes by about $12 billion in 2004 through potentially abusive tax transactions, according to Internal Revenue data. Some experts say companies save far more than that each year through elaborate tax-cutting maneuvers.”

Taxes take a big bite out of a company’s income. For most businesses, taxes are one of the largest single expenditures. Therefore, it is not surprising that firms like Wal-Mart spent time getting aggressive about finding ways to reduce their taxation.

Yet, although many companies work diligently at getting the tax burden reduced on ongoing businesses, it seems that far fewer incorporate taxation into their long-range strategic planning. My experience has been that tax specialists are rarely invited to the long range planning discussions. Taxation is often an afterthought in the process, if thought of at all.

If it is so important to the business of today, shouldn’t it get some attention when looking into the businesses of tomorrow?

Although it pains me to admit it, the principle here is that sometimes the way a business is structured as it is related to taxation can have a greater impact on the success of the strategy that the choice in how the business is run. Even when this is not the case, taxation strategies can have a major impact on the degree of success which a strategy has. Therefore, it might not be a bad idea to give a little time to the subject of taxes when developing a strategy.

I have seen companies who finalize their comprehensive strategy and then go to the tax expert and say, “Here is the strategy. Find the way to pay the least amount of taxes on this strategy.” Tax experts have told me that there is only so much magic they can do when brought in at the tail end. If they were brought into the discussion earlier, they claim they could be more effective in reducing the tax burden.

Many times a strategy leads a company to do things differently than in the past. It may suggest getting out of some businesses, acquiring some new skills, developing a new source of revenues, inventing a business model which doesn’t currently exist, and so on. As it turns out, there are many ways to accomplish these tasks. You can have acquisitions, joint ventures, venture funding, internal start-ups, as well as many other structures.

Each structure has differing levels of implications for taxation. If taxation considerations are brought earlier into the discussion, then perhaps the strategy would choose a different (and potentially far superior) path for getting the task accomplished.

I am not suggesting here that taxation become the main driver of the strategy or that the core of the company strategy revolve around questionable abusive tax schemes. What I am recommending is that perhaps tax issues should be brought into the discussion at an earlier stage.

Sometimes, an earlier approach to thinking about taxation can change your whole approach to how you look at your business. Many years ago, I was reading an article about a strategic financial consultant who specialized in helping small independent grocers. What he would tell his clients was that they were too focused on trying to improve profitability. He told them that this was a mistake. Instead, their goal should be to find ever higher levels of break-even.

His point was that for a small independent entrepreneur, his or her lifestyle should be more important than their earnings. Earnings get taxed. Lifestyles may not get taxed if structured properly. The less you pay in taxes, the more money there is to support a nice lifestyle.

Therefore, the more care an entrepreneur makes in structuring the combination of their business and their lifestyle, the more they can make their lifestyle tax deductible to their business. By shifting more of one’s lifestyle expenses to the business, you get several advantages. First, the business becomes less profitable, so you pay less on business taxes. Second, this could result in the entrepreneur having a lower personal income, so fewer personal taxes are paid. Third, by paying fewer taxes, there is more money available to enrich the lifestyle.
So in the end, the entrepreneur is having a better lifestyle, even though on paper it looks less profitable. Hence, the expert’s admonition to chase “ever higher levels of breakeven” rather than profits.

This may not be the best advice for your situation. However, the point is that the way you look at your business can change how you act. And if you look at your business more often through the eyes of a tax expert, you may act in ways that provide superior long-term benefits.

Tax issues are often not a part of the strategy-framing discussion. Given the fact that taxes are one of the single largest expenditures of a business, it may make sense to bring in tax experts at earlier points in the strategic discussion.

I used to spend a lot of time with a tax expert at one of the places where I worked. His annual bonus was based on each year bringing to the company two new approaches to the business structure which would meaningfully reduce taxes. One year, he told me that he had three great ideas. He refused to tell the company about the third idea. He only told them about the first two (which qualified him to get a full bonus). Then he figured he’d save the third idea for the following year, which would put him halfway towards his bonus before the year even began.

I guess if you are looking for a tax expert to use his magic to take advantage of the tax rules, you’ll find someone who is also an expert at taking advantage of the bonus rules.

Sunday, October 28, 2007

Beauty Pageant

You’d think that if a contest is referred to as a “Beauty Pageant,” that beauty would be the most important factor. However, from where I sit, that doesn’t seem to be the case.

When I look at the finalists for a beauty pageant, what I first notice is that all of the women are beautiful. Not only that, but they seem to be beautiful in a similar way. They all have about the same height, weight and the same body shape. They all have great poise and they all flash a beautiful smile. There isn’t an ugly one in the bunch.

If beauty were all that mattered, they’d all be winners. However, eventually a single winner is chosen. Since they are all nearly equally beautiful, beauty alone cannot be what determines the final winner. Something else must be involved.

Is it who can best maintain the image of the pageant and best represent herself while reigning as the winner? If so, then perhaps choice has to do with background checks to see if this is the type of person who might embarrass the pageant with her behavior (or the behavior of a boyfriend). Maybe it has to do with how many (and which) languages the woman can speak and how eloquently she can speak. Perhaps thought is given to how well the candidate can hold up under all of the busy travel schedule.

Maybe it has to do with geography. If last year’s winner came from a certain geographic area, perhaps balance is needed by picking someone from a different geography this year. Or maybe areas with a larger population are weighted higher in the rankings, because they would have more local support.

Maybe it has to do with some intangible way in which she can schmooze with the judges. Some personalities just “click” better than others.

I don’t know the answer. Nobody has ever asked me to judge a beauty pageant. And I doubt they ever will.

The problem with beauty pageants is that everyone is similarly beautiful. As a result, the idea of beauty tends not to differentiate well between the candidates. Therefore, something else must act as the tie-breaker.

In a similar fashion, most business sectors are full of companies who similarly perform well in that sector. Over time, all of the poor performers are weeded out. Every business that is left tends to be similarly good at providing the basic business functions in that sector. Therefore, something else must act as the tie-breaker when choosing which business one will patronize.

Hence, the irony. Beauty pageants are not determined by beauty because all the candidates possess beauty. Similarly, business patronage is not determined by how well the business functions at the basic business service, because they all do that well.

The principle here is that choice tends to be made at the periphery rather than at the center. The choice of which beauty pageant contestant wins is not at the center, which is beauty. Instead, the choice is made based on peripheral features, like personality, internal pageant politics, geography and so on.

The same process occurs in business. Choice is not made on the core competency at the center of what industry the business is in. It cannot be, because at the center they all pass the test. The differentiation upon which choice is ultimately made must be on the periphery.

For example, I have spent most of my life in the retail industry. At the center, in the core of the retail industry is the idea of merchandising. This is the act of procuring the right product from a vendor and then offering it for sale in a reasonable way at a reasonable price. Since the function of merchandising is so critical to the essence of retailing, one would think that merchandising would be the key driver in store choice.

However, when you talk to customers, they will give you all kinds of reasons why they pick a store, and merchandising is often not a part of their answer. Instead, customers refer to items on the periphery. For example, many talk about locational convenience (they shop the store that is the closest and easiest to get to). Others choose a store because of its image (they want to be associated with a store whose good image will enhance their own image).

Does this mean that merchandising is unimportant for a retailer? Of course not. Selling undesirable merchandise poorly will kill a retailer. However, in today’s world of retailing, pretty much every retailer does merchandising pretty well. You find similar quality products sold at similar prices in similar ways.

Take, for example, office supply superstores. If you blindfolded a person and put them inside one of these stores, when they took off the blindfold it would be difficult for them to know whether they were in a Staples, Office Max or Office Depot. They all have about the same stuff sold in the same way. Merchandising does not do much to differentiate.

Customers expect all stores to be good merchants, so they look elsewhere to find a reason to choose one store over another. Just as beauty no longer differentiates at the beauty pageant, merchandising doesn’t differentiate much in retailing. Therefore, one must go to the periphery to create a favorable point of differentiation.

