Wednesday, December 26, 2012

Strategic Planning Analogy #481: Law of Extremes


Back about 40 years ago, Wal-Mart had not yet fully cemented its image as a low cost leader.  Other retailers were still challenging Wal-Mart on price supremacy.  One of those chains was TG&Y variety stores.

TG&Y decided to get into a price war with Wal-Mart.  The item chosen to go to war over was a pair of jeans.  TG&Y would lower the price on jeans and Wal-Mart would retaliate with an even lower price.  This pattern continued for many rounds.

Eventually, Wal-Mart dropped the price of jeans to 9 cents a pair.  At that point, TG&Y gave up and stopped the price war.  Wal-Mart had won supremacy on price, and not too long thereafter, TG&Y ceased to exist.

Yes, 40 years ago, you could buy a lot more for 9 cents than you can today.  But even 40 years ago, 9 cents was an unrealistically low price for a pair of blue jeans.  Every jean sold at 9 cents would be a huge loss for Wal-Mart.  But that was the sacrifice Wal-Mart had to make in order to win the image of price against TG&Y.

Times may have changed in the last 40 years, but this type of activity still goes on.  Business leaders understand the value of owning an image and will go to extremes in order to win that image.  This seems especially true on the internet. 

In order to create a large network, internet firms will go to great lengths to get people hooked into their system.  Most end up giving away their product for free.  Other go even further by “paying” people to get on-board, either with badges, coupons or some other form of promotion.  It’s hard to make a living if you have to pay people to use your product.

And it’s not just price where companies go to extremes.  Luxury automobile brands are fighting against each other to own the word “luxury.”  They keep upping the ante by adding ever more exotic features to their automobiles.  At some point, even many luxury auto buyers will balk at paying the premium so that auto makers can get an adequate return on investment for these exotic features.

For most auto dealers, the maintenance area is among its most profitable areas, even more profitable than selling cars.  But, to increase the luxury treatment experience, many luxury dealers are throwing in maintenance for free.  Now, they’ve cut off a key source of profits.

The world is very competitive.  It takes a lot to dramatically own a position in that competitive market.  Every winner has to go to extremes to own their position, be it in price, luxury, service, convenience, technological innovation or whatever.  It’s as if the whole world is becoming the equivalent of 9 cent jeans—a world where the only way you can win is to create a costly, unsustainable extreme.

How do you create a profit if the entry level cost to achieve a winning position is unsustainably high?  That requires a sophisticated strategy.

The principle here has to do with what I call the Law of Extremes.  It is one of my 23 laws of strategy.  (I know I said in an earlier blog that it was 22 laws, but I’ve since added another law.)  The law of extremes goes like this:  “Creating performance levels needed for ownership requires trade-offs and subsidies.”

Another way of saying this is that when the core business can no longer sustain the extremes, you have to:

1)      Add secondary businesses (called subsidies) to provide cash to cover the extremes; and/or
2)      Subtract secondary activities which take away cash from the building the extreme position (a process called trade-offs).
We will look at each of these separately.

Subsidies are non-core activities or businesses which are principally done only to fund the core.  An example of this practice is the “Freemium” model used by many internet businesses.  The idea is that the core business is free.  Yet in order to afford to give away the business for free, a small subset (often under 3%) pay a price in order to get premium extras.  In other words, around 3% of the users of the internet site subsidize the activity of the other 97% so that the site can make money.  Many internet sites use a freemium model like this, including Linkedin and Pandora.

Another subsidy common on the internet is to use advertising.  If you cannot get the users to pay for your extreme pricing position of free, then you have to get advertisers to pay for the site.  Another subsidy example is when internet sites sell information about you to other business that would pay for that information (watch out when companies put cookies on your device—it can be their door to a subsidy business selling your behavior).   

This subsidy phenomenon also occurs in the retail space.  In consumer electronics, the pricing policies are very extreme, often selling the main items near or below cost.  To subsidize these prices, the retailers need to bundle profitable subsidy purchases to the transaction.  A familiar one is the extended warranty, which is often more profitable to the retailer than selling the item being insured.  Other examples are selling ad space on the screens of the computers being sold, selling extra ink with the printer, selling smartphone accessories, and so on.

This is also seen in fast food restaurants where the core hamburger is sold at a loss and is subsidized by the sales of more profitable french fries and beverages.  (I’ve gotten in the habit of buying a second burger instead of the fries in order to get a better extreme value for myself). 

