Thursday, September 16, 2010
Strategic Planning Analogy #352: Tug o’ War
Tug o’ War is a simple game. All you need are two teams and a large rope. The two teams each grab onto the opposite ends of a rope and pull as hard as they can. The team which out-pulls the other, causing the other team to cross into their territory, wins.
Having played the game a few times, I know it can be a very difficult and strenuous game if both teams are of equal strength. When the teams have equal strength, the game seemingly goes on forever and you get extremely exhausted. It’s more fun if your team is a lot stronger than the opposition. Then, you don’t have to work as hard and you win more quickly and more often.
In Tug o’ War, winning comes from amassing more power at the point of struggle than your competition. The one with the relatively larger strength wins. The same is true in the business world. The one with the larger relative strength usually wins.
Think of the rope in Tug o’ War as being like your supply chain. The person on the other side of the rope is someone else in your supply chain, either upstream (supplier) or downstream (distributor, customer). Within a supply chain, there is a certain amount of revenue and a certain amount of costs. These revenues and costs need to be allocated amongst all the players within the supply chain. If you are a good negotiator, you can get a disproportionately higher percentage of the supply chain revenues while absorbing a disproportionately lower percentage of the costs. Your gains come from the losses of others within your supply chain.
Of course, while you are trying to get a disproportionate advantage against others in the supply chain, others in the supply chain are trying to do the same to you. Hence, the big struggle, like a game of Tug o’ War. And, like in the game, the one with the most power typically wins the struggle.
As mentioned earlier, Tug o’ War is more fun if you are stronger than the team on the other side of the rope. The same is true in business supply chains. I’ve worked with retailers who were very strong relative to their suppliers and I’ve worked with retailers who were weak relative to their suppliers. Let me tell you, those experiences are very different.
When with the weak retailer, we were forever going to the suppliers begging for access to sell their product. We were willing to promise almost anything to get them to cooperate and sell to us. Needless to say, even if we did successfully get access, we didn’t make much money on the deal because the negotiation favored the supplier, who was much stronger.
Conversely, when the retailer was relatively much stronger, the roles were reversed. The vendors came knocking at the doors of the retailer, begging us to sell their wares. To gain access to our stores, they would offer almost anything—even including some equity ownership in their company. In this case, retailer got the most favorable end of the negotiation.
The more power you bring to the supply chain, the better your negotiation of who gets the revenues and who pays the costs. Getting such power rarely comes by accident. It takes strategic effort.
Therefore, when strategizing about the battles ahead, don’t just build your strategy around the struggles against your competition. Remember, you also have this tug o’ war with your supply chain as well. In fact, your ultimate profitability may have more to do with how your supply chain tug o’ war turns out than how your competitive battle turns out. This is because a winning tug o’ war strategy in the supply chain not only makes your individual transactions more profitable, but it can also give you an edge in your fight against the competition (particularly if their tug o’ war within the supply chain was less successful).
How much of your strategic effort is focused on your supply chain tug o’ war?
The principle here has to do with accumulating the right amount of power within the supply chain. The key here is determining what the right amount of power is and what it takes to get it. This is not just about getting the most power you can. Remember, it is not absolute power which is important, but relative power. It does little good to focus on building your power if you still end up significantly less powerful than your supply chain partner on the other end of the rope. Also, as we will see later, there can be risks if you gain too much power. The goal is not to obtain all of the power, but only enough to gain advantage.
So what can we learn from the game of Tug o’ War to help us with this supply chain strategy?
1) Don’t Let the Other Side Get Too Strong
In Tug o’ War, you can still win if you are weak. All you need to do is ensure that the opposition is even weaker. There are steps you can take in your strategy to proactively try to keep other players in your supply chain weaker than you. Take, for example, the relationship between franchisors and franchisees. If you are a franchisor, you have a choice in whom you franchise to. Are you making those early front-end choices strategically for the long-term Tug o’ War between franchisor-franchisee?
At first, it may seem easier to franchise your concept to a small number of large franchisees. After all, this eliminates the hassles of dealing with a lot of small operations. Through only a few deals, you can quickly get huge geographic penetration for your concept. In addition, these large franchisees tend to be successful and well financed, reducing the risk of failure.
