Thursday, April 28, 2011

Strategic Planning Analogy #390: Hide the Scores

Imagine you are an athlete and they changed the rules of the game you play. The first change is that the place where points are scored cannot be seen by the players. It is obscured from their view. For example, if you play hockey or soccer, you cannot see anything that happens near the goal area. Once the ball or puck enters the goal area, you cannot see where it went. Similarly, if you play basketball, you cannot see anything that happens near the hoop. Once you shoot the ball, you cannot see if it went into the hoop or not. Scoring becomes a mystery.

The second rule change would be that the referees, who are the only ones who can see the scoring, have up to five years to determine if any scoring occurred.

As a result of these changes, the athletes would have no immediate feedback. They would have no idea if their actions were successful. Player statistics would be virtually non-existent. Worse yet, the players might have to wait up to five years to find out if they even won the game. With the way players switch teams today, they more than likely would have switched to a new team before they even know if they were successful on the prior team. And, of course, without up-to-date statistics, it would be difficult for the players to negotiate salaries. No, I don’t think the athletes would like these rule changes.

The fans wouldn’t like the situation, either. It’s hard to get excited about going to watch a game where you don’t know the score and won’t know the results until five years after watching it.

These rules would be hated so much that I can assure you that they would never be enacted.

Unfortunately, as bad as these rules are, they are very similar to the rules executives face every day in the game of business. For many of the tough decisions that CEOs and strategists make, there is no immediate feedback. They cannot see if it was successful right away. It can take up to five years before one knows whether that tough decision was made correctly or not.

For example, Cisco’s decision to use the Flip camera as part of a push to diversify into consumer electronics initially looked very promising. The Flip camera was loved by the market when introduced and when purchased by Cisco in March 2009. Initial sales were very promising. It wasn’t until years later that the ultimate results of that diversification decision were in. The decision to diversify into consumer electronics was a complete failure for Cisco. They couldn’t even find a buyer for the Flip camera business and just shut it down two years after purchasing the business. And, of course, the decision to diversify was made well before making the purchase of Flip, making this around a three year feedback cycle.

And this three years was a relatively quick feedback (best case scenario). Consumer electronics tends to reward winners and losers much faster than most other industries. And most companies probably would have waited a couple of years longer than Cisco for even more feedback before pulling the plug.

Given that the average tenure for a CEO or strategist is less than 5 years, executives can move to a new company before knowing whether they were ultimately successful at the prior company. Trying to put together any kind of up-to-date statistics on CEO performance can be fairly meaningless, because it can take many years before the full impact of the really big decisions can be seen. That is why it is so difficult to determine what fair compensation for top executives should be.

Like the athletes in the story, CEOs tend to hate this condition of uncertainty. And like the fans, stock analysts and stock traders also hate this uncertainty. It’s hard to recommend or buy stocks when you won’t know the complete score for past actions for up to five years.

Yet, even though it may be hated, this is reality.

The principle here is that successful CEOs and strategists need to resist the temptation to act based solely on immediate feedback. Instead, they need to focus a significant part of their time pursuing long-term visions, even when it is difficult at the time to know how those decisions will turn out.

There is a tendency to try to avoid these uncertainty issues and try to make business rules more like sports rules. Compensation packages look for ways to immediately score a leader’s performance. Stock analysts find all sorts of near-term scoring to look at in order to rate a company. As a result, you get companies so focused on the next quarter’s performance that critical long-term decisions get pushed aside.

Decisions are made to increase near-term statistics rather than to win the long-term game.

HBS Study
I was reminded of this situation by a recent study reported by the Harvard Business School. The study was trying to correlate the day to day activities of a CEO with company performance. The scoring mechanism used by the study was productivity. What they found out was that:

1. The more hours a CEO was at work, the higher the productivity

2. If most of that CEO working time was focused internally on employees, productivity went up.

3. If most of that CEO working time was focused externally on customers or the marketplace, there was no impact on productivity.

Hence, one might conclude from this study that CEOs should spend a lot of time in the office dealing with employees.

Wrong Focus
However, I see a major problem with this conclusion. In particular, the scoring methodology is all wrong. We’re measuring productivity in this study, not long-term success.

Isn’t productivity more the responsibility of the COO (Chief Operations Officer), not the CEO? Naturally, if all you want is greater productivity, spend a lot of time pushing your employees. But there’s a big problem with this approach. You can end up having the most productive process for an obsolete solution.

Kodak spent a lot of time perfecting productivity on analog film and totally missed the transition to digital imaging. Blockbuster perfected productivity on moving DVDs through stores and missed out on winning the transition to receiving movies via direct mail and digital streaming.

Focusing on getting better and better at doing an old task gets you nowhere when that task is no longer needed. And trust me, all business models eventually become obsolete. That is why efficiency (doing things well) is not enough. You also need effectiveness (doing the right things).

That’s why CEOs and strategists should spend considerable time looking beyond the tasks of today. They need to look for where the company needs to be tomorrow. Time should be spent addressing issues like:

1) What needs to be added to the portfolio?
2) What needs to be deleted from the portfolio?
3) What will make our current business model obsolete?
4) What will be the next big thing to threaten our core?
5) Where are the gaps in our competencies when transitioning to the business model of the future?

These questions won’t get answered by spending all day in the office putting pressure on your employees. To answer these questions requires getting away from the daily grind and spending time alone in thought. It requires getting out into the field to talk to customers and see what is going on. It requires broadening your horizons. It requires putting up blinders around those near-term measures, so that you are not fixated on them all the time. It requires making bold moves, even though you may not know the outcome of those moves for a long time. It requires ignoring the results of that HBS research.

