Thursday, September 22, 2011

Strategic Planning Analogy #414: Which Comes First—Goals or Strategies?

Let’s assume that you want to race in the Olympics. Let’s further assume that they way you qualify for the Olympics is by agreeing (in writing) to guarantee achieving a specific time when you race (quick enough to win committee approval). And, if you fail to achieve that time, you will owe the Olympic Committee a large sum of money. Then, to make it even more interesting, the Olympic Committee does not tell you which type of race you will be competing in until after you commit to a specific time.

When making the time commitment, you do not know if the race is a short sprint or a long marathon. You don’t know if the race involves running, speed skating, swimming or bobsleds. Perhaps there are hurdles or other obstacles. Perhaps not.

It seems to me that committing to a race time before you knew what the race was would be an act of insanity. It’s a good thing the Olympics aren’t run that way.

Although the Olympics are not run that way, it seems that many businesses are run that way. When starting their strategic planning process, these companies begin with goal-setting. The goal could be a level of sales, or profits, or a percent return on investment, or a stock price. Setting these goals is a lot like setting the goal of the time you want to achieve in a race.

Then these companies get management to commit to hitting these goals, and tie their bonuses to achieving these goals.

It isn’t until all this is completed that these companies start looking for a strategy which can achieve that commitment. To me, choosing the strategy after committing to a goal is a lot like being told what race you are going to run after committing to a race time. It is often a process of foolhardiness. And, unfortunately, I think a lot of companies are on this foolish path.

The principle here is that long-term success is more likely to occur if goals are set after conceiving the strategy rather than before. In this blog we will look at some of the negative consequences of putting goals first. In the next blog we will look at some potential solutions to this problem.

When a company puts goal-setting ahead of strategy-forming they increase the likelihood of six bad outcomes.

Bad Outcome #1: The Wrong Goal is Set
Setting the goal before knowing what to do can lead to two types of improper goal setting. The first is choosing the wrong metrics. For example, at different stages of the lifecycle, different metrics may be more appropriate. Rapid sales growth targets may make more sense during the rapid growth phase but be inappropriate during the decline phase, when cost control may be a more appropriate metric. You cannot know what the most appropriate metric is until you understand the type of plan you are putting in place.

Even if the right metric is chosen, you might choose the wrong target level—too high or too low. How can you know what the appropriate target level is before you know what you are doing? Set it too low and you may miss opportunities (and reward too generously). Set it too high and you may encourage people to take on bad behavior (as we will see below).

Bad Outcome #2: The Wrong Actions Are Taken
People act based on how they are measured, so if you measure the wrong things, people will tend do the wrong things.

If the metric is inappropriate for the circumstances, it might force people to apply strategies consistent with the metric but wrong for the circumstance. For example, if a business has recently reached maturity but the goals are more appropriate for an earlier rapid growth stage, one might try to apply rapid growth strategies in order to try to reach the rapid growth goals. This could lead to investing in over capacity and money-losing sales strategies, in an attempt to try to achieve no-longer-realistic top line growth commitments.

Going back to the story, you might be best suited for running a marathon, but because you promised a quick race, you are forced to run a sprint. So instead of playing to your strengths—a place where you can win—you go with your weakness in a place where you will lose. Figure out the race you are most likely to win before committing to an outcome.

Bad Outcome #3: Undesirable Increase in Risks Are Taken
Many times, aggressive goals cannot be achieved by the core business. You end up with what is commonly called a “planning gap”—the difference between what the current strategy provides and what you want to achieve. The bigger the gap, the more one has to do to fill it. This can lead to taking on a lot more risks in order to fill the gap, such as diversifying further from one’s core or doing some hasty acquisitions.

We know most acquisitions fail, and if they are being done primarily to fill a gap rather than to fill a synergistic strategic need, the risk is even higher. In addition, so much focus could be placed on filling the gap that the eyes are taken off the core, increasing the risk of problems there as well.