Unfortunately, when you take such a move, you have made the franchisee relatively stronger in the franchisor-franchisee tug o’ war. A large franchisee has more leverage in the negotiations and can gain more advantage. Your one-time decision has created decades of tougher Tug o’ War battles than there needed to be.
Take, for example, NPC International. They own about 1,200 Pizza Hut franchises. Just their volume alone would make NPC a top ten fast food retailer in the United States. Worse yet for Pizza Hut, NPC now controls about 20% of Pizza Hut’s volume in the United States. That gives NPC a lot of power in negotiating with Pizza Hut. For example, instead of accepting the typical supply distribution arrangement Pizza Hut offers its franchisees, NPC in August negotiated a separate deal to get their supplies from McLane Foodservice. I’m sure that this deal between NPC and McLane Foodservice puts disproportionately less of the total supply chain profits in the hands of Pizza Hut.
And it is Pizza Hut’s fault, because they allowed this franchisee to get too powerful. NPC International got large by buying up other franchisees. Strategically, it might have been in more beneficial if Pizza Hut had outbid NPC and then placed those units in the hands of others where the power of the franchisees would have been more dispersed. Then Pizza Hut would have had more power when distribution decisions by the franchisees were being made.
2) Build Your Own Strength With the Help of Others
Even if your team is small and weak you can still win Tug o’ War if you can partner with others who will pull along with you on the same side. In other words, if your negotiating clout is weak, then don’t negotiate alone. Form alliances with others.
The internet has shown that if individual consumers work together en mass, they gain a lot more clout and get better deals (think firms like Groupon). Cooperative buying organizations have been around a long time, where groups of people or companies negotiate together in order to get a better deal. Technology is making such buying even easier. Take advantage of these opportunities increase your relative strength at the point when Tug o’ War negotiating occurs.
3) Keep the Game Fun for Both Sides
If you build up too much power, nobody will want to play Tug O’ War with you because they won’t have any fun. The same is true in business. If you gain too much power, and exploit that power too strongly, nobody will want to play with you. And if nobody in the supply chain wants to play with you anymore, you cannot run your business anymore.
Think of the U.S. automobile industry. The manufacturers had used their power so aggressively to squeeze concessions out of their suppliers that the suppliers could no longer make a profit serving the automobile industry. Many suppliers started diversifying away from the automobile industry and started to no longer bid on projects in the automobile industry. Those suppliers which remained started going bankrupt, causing all sorts of problems for the automobile companies purchasing from them. The result was that the automobile companies now had fewer supply options and the remaining options were shakier. This is all because they had taken the power principle too far.
Remember, the goal is to win with your supply chain, not to obliterate it. Although they may be on the opposite side of the rope, they are still your partners. You cannot survive without them. Getting a disproportionately better deal does not mean taking it all and leaving them with nothing.
Besides, the cost to get that much power may be more than what you can get in concessions (diseconomies of scale). And if you exploit your power too much, you can have government agencies coming after you.
4) Be Careful When Pulling on Both Sides of the Rope.
Some people argue that the best way to avoid problems in the supply chain is to diversify into the rest of the supply chain. In other words, become your own supplier and/or distributor. Now there can be some benefits to this approach, because you cut out some middleman expenses. However, this approach can often be a disaster.
The problem is this—if you own both sides of the negotiating table, then you cannot get a disproportionate advantage. Although you get to absorb all of the revenue, you also have to absorb all of the costs and all of the risks.
It is like trying to play Tug o’ War while holding both ends of the rope at the same time. There is no way to win an advantage.
In addition, if you own a supplier or distributor, that often means that your competition will no longer want to use that same supplier/distributor for fear that it will put more profits in the hands of their competition. As a result, your ownership could weaken the power of that supplier/distributor in its own Tug o’ War battles.
A large part of a company’s success may be due to how well they play Tug o’ War with their supply chain partners. Therefore, supply chain power management should be a key part of any strategic planning exercise.
Negotiations with supply partners do not always have to be adversarial. Sometimes you can find some win-win alternatives where you can make your whole supply chain more competitive against competing supply chain alternatives. But don’t be naïve when negotiating and assume your partners always have your best interests at heart. I remember one wholesaler saying that his suppliers all told him that he was their favorite customer. At first he was happy because he thought that was a compliment. Then he realized that he was their favorite customer because they got their best differential advantage when negotiating with him. He stopped being happy and started negotiating harder.