In other words, it requires resisting the temptation to focus only on an instant score like an athlete. Instead, it requires taking responsibility for those actions which only CEOs and strategists can answer—what do we need to transition to and how to we make that transition.

Successful CEOs and strategists need to break away from the temptation to fixate on near-term measurements and instead spend a considerable amount of their time making decisions about key factors where the results of those decisions may not be known for another five years. Otherwise, they may find themselves perfecting the obsolete.

Yes, CEOs cannot completely ignore the tyranny of the immediate—the fires which need to be put out right away. But one cannot ignore the long-term either. Most experts seem to feel that CEOs should spend about a third of their time on long-term issues. Yet most studies show that CEOs spend far, far less time than that on long-term issues. The only way to increase the time is to back away from such a strong focus on near-term scoring.

Wednesday, April 20, 2011

Strategic Planning Analogy #389: Ransom Pricing

My wife and I recently purchased the DVDs for all eight seasons of the TV show “24.” As you may recall, each season of 24 consisted of a terrorist attack on the United States. Jack Bauer and his co-workers at the government agency CTU (Counter-Terrorist Unit) had only 24 hours each season to stop the terrorists.

A common plot device used over the eight seasons of the TV show was the hostage/ransom situation. Typically, someone Jack Bauer cared deeply about would be taken hostage by the terrorists. The hostages would then make outrageous ransom demands. If Jack did not follow through on the demands, the person he loved would be killed.

This taught me something very important: Don’t ever let Jack Bauer care deeply about you. For when that happens, you get captured by terrorists and there is a good chance they will kill you.

In the TV show 24, terrorists could convince Jack Bauer to do things he would not normally do in order to save his loved ones. Jack was willing to pay a high price to get his loved ones released, including putting his own life at risk. Jack didn’t spend a lot of time trying to negotiate a lower ransom fee. Jack didn’t wait until the terrorists decided to hold a Clearance Sale on Hostages, where ransom demands were reduced for a limited time. No, Jack would ask what the demands were and then try to satisfy the demands as soon as possible (no matter what the price).

Most companies would love to be in the position of those terrorists when it comes to pricing. The terrorists could charge pretty much whatever ransom fee they wanted. There was no fear of getting into a pricing war. They never had to put the hostages “on Sale.” And the terrorists knew that Jack would rush to pay that price as soon as possible.

Unfortunately, most companies find themselves in the opposite situation. Intense competition gets them into price wars, where margins are eroded to next to nothing. And then customers wait for even further price reductions. If the company makes customers work too hard to get the product or service, the customers will lose interest and go somewhere else. Rather than being able to collect whatever “ransom”-sized fee they want, the companies find themselves having to pay whatever “bribe”-like incentives are needed in order to get customers interested.

The principle here is that if you want to be able to charge ransom-like fees for your product or service, then you need a strategy more akin to that of a terrorist holding a hostage. Otherwise, you will become a victim of low-margin price wars. This is not to imply that you need to become a terrorist. It just means you need to borrow some of their strategic tactics.

There are three tactics terrorists use to create a favorable pricing situation for themselves.

1) Create/Exploit Deep Emotional Ties
Jack Bauer would only cave in to terrorist demands if it involved people he cared deeply about. How deeply do your customers care about what you have to offer? Is there a deep emotional tie between your brand and your customer? To what extent will your customers go to maintain that emotional bond?

For example, would you pay a higher ransom to get back your mother or your refrigerator? Most of you, I assume, would pay more to get back your mother, in large part because you have a stronger emotional attachment to your mother than your refrigerator.

Most of the companies which command premium (ransom-like) prices have positioned their products to hold a strong emotional tie to their customers. Examples include Harley-Davidson (motorcycles), John Deere (tractors), and Apple (iPods, iPads, iPhones). The tie is so tight that one’s own sense of identity is wrapped up into the identity of the product. The product represents who you are as a person. Abandoning the product would be like abandoning a piece of yourself. You will pay almost any ransom to maintain that emotional identity.

Harley-Davidson owners have owner clubs (Harley Owners Group, or H.O.G.s). Even though other companies make higher quality motorcycles at lower prices, emotionally loyal Harley owners will never consider them at any price. It is common for these owners to get tattoos of the Harley Davidson logo. This emotional attachment allows Harley-Davidson to stay out of price wars and charge more ransom-like pricing.

There were lots of firms which came out with music players to compete with the iPod, but they didn’t stand a chance, because of the emotional bond and attachment between the iPod and image-conscious teens. To own another brand would be to commit severe damage to your coolness image. As a result, while the competition kept lowering prices to lure away business, the iPod kept both the business and the premium (ransom-like) price.

I have always been fascinated by the cars and trucks I see on the road with a particular decal posted on the window. The decal is of a young boy urinating on the logo of a competing brand. If you can create such a strong emotional bond that your customers see the competition as good for nothing but urinating on, then you know they will not be easily swayed to switch to that competing brand merely due to a small price reduction. You have earned the right to charge ransom prices.

2) Create a Unique or Irreplaceable Offer
I think there is another reason why you would pay more to ransom your mother than ransom your refrigerator. You have only one mother. She is irreplaceable. By contrast, you can always get another refrigerator, perhaps even better than the old one. And the food inside is also easy to replace. Why pay a huge ransom to a terrorist to get the old refrigerator, if you can just go to a store pay less to get a brand new replacement?

