Monday, January 3, 2011

Strategic Planning Analogy #370: Infrastructure

Although China and India are both large countries with rapidly growing economies, there are many differences in how the countries operate. One of those areas where countries differ is in the approach to building the national infrastructure (transportation, utility grid, etc.).

In general, China has tried to get in front of the issue by attempting to build the infrastructure in advance of growth. The idea is to anticipate future needs and build the infrastructure prior to building the economic elements which will rely on that infrastructure. By building extra capacity into the infrastructure in advance, China believes that the infrastructure can be built more efficiently. In addition, by building in extra capacity, the Chinese hope that economic growth will continue to remain strong, since the economy is less likely to be held back by a lack of infrastructure.

By contrast, India tends to have more of a tradition of chasing the economy with its infrastructure. The current infrastructure tends to be left in place until economic growth stretches the infrastructure to near its capacity (or a bit beyond). Then the Indian government steps in and tries to upgrade to infrastructure to catch up with near-term capacity. Unfortunately, by the time the upgraded infrastructure capacity is in place, the economy has already outgrown this capacity, so the infrastructure rarely ever catches up with demand.

Both approaches to infrastructure have their plusses and minuses, and taken to an extreme, either approach can lead to problems. However, most experts would say that a more proactive approach to infrastructure (similar to China) is preferable to a reactive approach (similar to India).

Just a countries need to build an infrastructure for their economy, companies need to build an infrastructure for their businesses. A company’s infrastructure would include things like:

1) Manufacturing Capacity
2) Distribution Network
3) Sales Network
4) Intellectual Capacity
5) A Sufficient Amount of Adequately Trained Labor
6) Access to Raw Materials in Sufficient Amounts at Competitive Prices
7) Access to Customers
8) An Adequately Filled and Functioning Innovation/New Product Pipeline

Unfortunately, it seems that a lot of companies take more of an approach like that of India when it comes to their infrastructure, rather than following the approach of China. There is this idea that the only “good” infrastructure is a “lean” infrastructure, and that every cost which can be driven out of infrastructure should be driven out. Additional infrastructure expenditures are never spent in advance and are instead always trying to catch up with current needs. As one can see by looking at many of the problems facing India, such an approach can become costly and counterproductive.

Now I’m not advocating big, bloated, bureaucratic infrastructures. Waste is never a good thing. However, if you do not feed your business with an adequate infrastructure, you will starve the business and limit your ability to grow and prosper.

You may have the greatest business idea in the world. But if you have no way to get adequate amounts of raw materials, or no way to manufacture adequate quantities, or not enough qualified employees to product sufficient quantities at the required quality level, or no way to get the goods to the customer in a timely manner, then you will most likely fail. At the very best, you will far less prosperous than you would have been if that entire infrastructure had been in place.

The principle here is that infrastructure concerns should be an integral part of a strategic plan. If the business infrastructure is not of sufficient capacity to meet the demands of the plan, then you will not achieve the plan. For example, having a strategic goal to sell a billion dollars worth of goods is a worthless goal if your infrastructure can only support the production, distribution and selling of a thousand dollars worth of goods. To win, you need an infrastructure with the capacity to achieve what you desire. And the only way to achieve that is by putting infrastructure capacity concerns directly into the plan.

To those who prefer to chase after infrastructure like India, I have the following responses.

A) You Do Not Operate In A Vacuum.
In most cases, there are other companies operating in the same space as you are, trying to give the customers a similar solution. If the competition invests in adequate infrastructure and you do not, then they will be in a superior position to capture most of the demand. For example, I know of a retailer who refused to adequately reinvest in their store infrastructure. Their stores became old, ugly and in disrepair. The customers had moved to newer and nicer neighborhoods, but the stores were stuck in the old, decaying neighborhoods. At the same time, competition built nice, new stores in the better, newer neighborhoods, closer to the customers. As a result, the customers defected to the competition—because they had the superior store infrastructure.

