Friday, November 6, 2009

Strategic Planning Analogy #289: Basic Training

Many people have stories about the terrible ordeal they went through in Army basic training (also known as Boot Camp). They tell about how the Sergeants yelled at them unceasingly and how the Sergeants tried to punish and humiliate them in front of the others.

When my son went through basic training, it was relatively painless. The Sergeants pretty much left him alone. I asked him how he was able to do that. His response:

“I quickly found out that there were two groups of people that got picked on. One group was the laggards, who were having trouble keeping up with the rest. They were yelled at to get them to work harder.

“The second group was those who excelled much better than average. They were yelled at to break their egos. The ones in the middle were pretty much ignored. So I tried to be in that anonymous middle at everything we did.”

Leave it to the army to make “aiming for average” a virtue.

One of the key factors to consider in business decisions is risk. Typically, we try to develop strategies that minimize risk (relative to the reward). Even if we cannot eliminate risk, we try to find ways to manage it so that we are best prepared to withstand it.

My son found a way to minimize/manage the risk of punishment and humiliation in the army. He noticed that the risk increased the further he varied from normal, average behavior, either in a positive or negative direction. By hiding in the middle, with the masses, he could avoid a lot of that punishment and humiliation.

This same principle is true in the business world. As we will see later in this blog, many of the most dangerous risks to your business are at the points where you are the most unlike your peers. There is more safety in the anonymous middle.

The principle here is that we need to keep a careful eye on those points in our strategy where were stand out from the crowd, because that can often be the source of some of our greatest risks.

Think, for a moment, about the recent financial crisis. At first, the US government thought that the crisis would only impact the outliers who were overly aggressive in the problem mortgages. Therefore, the government was willing to let Lehman Brothers fail, because it was thought to be a rare outlier. However, once it was determined that the financial crisis was going to devastate the anonymous middle of the financial world, the US government put into action a massive bailout program to try to save as many as possible.

By staying in the middle, the risk was minimized. They got a bailout. But Lehman, by appearing to be a little more aggressive, was allowed to fail.

Or let’s suppose that most of the companies in your industry are headquartered in Country A. You are unusual in that you are headquartered in Country B. In your industry, there are many transactions between Country A and Country B. As the currency exchange rate between the two countries vary, it impacts those inter-country transactions.

For the majority, who are all headquartered in Country A, the currency risk is relatively small. Since they all have the same problem, they can adjust fees to compensate and still make about the same amount of money and still be competitive with all the others headquartered there. However, because you are headquartered in Country B, the exchange rates have the opposite impact on your business. When you adjust, you are out of sync with everyone else—sometimes for the good, sometimes for the bad. Your difference in location increases your exchange risk relative to your competition.

In October of 2009, McKinsey & Company released a paper on managing risk. One of the points made in that paper was that some of the largest risks to your business [what they call risk cascades] come at the point where you are the most different from your competition. To quote the paper:

“Companies are particularly vulnerable to this type of risk cascade when their currency exposures, supply bases, or cost structures differ from those of their rivals. In fact, all differences in business models create the potential for a competitive risk exposure, favorable or unfavorable.”

This creates an interesting dilemma. Most of the writings on strategy emphasize the benefits of differentiation. They explain that it is what makes you different that provides the opportunity to become superior in some way to some segment. To quote Michael Porter, “Strategy is about making choices, trade-offs; it's about deliberately choosing to be different.” I talked about this in greater detail in an earlier blog.

Yet, this same benefit from differentiation also increases your risk. My son avoided risk in army basic training by avoiding differentiation. Yet we, as strategists, know that this is not an option for us if we want to excel.

That is why the McKinsey article goes on to say, “The point isn’t that a company should imitate its competitors, but rather that it should think about the risks it implicitly assumes when its strategy departs from theirs.”

You may currently be taking comfort in the elaborate and sophisticated strategy you have put in place. However, a small detail, such as being located in the wrong country, could create a currency risk that puts that entire strategy in jeopardy.

Therefore, when looking for points of risk vulnerabilities, don’t just focus on the grand design of your strategy. Look for the little details where you stand out from the anonymous middle.

Perhaps you are a little more labor intensive, or a little more capital intensive, or you rely on a different set of suppliers. Whatever it is, that little difference puts you at odds with the rest of the industry. That means that when there are corresponding market shifts in labor costs/availability, capital costs/availability or supplier costs/availability, you are effected more than the rest of the market, because you have more at stake.

If you are in the anonymous middle, you adjust similarly with everyone else on these issues and get by. You might even get a bailout. But if you are an outlier, watch out, because that difference can radically decrease your competitiveness when changes occur.

It is impossible to keep track of every issue that could possibly impact your business. There aren’t enough hours in the day. As a result, you need to prioritize. Near the top of that priority list should be the issues which arise out of the points of difference in your strategy.

Although differentiation is a key aspect of a great strategy, it is also a key source of risk. Since we do not have the option of avoiding differentiation in strategy, we do not have the option of avoiding the added risk inherent in that point of differentiation. Therefore, a business’ risk-assessment process should prioritize a focus on the risk factors closely associated with their points of differentiation.

Although it is true that there is “safety in numbers,” it is also true that nothing great ever happens unless you go against the crowds. Hence, risk cannot be avoided if you seek greatness. So rather than avoid it, accept it and manage it.

1 comment:

  1. Gerald,
    This is a serious and hair-raising issue as it affects our lives in every perspective. My daughter voluntarily dropped her 3.75 at the university to put up with the risk of calling her nerdy.
    The Black Swan, the Blue Ocean strategies and others do increase the risk of standing out of the crowd. But, in life you do not get ant thing for nothing. The risk is to pay more for what you benefit. The risk is greater when differentiation is greater. I concur.