That’s why terrorists hold up for ransom items which are unique and difficult to replace, like your mother. It is worth more to you, because you have no way to replace it. And the same idea applies to business. If you want to be able to charge ransom-like prices, you need to offer something which is unique—where there are few alternatives.

It sort of goes along with the idea of The Godfather in wanting to “make an offer he can’t refuse.” You cannot refuse an offer if there are no suitable alternatives.

That is why there is such a big movement among retailers to sell unique products and brands not available at any other store. If the retailer can convince you to desire that product, then the retailer knows that you will have to go to them to get it. With no other options, the retailer stays out of price wars. They can charge a higher price, because you have no other choice if you want that product.

Apple products link the hardware to the software to the apps to the app store. If you want a unique killer app, you have to link into the whole Apple system (no matter what the price). There are no other choices, because it is a closed system. Even though people did not prefer the AT&T mobile network, they accepted it as part of the cost of getting an iPhone in the US, since at first it was the only system iPhone worked on. You cannot haggle on prices for the various parts because of the unique linkage.

General Motors is the only firm in the US to offer the OnStar service on its cars. If you are the type of person for whom the OnStar service is critically important, than you have to own a GM car, no matter the price.

If people see your product or service as no different than the competition, then you become a commodity. With no perceived difference, sales go to the firm with the lowest prices. The only way to get out of that price war is to find a way to differentiate yourself from the pack. Find some sort of unique added value that a group of people will pay more for. Or link up and bundle yourself to other desirable products. Make it impossible to do direct comparisons with competition. Only then can you extract ransom-like prices.

3) Have the Power to Follow-Through on Threats
Usually, the terrorists told Jack Bauer on 24 that if he did not do as he was told, they would kill Jack’s loved one. Jack obeyed because he knew that these terrorists had the will and the power to carry out their threat. These terrorists were used to killing and had no qualms about killing a loved one of Jack.

Conversely, if the terrorists did not have the will or the power to carry out their threat, the ransom demand loses value. If you know that the threat to kill is a hollow threat they will not carry out, then you can ignore the demands. I’ve often seen this with children in public places. When parents tell an unruly child to behave “or else”, some immediately behave while others continue the bad behavior. Although there can be many reasons for this, one reason is because children know whether the “or else” is a hollow threat. If it is a hollow threat, then there is no reason to take it seriously.

One of the reasons why Best Buy was so profitable at its peak was because its vendors knew that Best Buy followed through on its threats. When a new technology was developing, Best Buy would tell all the vendors in the field that they would not support all of the brands trying to claim a position in this space. They would point to history, where the brands Best Buy supported thrived, and the ones they did not back usually failed. Then, they would essentially ask the vendors how much of a “ransom” they were willing to pay to get the support of Best Buy (and avoid not getting their support). Because Best Buy carried out its “threats”, people took these negotiations very seriously, and Best Buy reaped higher profit margins.

Lots of people procrastinate and wait for sales when they know that a retailer does not have the will to resist holding a sale. However, if a retailer gets a reputation for following through on a threat of not holding sales, then customers will tend to not wait and buy early at full mark-up prices.

If you want to escape endless price wars and instead charge prices with healthy margins, think like a terrorist in a hostage situation. Terrorists can extract a huge ransom price because they:

1) Choose Hostages with High Emotional Value
2) Choose Hostages with are Unique and Difficult to Replace
3) Follow through on their Powerful Threats

As a company, you can do similar things to create your ransom-like pricing.

1) Create Strong Emotional Ties Between Your Brand and the Customer
2) Create an Offering which is Unique and Irreplaceable in the Marketplace
3) Follow Through on Your Threats.

A strategy to follow the leader will never set you apart in a manner which allows ransom-pricing. Instead, strike out on your own and create a unique offering which has high emotional appeal.

Thursday, April 14, 2011

Strategic Planning Analogy #388: Bad Habits

Back around the late 1990s, J.M. McGinnis and other medical researchers looked onto the causes of illness and death in the United States. The results appeared in several places, including a 2004 edition of the Journal of the American Medical Association and the website of the Robert Wood Johnson Foundation.

The conclusion of the research? “Dietary patterns and sedentary lifestyles represent the most common source of unnecessary death and disease among Americans.”

They claim that between 40 and 47% of the deaths reported in 1996 were attributable to our behavior patterns, including behaviors such as:

a) Poor Diet
b) Sedentary Lifestyles
c) Use of Tobacco, Alcohol or Drug Abuse
d) Sexual Behavior.

If you look at the 90.6 million illnesses and injuries requiring medical treatment in 1996, the results are even more dramatic. About 33% of the medical treatments were due to poor diet and exercise. About another 57% were due to alcohol, tobacco, drugs, and sexual behavior. In fact, over 90% of the illnesses and injuries were caused by our poor behavior patterns.

Although this data is a bit dated, the research said that since our behavior patterns have been trending in the wrong direction, these percentages are probably getting even worse.

Therefore, next time we want to point fingers at who is causing high health care costs, we’d better save a few fingers to point at ourselves.

This story has some good news and some bad news. The good news is that we are in control of the key element behind illness, injuries and death. The bad news is that there is not a magical instant cure. We got into the problem through a lifetime of bad habits and it will take a major and lifelong change in lifestyle to fix it.

This same phenomenon also seems to apply to businesses. Businesses get sick or die for many reasons, but one major cause has to do with bad business habits and business lifestyles. As a result, there is some good news—we can fix the problem, because we control the cause. However, the bad news is that the fix requires a major overhaul in the way a company thinks and acts on a daily basis.