As a result, good strategy needs to keep two things in mind:

#1: Don’t Fall Out of Consumer Expectations for the Core
Although the core business may not create the reason why people choose your firm, it could be the reason why they reject your firm if you do it poorly. Ugly women don’t even get a chance to compete into the beauty pageant. Similarly, businesses that fail at the core do not get a chance to really compete in the marketplace.

There is a minimum level of performance needed at the core. It is the minimum tablestakes needed just to play. You have to meet this minimum level at the core. It is a necessary first step, but it is not enough. You must look beyond the core.

#2: Provide a Favorable Point of Differentiation on the Periphery
In addition, one needs to add a reason on the periphery which would cause people to prefer your firm over the competition. In the case of retailing, that could be something like added convenience, better service, more exciting promotions, a better image, and so on.

You need to stand for something positive at a place where you can win. Since it is difficult to stand out at the core, choose something on the periphery.

To win in business, one needs to convince the consumer that you are the superior choice. Since most of the competition is equally good at the core attribute of the industry, it is hard to develop superiority there. Even if you could get a little edge at the core, it would temporary, because the others would quickly neutralize it. As a result, one must look to the periphery to find that sustainable point of superiority.

I’ve seen retailers get into trouble and start losing their customer base. In some cases, I have seen the executives of these companies react by going after the merchants. The rationale is that merchandising is at the core of the business, so if the business is going bad, there must be something wrong at the core. In reality, the problem often was that the company had never developed any type of superiority on the periphery. Merchandising can only take a retailer so far. Beyond a certain point, spending more time focusing on the merchandising would not help these businesses as much as finding that point of superiority. This same principle applies in all businesses.

Thursday, October 25, 2007

Friction is Hot

Unfortunately, I experienced Black Ice before I knew what it was. It was the day before Christmas one year when I was living in Minnesota. I was driving to work when in front of me I saw a car lose control and start spinning all over the expressway.

I quickly reacted by slamming on the breaks. That was a mistake. Suddenly, my car was spinning all over the highway as well.

I was shocked, because I did not see any ice on the road. Later, I was told that if the weather conditions are right, ice can form on the highway in a manner that does not appear to be icy. It is called Black Ice because it looks just like the color of the highway.

It may not look like ice, but it acts like ice. There was no friction and it caused me to lose control. Fortunately, because it was the day before Christmas, a lot of people were on vacation, so there were fewer than the normal number of cars on the road. I was able to safely get my car to the side of the road without hitting anything. Then I slowly made it the rest of the way to work.

When a car has no friction with the road, one loses control of the car and significantly increases the risk of danger. The same situation can occur in business. Business friction occurs when the free flow of commerce is hit by an imbalance between supply and demand (or access) for either products, services or information. This friction, also known as business bottlenecks, slows down commerce until the imbalance is straightened out.

At first, one would think that business friction is a bad thing and that the freer the flow of business, the better. However, as we will see in this blog, without friction one looses control of how to create a profit. Friction is the tool which keeps your business model from spinning out of control and provides your firm with the means of adding value (for which you can charge a reasonable fee).

Beware of people promoting a frictionless business model. It may look safe and desirable, but it is Black Ice—which can take you by surprise and spin you out into danger.

The principle here is to proactively create a role for friction when planning your business model. Business friction can be your friend if you plan it wisely.

To understand the importance of friction, let us imagine a business model which is friction-free. In a friction-free world, everyone is pretty much on equal footing, making it difficult to gain a competitive edge. For example:

1) The search for suppliers and customers would be a non-issue, because you would know everything about all of them.

2) It would be difficult to get an upper hand in bargaining, because you would not have much of any differential advantage since all is known and easily available to everyone. If they don’t get it from you, they can easily get it somewhere else. In a sense, if everyone has equal power, then nobody had any power.

3) Middlemen and intermediaries would have no reason to exist, since knowledge and access is easily available to everyone.

4) In a world where everything is known and access is easy, there is much less risk. Less risk leads to less reward.

5) All business transactions would become more like dealing in commodities, which takes a lot of the profit margin out of the business.

6) Customers will be more knowledgeable and have more options. This will give them greater power of choice and a greater ability to demand more for less (which hurts profits).

People like to say that if one can eliminate the friction (that is, get rid of market inefficiencies) one can eliminate a lot of costs from the system. At first, that sounds very good. Isn’t efficiency a good thing? Aren’t people usually rewarded for cutting costs?

However, keep in mind that one company’s expenses are typically another company’s sales and profits. Or to put it another way, every time another company finds a way to increase efficiency, they may be doing it by eliminating the way in which you earn a living.

For example, it’s tough to make a living as a travel agent when sites like Expedia.com take all the friction out of the transaction. What used to be special proprietary knowledge known only by the travel agent is now available to everyone with the click of a mouse. Without that friction of proprietary knowledge, the travel agent business model spins out of control.

It’s tough for a salesman to sell a car at much of a profit when web sites tell customers what the dealer’s wholesale cost is for the car as well as telling the customer what every other dealer is selling the car for. And if you don’t like any of the local car dealers, the internet can connect you with people selling cars in other locations. The old model is spinning out of control.

In today’s Wall Street Journal, there was an article about the $1.8 billion buyout of Goodman Global by buyout firm Hellman & Friedman. What made this deal unusual was the fact that a group of hedge funds directly took on the financing of the project. This debt was not underwritten by one of the large Wall Street houses. They were frozen out of the deal. Given the frictionless way in which knowledge and money now flows, the value added by investment bankers is severely diminished. Deals can be done without them.

In order for your company to gain control over its business model and ensure the ability to make desirable levels of profitability, you need to find ways to create friction in your favor. One needs a strategic plan which un-levels the playing field and tips it to your advantage.

This could be done in a number of ways, such as:

1) Finding where the scarcest resource is in your business ecosystem and then trying to get a disproportionate amount of that scarce resource (be it raw materials, knowledge, business contacts, access to customer lists, distribution channels, etc.)

2) Trying to resist the trend towards commoditization by introducing as much propriety or exclusiveness into the system as possible. For example, instead of selling the same CD as everyone else, get an exclusive on a version of the CD which comes with extra tracks. Or you can do like Wal-Mart has done and become the sole and exclusive distributor for the new CD by the Eagles. Or try to get patents on whatever you do, so that others cannot do it without paying you a royalty.

3) Another way to attack commoditization is by wrapping the common inside the uncommon. For example, you can supply the same basic good, but with so many additional unique services wrapped into the package that you have created a unique total package.

4) Finally, one can become more inclusive in the process with the customer. The more the customer feels they helped to develop the product, the more loyal they will be (after all, if they reject something they helped build, they are in a way rejecting themselves).

Without taking active steps to build friction to your favor, you can end up with what happened during the dot com bubble. During the dot com bubble, people were bragging about how much friction they were taking out of the system. However, as they took out the friction, they also took out the profitability. They were really just pouring black ice onto the landscape. This lead to the dot com bust, when all the unprofitable business models spun out of control.

Back at the height of the dot com phenomenon (October 2000), Scott Rosenberg wrote about this condition in Salon.com. Here is what he said:

“Friction, as it turns out, is the parent of the profit margin. The more you move toward a perfect market mechanism the fewer opportunities there are for anyone to make money. What’s the ultimate embodiment of friction-free economics? A marketplace in which everything is free, instantly available and infinitely duplicable, with no cost of goods, no transaction costs and no inventory depreciation: in other words, Napster. Napster, unsurprisingly turns out to be hugely popular with consumers—and anathema to producers and distributors. The one thing that’s missing from the model is cash. No friction? No revenue, and no profit. Whoops!”

Although friction in business looks like the enemy, it can be your best friend if you manage it properly. To do so takes proactive planning. Put friction into your business model.

When you bend a paper clip back and forth a few times, the friction causes the paper clip to get hot. If you want your business to get hot, put a little friction into the mix.

Wednesday, October 24, 2007

Do You Do Breakpack?

Back when I worked at the headquarters of a grocery wholesaler, I frequently made trips out to the divisions for meetings. After the meetings were over, I would always ask if someone could give me a tour of the warehouse. The division presidents loved this. They were like proud Papa’s who wanted to show off pictures of their children. They loved their warehouse and enjoyed showing it off.