The irony here is that in a world of extremes, the core business becomes almost like a loss-leader for the subsidy add-on businesses.  At some point, it’s hard to tell what is the real core business anymore.  IF the subsidies are where all the profits come from, does that become the new core?  The extreme image won with the traditional core could now be seen as a loss leader positioning to mask the real positioning, which is to be best at selling the subsidies.

It goes to show that business strategies are getting more complex.  If subsidies are not integral to your business model, the model may no longer work in a 9 cent jeans world.

If subsidies are about adding income to the business, then trade-offs are about subtracting costs from the business model.  The principle behind trade-offs is as follows.  If you try to be all things to all people, you will probably never obtain an extreme position on anything.  For example, if you try to be the highest quality, lowest priced and fastest in innovation, you will have to make compromises which will prevent you from being the most extreme in any of these attributes.   There will be specialists focusing on only price or only quality or only innovation which will be the most extreme and win the battle for these positions. 

Therefore, to win in one space, you may need to stop pouring money into other spaces, so that more money can be funneled to the space where you want to win.

An example would be extreme low price “hard discount” grocers, like Aldi, Save-A-Lot, and Lidl. They have prices substantially below conventional grocers—extreme enough to win the low price image.  Yet those low prices are sustainable because these firms make trade-offs.  They stop doing many things the conventional operators do which add costs.  Examples include:

1)      Smaller, Less Costly Assortments (only one brand in one size per category)
2)      Eliminating Lower Margin Branded Goods by Going Direct to the source to create their own brand.
3)      Large reductions in labor by not having service departments, not stacking products individually on shelves, etc.
4)      Lower rent by building smaller stores in less prime real estate.
By trading away variety, ambiance, convenience, selection and other such factors, they can divert cash flow from those activities into sustainable extreme prices.

Southwest Airlines is another example.  They make money when other airlines don’t because they do more trade-offs than traditional airlines.  Activities like only selling point to point tickets, refusing to sell tickets on third party travel websites, focusing on only one-sized plane, and other non-conventional approaches, they have eliminated a lot of costs borne by their competitors.  This allows them to focus on the things important to their image and still make a profit.

The idea with trade-offs is that your successes is defined as much by what you don’t do as by what you do.  Your strategy needs to delineate what activities go onto each list (the do’s and the don’ts).

In a highly competitive world, it takes extreme levels of performance in order to win a position.  Gaining extreme positions is costly.  In order to afford the cost and still make a profit, firms need strategies about subsidies and trade-offs.  Subsidies are the add-on activities which provide extra cash flow beyond the core.  Trade-offs take away activities which to not reinforce the extreme position in order to provide extra cash flow to invest in the extreme.

The things which “delight” the customer tend to “deplete” the cash of the company.  To remedy the situation, the company needs to “destroy” unnecessary costs and “deploy” subsidy businesses. And that is “de-truth.”

Wednesday, December 19, 2012

Strategic Planning Analogy #480: Landing a Strategy

I used to live in a city which had a small regional airport.  The city wanted to get more of the large airlines to land at this airport, but the airlines kept refusing.

The airlines said that they would not schedule flights to that airport because the runway was too short.  Sure, it was long enough to land the smaller planes that the airlines use, but not long enough to land the largest jets.  Because the airlines want flexibility in the use of their airplane fleet, they didn’t want to schedule flights into airports which couldn’t handle their largest planes.

After hearing the complaints, the city invested in building longer runways.  And not long after the longer runway was built, a large 747 jumbo jet landed at the airport in grand fashion.

I think it was many, many years later before the second large jet landed there, but it didn’t matter.  The renovations and the longer runway resulted in getting more scheduled flights at the airport.

I like to use the term “landing a strategy.”  This concept refers to getting a strategy from being just a cool idea floating in the clouds to being a reality playing out on the ground where the company is operating.

Landing a strategy is a lot like landing an airplane.  If the airport’s runway is too short, the larger jet will not be fully landed before it runs out of runway.  The plane will keep moving at a high rate of speed beyond the edge of the runway and crash into something, creating a total disaster.  That’s why airlines insist on having long runways before committing to an airport.

It takes a lot of time and money to land a strategy (to get it from idea to reality).  If you run out of time and money before the strategy is fully landed, you are like a pilot in a big plane that ran out of runway.  Your strategic attempts are about to go off the runway and crash into something, creating a total disaster.

Due to our optimism, we may think we need a shorter runway (less time and money) than we really need to land our strategy.  As a result, we may already be well into the strategic transformation before we realize that we are trying to land our strategy at an airport (i.e., company) whose runway is not long enough (not enough time or money to finish the transformation).  Then we find ourselves frantically trying to lengthen the runway at the same time our plane (i.e, strategy) is already approaching the runway.  That’s not a very wise approach.

