Tuesday, July 6, 2010

Strategic Planning Analogy #336: Gold Rush

Over the centuries, there have been numerous occurrences of people discovering deposits of gold or some other precious metal. Once the word gets out, almost immediately thousands upon thousands of people rush to the site to make their fortune.

The ones that come to mind for me are the San Francisco Gold Rush of 1849 and the Klondike (or Yukon) Gold Rush of 1897. San Francisco (then called Yerba Buena) went from being a small town of 79 buildings and a few hundred people the year before the gold rush to a population of 100,000 in the following year. In Klondike, the population went from practically nothing to around 40,000 after gold was discovered there. That’s a lot of people looking for gold.

Unfortunately, whenever a gold rush occurs, only a small handful actually become rich off the gold. Most soon leave the area and return home as poor as when they started (or worse). Many mining towns quickly disappear once the gold disappears, leaving just abandoned buildings. The gold may be precious, but the places where it is found (and the people finding it) are treated as disposable.

The business world is a lot like those gold miners. When word gets out that there is a hot, new growth industry, lots of businesses flood into the marketplace. Soon there is a glut of businesses all fighting to make their fortune in an over-crowded space. Recent examples would be the rush of business into the dot-com boom of the 1990s, the Web 2.0 boom of the 2000s and now the rush into sustainable energy businesses.

And, like with the miners, only a few of these businesses actually survive and make a fortune. Most of the businesses soon go under. I remember being in Seattle and San Francisco soon after the dot-com bubble burst. There were abandoned office spaces all over the place, almost like the mining ghost towns that were abandoned.

The key principle here is that just because an industry becomes hot does not mean that everyone who tries to make a fortune in that industry will become hot. Most of the companies who flock into such an industry will, in fact, fail. Just as most gold miners do not make a fortune in mining, even when they are in a “hot” location, most businesses do not make a fortune in hot industries.

As Michael Porter likes to point out, it is very difficult to earn high profits in an industry which is historically not very profitable (think airlines in the US). But this does not mean that it is very easy to make profits in an industry with higher profits. The reason? Profits do not flow equally to all players.
A few will do very well while the rest struggle. For every Amazon and Ebay that successfully came out of the dot-com boom, there are thousands who died a horrible death.

So what can we learn from the gold miners to help us be one of the few that makes a fortune in a hot market?

1) Choose a Prosperous Position
Just because gold was found near San Francisco in 1848 and near Klondike in 1897 does not mean that every patch of land near San Francisco or Klondike was full of gold. A few spots were full of gold, but most were not. If you wanted to make a fortune in gold, you needed to stake a claim to a spot rich in gold. The rest of the stakes were fairly worthless. It doesn’t matter how industrious you are at panning for gold when the creek has no gold.

The same is true in the business world. Just because some people were having success in some spots during the dot-com boom does not mean that every dot-com business plan was destined for fame and fortune. During that period, I saw a number of dot-com business plans that were absolutely horrible. The business models were not well thought out. Many projected costs higher than revenues into perpetuity. For some reason, these people felt that if you took a bad business model and put it on the internet, something magical would happen, causing it to suddenly be a great business plan.

Just as successful miners positioned themselves near where the larger deposits of gold were, successful businesses need to be concerned with their business positioning. You need to position your business at a place where you can provide high value to a chosen customer—high enough value so that they will pay you more for your offering than what it costs you to deliver it.

Rushing into a hot market without a sense about how you are positioned to win is like rushing to Klondike without a sense of where the gold is.

Over the years, I’ve heard a number of businesses who enter a hot market without a plan positioning them to win say something like this: “We’re not strong enough to take the leading position, but the market is so big and so prosperous that we will get our fair share and still do alright.” Who said that market share is “fair” and handed out proportionately to everyone who shows up? Markets always eventually go through a consolidation, with the strong getting stronger and the weak going away. If you do not have a position where you can win, you will not get that “fair share” of markets or of profits. You will end up with nothing.

It is not enough to just find a hot market. You need to find a place within that market where you can win.