Now I didn’t ask because I loved to see warehouses. Once you’ve seen a few, you realize they are rather dull. I did it to make the people out in the field feel better. In order to make it look like I was truly interested in what was going on, I had a predetermined set of questions to ask them which I had memorized in advance. It included things like “Do you do breakpack?” and “When was the last time you re-racked the warehouse?” I really wasn’t all that interested in the answers to the questions, but I acted as if I was.

Throughout the tour, I would always praise everyone for the great work they were doing. A little praise went a long way.

As one of the division presidents put it to me, “You’re not like those other guys from headquarters. As soon as the meeting is over, they rush out of here, telling me that they have to hurry to catch a plane. Hell, this is a small town. I know when all of the flights are scheduled to leave, and there is never a flight at that time for them to rush to. They just don’t want to spend time with me.”

For a strategy to succeed it must, at some point, affect the way your front-line employees interact with the customer. It doesn’t matter how clever your strategy is. If it is delivered to the customer by surly, inconsiderate employees, it will have difficulty succeeding.

People still matter. Your strategy must never forget that it is only as good as the way it is delivered out in the field. The front-line employees have the power to make or break the strategy. Therefore, it is important to make sure your front-line employees are properly motivated to make the strategy work.

That is why I always tried to pump up the troops when I went out into the field. I wanted them to feel special…to feel proud. A front-line employee who is proud of what they are doing will do a better job (for more on this, see my blog “Soulless Capitalism”). Customers will recognize this enthusiasm and reward the company with additional business.

If you are a division president and you know that corporate doesn’t want to spend any time with you, and that they’d rather hang out at an airport restaurant than talk to you, then you are less likely to feel loyal to the headquarters. The rest of the people in the division will pick up on that attitude, and before you know it, the front-line troops are not supporting the strategy.

The principle here is to make sure that your strategic process incorporates the impact of the frontline troops. These people need to embrace the strategy and feel proud about being a part of it. By doing so, you will better deliver the benefits of the strategy at the point where it matters most—where the company intersects with its customers.

This point was brought to light recently in a survey conducted by Maritz Research. This survey found a linkage between how a manager treats the frontline troops and how the troops interact with the customer. According to the research, “Honest, caring, cheerful, generous and flexible workforce supervisors do the best job of motivating employees to deliver great service and create customer loyalty...Employees who serve under this kind of positive supervisor tend to feel the strongest affinity for customers and also believe that the company does an outstanding job of serving its customers.”

By contrast, the tough, controlling, Machiavellian “win-at-any-cost” supervisors de-motivate the troops. “Not only are these managers poor at motivating their employees, but those who work for this type of supervisor have some of the poorest attitudes towards their company’s customers.”

Which would you rather have: frontline employees with a strong affinity for customers or frontline employees with poor attitudes towards customers? You can help control which of these types of frontline employees you have based on they way you manage them. This could have a greater impact on success than the cleverness of the strategy.

Therefore, the way frontline troops are managed should be addressed as part of your approach to bringing the strategy to life. And, since attitudes tend to trickle down from the top, your key executives need to be practicing the right attitudes as well.

This is well illustrated in a book which was recently published, called “The Education of an Accidental CEO.” This is the story of David Novak, the successful CEO of Yum Brands, owners of the Taco Bell, KFC, Pizza Hut, Long John Silvers and A&W brands.

In the book, Novak credits most of his success to his ability to fire up the troops and get them properly motivated. Novak tries to be positive and enthusiastic, making sure that he treats the troops in a respectful and praiseworthy manner.

To quote Novak, “You can never underestimate the power of telling someone he is dong a good job. The higher up the ladder you are, he more important it is to give credit rather than receive it…Always be on the lookout for reasons to celebrate the achievements of others.”

Novak intuitively understood what Maritz quantified in the survey. If you treat your employees with respect, then they will treat the customers with respect. These customers will then become more loyal and success will follow.

Hence, management style is important and needs to be incorporated as a part of the strategy.

Strategies need to be more than just ideas or concepts. For them to succeed, they have to impact the interaction between your frontline troops and the customer. Customers typically respond better if they are treated well and believe that the frontline troops care about them. Similarly, frontline troops are more likely to care about the customer if their superiors show that they care about the troops. Therefore, care and consideration should be an integral part of the strategic plan. Don’t always just rush off to the airport at your first opportunity. Take some time to shower the troops with praise.

During the most recent Super Bowl (Super Bowl XLII), much commentary was made about the coaching styles of the head coaches of the two teams. Both Tony Dungy of the Indianapolis Colts and Lovie Smith of the Chicago Bears used a positive coaching style similar to what is advocated in this blog. This is in stark contrast to the typical head coach, who tends to yell a lot and focus on what players are doing wrong. Many believe that this positive approach had a lot to do with the success of these two teams. I think it can also have a positive impact on the success of your team.

Tuesday, October 23, 2007


Sometimes I get jealous of people who have a clear vision of what they want to do in life. I have a friend who, at the age of 5, already knew exactly what he wanted to do with his life. He wanted to be an electrical engineer.

He spent most of his childhood fiddling around with electronic gadgets. When he went off to college, he got a bachelor’s, master’s and PhD degree—all in electrical engineering. Then he went and got a job at a large company in the field doing leading edge work in electrical engineering.

After awhile, he decided to become a professor of electrical engineering at a large, prestigious university. Now he teaches and does even more leading edge electrical engineering research at the university. He has lived a rich, full life doing exactly what he had clearly determined to do way back when he was 5 years old.

Me? I’m over 50 years old and I’m still trying to figure out what I want to be when I grow up.

It’s nice when one has a clear vision of what they want to do with their life. It allows them to focus. They don’t have to waste time searching. They know their path in life. That’s why sometimes I wish I could just get a letter in the mail fully detailing the divinely inspired plan for my life.

This is also very important for businesses. It is much easier for a business to succeed if everyone involved clearly understands the life path of the corporation. It lets the company focus on success. That’s why I’m sure many CEOs wish they could just get a letter in the mail fully detailing the divinely inspired plan for their business.

My suspicion is that there are a lot more people like me than there are like my friend, who had a clear vision since early childhood. I also suspect that a lot of businesses struggle with this issue. Although strategic planning can do many things for a company, probably its most important benefit comes from bringing clarity of purpose to a business.

The principle here is the importance of clarity to success. McKinsey and Company recently did a large study to determine what are the most important factors to success in business. They analyzed about 100,000 questionnaires to uncover the practices at 400 business units in 230 companies around the world.

McKinsey discovered that there were three factors which caused a dramatic improvement in performance. Nothing else came close in its impact. The three major factors all had to do with clarity:

1) Clarity of Goal (or as they put it, a compelling vision of change or direction);

2) Clarity of Path (an unencumbered internal process to reach the goal, or as McKinsey put it, an environment that encourages openness, trust and challenge—i.e., the right culture); and

3) Clarity of Expectations (or as McKinsey put it, clear roles for employees and clear understanding of who it accountable for what).

If you know where you are heading, you clear away the bureaucratic obstacles, and then let everyone know what is expected of them, then you have the highest potential for success.

Over the years, I have spoken with large numbers of people about strategy. A common problem I find is people fretting about trying to find the perfect strategy. They have narrowed down the list of options to a few choices, but they are having difficulties narrowing down the list to the single best alternative.

What I usually tell these people is that it is more important to just pick something and get a clear focus around it than to fuss and fret over whether you have made the absolute best choice. Usually, most anything on their short list has the potential for success if focused on. However, if you waver and go after too many options at the same time, you will probably fail. Picking which path is not as important as shedding the light of clarity on whatever path you pick.

Perhaps my friend could have also been successful if he had focused on a different career path. However, because he picked a path early in life, he was able to focus and succeed on the path that was chosen. If he had procrastinated about his future, he may have had no success at all.

The best way to tell if your strategic planning process is a success is not by the quality of the binders or the speeches. No, the best way to determine success is by the amount of clarity it brings to the organization. When you are done:

1) Does everyone clearly understand the goal?
2) Does everyone clearly understand their role and are willing to be held accountable to achieving it?
3) Is everyone so fixated on the larger picture that internal barriers and petty politics are gone and is replaced by openness and cooperation?