I have had the privilege of spending time both with companies having long periods of health/success and companies with long periods of sickness/failure. What I have noticed is that the successful companies act differently from the unsuccessful—they have different behavior patterns. These behavior patterns impact results. Therefore, if we want a strategy which provides great results, we need to address how a company behaves on a day-to-day basis.

In this blog, we will look at three types of behavior patterns which can seriously impact business success.

1. Malnutrition
If you starve a body of nutritious food over a long period of time, there will be long-term health problems. The same is true of businesses. If you starve of business of nutritious investments, there will be long-term health problems.

Nutritious investments nourish a business’ health in one of three ways.

a) They add the COMPETENCIES needed to succeed. Healthy companies have the appropriate knowledge and skills needed to execute a strategy. This requires regular investments in areas like data gathering, education, training, and research. These are not random investments, but targeted specifically at improving the company’s ability to know what to do and how to do what it takes to win at their strategy. Since the environment and technology continues to change, one needs to continually invest in this competency nutrition to remain relevant.

b) They add the CAPACITY needed to succeed. You cannot become a large, successful company without investing in what is needed to operate a large successful company. Investments are needed to create an organization and infrastructure large enough to do the task at hand. For example, Wal-Mart is a large, successful company because they first invested in the capacity needed for succeeding at such a large size. Not only did they invest in building the necessary store capacity, but they invested in building a huge, world-class distribution network as well as one of the largest computer installations in the world. All are essential to Wal-Mart achieving their strategy. If you are not achieving the scale and scope you desire, perhaps it is because you have not invested enough in what is needed to achieve scale and scope (people, factories, points of distribution, sales force, etc.).

c) They add the DIFFERENTIATION needed to succeed. Successful strategies have a point of differentiation…an area where the company has a superior advantage over the competition. This competitive edge can wither away over time unless regular investments are made to enhance this point of differentiation.

The healthy companies regularly and continually make investments focused in these three areas (competency, capacity, and differentiation). It is a natural part of their day-to-day operations.

Unhealthy companies starve themselves of these investments. Either they regularly refuse to make any meaningful investments (for the short-term benefit of putting more cash on the bottom line today) or they invest in non-nutritious “junk food” (business fads, executive perks, or items unrelated to the strategy). These bad habits might make you feel good for a very short period, but in the long run they will make your business very sick.

2. Obesity
Being overweight can contribute to a large number of illnesses, including high blood pressure, excessive cholesterol, diabetes, among many others. Just as excessive fat in a human damages a body, excessive fat in a business damages a company. Business fat includes the following:

a) Excessive Bureaucracy (rules, procedures, silos, power bases, approval processes, paperwork, etc.)
b) Excessive Complexity (too many product versions, too many decision points, too much operational inefficiency)

Nearly all the problems you see in a Dilbert cartoon come from these types of obesity.

Successful companies work diligently on a regular basis to help keep these excesses out of their organizations. They take away as much of the weight of bureaucracy and complexity as they can, so that the people on the front lines are empowered and free to do the right thing on a timely basis. By never letting the fat build up, they never have the trauma of trying to get rid of it.

Unhealthy companies, on the other hand, keep piling on more fat until (like clogged arteries) nothing can move anymore. And once the movement stops, it is hard to eliminate the fat and get it moving again.

It’s not that people intentionally want to be fat. They just live a lifestyle which makes fat happen. The same is true for businesses. Be on the lookout for fat-causing habits.

3. Sedentary Lifestyle
Long periods of inactivity can cause atrophy and other health problems. By contrast, healthy bodies tend to come from a lifestyle of regular exercise on a frequent basis. The same is true for business.

Healthy companies have a bias towards action. They like to experiment and try new things (focused in the direction of the strategy). When there is a problem, their first reaction is to figure out what to do to make things right.

Unhealthy companies have a bias towards inaction. They prefer to stick with the status quo and resist change. When there is a problem, the first reaction is to try to place blame on someone else (and get someone else to fix it).

A company used to action on a regular basis can be more easily mobilized to act when needed in the future. Its muscles have been trained to move together and handle the load via regular exercise. By contrast, a company used to inaction will have significant difficulties when it is time for a major strategic reinvention.

The goal of strategy is to create a stronger, more successful company. Strong, successful companies tend to behave differently from unsuccessful ones. Just as a person’s daily lifestyle and habits impact their health, the daily lifestyle and habits of a company impact long-term business health and success. Therefore, a strategic planning needs to address any of the bad habits which are hindering success. Examples of bad daily habits which can impede success are:

a) Insufficient Investments in Key Elements of the Business (starving the company).
b) Allowing Excessive Bureaucratic Fat and Complexity to Creep in (overburdening the company).
c) A bias Towards Inaction (unable to adapt and change when needed).

Most of the literature on strategic planning talks about the big picture issues, like Visions and Mission Statements. Although this type of activity is essential, it is a worthless endeavor if a company is not healthy enough to make the vision a reality.

We’ve all heard the complaints about the fact that most companies fail at ever achieving those big-picture goals and visions. If we want to stop the complaining, then we need to address those root causes of failure—the bad habits on a daily basis. Don’t just blame someone else for the poor implementation. Get involved.

Remember, at some point, all strategic activity is a waste of time if it is never achieved. If you personally do not want to be seen as a waste of time in your organization, then move beyond just setting the big picture and help bring it to reality by getting involved in how a company behaves on a day-to-day basis.

