Monday, February 18, 2008

Analogy #156: Don’t Blame Me, It’s the Environment

I knew an old grocery wholesale executive who liked to tell the same story, year after year. After having heard it so many times, I can almost recite it by heart. Being in the grocery wholesale business, this executive spent a significant part of his time visiting grocery retailers. Whenever he would go to visit a grocery retailer whose store was not doing well, he would hear the grocer complain that it was not his fault that his store was doing poorly. He would blame his problems on the environment, saying things like:

“The economy is bad. There is too much unemployment in the area.”

“The weather is bad. Nobody shops much in this weather.”

“The population is declining. There aren’t enough people living here anymore.”

“People are eating out in restaurants more and not buying as many groceries.”

The retailer would then conclude by saying, “It’s not my fault…nobody could make money in this environment.”

At this point, the wholesale executive would leave the store, and in every case he could go down the street and find a different grocery store that was thriving in that same environment. His point was that there are ways to make money in any environment, and somebody will figure it out. It may as well be you. The environment is not the reason the store was failing. It was because the store manager did not know how to adapt to the environment.

When things are going poorly, it is easier for executives to blame the external environment rather than blame themselves. “It’s not my fault,” they say. “No executive could have been successful in the environment I was faced with.”

However, at some point, shareholders do not care why your business is doing poorly. The shareholders will just move their money to a company that is thriving in that same environment. And trust me, there will always being a thriving company for the shareholders to invest in, that will give them a better return, regardless of the economy.

It’s true that the environment is not always favorable to a particular business model. But where is it written that a company has to stick to a particular business model that is no longer appropriate for the environment?

One of the most important reasons for doing strategic planning is to discover (with enough advance notice) those trends that will destroy your strategy so that a better strategy for that coming environment can be found and put in its place. If a company starts its transition soon enough, it will never find itself in a position where its strategy is out of tune with the environment.

If you wait until disaster surrounds you before taking action, your options are rather limited. However, if you do strategic planning in advance, you can anticipate future problems and prepare a plan to thrive in whatever the future has to offer.

Back at the end of the 20th century, an industry whose entire livelihood was threatened by changes in the environment would have been the US grocery wholesale industry. These food wholesalers were suffering from two major environmental problems:

1) The primary customer of the food wholesaler, the independent grocery store, was disappearing.
During the 1980s and 1990s, the growth and consolidation of the large supermarket chains, combined with the rapid growth of the Wal-Mart Supercenter put the weaker independents out of business and was threatening the viability of even the stronger independent grocers. Between their economies of scale and the ability to use general merchandise to subsidize grocery prices, these chains were putting independents at a major disadvantage. Many independents gave up and sold their stores to these self-distributing chains. I don’t care how great you are at wholesaling food for independent grocers. If your customers are going away, then you are in trouble.

2) Even at its most efficient, the food wholesale business model was less efficient at distribution than a large, self-distributing chain.
Food wholesalers are at an efficiency disadvantage, because they service a wide variety of independent stores over which they have limited influence. Because all of the needs of their independent customers are different, they cannot design a warehouse and distribution network that is optimal for any one of them in particular. By contrast, a large supermarket chain can run all of its stores the same way. As a result, they can create their own warehouse and distribution network that optimizes for that type of store. This makes self-distribution for large chains more efficient than food wholesaling for independents.

Therefore, in many ways it does not matter how well run and efficient a food wholesaling business is managed. If your industry is running out of customers and the business model your industry uses is less efficient than the alternative, even the best executive will have difficulties. Consequently, a food wholesaling executive might say that their problems are not their fault. It is an environment where no executive could succeed.

That type of response, however, is unacceptable. The environment cannot be blamed for any company’s failure. This trend did not happen overnight. It gradually happened over many years. There was plenty of time for a food wholesaler to detect this trend and adapt by altering its strategy.

Executives in such a situation have two choices. Either:

a) Use strategic planning to change the business model to better adapt to the changing environment; or
b) Stay with the current business model let the environment dictate a more dire future for the business.

Let’s take a look at how three companies reacted to this situation: Fleming Companies, Supervalu, and Cardinal Foods.

Entering the 1980s, Fleming Companies was one of the largest and most successful food wholesalers in the US. Given its past success, it saw no reason to radically change its strategy. It decided to continue to concentrate primarily on wholesaling groceries, primarily to independents. Yes, the trends were working against them, but they thought they could beat the odds due to their size.

As Fleming continued to stick to its original strategy, the ever more hostile strategy took its toll. Its customer base of independents began to whither away. In desperation, it took on ever more risky business, including a very risky deal with K Mart. In further desperation, Fleming lied about its financial health by getting its vendors to help it use deceptive accounting practices.

Eventually K Mart declared bankruptcy and the SEC began an investigation into its accounting practices. As a result, in April 2003 Fleming declared bankruptcy. The Fleming Companies, as it was known, ceased to exist.

Fleming could claim to be a victim of a bad environment, a firm with few options. It could claim that bankruptcy was inevitable, given the harsh conditions of a declining client base. However, Supervalu and Cardinal Foods had a different outcome.

Going into the 1980s, Supervalu was about as large and as strong as Fleming. However, Supervalu could see the trends on the horizon and was willing to do something about it. Rather than depend solely on the fate of the independent grocer for its future, Supervalu decided to become its own customer. In other words, it changed its strategy. Supervalue started moving from being a wholesaler to becoming more of a retailer. It started slowly, in order to keep the independent customers from getting upset and fleeing.

Then it started looking for the big deal to get into grocery retailing in a big way. After several attempts, it bought the Albertsons chain, making it one of the top 5 grocery retailers in the United States. Now Supervalu is doing fine.

By contrast, Cardinal Foods was a small player in grocery retailing. In looking at the trends, it could see that there was no long term hope for a small grocery wholesaler. Such a strategy was doomed. Therefore, in the late 1970s, it decided to change its strategic direction. Cardinal Foods decided to take its wholesale distribution expertise to an area where the environment was more favorable—pharmaceutical distribution. Starting in 1979 Cardinal began to acquire a number of pharmacy distribution companies. By 1997, it had acquired 15 such firms, making it a major national player in pharmacy wholesaling. In fact, the pharmaceutical business was doing so well for Cardinal, that it changed its name to Cardinal Health and exited the food wholesale business in 1988.

Starting in the mid 1990s, Cardinal Health expanded further into the medical business, while continuing to strengthen its pharmacy distribution core. Now, Cardinal Health has sales of over $80 billion and is one of the largest companies in the US based on sales.

So, was sticking to a strategy of primarily being a wholesaler to independent grocers a failing strategy? Yes. Does that mean that companies in that industry were destined to fail? No. By using the tools of strategic planning, Supervalu and Cardinal Foods had the time and the initiative to modify their strategy so that they could survive in the new environment. Fleming has no excuse. It cannot blame the environment. It can only blame itself for not preparing in advance through effective strategic planning as Supervalu and Cardinal Health did.

Although environmental trends may cause a particular business model to fail, it does not mean that the company using that business model has to fail. Good strategic planning includes understanding the impact of environmental trends on business models and proactively finding new models more appropriate for the changing environment. Over the long haul, management cannot use the environment as an excuse for poor performance. Good management anticipates the environmental changes and plans a new strategy that will thrive in the new environment.

In general, shareholders do not care if a management is operating an inappropriate business model as well as humanly possible. Perfecting the obsolete is not their goal. Their goal is financial success, which comes from excellent performance with the appropriate business model for the environment. Your goal should be the same. Don’t be afraid to adapt like Cardinal Health did.

No comments:

Post a Comment