Strategy without clarity equals disaster. Strategy with clarity equals success.

I am reminded of an old episode of the TV show Star Trek: The Next Generation. Captain Jean-Luc Picard and Dr. Beverly Crusher are captured by the enemy. The enemy puts a device on them which has the side effect of letting them sense what is on each other’s mind. Captain Picard and Dr. Crusher eventually escape from the enemy. The problem is that they do not know where they are, so it is difficult to know which is the best escape path.

Being the leader that he is, Captain Picard makes a number of decisions as to the best way to go. Each time, he sounds very convincing about the correctness of his choices. However, eventually Dr. Crusher speaks up. She says that for all these years when she has heard Captain Picard give commands, she always though he was very certain of what was the right thing to do, because he always sounded so confident when giving the order. However, now that she was able to read his mind, she discovered that he often only has a vague notion of what is correct, and sometimes he is just guessing.

The captain replied that this is what leaders do. They struggle internally with tough decisions, but externally they give the confidence needed to rally the troops behind the decision. They make the commands clear and unwavering, to give the appearance of being the obvious best choice.

In many ways, this is what strategic planning should do. It needs to tackle some tough issues. However, once the tough decision-making is done, the process must clearly and confidently communicate the decision in a way which gets the troops focused on making it succeed.

The job is not over when the choice is made. One also needs to make sure it is understood and embraced.

In addition, one needs to clearly assign responsibilities, with individual consequences if not carried out. In other words, strategy should not just be stated as a nice thing and then hope that people will do something. Clear accountability needs to be spelled out. Perhaps individual accountability contracts need to be written out. Compensation needs to be tied to carrying out one’s portion of the strategy. Do not assume things will magically happen. Make it clear who is responsible for what.

Finally, one needs to incorporate corporate culture into the strategy, so that internal bureaucracy does not block the path to victory. Although there may be individual responsibilities, one cannot let individualism get in the way of the combined effort. Clear away anything in the culture which prohibits the cooperative effort needed to achieve success.

Although strategic planning serves many functions, its most important function should be to provide clarity to an organization. Clarity has three aspects: clarity of goal, clarity of path and clarity of responsibility. Without this comprehensive clarity, strategy is little more than some interesting ideas that end up going nowhere.

Although you may never get that letter with the divinely inspired detailed plan for your business, you can write that letter for the rest of your business.

Monday, October 22, 2007

Chasing Fads

Several years ago, back at the height of the popularity of the Balanced Scorecard, my company sent me to a Balanced Scorecard conference. There was a rather large crowd at this conference. Even so, the organizers wanted to find out more about who showed up, so they had us go around the room and tell a little about ourselves.

I was surprised to find out that the majority of the people who were attending this conference had job titles something like “Director of Balanced Scorecarding.” I had no idea jobs like that even existed. Even more interesting was the fact that their prior job titles tended to be something like “Director of TQM (Total Quality Management)” or some other similar management fad.

Apparently, these were professional fad jumpers. Whatever the latest management fad was, they would latch themselves to it and make a full-time job out of it. When the fad would start to wane, they would jump to the next fad and make a job out of it. They could spend their entire career playing with the latest management gimmick and never have a real job doing real things. They got to spend lots of time going to seminars to learn the fad. By the time management realized that what they were doing was just a fad, they would hopefully be on to the next new gimmick.

After I got back from the conference, the CFO asked me what I learned. I told him that all of the benefits claimed by Balanced Scorecarding could pretty much be achieved by management practices we already had in place. Sure, the nomenclature we used was different, the process was slightly different and the graphics looked different, but it would pretty much achieve the same results. I told him I saw no need to disrupt what was working for our company in order to mimic their jargon and graphics.

The CFO replied, “That’s pretty much what I thought.” And the Balanced Scorecard was never mentioned at our company again.

Business management and business strategies tend to be very fad-ish. The problem with fads is that they consume a lot of time and energy for a brief period, but seldom lead to much of any lasting value. As seen in the story above, companies can create all kinds of jobs and infrastructure around a fad and get nothing but a career springboard to the next fad.

Worse yet, the distraction of the fad keeps people from being focused on what really matters. Rather than building solid strategies, time is spent building worthless mission statements using the latest fad buzzwords. Rather than focusing on outcomes, they focus on the process.

After the dot-com bubble burst, management fads tended to have something to do with cutting costs. Eventually people figured out that you cannot cut your way to greatness, so the current fad has to do with innovation. Just look at the latest IBM television ads…they are all about innovation. This blog will use the latest fad of innovation to illustrate how fads can be counterproductive.

Consultants love fads because it can give them the ability to look like saviors—they possess the wisdom of the latest fad which can make you a success. If you would only hire them and pay them huge sums of money, they will share the wisdom of the latest fad with you.

So naturally, firms like McKinsey and Company want to look like experts in innovation. How do they do that? Well, in the case of McKinsey, they did a survey in September of over 1,400 business executives (I was one of them) and asked them their thoughts about innovation. (It reminds me of the old joke about consultants—they steal your watch and then tell you what time it is. Here, they are asking the people they want to consult with what they think before giving them advice.)

What McKinsey found was that about 70% of corporate leaders say that innovation is among their top three priorities for driving growth. So apparently the buzz word is in—people feel good about looking to innovation as the latest fad to save them.

However, the actions of these executives do not match their words. According to the survey:

1) Most executives do not talk about innovation in any meaningful way at executive and leadership meetings.
2) Most executives do not have their compensation tied to innovation.
3) Most executives claim their culture does not encourage innovation.
4) Most executives claim they do not have the right types of people for innovation.
5) Most executives claim they are not risk takers themselves and so by example tend to discourage innovative risk-taking in others.

So at this point, with that type of approach, one can pretty much guess what the outcome will be…there will be very little true innovation to come out of this process. Then executives will say “I guess innovation does not work. I guess I’ll have to look for some other way to save the company.” Then it’s on to the next fad.

Believing in the myth that by wrapping our arms around some fad we can magically bring prosperity to the company gives a false sense of hope. By clinging to this false hope, we feel less compelled to do the hard work of making our business better, one small tactic after another. Instead, we rest on the promise that the latest “whatever” will be so successful that we don’t have to worry about those pesky details any longer. In this case, the belief is that innovation will create so many new avenues for growth that it is okay to slack off a bit on the core business and let it crumble just a bit.

Worse case scenario, management has so much confidence in the magic of the fad that they don’t see the need to manage it closely and put in place safeguards to enhance the likelihood of success. It is seen as too powerful a force not to work all on its own. This may explain why the executives in the survey believe in innovation, but do little to enhance its potential within the company.

What the experts don’t like to mention is that most innovation processes are very costly and most innovations fail. Putting a greater emphasis on innovation also increases the risk profile of the company. Although risk has a lovely upside, it also has an ugly downside. A large focus on innovation may not be appropriate for your company’s strategy.

For example, if you are a large and powerful market leader, it may make more sense to be a “fast follower” than an innovation leader. For years, big leaders like Coke and Microsoft have let others take all of the expense and risk of innovating. Once someone else’s innovation looks promising (like diet cola or Netscape), these firms rapidly copy the innovation and then use all of their marketing might and muscle to win the battle for market share.

If your industry is in decline, there may not be enough demand to justify the expense of innovation. Price competition may be too intense and customers might not be willing to pay too much more for the innovation. Instead, it might make more sense to have a “harvest” strategy where you cut costs at a faster rate then the industry decline.

The point is that there is no one-size-fits-all magic bullet that is right for everyone. Every situation is different. You have to find the ideal strategy for YOU, not some generic strategy that kinda works for everyone. Remember, if you are using the same strategy as everyone else, how are you creating a positive competitive differentiation versus the competition? Finding what makes sense for your business requires setting aside the hype of the latest fad and digging in deep to find your unique edge. Strategic short-cuts rarely get you to your destination. They only send you on wild goose chases.

Now if innovation is the proper path for your firm, then put your money where your mouth is and do whatever it takes to be the innovation leader. Lip service is not enough. You need to change your entire culture to become more innovation-friendly. Don’t be like the executives in the survey.