Tuesday, April 12, 2011

Strategic Planning Analogy #387: Loss-Leader Customers

The movie “The Lincoln Lawyer” is about a lawyer who defends mostly criminals and low-life people from the bad side of town. One of the groups he frequently defends is a rough motorcycle gang. Everyone knows this motorcycle gang is involved in illegal activities, but the Lincoln Lawyer, named Mick Haller, keeps enough distance so that he doesn’t know what that activity is.

At one point in the movie, Mick needs some help, so he asks the motorcycle gang to beat up somebody who was threatening him. Later, when the gang needs Mick’s legal help again, they ask for a discount on the legal fees in return for beating up that person. Mick goes further and says he will take the case for free.

Earl, Mick’s driver, is surprised that Mick is willing to take the case for free. After all, Mick’s reputation is to do whatever it takes to make as much money off a deal as possible. Mick’s response, “Repeat customer, Earl; we will stick it to them the next time.”

It seems that everyone knows about the principles of loss-leader pricing. The idea is that you price certain items at a loss, because you know that the customers lured by that loss will eventually spend enough to more than compensate for that loss. For example, if a supermarket sells milk at a loss, it will get more customers in the door to buy a basketful of profitable groceries. Having spent a few decades in retail, I’ve seen the effectiveness of loss-leader pricing.

Even the Lincoln Lawyer knew how to use loss leader pricing on a tough motorcycle gang. By giving the gang one deal for free, he knew that:

1) The gang would be a more loyal customer in the future (ensuring Mick more business);
2) The gang would be less likely to haggle over future fees, since they had gotten such a good deal on the free one (so Mick can charge more in the future—enough to more than recoup his expenses on the free deal);
3) The gang will be more willing to do more favors for Mick (for free) in the future;
4) The gang will recommend him to others (creating even more customers).

If you can use loss leader pricing on legal fees to tough motorcycle gangs, then you can use it on just about anything.

But here is the twist. Although it is common to think of products and services as loss leaders, we do not often think of having customers as loss leaders. As we will see in this blog, having loss leader customers can be just as viable a strategy as having loss leader products and services.

The principle here is that you can develop a strategy where some of your “best” customers can be customers with whom you never make a profit. The reason is because these “best customers” are used strategically as “loss leader customers.”

Just as a supermarket can decide to never make a profit on milk because it helps them make greater profits on other items it sells, you can decide to never make a profit on certain customers because it will help you make greater profits on other customers. We will look at four strategies for loss-leader customers.

1. Gaining Credibility
In the fashion business, credibility and image mean everything. If your fashion product is not seen as the hot /“in”/gotta-have-it product, then it will fail. One way to get credibility as being a desirable fashion is to associate your product with the hot tastemakers. If you can get the hottest movie stars and athletes to wear or use your product, then the desirability of that customer will transfer to your product.

That is why people in the fashion business spend a lot of time and effort to get the hottest people to use their product. They know that they may never make a profit off of these customers (since they give these celebrities the product for free or even pay them to use it). However, these loss-leader customers make the fashion item more desirable to other customers. The celebrities give the product fashion credibility, creating a larger group of profitable customers who want the item.

But it doesn’t just have to be fashion items. I know of a cell phone service provider who was targeting the teen market. They gave away the service for free to the cool kids in school, such as cheerleaders. These were the loss-leader customers. When other teens saw that the cool kids were using this service, then they wanted to use it, too. Hence, the company got a larger pool of profitable customers, because they first invested in loss-leader customers.

I worked with a furniture retailer who did everything possible to please the members of the local garden club. The garden club had a reputation for having members with the highest of taste in home decor. By associating his furniture store with the garden club, he was gaining credibility as having a store with high-taste furniture. This meant that others who wanted a tasteful house would buy their furniture from this retailer, because the loss-leader garden club members were associated with this retailer.

This also works for industrial business products. There may be a business customer who has a reputation for being a very astute buyer of equipment. You may want to sell to them at a loss, because that will make other potential customers will see your product more favorably. Since that loss-leader company is perceived as always making a good buy, by selling to them you gain credibility as being a good buy to others.

2. Gaining Exposure
In a crowded marketplace, it is often difficult to make your product stand out and get noticed. One way to do this is by using loss-leader customers. For example, one can give away free samples of a product to influential bloggers. If these bloggers then say favorable things about your product or service in their blog, you gain invaluable exposure in the marketplace. You won’t make any money off the blogger (loss leader customer), but you may make a ton of money off the people who read the blog (profitable customers).

Anyone who has lots of access and exposure to the public can become a great loss leader customer. If you can get them to talk well about you, then you may gain a large mass of profitable customers from the people who see or hear them.

There is a big movement now to find out who the most influential Tweeters, You Tube users, and other Social Media users are. If you can influence these influencers, then you gain great exposure.

Even paid endorsements, such as getting your logo on the shirt of a famous golfer work. People see the logo on TV in a non-threatening way and it gets planted in their mind. There is a reason why you see so many product logos on race cars. It works.

3. Setting Standards
Often times, a product needs a critical mass of customers in order to be profitable. The idea is that people want to use the product which is the industry standard. The winner of the battle for the industry standard gets virtually all the business, while the loser gets almost nothing.

Think of the old battle for the standard on video tape. VHS won the battle and Beta lost. Or, with DVDs, Blue Ray won the battle and HD-DVD lost. The winners got all the business, the losers disappeared.

With so much at stake, it can very much be worthwhile to gather a large number of loss-leader customers in order to tilt the battle in your favor. The quicker you can tilt preference in your direction, the sooner you can be perceived as the de facto standard.