When a strategic transformation runs out of runway, the worst possible scenario occurs.  The old strategy is bankrupt because all the time and effort and money went into the transformation.  The old strategy is too obsolete to create sufficient cash flow to keep the transformation going (running out of money). The time for bankruptcy under the old model keeps getting closer (running out of time).  Yet, because there is not enough time and money left to finish the transition to the new strategy, you don’t end up the replacement strategy, either.  Instead, you are stuck with neither strategy.  A total disaster.

Think about Kodak.  It didn’t start trying to land a digital strategy until the analog business was almost dead.  The old analog business was not producing cash flow and was soon to die (no time or money).  As a result, Kodak’s runway was too short.  They ran out of time and money before a digital strategy could be landed.  The company ran off the runway and imploded.

The airlines in the story had a safer approach.  First make sure the runway is plenty long enough.  Then, only after the long runway is built, will the airlines consider trying land planes there.  Our strategic approaches could learn from this.

The principle here is about change management.  Nearly all new strategic initiatives require significant change in the business in order to become reality.  You may have a great new strategy, but if you mis-manage the change process to get there, you will not effectively land the strategy.  It will crash and make a disaster.  

If you cannot effectively land the strategy, it is irrelevant how great that new strategy was.  It will crash when you run out of runway, just like a bad strategy.

Therefore, a key piece of change management needs to be assessment of the length of your runway.  If the runway isn’t long enough (not enough time and money), then the process is doomed.

Option #1 Lengthening the Runway
If the runway is too short, one solution may be to lengthen the runway.  In other words, before embarking on the transformation, look for ways to either:

  1. Increase Cash Flow; or
  2. Slow Down the Demise of the Status Quo.
These actions may not have any direct relationship to the change you are trying to accomplish, but if you do not do them, you will not have enough time or money to do those things which directly relate to the change.  So you need to do them as well.

Tactics to lengthen the runway could include:

  1. Selling off peripheral assets.
  2. Restructuring the Balance Sheet.
  3. Massive layoffs in peripheral areas
  4. Sale and lease-back of properties.
  5. Looking for legal or governmental protections of the core to keep threats to the core further away.
One of the main reasons why Ford Motor Company did not have to go through bankruptcy and government bailout while GM and Chrysler did was because Ford had taken many of these types of steps to lengthen their runway prior to the great recession.  As a result, Ford’s runway was long enough to last until they could transition through the economic recession and get to their revitalized strategy.

GM and Chrysler ran out of runway because they did not do enough of these types of things.  Without a lot of outside help, they would have crashed when their runways ran out.

Option #2 Shortening the Plane
If lengthening the runway is not enough, you can try to switch to a smaller plane.  By this, I mean that instead of trying to create massive change all at once, you can chop up the change into smaller bundles (like smaller planes) which require less time and money to land (and thus can use a shorter runway).  Those smaller changes with the quickest payback can be done first and create the new money and extra time needed to land the rest of the transformation.

Thus, you fund the latter change by strategically creating funding via the early changes.

Netflix was originally designed to be a digital downloading service (which is why the company was called Netflix instead of Mailflix).  However, the company realized that it would take massive amounts of time and money to create the Netflix model.  Therefore, Netflix started with a smaller plane (movies by mail). 

Movies by mail required less time and money to start up.  And it got Netflix a huge subscriber base and clout in the marketplace that could be applied to the ultimate vision.  And because the near-term model was profitable, it could fund the efforts needed to make the ultimate transition.

Option #3 Changing the Flight Schedule
A third option is to change the scheduling of your flight—prepare to land your plane earlier.  The idea here is that if you start the transformation earlier, before the status quo deteriorates too much, you have many advantages:

  1. The old strategy is stronger and producing more cash flow to fund the landing.
  2. The company’s image and clout are stronger which makes it easier to introduce your change to the marketplace.
  3. The ultimate demise of the status quo is further away, so you have more time.
Kodak essentially invented the world digital imaging.  They had plenty of time, clout and money to implement the change.  The problem was they waited too long to do anything about it.  If they had scheduled the landing of the digital transformation much earlier, the odds are good that it would have succeeded. 

The problem is that companies worry about cannibalization.  After all, the sooner you start the transformation, the quicker you cannibalize the old core.  What you need to realize is that someone is going to eat your core.  Your only real option is to decide whether you are going to do the eating or someone else is going to do the eating.  And if you wait, like Kodak did, and let the competition eat your core, you have no runway to get to the replacement.  All you are is eaten.