Perhaps the only way to narrow the gap is to assume the best case scenario—everything has to go right. The best case scenario is rarely the most likely case scenario. As a result, your strategy takes on added risk for failure if you have to skew assumptions in order to make the strategy fit the goal.

Bad Outcome #4: Long-Term Prospects Are Destroyed
When the numbers come first, people’s priority is to try to hit those numbers—whichever way they can. There are lots of ways to hit a number, and a lot of those ways are destructive in the long run. To hit aggressive numbers in a short time span, one usually has to make trade-offs which hurt the long run. For example, to hit near term profits, future-oriented activities (like R&D or innovation) may get cut too much. To hit aggressive near-term sales, one may create costly promotions which merely steal away sales from the future. To hit near-term return on capital numbers, one may underinvest in long-term capital projects.

One of the first cases I had in business school was about a manager who made his numbers by cutting out all maintenance costs. Eventually, everything broke down and the long term costs of repair were much higher than those maintenance costs which were cut. This is an important lesson which can be lost if aggressive goals are put in place which can only be met by making bad trade-offs with the future.

A lot of Warren Buffet’s success is due to taking the long view. He knows that he will usually get more out of an investment if he manages it for the long term rather than a quick payback. But if goals come first, one can start managing for what’s best for the goals rather than managing for what’s best for the business. That usually means trouble for the long-term prospects.

Bad Outcome #5: Avoidable Failures Are Perpetuated
If you look at a business purely objectively, you might come to the conclusion that it should be shut down or sold. However, if you start with an inappropriate goal, you may be hesitant to retreat from the business, because you feel you need every bit of business possible in order to try to reach the target. For example, I worked with a company that had a business line which they probably should have gotten out of. They didn’t because they told me they “needed the sales” (even though they were unprofitable sales) in order to hit their sales growth targets. I had suggested a more profitable approach, but it produced fewer sales, so it was rejected. Instead, the failed approach was perpetuated.

If people commit to unrealistic goals, then they will not have a realistic way to achieve it. This inevitably leads to not achieving the goal. Disappointment and failure are the most likely result. All the stakeholders get angry. These “guaranteed” failures and disappointments could have been avoided if bad businesses were cut out sooner, and promises were made which had a high likelihood of success, because they were first grounded in doing the right things. If you choose the right strategy first, then you know which goals to promise, and then you can meet them.

Bad Outcome #6: New, Better Options Can Be Missed
If you don’t first have a strategy to help you set your goal, then often times the only thing you have to base the goal on is the past. And as we all know in strategy, the past is often not the best guide for what to do in the future. This backwards orientation (extrapolation of the past plus stretch), may keep us mentally oriented towards modified status quo strategies rather than new breakthrough strategies.

Breakthrough strategies typically come from starting with a clean slate, not extrapolations from the past (which at best, only gives you incrementalism).

In fact, by setting goals prior to setting strategy, management is in essence telling people that the old strategy is good enough. After all, how can you realistically set a future goal before considering strategic change unless you believe no meaningful change is necessary?

Many companies use a strategic process where goals are set before the strategy is chosen. This approach increases the likelihood of bad results and missed opportunities. Committing to a race time before you know what the race is sounds backwards. The same is true of setting numeric performance goals before you know what strategy will be performed. In the next blog we will look at ways to minimize this problem.

Setting the goals first sounds like wishful thinking. Last time I checked, you don’t automatically get what you wish for. I could wish I was taller or younger, but it isn’t going to happen. No, we should start first by optimizing what is in the realm of the possible and set our goals from there.

1 comment:

  1. Gerald Nanninga,

    First, there is a minor mistake in the second line
    that they way you qualify for the Olympics

    As much as I agree with this post; still I have a problem with it. One definition of strategy is knowing where to go.What is the ultimate goal? Strategic planning following in determining the paths towards the grand goal. Could you please elaborate on this? Thank you