Every company is different. As a result, every company needs to develop its own particular strategy to take advantage of its uniqueness. Following the latest fad may give the fad-jumpers the next step on their personal career path, but it rarely leads to building a strong, vibrant corporation.

If you want to integrate new ideas into the heart of your business, it helps to elicit the time of operational leaders in the business. Getting operational leaders within the business to sponsor a process tends to work better than isolated professional “Directors of Scorecarding” who live on the periphery of the business and have no natural base of power (and typically are not well in tune with how the business really works).

Saturday, October 20, 2007

Corporate Strategist, Plan Thyself (Part 3)

Once upon a time, there was a man who approached a football coach and said the following:

“I am a great football player. Look at all of my awards. Look at all of my trophies. I am recognized throughout the land as a great football player, and I would like to join your team.”

“Wonderful!,” replied the coach. “We have a shortage of good linesmen. Get out there onto the practice field with the other players. Get up on the line and show me what you’ve got.”

The man did as the coach asked. As it turns out, he performed terribly on the line. He was so weak relative to the player on the opposing side that he eventually had to be taken off the field on a stretcher.

As the stretcher was being taken off the field, the coach went up to the injured player and said, “I thought you said you were a great football player. You looked awful out there.”

The injured man replied, “I am a great football punter, not a linesman.”

Just because a person may be great at playing a particular position in football does not mean that they are great playing every position in football. Different positions require different skills and abilities. That is why football players tend to specialize at excellence in only a couple of similar areas.

As we saw in the story above, this man was well regarded as a punter and had lots of trophies for that skill. However, being a great punter does not provide the skills needed to be a great linesman. Rather than claiming to be a great football player, he should have limited his claim to being a great punter.

A similar situation often happens in the business world. A corporation has success in a particular area, and suddenly they declare themselves to be a great corporation. It may be that their success came in a narrow specialty. However, by classifying themselves as a great corporation, they may get the idea that their skills are broader than they really are.

As a result, the corporation may decide to tackle strategies where they have no right to be, much as that punter did. And, similar to the punter, the corporation may come out of the battle weak and on a stretcher.

This is the third in a series on building strategic plans for the role of the corporate headquarters. As we have seen in one of the prior blogs, corporate headquarters needs a strategy as much as its divisions. If the corporation headquarters does not have a definitive strategy for adding value to its divisions, then perhaps the divisions should be spun off and the corporation folded.

In the last blog, we looked at various ways a corporation can add value based on how much it gets involved in the activities of the divisions. In this blog, we will look at ways in which a corporation can specialize its skillset to help certain types of divisions. Much like a punter specializes in punting, a specialized corporation will build a particular type of portfolio—the types of divisions that benefit most from the corporation’s specialized skill.

To illustrate this point, we will look at the various lifecycle stages which a division goes through. These life stages go from new business incubation, through rapid growth, into maturity and then fall into decline. At each stage, a division has different success requirements. If a corporation can excel at building success for one of these life stages, then they can develop a corporate strategy of adding value for firms at that stage in their lifecycle. Then the corporate portfolio would specialize in being full of divisions at that particular life stage.

Listed below are six ways a corporation could specialize, depending on life stage of the divisions.

1) Entrepreneur/Visionary
In this specialty, the corporation is skilled at envisioning what the Next Big Thing is going to be. This requires being able to examine the marketplace to see where demand is evolving to and where the holes are in currently meeting that demand. Then, once finding where that next great opportunity might be, the corporation is skilled at making the right initial investments to create or acquire what will evolve into that next big thing.

Once the company proves the inevitability of that next big thing, the corporation can cash in on the value added by selling the division at a huge multiple, or spinning it out into an IPO, or hold it for a longer term gain.

2) Venture Capitalist
This is the corporation which may not have the entrepreneurial skills to dream up the next big thing, but has the skills to recognize the next big thing when it is in its infancy. Often times, these new ventures are started by people who are skilled at visioning, but not skilled at running professional businesses. As a result, the venture capitalist type of corporation provides funding, nurturing and teaching, so that the young division can make the leap to the next level of development—becoming a stable business.

As with the entrepreneur/visionary corporation, most of the value is unlocked at the time that corporation cashes in their ownership position. The venture capitalist corporation can cash in on the value it adds by spinning out the venture into an IPO or by selling at an incredibly high multiple to a deep-pocketed firm.

3) Growth Funder
During the rapid growth phase of a division, they tend to consume a lot more capital than they provide. Eventually, the cash flow is expected to turn positive, but at this stage, the division is in need of funding. A growth funder corporation is skilled at understanding how to help divisions through this rapid growth phase. They have the resources and discipline to properly stage the funding of the growth. In addition, the corporation understands how to properly scale up the infrastructure to support the growth.

In general, the growth funder adds value to helping the division grow in a way that doesn’t overstress the young division’s capabilities. By giving it a strong operating infrastructure, the corporation enhances the likelihood that the growth will be successful and lead to profitable market leadership.

4) Operator
Once a firm reaches maturity, ultimate success shifts even more towards operating efficiency. “Operator” corporations are experts in understanding how to be a great and efficient operator. They know the tricks to squeeze out a little more in sales and a little less in costs. They mentor the firm and help it install the various procedures and investments needed to get to a higher level of performance.

Here, the value added by the corporation is relatively immediate. As the improvements to the operation improve the cash flow created, the stock multiple on that cash flow comes into play right away.

5) Turnaround Expert
Sometimes, companies fall from maturity into decline prematurely. A turnaround expert can breathe new life into the falling division and extend its useful life. Often times, large corporations who are not turnaround experts and prefer growth businesses will sell off these divisions relatively inexpensively. This is what is happening at a lot of the big consumer product companies these days, like Unilever and Proctor and Gamble. The turnaround expert can buy these established, but falling brands from companies such as these and get more life out of them, usually by unburdening them from the large infrastructure of the old corporation.

Whereas corporations who add value to early stage life cycles get most of the value out at the time they sell, for a turnaround expert, they establish a lot of the value in their ability to buy the brand inexpensively and then bring it back to former glory.

6) Bottom Feeder
This is the corporation who can find pockets of value in even the most distressed of organizations. Usually, bottom feeders get the assets at bargain basement prices. Then they redeploy the assets in a way that makes money. Maybe all they keep are the rights to some brand names that are moved to a more successful operating division. Or perhaps the only thing of value is the real estate, which is repurposed. As with the turnaround expert, much of the value added comes from buying well and then having a better idea of knowing what to do with what was bought.

If a corporation specializes in developing skills which add value in a particular way, then the corporation can have a strategy of building a portfolio of businesses which would benefit most from that specialized skill set.

In many of these instances, once the corporation adds its value to the division, it may be in the corporation’s best interest to divest of the division and find new ones to fix. Hence, the corporation becomes the constant, and the divisions are like raw materials to be manufactured into something better and then sold at a profit.

Sunday, October 14, 2007

Corporate Strategist, Plan Thyself (Part 2)

Earlier this year, McKinsey conducted a survey with a large number of business people regarding strategic planning. They not only surveyed people at the corporate headquarters, but also executives at the division level.

To me, the most interesting part of the results had to do with the idea of collaboration. The survey asked these business executives about how much collaboration there was at their company between headquarters and the divisions on strategy formulation.

The study found that the executives at corporate tended to think that there was a lot more collaboration going on than executives at the division level. Whereas corporate saw their conversations with the divisions as collaboration, it would appear that the divisions were more likely to see those same conversations as something else, like commands or meddling. I guess collaboration, like love, is in the eyes of the beholder.

As this survey seems to point out, not everyone perceives the value of corporate in the same way. In the last blog (see “Corporate Strategist, Plan Thyself (Part 1)”), we saw that it should not be automatically assumed that a large corporation running many divisions is the ideal way to run your business. If the corporation is not adding sufficient value, it should be drastically cut back, or perhaps even eliminated/outsourced.

In this blog we will look at ways in which a corporation can add value.

We will briefly describe six ways in which a corporate headquarters can add value to its divisions. We will start with the simplest and least involving forms of value and work our way up. In general, as we move up the ladder, there is greater potential for the headquarters to add value. Also, in most cases the process builds, in that each succeeding level also tends to incorporate the prior levels as well.