Remember, the best product does not always become the standard. There were many who thought that Beta and HD-DVD were superior products. Yet they lost the battle because they did not get enough early usage. By investing heavily in loss leader customers, you can get the momentum in your favor perhaps more effectively than investing in product superiority.

This applies to more than just high tech. Back when the Discover credit card was being introduced, it faced a difficult path. Visa and MasterCard were already the standard. Retailers did not want to offer use of the card because nobody had the card. Shoppers did not want to have the card because no retailer was using it. The product almost did not get off the ground.

Eventually Discover convinced the Dayton Hudson company to accept the credit card. They owned the Target store chain and many influential department store groups. That was enough of a start to get people to want the card and other retailers to then accept the card. I am sure that Dayton Hudson got a preferential deal to help make Discover another standard. And it was worth it for both Dayton Hudson and Discover.

4. Reaching Friends
When I was in high school there was a club which sold records by mail. They had a deal where every time you got one of your friends to join the club, you got free records. Well, a friend of mine and I worked hard to get as many people at our high school to join the club as we could. We got a ton of free records and the company got a ton of new members.

My friend and I were loss leader customers for the record club because we got our records for free. But it was worth it to them, because we exposed them to all of our friends (profitable customers). Hence, some customers are valuable to you, even if you lose money on them, if they can give you access to their friends.

Today, companies like Groupon work under a similar principle. They provide incentives to use social media to gather up your friends and expose them to a particular company. At home merchandise parties also work under this principle. They get you to invite your friends to a party which happens to include a sales pitch.

So What are the Strategic Implications
There are two main strategic implications from this principle. First, consider strategies which use loss-leader customers in order to reach a greater pool of profitable customers. Remember, just as you don’t have to make money off every product to be a success, you don’t have to make money off every customer to be a success.

Second consider strategies which make you desirable as a loss leader customer. In other words, make a profit off of the companies catering to you at a loss. Many sports and entertainment figures make more money off of endorsements than they do off their core activity. They are exploiting their loss-leader status. You may be able to do this as well. Convince vendors to give you an outstanding deal because of your loss leader status.

Just as products can be loss-leaders, so can customers. Consider strategies where you can either create loss-leader customers, or become a loss leader customer for someone else.

If the Lincoln Lawyer can use a loss leader principle on a rough motorcycle gang, then what’s stopping you from finding a way to apply loss-leader customer ideas in your business?

Wednesday, April 6, 2011

Strategic Planning Analogy #386: Embracing Maturity

I enjoy talking to new first-time parents about their small children. The new parents truly love their little baby and think parenting them is such a wonderful thing.

Then they will mention some little parenting problem they are having. I warn them that this little problem is nothing compared to all the problems they will face when that child becomes a teenager.

Many of those who have had experience or knowledge about parenting teenagers have half-jokingly mentioned to me a desire to hand off their children when they become teenagers and pick them back up when they reach their twenties. Of course, the problem would be finding someone to hand them off to during that period.

Being the parent of a cute little baby can seem like such a wonderful, fulfilling experience. Being the parent of a teenager, however, can often seem like torture—something to be avoided if possible. Unfortunately, those cute little babies eventually grow up into those frustrating teenagers. You can’t just stop being a parent when the child is no longer a cute little baby.

A similar situation appears to happen with many strategic planners. In general, strategic planning for brand new baby businesses can be seen as wonderful and fulfilling. You get to set the direction and positioning from scratch. With all that potential growth in front of it, there are lots of fun strategic options to consider.

However, when a business reaches maturity, strategic planning can seem more frustrating. Positions are already set and difficult to change. The fun of growth has been replaced by the pain of intense competition. Rather than talking about great strategic options, the discussion moves to cutting costs. In business maturity, it appears as if strategy is less influential on outcomes (sort of like parenting a teenager).

Like those parents, many strategists would be happy to just deal with the baby businesses and hand off those mature businesses to someone else. But guess what? Most industries and most businesses in the world are relatively mature. That’s where most of the action is. If strategists want to be relevant, then they had better get excited about building strategies for mature businesses.

It bothers me that the discipline of strategic planning is out of favor in so many areas of business. Its influence has diminished significantly. There are many reasons for this phenomenon. I believe that one of the many reasons why strategic planning is seen as irrelevant is because the discipline tends to be pre-occupied with early stage businesses. Little focus from strategic planning thought leaders is given to strategic planning in the mature stage of a business. Therefore, it is no wonder that mature businesses see little value to intense strategic planning. And since most businesses are mature, that makes strategic planning appear irrelevant in most places.

One way for strategic planning is to regain its stature is by making it appear more indispensible in the way mature businesses are run. In this blog, we will look at four ways to do this.

1. Reclaim Productivity as a Strategic Agenda
As I have mentioned many times before, I believe that there are three components to effective strategic planning;

a) Positioning – A reason for consumers to prefer you.

b) Pursuit – Aggressively achieving as many ways to exploit that position as possible (top line orientation)

c) Productivity – Making the most money off the areas where you pursue (bottom line orientation).

Although all three are important at all phases of a business lifecycle, productivity tends to be the area requiring the most attention during the mature phase. Therefore, for strategic planning to be relevant and essential during maturity, it needs to take ownership of the productivity agenda.

In many places, productivity is not even seen as a strategic activity (even among some strategic planners). Strategists aren’t even invited to the table when productivity is discussed. It is just seen as a cost cutting exercise, or at best, a budgeting exercise. Just tell people to cut 15% of costs from their budget and you are done.

In reality, productivity is very much a strategic issue. Not all cuts are created equal. Some cuts hurt your strategic position more than others. If strategic implications are not addressed during cost cutting, the wrong cuts can be made—cuts which can totally undermine a business.