Strategic initiatives usually require change.  Change requires time and money (and usually more than you initially realize).  Therefore, if you want to land your strategy, you’d better make sure there is enough time and money to get the change implemented.  If there isn’t, you will need to adjust your approach to that change by either:

  1. Finding more time and money;
  2. Starting with smaller change initiative bundles; or
  3. Starting the whole process sooner.
I worked with a company that was running out of runway.  They did not have enough time or money to finish their transition.  The solution they picked was to sell the business to someone with deeper pockets and more time.  In other words, they sold the plane to a company which owned a better airport with a longer runway.  So, before you panic, look for creative ways to get a longer runway.  Creative solutions are out there.

Thursday, December 13, 2012

Strategic Planning Analogy #479: Playing to Win

Back in the very early days of personal computers (before the IBM PC), there were a lot of small upstart companies that wanted to get into the business.  Most of them said something like the following:

“We may not be big enough or strong enough to become the market leader, but we think we can get about a 15% market share.  And that should be large enough to make a good return on investment.”

The problem with this approach was that:

1)      The leaders would already have about 50% of the market share in personal computers.

2)      There were about a dozen firms who wanted to get about 15% share out of the remaining 50% of share available (that math doesn’t work).

As a result, most of these upstart companies only got about 5% share or less.  This was insufficient for profitability and they quickly went bankrupt.

Later, when IBM entered the market with the first “PC” (and the first software from Microsoft), even most of the market leaders, like Radio Shack and Commodore, had to give up the business.

If you look at the strategy of most of the early entrants to personal computing, they were not playing to win.  Instead, they were playing to exist.  The idea was they did not need to aggressively pursue superiority in positioning or features.  Instead, these companies felt that all they needed to do was “show up”, and the rapidly growing market would have enough space to absorb them at about 15% market share.

That approach was a dismal failure.  By not playing to win, they ended up with nothing.  When IBM entered the market, it was aggressively playing to win—and it was the clear winner for quite awhile.

When designing a strategy, are you approaching the market more like those early entrants (just show up and hope to get sufficient share) or like IBM (go big and play to win)?

The principle here is based on Law #12 of my 22 Laws of Strategy.  This is the Law of Winning, which says, “If you do not play to win, you will lose.”  Playing to win requires:

a)      Designing and Achieving a Winning Position (unique, desirable)

b)      Aggressively Pursuing that Position in the Marketplace

c)      Developing a business model so that you can have superiority in your position and still make money.

This is not what those early personal computer manufacturers did.  They built “me-too” products using similar business models and shipped them out to whomever would buy them.  And by not playing to win, they lost.

IBM played to win.  They developed a superior product.  They installed superior software (MS DOS).  They aggressively advertised the brand (to the point where PC became a generic name for the whole category).  They put the full force of IBM behind it.  And they became a winner.

The Rule of 1.5
If anything, the importance of playing to win is even stronger in today’s economy.  One reason why “playing to exist” no longer works well is due to the rule of 1.5.  Back in the 1980’s it was called the rule of three, which stated that most businesses had 3 strong players:  a leader, a close challenger, and a rebel/innovator.  The prime example used back then was US colas: Leader=Coke; Challenger=Pepsi; Rebel/Innovator=RC.

However, over time, this paradigm has mostly disappeared.  The reason can be found in a 1995 book called the Winner-Take-All Society, by Frank and Cook.  The book showed that in industry after industry, the advantages of leadership were getting stronger and stronger.  Challengers were at an ever greater disadvantage.  Brands were beginning to realize that it made more sense for a challenger to reposition itself as a leader in different market position than to go directly after a leader.

The net result is what I call the rule of 1.5.  Now most markets have a single strong leader with only minor challengers.  Think about US retailing.  Where it used to be Best Buy vs. Circuit City, it is now only Best Buy.  Where it used to be Bed Bath & Beyond and Linens-N-Things, it is now just Bed Bath & Beyond.  And who is the strong challenger to Walmart or Amazon?

Even in colas, Coke has increased its dominance over Pepsi to the point where its greatest challenger is now Diet Coke (which leads in a different position).  And RC cola barely exists anymore (and survives via association with Dr. Pepper, a leader in its own category of beverages).

That is why you need to play to win, because there is no guarantee that there will even be room for a profitable number 2 or 3 or 4.   Take it from me…when I was working at Best Buy and founder Dick Schulze was still running the show, there was no doubt that he was aggressively and passionately playing to win.  And win they did.

Metcalf’s Law
If anything, the digital economy with the internet and social media has accelerated this phenomenon.  It was first described as Metcalf’s law, which states that the value of a network is equal to the square of the number of connections to that network (or U=y2).