1) Protective Parent, Protected Child

In this version, the corporation protects and shields the divisions from having to deal with all the messy details of being a corporation, so that the divisions can focus on their particular businesses. The headquarters handles (a) communicating with shareholders and analysts, (b) managing shareholder regulatory authorities, (c) defining the corporate governance system, and (d) preparing and filing external financial reports.

By dealing with the messy issues and distractions like Sarbanes Oxley compliance and public relations, the headquarters unburdens the divisions so that they can focus more on trying to make money. Although this is adding value, it is not a whole lot of value and does not require a very large corporate infrastructure.

2) Coach, Team

In this scenario, the corporation helps the divisions become better than they would be on their own by using its expertise to coach the divisions on how to be professional business organizations. This involves tasks like (a) setting expectations (performance targets and goals), (b) challenging and setting cultural norms, values and behaviors (how to act), (c) showing how to protect corporate assets (brand names, cash), (d) defining operating rules and policies.

In other words, the coaching headquarters shows the divisions what role they are playing, what is expected, and how to do it in an efficient, professional manner. Usually, the coaching headquarters also acts like the parent in option #1. This adds more value than option #1 alone, but still not a lot. If the division were a stand-alone business, it might be able to get this same value cheaper through using consultants.

3) Banker, Borrower

In this scenario, the corporation adds value by taking the excess cash out of each of the divisions and then reallocating it based on where it can get the best return. In this manner, the corporation acts as the bank. If the division wants money, it must make a compelling case before getting it.

The corporation adds value as a banker because (a) it typically has a lower cost of capital than a stand-alone division, (b) it has more options for sources and uses of capital, thereby allowing it to make better investments than a stand-alone business whose options are more limited, (c) it can typically add more rigor to how things get financed, creating better decisions.

This level increases the value added, but as we saw in the last blog, capital is not particularly scarce and good stand-alone divisions would still have lots of options for gaining capital without a corporate headquarters.

4) Builder, Legos

In this scenario, the corporation takes a more holistic look at their portfolio. Individual businesses are not seen independently, but rather as role players in the larger portfolio. The role of the corporation is to envision the ideal portfolio for a given corporate strategy and they use their power to design and build that portfolio. In this fashion, the corporation is a strategy builder, snapping together divisions as if they were Legos.

As such, the corporation (a) determines the larger strategy and what competencies are needed in the portfolio to make it happen, (b) manages the acquisition and divestiture process to get those competencies, (c) initiates new ventures, (d) acquires/divests/organizes divisions and their structure, (e) places expectations on the divisions as to how they contribute to the larger strategy. This is starting to get more sophisticated in terms of corporate value add. It not only looks for ways to make the individual businesses better, but looks for ways they can contribute to something which goes beyond their individual business.

5) Specialist, Clients

In this version, a larger percentage of the tasks of business become centralized at the corporate level. The logic is that by centralizing these functions, the corporation can become better at delivering the services than if each division did them separately. This would be a result of economies of scale, the ability to hire more qualified individuals, and a more steady stream of work, so that expertise can become more specialized. This could involve what companies typically call “shared services.” It could include things like Legal, Finance, Human Resource benefit administration, Foreign exchange, and so on.

Although this creates even greater opportunities for corporate to create value, it can also create greater opportunities for corporate to destroy value if they do the centralization improperly (see the blog “Sometimes It’s not nice to share”). This is the double edged sword of value creation. The more corporate gets involved, the more it can help as well as the greater the likelihood it can hurt. As we move up the ladder of involvement, the rewards may be greater, but so are the risks.

6) Synergist/Alchemist, Resources

This is the highest level of corporate involvement into the divisions. At this point the divisions have very little independence. The corporation is actively working to get the most out of what it owns. People, resources, patents, and competencies are frequently moved from division to division for the greater good. All potential synergies in cross-divisional activity are looked for. Even if a decision serves to destroy some value at a particular division, it may demanded by corporate if it is for the greater good of the overall portfolio.

At this point, not only have many key functionalities been moved to corporate, but also a greater percentage of the overall business decisions. As mentioned earlier, if done well, this can add great value, but if done poorly can destroy value.

There are many ways in which a corporation can position its headquarters to add value. Depending on the level of value added, one will get different sizes and structures of headquarters (as well as different levels of risk). Since there is no one-size-fits-all headquarters approach, you have to make a choice. You must determine which option is right for you. It is important to proactively plan the strategic role of the corporation in advance in order to ensure that (a) you are building the headquarter structure properly, and (b) you are truly adding the most value.

If you ask the divisions what kind of corporate structure they would like for a headquarters, they would probably not pick one of the higher levels. Of course, this is like asking young children what type of discipline they want from their parents. This is a decision that cannot be left to the children.

Wednesday, October 10, 2007

Corporate Planners, Plan Thyself (part 1)

There’s an old joke that circulates around the business world. It goes like this: What are the three biggest lies in the world? Answer:

1) I’ll respect you in the morning.
2) The check is in the mail.
3) I’m from Corporate, and I’m here to help.

I used to work for a company where the divisions hated the corporate office (which would probably describe most large companies). At the time, I was working at the corporate office and needed to fly out to the divisions to help them with their planning.

To try to break down the barriers between corporate and division, the first thing I would do when visiting a division office for the first time was to shake the hands of all of the division executives and say, “I’m from corporate, and I’m here to help.” At first I would get a lot of odd looks, because the division executives did not know where I was coming from when I said that old punch line.

Later, I would tell them that I used to be a division person and that I hated corporate as much as they did—maybe even more, because I had to deal with the corporate executives on a more frequent basis. After that, the barriers were broken and we got along just fine.

There’s a reason why most people at the division level hate corporate. They don’t perceive any value coming out of corporate. The logic at the division usually goes something like this:

1) Corporate really doesn’t understand what is going on out here in the field. As a result, they ask us to do things which make it harder to earn a profit. They don’t help us, they hurt us.

2) Corporate sucks all of the profits out of the division to pay for their lavish lifestyle at the corporate level. They live high on the hog while we slave away out here with insufficient funding.

3) The real profits are made out in the field where the paying customers are. Yet, instead of rewarding us for doing the deals, they pat themselves on the back and keep the big bonuses for themselves. In retailing, the phrase that was often used to describe this was “there are no cash registers at the home office.” If retail profits typically have to come via a cash register, then the people closest to the cash registers should be rewarded highly.

Whether or not you agree with these reasons is immaterial. If the divisions believe it, they will act accordingly. And you have to find ways to deal with that attitude, just as I did in the story above.

Divisions typically resent corporate because they do not perceive adequate value for the cost. This raises a valid question which all corporations should consider…how much value does corporate actually bring to the organization? Are all of the stakeholders getting a good return on the investment in corporate, including shareholders, customers and division employees? If corporate significantly shrank or disappeared, would the divisions be better off or worse?

This is the first in a series of blogs discussing strategic planning for the corporate function. We often talk about doing strategic planning of the business portfolio or of planning for individual divisions or departments. However, we also need to strategically position the corporate headquarters. We need to ask ourselves why the corporate function exists, how it is supposed to add value, and how to optimize that value-adding function.

In today’s blog, we will try to destroy the notion that large corporate operations running a number of divisions is an essential and inevitable way to run a business. On the contrary, large corporate functions are optional and should only be put in place if the value it provides exceeds the cost.

The logic behind this is as follows:

1) A knowledge economy is less dependent on such structure than the old manufacturing-based economy.

2) Technology and globalization make it possible to get work done without such a structure.

3) Many supposed corporate synergies actually turn out to be dis-synergies.

4) Networking can often achieve the same results without the costly infrastructure.

These points are briefly discussed below.

1) A knowledge economy is less dependent on such structure than the old manufacturing-based economy. In the old manufacturing economy, success depended on amassing a large number of resources. One needed large, expensive factories, large pools of unskilled labor, and access to lots of cash. Big companies with big corporate infrastructures were typically needed to pull this off. The corporate office used its clout to get the cash and provided the brains for the unskilled workers.