For example, a few years back the consumer electronics retailer Circuit City wanted to increase productivity. They noticed that labor was one of their largest costs at store level. They also noticed that their most experienced sales people tended to be the most expensive sales people. Therefore, to increase productivity, Circuit City got rid of its most experienced sales people. It wasn’t too long thereafter that Circuit City declared bankruptcy. As it turns out, those experienced sales people were a critical component of the strategic success of Circuit City. Eliminating those people also eliminated the chance of strategic success.

Strategists need to be at the table to point out the strategic implications associated with various cost-cutting options (and perhaps provide cost-cutting options of their own). This isn’t an option. The destiny of the business is at stake.

2. Move the Discussion Away from Merely Cost-Cutting
Some of the best ways to increase productivity have nothing to do with cutting costs. Often the productivity problem is not how much you spend, but rather what you do. It is a more a question of effectiveness of process rather than efficiency of spending.

For example, I could be the most efficient Morse Code operator on the planet. However, that does not make me the most effective communicator on the planet. Almost nobody understands Morse Code anymore, so nobody will hear my Morse Code message, no matter how efficiently I use it. Rather than trying to make my Morse Code process more efficient, I need to switch to a more effective communication process, like Twitter, Facebook or Email.

If you only focus on cost-cutting, you may miss far more effective options for improving the bottom line via changes in process. Strategists can be an important source for discovering and championing alternative processes.

Strategists can also play a vital role in helping companies avoid new processes which negatively impact a strategy. Take outsourcing, as an example. It makes a lot more sense to change a process from in-house to outsource when the process is less critical to the overall strategy. By contrast, if you outsource a core competency, you may destroy your ability to control your destiny and destroy your competitive advantage.

3. Help People See Productivity as an Investment Opportunity
Productivity is ultimately about increasing profits. Sometimes, you can increase profits faster by investing rather than cutting. If the return on investment is high, investments make sense, even in the mature phase of a lifecycle. Strategists can play a key roll during maturity by discovering and championing those types of investment opportunities.

Strategists are already often a key part of investment decisions during the early phases of a lifecycle. Why not continue that roll into the mature phase?

4. Change M&A to M&A&D
M&A stands for Mergers & Acquisitions. These are activities which tend to do with building and growing a business. However, as a business reaches maturity, it makes sense to give more consideration to the strategies of shrinking and eliminating businesses. This would be the strategies of Divestiture.

Most companies do not take a proactive approach to divestitures as a strategy. Instead, it is seen as the option of last resort—to be used only when backed into a corner with no other option. The thought of divesting while a company is still doing well is often never considered. Yet, the most profitable time to divest may be when the company is still doing well.

Look at the chart below. Outsiders often tend to overestimate the value when a company is just reaching maturity. They may mistakenly see it as still in the growth phase or see a longer mature horizon than you do. Conversely, once there is no longer any doubt that a company is in decline, the potential pool of people to sell to shrinks dramatically. The “bottom-feeders” who go after distressed companies tend to be very cheap and pay very little. As a result, in decline, others tend to underestimate your value. As a result, divesting early can be a great strategic option. We talked about this more in earlier blogs (here & here).

Therefore, divestitures can be just as strategic as acquisitions (read more here). And just as strategists are often a part of the acquisition discussion, they should be a part of the divestiture discussion. And this is more likely to happen if you change M&A to M&A&D—Mergers & Acquisitions & Divestitures.

One way to improve the stature of strategic planning in companies is by making strategic planning appear more vital in the mature phase of the life cycle. This can be done by:

1. Reclaiming Productivity as a Strategic Agenda
2. Moving the Maturity Discussion Away from Merely Cost-Cutting
3. Helping People See Productivity as an Investment Opportunity
4. Changing M&A to M&A&D

There’s an old poem which goes something like this:

“The problem with kittens is that,
They eventually grow up to be cats.”

We need to move beyond a focus on cute kittens and embrace the reality of mature cats.

Saturday, April 2, 2011

Strategic Planning Analogy #385: Truthful Exaggerations

My wife doesn’t like it when I exaggerate. When she starts getting on my case and criticizing my exaggerating, I like to answer as follows:

“Oh, no. I never ever, ever, ever, EVER, E-V-E-R exaggerate. I’ve never ever exaggerated in my whole, entire life.”

Somehow, she doesn’t see the humor in that response like I do.

I think the reason why my wife doesn’t like my exaggerating is because she sees it as similar to lying. But what if you could exaggerate and tell the truth at the same time?

Businesses can do this. They can exaggerate their business model in one of a variety of different directions. For example, a business could exaggerate its product assortment. They could make it much broader, significantly narrower, more distinctive, or far more customized than the typical company in their industry. Similarly, they could exaggerate service levels, prices, features, and so on, relative to everyone else.

Then, a company could tell the world about the benefits of that exaggeration. In doing so, they would be talking exaggerations and telling the truth at the same time. I think even my wife would be okay with that.

The principle here is that you will never achieve above average results if you act like everyone else in your industry. Having a business model just like everyone else will make you, by definition, average. If you want superior results, you have to do something different. You have to exaggerate the industry business model to the extent that:

a) Customers will perceive you differently from other industry players (enough to change their expectations of how to interact with you);

b) You can exploit the inherent difference caused by the exaggeration in a manner which allows you to tap into extra profit opportunities that the rest of the industry cannot imitate.

Allow me to demonstrate this with a couple of examples.