B) Human Capital Is Fluid.
In today’s knowledge-based economy, a key part of one’s infrastructure is the knowledge in your employees’ brains. Unfortunately, that employee is relatively free to leave your company at any time. When that employee walks out the door, a lot of your intellectual capacity leaves as well. That is why Google treats its employees so well, spending money on things like free food, and recently giving everyone a 10% raise in pay. Google realized that was money well spent if it keeps that intellectual capacity in place at a time when other companies are trying to hire that capacity away from them. The patience level of employees only goes so far. If you wait to long to reward them, or deny them the tools they need, they will leave.

C) Playing Catch-Up Never Leads to First Mover Advantage
You can never build a leading edge if all of your investments in infrastructure lag behind the industry. Much has been written about the advantage of being a first mover. To be a first mover, one needs to get the capacity in place quickly. Apple had first mover advantage with the iPhone and iPad because it had the infrastructure needed to get to market well before the competition. Microsoft keeps failing in its attempts to catch up to Apple in these spaces, because its infrastructure is not built in a way which allows them the speed and creativity to win in these areas. You can read more about this principle here.

D) Spending More Up Front Often Costs Less in the Long Run
Many times, it is cheaper to spend the money to build a better infrastructure than to try to limp along on the “lean” process currently in place. For example, I know a retailer who refused to upgrade its outdated warehouse & distribution system. Yes, it would have cost money to do so, but the payback was less than a year. And the old system was so inefficient that it made it impossible for the retailer to make a profit on a large percentage of the products going through the old system. The inefficient costs in the old system wiped out much of the profits.

I know of another situation where a retailer liked to brag that it had one of the least expensive IT departments in the industry. Of course, it also had one of the least effective IT departments in the industry, which cost the company dearly. The bare bones IT operation starved the company of the data it needed to be competitive in the marketplace. Lowest cost infrastructure is rarely the most cost-effective.

E) Not All Infrastructure Solutions Are Costly
Some are reluctant to build sufficient capacity because they are afraid it will be prohibitively expensive, particularly in the near-term. However, there are often ways to get capacity without a lot of upfront investment. For example, one can arrange for outsourcing. There is a reason why so many companies in the US outsource their payroll infrastructure to ADP. It is a way to get a state of the art payroll infrastructure without having to make a huge up-front capital expenditure.

One can also come up with creative payment plans. For example, it is common for retailers to place both a fixed and variable component into their store rent. The variable amount of the rent goes up in proportion to store sales. By making part of the infrastructure cost variable, the retailer only has to pay the higher rent if it is justified (and affordable) with higher sales.

Just because one has access to infrastructure does not mean they have to own it. There are lots of creative ways to partner with others to get that access without a lot of up-front investment.

Strategic goals are only as good as the infrastructure capacity behind them. Without the proper infrastructure investments, one cannot reach one’s goals. Therefore, the strategic process needs to concern itself with infrastructure.

Remember, the ultimate goal is not to spend the least on infrastructure, but to make the most in profits. Wal-Mart is a very large and very profitable company. It did not get there by being cheap on infrastructure. They spent a ton of money on infrastructure, especially in IT, distribution and new stores. It would have been impossible for Wal-Mart to get as large as it has without that huge infrastructure investment. And, even though it spent more on infrastructure than any other retailer, it has one of the lowest cost structures in the industry. The investments caused Wal-Mart to be more efficient. It was money well spent.

1 comment:

  1. Gerald Nanninga,
    Again, you provide a thought-provoking strategic post. I tend to avoid tail-chasing and prefer in-advance planning. On a mini-scale the issue becomes more evident. In countries where out-of-town airports were built, more often than not, the capacity of the airport roads was enough to meet the current demand. As airport roads drive economic activities authorities had to widen these roads soon. The cost of land acquisition, compensation for demolished building, environmental problems just to name few escalated the cost and inconveniences of roads expansion. As people are first cost minded they are also first-need (current-need) minded. This is a costly alternative.