In a knowledge-based economy, the workers are highly trained experts in their fields, who know more about their expertise than corporate (corporate has less value to offer the typical employee). There is less of a need to amass huge factories and thousands of employees, so there is less of a need for a corporate function to coordinate this.

As we will see below, even if factories and money are needed, they are easier to come by. You can easily outsource manufacturing and there are many new sources of investment money which do no require your being a large publicly-traded corporation like venture capital, hedge funds, financial institutions, and so on.

2) Technology and globalization make it possible to get work done without such a structure. In the old days, one of the key functions of corporate middle management was to be an intermediary between the field and the top leaders. These middle managers would gather the data in the field and get it to corporate. Then, when the top leaders made a decision, their role was to relay the orders back to the field.

Modern technology virtually eliminates this corporate task. Data from the field is downloaded directly to headquarters via satellite or internet in real time. Cell phones, Blackberrys, Video Conferencing, emails and other such communication tools make it easy for top management to get directly in touch with the field on a very rapid basis. As a result, it is easy to flatten the corporate infrastructure and take out many layers of management which used to be necessary for relaying information back and forth.

Through the internet, it is easy to find information and sources for getting work done. Small businesses can outsource just about anything through the internet, such as product design, marketing, and manufacturing. There are even social networking sights so that you can find peers to bounce ideas off of. This allows a few people working in a garage access to the types of skill sets which in the past could only be found within a large corporate bureaucracy. For more on this topic, see the article on Minipreneurs from Trendwatching.com.

3) Many supposed corporate synergies actually turn out to be dis-synergies. In an earlier blog (see “Sometimes It’s Not Nice to Share”) I talked about how many corporate headquarters try to create cost advantage synergies through “shared services.” In other words, instead of developing expertise in certain areas at each division, centralize the function at corporate and share it amongst the divisions. Although this sounds good in theory, that prior blog showed that in many cases the corporate approach destroys value rather than adding value, because it raises total costs, reduces flexibility, increases time to get something done, and generalizes functions which work better when specialized to the division. Hence, the corporate approach may be destroying functional values rather than increasing them.

4) Networking can often achieve the same results without the costly infrastructure. In another blog I wrote recently (see “Howdy Partner”) I pointed out the fact that networking with others can often be more productive than trying to create it all in-house via a corporate infrastructure. The idea was that control is more important than ownership, and as long as your network with others allows you to maintain sufficient control, it can be far more productive than when you try to own everything. Networks allow you to connect with dedicated experts, who can better suit your needs than a generalist visiting from corporate.

In today’s society, a large corporate infrastructure is no longer essential. There are often more effective ways to get many of those resources at a higher value. Therefore, the large corporate center is not a given. It should only exist if it fits into the overall strategy. It’s strategic function and purpose needs to be planned, just as much, if not more than the divisions.

Eddie Lampert’s ESL Investments, the multi-billion dollar fund that has the majority ownership of Seas Holdings, has only about 15 employees. Not a whole lot of corporate infrastructure there, but ESL Investments has made its investors very rich over the years.

Sunday, October 7, 2007


When I was a boy, I was terrible at sports. I had very little muscle tone and was not well coordinated. As a result, I avoided sports in order to avoid ridicule.

The exception was high school gym class. Here I had no choice. Playing the sport was mandatory. It was my daily bout with humiliation.

The one exception to this rule was when the gym class played touch football. I was not a big fan of the game and I didn’t know the rules all that well, but still you had to play the game.

I would play as a tackle on defense. I was told that my role was to try to touch the quarterback before he got rid of the ball. I figured that the easiest way to get to the quarterback would be if I lined up in a place where there was nobody from the other side was standing. Since everyone knew how terrible I was at sports, the other team didn’t seem worried that I lined up in a place that was unguarded.

When the ball was snapped, I just ran unabated to the quarterback and touched him for a sack. Even someone as bad at sports as I was could occasionally get to a quarterback if nobody stopped him. Eventually, the other team figured this out and made sure someone tried to block me. But I figured that avoiding a tackle would still be my best tactic, so when the ball was snapped, I’d just spin to the left or the right and run in untackled towards the quarterback.

To keep me from spinning to the left or to the right, the other team started putting two guys on me—one on each side so I could not spin. Since I was in such poor athletic condition, there was no way that I could overcome that. However, by double teaming me, it left someone else uncovered who was often able to sack the quarterback. So I was still helping out my team.

Businesses often use sports analogies to describe their strategies. They talk about “winning” or “defeating the enemy.” The strategy sometimes is described as a direct confrontation with a competitor and that we must fight hard to overcome them in glorious victory.

Although there are some benefits to describing strategy in sports-related terms, it can lead to some problems if taken too far. There are two weaknesses to a sports mindset. First, it assumes that the battle is a head to head confrontation with a single opponent. Second, it assumes that both sides are playing the same game by the same rules.

As we saw in the story above, I was not well schooled in knowledge about the game of football and only vaguely understood the rules. I only knew that I was supposed to try to touch the quarterback before he got rid of the ball. To achieve this goal, I did two things. First, I tried to avoid direct confrontation with the opposing team. Second, I didn’t pay any attention to the conventional rules which would make a tackle believe that they had to “tackle” someone (after all, it is part of the position’s name).

Because I avoided direct confrontation and didn’t play by the conventional “rules” of my position, I was able to succeed, even though I had no athletic skills.

Business strategies often work the same way. In most cases, business success does not come from directly attacking a competitor and their position, but rather by avoiding direct confrontation and moving into an uncontested space. In addition, most winning strategies tend to reinvent the rules for playing the game.

Think of how easy it would be to win a sporting event if you played in an arena where there was no opposing team, or if there was opposition, they were forced into playing by a less competitive set of rules than your team. Well, if you invent your strategy properly, you can set up that type of situation for your company.

The principle here is “avoidance.” Great strategies typically either avoid direct confrontation with a competitor, or they avoid playing by the conventional rules of the marketplace.

1) Avoid Direct Confrontation
Over the years, there have been many classic head to head battles in the marketplace: Coke vs. Pepsi, McDonalds vs. Burger King, General Motors vs. Ford, and so on. One thing history tells us is that even over long periods of time, direct confrontations rarely cause a change in leadership. Coke stays on top of Pepsi, McDonalds stays on top of Burger King, General Motors stays on top of Ford, and so on. Head to head confrontations by a challenger are rarely successful.

Instead, success usually comes when a challenger avoids direct confrontation and moves into uncontested space. Pepsi may have lost the cola war, but they have a winner in Mountain Dew, which took on an uncontested space in the beverage market. Every time Coke has tried a direct attack on Mountain Dew, they have lost (remember Mello Yello?).

And then there was little Gatorade, who invented an entirely new beverage category, called sports drinks. By building strength in a brand new and uncontested space, it was difficult to overcome. The only way Pepsi could win in the new space was to acquire Gatorade.

Ford may have lost the automobile war, but they took an early lead in what was at the time the more uncontested space of pickup trucks. Ford has been able to successfully withstand direct attacks from GM on their pickup business for generations.

Finding a new, uncontested area and gaining an early strength can give a company an edge which is hard to lose. Good strategies exploit this principle. I heard a great story recently about Steve Jobs at Apple. When he came back to run Apple the second time, Jobs was taking over a company that had some difficulties. At that time, Jobs was asked what he was going to do in order to get Apple back in shape. His answer was that he was going to wait for the next big thing. As it turns out, the next big thing was digital music. Jobs quickly dove in to capture that new uncontested space with the ipod.

Jobs knew that if he tried a direct confrontation in computers, he would lose, so he looked for new uncontested space where his core competencies would be useful. With the ipod, Jobs made Apple into a strong winner again.

2) Avoid Conventional Rules
The second principle is winning by avoiding conventional rules. In this way, business is not like sports. The rules in business are not etched in stone. You can steal share away from the competition by playing by a different set of rules.

Take the retailer DSW. Its early success came by reinventing the rules about how shoes are sold. Before DSW, the traditional way of selling shoes in department stores was to hide nearly all of the inventory in a back room. Consumers were forced to give up control and sit down while a salesperson made choices for them out of the back room. DSW changed all that by putting all of the inventory on the sales floor. Customers could control their destiny and make their own choices.