Save-A-Lot is a large chain of limited assortment hard discount grocery stores. It is very similar to Aldi. Save-A-Lot is very different from the traditional supermarket because of its exaggeration related to assortment. Save-A-Lot carries only a small fraction of the number of items (called stock keeping units, or SKUs) found in a typical supermarket. Typically, there is only one brand in each category, like one brand of peanut butter, one brand of ketchup, one brand of canned vegetables. And that one brand is a private label controlled by Save-A-Lot.

Service levels are also exaggerated—much less than a typical supermarket. You have to purchase your shopping bags. You have to bag your own groceries. The stores are typically not open as long as a traditional supermarket. There is nobody there to make you a custom cut of meat.

Because of these exaggerations in assortment and service, Save-A-Lot has a much lower operating cost than a typical supermarket. This allows them to charge much lower prices and still make a good profit.

The customer sees that Save-A-Lot is obviously not playing the same game as a typical supermarket. The stores are much smaller, they don’t carry everything, the brands are unfamiliar, and the prices are a lot lower. The customer is willing to accept a selection and service level they would never tolerate from a traditional supermarket, because they see it as a fair tradeoff to get the lower prices that they cannot get from a supermarket.

Save-A-Lot has permission to shout about having exaggerated low prices, because the exaggerated business model makes lower prices possible. In other words, this is an exaggerated statement rooted in truth, something my wife can accept.

This exaggeration allows Save-A-Lot to tap into profit opportunities unavailable to traditional supermarkets. I remember talking to Bill Moran, founder of Save-A-Lot about this. He said the following:

“The beauty about being a limited assortment store is that people do not expect you to carry everything. As a result, I only need to carry those items I can make a profit on.”

In other words, the exaggeration allows him to avoid carrying a lot of the loss-leaders which customers expect traditional supermarkets to carry. The example Bill Moran gave me was jars of baby food. He said that in some markets, jarred baby food is priced at a loss. In those markets, Save-A-Lot carries no jars of baby food. In other markets, baby food is priced more normally, so in those markets he carries his private label baby food, where he could under-price the supermarkets and still make a profit.

Another example is Kraft Velveeta cheese. Bill Moran could never find a way to make a private label version of Velveeta which tasted as good and could profitably under-price Velveeta. As a result, Save-A-Lot has no Velveeta-like cheese. When customers ask why Save-A-Lot doesn’t carry a Velveeta-like cheese, he would tell them that he couldn’t find a way to give them a value on the product. If he had to carry it, he would have to raise the other prices in the store to make up for it. Because customers know that Save-A-Lot is a Limited Assortment store (and they appreciate the drive to keep prices low), they accept the explanation and are happy.

Now think of what would happen to a traditional supermarket if they told the customer they didn’t carry their favorite brand because they couldn’t make a profit on it. The customers would have a fit, because they expect a full assortment from supermarkets. In fact, back in 2009 and 2010, Wal-Mart tried to cut way back on the grocery assortment in their superstores. The customers got angry and took their business to the competition. Wal-Mart lost market share. Eventually Wal-Mart had to go back and add a lot of those items back to their mix. Wal-Mart could not use the same profit tactic as Save-A-Lot, because they had not exaggerated the business model enough to get permission from the customers to do so.

And, by the way, Save-A-Lot is one of the more profitable parts of the Supervalu corporate portfolio, a portfolio which includes traditional supermarkets. It creates above average results because it does something different with the business model (made possible through exaggeration).

Southwest Airlines
Southwest Airlines is another company operating under an exaggerated business model. The key point of exaggeration is that they only do point-to-point flying. In other words, Southwest will not book you through on multi-stop flights. They do not use the traditional hub-and-spoke approach to create a lot of flight connections. If you need to make a connection on Southwest, you have to go pick up your bags and re-check them in. You also have to go through the ticketing process again.

Southwest uses this point-to-point exaggeration (a few other similar exaggerations) to create a meaningfully different business model, which they can exploit in a manner which allows them to be more profitable while still charging far lower prices. Customers believe them when Southwest shouts about their lower prices, because they know they do things differently in a way that justifies the lower prices. It is not just a price war. It is a true pricing differential caused by a true costing differential. This is truthful exaggeration.

Let’s just look at one aspect of this. In a point-to-point system, every bag on a plane has the identical journey. Baggage for a Southwest plane all comes in from that airport’s baggage drop off. There are no transfers from other planes to that plane. Similarly, all the Southwest baggage leaves a plane and goes to the same place, the baggage pick-up area. None of it is transferred to another plane. This makes the cost of running baggage for Southwest far lower than for a traditional airline, which has transfers of baggage going all over the place, even to competitor’s planes.

As a result, while other airlines feel a need to charge high fees for checking baggage, Southwest can brag that bags fly free. Southwest did the math and found out that because their baggage costs are so low (due to the exaggerated business model), they can afford to do baggage for free because it created enough extra market share to more than cover any losses due to not charging for bags.

And it should also be pointed out that for decades, Southwest has been far more profitable than then average US airline. By being different, they can tap into profit opportunities the traditional operators cannot touch.

Hollow claims are not the path to superior results. If you want above average results, you need to act differently from the rest of the industry—you need to exaggerate the business model in a meaningful way. These exaggerations change consumer perception and business processes in such a way that you can tap into extra profit opportunities unavailable to the rest of the industry.

Take a tip from my wife: If you want to get away with saying an exaggeration, first you had better BE an exaggeration. Otherwise, you are just a liar. Truthful exaggerations are the way to go. Are your strategies based on truthful exaggerations?