2) Protect Your Stake
When a gold miner found a prosperous stake, their next worry would be to protect that stake from those who would want to take it away from them. These people might try to steal the location away from them, go upstream to get closer to the gold source before it reached them, or build as close to the successful miner as they could to siphon gold away from their operation.

The same situation exists today. If you find success, others will try to take that success away from you. They may try to “steal” your market share by copying you or take you to court to slow you down or shut you down.

The point is that just because you are in a hot business does not mean that you are safer. In some ways, you are less safe because there are more people trying to “steal” your business.

Therefore, you must become like the successful miners and not sit back and relax in your success. You need to protect your stake by aggressively working to protect your winning position. This may require reinvestments to extend your lead in providing value. It may require getting closer to your customers so they have less reason to leave you.

Amazon survived the dot-com bust because it worked hard to create the greatest value in its field. Rather than take profits out of the business early, it reinvested to create leading edge benefits.

3) Consider Support Services
Back during the San Francisco gold rush, there was a man who heard all the miners complaining about their pants. They said that mining was rough work and their pants were not strong enough to hold up under the work. They were tired of always having to replace their pants.

Well, when this man heard these complaints, he looked for solution. He found a supply of heavy denim cloth and rivets, originally brought to San Francisco to make tents for the miners. He took these materials and made pants out of them. The pants were a huge success.

And that was how denim blue jeans were invented. The man who invented them, Levi Strauss, made a fortune with his Levi’s jeans.

The point here is that often the most prosperous part of a hot market is not in the center—where competition is intense—but on the edge, supplying support to the core business. In these mining towns, often the most prosperous place to be was not as a miner, but as someone catering to the needs of the miner. This included supplying them with denim jeans, supplying them with food, and providing places for them to gamble away all that they earned.

Just as Levi Strauss made more money selling jeans to the miners than what most of the miners made, Cisco made more money selling servers to the dot-com businesses than the dot-com businesses made during the boom. A lot of the profitability in the internet boom has also gone into the pockets of support delivery services like FedEx or DHL. In the current rush to build electric cars, I would not be surprised if the battery suppliers make more money than the car companies.

Therefore, when looking for a prosperous strategy in a hot market, consider opportunities on the edge to support core. It may be a better option.

Don’t be lulled into thinking that just because you are operating in a hot industry, all your problems are over. Success in a hot industry is not a given. In fact, most of the players in a hot industry fail. To succeed, you still need to work on the basics—creating a winning position in the marketplace, building barriers so that others cannot steal away your success, and looking at support businesses as a source of profits.

I once visited an abandoned gold mine where most of the gold had long since been extracted. It had been turned into a tourist attraction. They let us pan for gold. Eventually, after many tries, I got this one tiny little flake of gold. I can see why miners would eventually give up if their stake was not in a superior location. Better to spend your time up-front choosing a superior location than to rush to work at an inferior position.

1 comment:

  1. Gerlad, Spot on! One of the things most companies fail to realize is your principle that - Profits do not flow equally to all players - and so trying to do slightly better than what the competitor already does well in a hot sector – does not get us anywhere. In my mind, every firm must differentiate with two offensive (EXPLOITATION & DIFFRENTIATION or Position/Protect strategies in your terminology) ) and two defensive strategies (PREVENTION and MITIGATION or support services strategies).

    1. Differentiation strategies are the “edgy” growth opportunities leveraging company’s strengths – or in your words, “Choose a Prosperous Position strategy”.

    2. Exploitation strategies are the “edgy” growth strategies to exploit competitor’s weaknesses – or in your words, “Choose a Prosperous Position strategy”

    3. Prevention strategies are the defensive/preventive strategies to overcome company’s weaknesses – or in your words, “ Protect Your Stake strategy”

    4. Mitigation strategies are the mitigation strategies to reduce company’s vulnerability from competitor’s threats- or in your words , “ Consider Support Services strategy”

    This type of all-inclusive well guarded strategy - not only helps us to go on the offensive, but also helps us to guard us from these gold rush disasters.