Traditionally, shoes at department stores were sold through extensive promotions. The standard price was held quite high, so that huge % discounts could be claimed on frequent sales. This forced customers to wait on buying shoes until there was a sale. DSW changed the rules by having everyday prices that were similar to the sale prices of the other companies. Now customers could come in any time they wanted and be assured of paying a low price.

By changing the rules, DSW created a more appealing consumer proposition, giving them more control over the experience at a better overall value. It was difficult for department stores to change their rules to match DSW. First, their stores were not designed to display all of the shoes. It would take extensive and expensive remodeling to adopt the new rules of display. Second, the entire department store’s strategy revolved around high regular prices with deeply discounted sales. It would be difficult for department stores to price shoes in a manner differently than the rules being used for the rest of their store.

Strategies tend to be more successful if they follow one or both of the following principles. First, they avoid direct confrontation with an established leader and instead try to create leadership in a new and relatively uncontested space. Second, they reinvent the rules of competition in their favor, preferably in a manner which is hard for others to easily imitate. These two rules of avoidance tend to be much more successful than direct head-to-head competition.

During the 1930s, the Green Bay Packers won nearly all of the football championships. Why? They had examined the rules of football and realized that the forward pass was legal. Nobody else in the league was using the forward pass at that time. As a result, opposing defenses were not designed for defending the forward pass. By changing the rules, they were able to win championships. You can do the same.

Thursday, October 4, 2007

Hometown Bias

At the height of the popularity of the Dave Matthews Band, I saw a documentary about the history of the band. The documentary makers went back to where the band started in Charlottesville, Virginia. They interviewed some of the people who remembered the early beginnings of the Dave Matthews Band.

One of the people they interviewed was a guy who used to hang out at the first little local clubs where the band played. This guy blurted out, “I knew from the very beginning that eventually the Dave Matthews Band would become hugely famous” (or something like that).

My first reaction upon hearing him was, “My, this guy has a good sense about what music will sell in this country.” Then, I started to think, “I’ll bet that every little garage band that ever started playing in some local bars had some adoring fans who said, “I just know that some day this band will become hugely famous.”

Although every one of these local bands probably had fans who “knew” they would become famous, in reality over 90% go nowhere. That Dave Matthews fan in the documentary wasn’t an astute judge of success. He just happened to be lucky enough to be living in a place that had a local band that was one of the rare groups to actually become famous.

Some of us aren’t as fortunate. Back in the 1970s when I was in college, I enjoyed the music of a local Michigan band called the Whiz Kids. Pat McCaffrey, the leader of the duo, was a highly talented musician. He would simultaneously play the bass using the bass pedals on an organ, while playing keyboards with his left hand and playing a saxophone with his right hand. It was a sight to behold. I “just knew” that the Whiz Kids would eventually become famous.

Well, it didn’t turn out that way. The Whiz Kids never broke into the big-time like Dave Matthews. I went on the internet recently to see if I could find out whatever happened to the Whiz Kids. I found out that on October 9th of 2007, Pat McCaffrey and the Whiz Kids will be performing the after dinner music at the 38th Annual Conference of the “Excess/Surplus Lines Claims Association.” It will be at the Hyatt Grand Champions Resort near Palm Springs. It was nice to see that Pat was still earning a living in music some 30 years later, but I don’t think the “Excess/Surplus Lines Claims Association” conference is the same as the types of gigs the Dave Matthew Band gets.

Strategies are used in businesses in order to help them determine where to place their “bets” on the future. Businesses have limited money, people & time, and they want to invest these limited resources where they believe they will get the best return.

As a result, the strategic process is often used to help find where the next big success will be. They are looking for strategies that will be “winners” for the company. Trying to pick the next winning strategy is similar to trying to predict who the next great band will be.

Just as over 90% of all those local bands never make it to the big time, around 90% of new business ventures never live up to expectations and destroy shareholder value. Every company believes they are betting on the next “Dave Matthews” type of business venture, when in reality, it is more like a “Whiz Kids” outcome (or worse).

In spite of the terrible odds, companies continue to try to pick winners. Take Kraft, for example. In recent years, they have spent a fortune on a huge number of new products and innovations, most of which were duds. The real money comes from things invented long ago, like Oreo cookies (which have been around since 1912) and Miracle Whip (a recipe they bought during the depression of the 1930s for about $300).

The principle here is “the hometown bias.” We tend to have a sense of pride around our home-grown ideas and strategies, just as the locals have a sense of pride for their home-grown bands. Just as it is easy to imagine how our local band could become famous, we can imagine how our home-grown ideas can hit the big-time.

This bias can blind us to reality. I spent some time as a radio DJ. It gave me the opportunity to listen to a great deal of music. I tried to analyze the situation to try to see if there were any common factors which caused some of those bands to become a big hit and why some went nowhere. I discovered that sometimes highly talented musicians made it big, and sometimes they didn’t. Similarly, sometimes marginally talented bands made it and sometimes they didn’t. I couldn’t find much of any correlation for factors which created success.

I think the Australian band Skyhooks (one of the bands I heard as a DJ and didn’t make it) put it well in one of their songs. They said that the successful bands find a “million dollar riff” (a lucky twist of music that tickles the ear).

Now I’m not implying that business success is all luck. But it is true that sometimes just as there are only small nuances between a dud riff and a million dollar riff, there are small nuances between a huge strategic success and a dud.

Here are some tips to help avoid some of the duds of strategy:

1) Be aware of the hometown bias.
Realize that there are more Whiz Kids than Dave Matthew Bands and that local pride can blind us to giving too much credit to our homegrown ideas. Stand back and look at it with a more critical eye. If your bias does not let you look at it critically, then use unbiased research to help you see how the concept will be seen in the real world.

2) Realize that pride and egos can distort our judgment.
Examine your options with a dispassionate eye. Although it may hurt our egos for a time, it is okay to stop a pet project if it is starting to look like a dud. Pulling the plug early can often be a very smart thing. It’s not an admission of failure, but rather an avoidance of a bigger failure later.

3) Sweat the Details.
Because the difference between huge success and huge failure in music can hinge on the nuance of a riff, it is really important to sweat the details. Great ideas are important, but great execution can often be even more important. Designing and selling digital music players was a great idea. A lot of companies dove into the business. Yet most of these companies have failed to catch on, in spite of it being a great idea. Ipods did catch on, however. One of the reasons they succeeded with that same idea when others didn’t was because Apple did a better job of sweating the details. They spent more time mastering the nuances of the business.

4) Spread your Bets.
In the music industry, even though the music labels had experts with the “golden ear” who had a good sense about what music would sell well, they were still often wrong. As a result, the music label would hedge their bets by investing in a large number of bands. The logic was that even if nine out of the ten guesses were wrong, the tenth would be so profitable that it would more than make up for the losses on the other nine. Similarly, businesses need to use tactics to reduce the risk, like:

a) Don’t put all your hopes into a single idea. Have multiple experiments going on all the time. That way, you stand a better chance of hitting the idea that makes you a winner.

b) Stage your investments. Don’t bet the whole thing at once. Invest in the idea in stages. If a stage fails, then you can back out before you’ve invested everything. If a stage succeeds, you can ramp up.

5) Understand that your idea will not be executed in a vacuum.
Eventually, your idea will need to be executed out in the marketplace, where competition will try to minimize your success (for more on this, see the blog, “Bombs Start Wars”). To avoid future disasters out in the marketplace, ask yourself these questions:

a) Does my idea provide a superior enough solution in the marketplace for a consumer problem to cause people to switch from their current solution alternative to mine?

b) If the big, powerful competitors also decide to enter this space, do I have what it takes to beat them in head-to-head competition?

Most new ideas fail. Don’t let egos or homegrown pride cause to you to back a bad idea. Be willing to do what is necessary up-front to reduce the bias and what is necessary later to pull the plug early if the idea does not pan out.

Good decision making requires looking at an issue both rationally and emotionally. Although we need to eliminate emotional biases that blind us to reality, we do not want to eliminate emotions entirely from our thinking. After all, our customers use emotions to make their purchases.