The new digital/social/mobile economy is all about building networks.  And the bigger your network, the more powerful you are.  Look at Facebook.  It did not get its high stock valuation due to current profits.  The high value was due to Metcalf’s Law and the millions upon millions upon millions of users in its network.  Linked in and others are also following this principle and building the largest networks of members in their space.

Once you build up a huge network, there are incentives for people to join your network and stay in your network.  It is referred to as “stickiness.” Hence, the networking leaders tend to become even stronger leaders and the challengers become weaker.  Who is the major challenger to Facebook?  Can a new competitor just “show up” and expect to gain a large following in Facebook’s space?

Part of the appeal of Apple is the network of partners and features it puts around its products.  The apps, the app store, the interface connections, the partnership deals and so on make the sum of the network greater than the parts, and makes it harder for any single player to challenge that network.

If you do not play to win in creating the network, you will ultimately lose in this economy.

The disproportionate advantages to being the market leader are huge and getting even stronger.  It is getting to the point where if you are not the leader, you will be hard pressed to even make an adequate profit.  As a result, every business needs a strategy built around leadership—a winning position in desirable space.  In addition, you need to aggressively pursue gaining and maintaining that position.  Others are also out there fighting to win, so if you are not equally fighting to win, they will become the winner instead of you.

Just showing up with a me-too product and hoping that the market is large enough to get you sufficient market share is no longer a viable strategy (if it ever was in the first place).  Those “just showing up” market shares are never as large as you think they should be and rarely lead to a viable business model.  Be aggressive and play to win or don’t play at all.

They say that imitation is the sincerest form of flattery.  That may be true, but imitation is not a very good approach to strategy.  Following the leader positions you as a follower, not a leader.  If you do not have a business model and an aggressiveness to get to a place where you can lead (or win), then all you have is a blueprint for losing.  The world already has a Facebook, Amazon and Walmart.  It doesn’t need an imitation of them.  Instead the world needs new positions to be conquered.  Are you scaling the mountain of imitation or a mountain where you can be first to the top and win? 


Tuesday, December 4, 2012

Strategic Planning Analogy #478: Casual Day Stickers

I worked at a company where every department in October was expected to come up with a way to raise funds for the United Way charity.  One year, our department decided to sell “Causal Day” stickers.  The idea was that if you bought and wore one of these stickers, you were allowed to wear casual clothes to work on that day of the week (not just on Casual Fridays). 

We went around the company trying to sell these stickers.  In many departments, we were unable to get much interest in buying the stickers.  However, when we got to the IT department, we were treated like heroes.  The IT people were buying as many stickers as we had.  They loved the idea of being casual every day and were willing to pay a lot for the privilege. 

We learned from that experience, and in future years we focused our time in the IT department, so that we were more productive in selling those stickers. 

Even though we all worked for the same company, we had different levels of demand for Casual Day stickers.  Some placed a high value on those stickers, while others saw little value to them.

This shows the point that not everyone is wired the same way.  Different things motivate different people.  If we try to treat everyone exactly the same way, we will not get exactly the same results from each person.  What motivates some will de-motivate others.

For strategic planning to be successful, one needs to go beyond merely having good ideas.  One also needs to find a way to motivate people to embrace and implement the good ideas.    And since people are motivated by different things, a one-size-fits-all approach to motivation is not the optimal way to get a strategy implemented everywhere in the organization.  

The principle here is that strategic objectives and tactics do not have to be treated the same way, and in fact should be treated differently. 

Unified Objectives
The overall strategic objectives need to be relatively unified.  This is because a company is more likely to own a position if everyone in the company is moving in the same direction to support it.  For example, if your strategy is rooted in low cost, low price, then you need the majority of the company’s effort moving in the direction of lowest cost and lowest price.  Otherwise, activities counter to that objective will creep into the company and dilute the objective. 

For example, if half the company is pursuing lower cost and another half is pursuing higher service, then you will probably lose on both fronts.  There will be more focused competitors winning on the low cost front and other focused competitors winning on the high service front.  As a result, by having some people trying to win on both fronts, you end up winning on neither front.

That is why a unified focus is so important for key strategic objectives.  Trade-offs need to be made in order to win competitive superiority on these objectives.  And if the company is not focused on making the same trade-offs, you will not win your objective.  One person’s action will counter another’s action.  This will confuse the customer as to what you stand for, so you will not really stand for anything.

Diversified Motivation Tactics
However, just because objectives need to be the same across the business does not mean that the motivational tools needed to get the objectives accomplished need to be the same across the business.  In fact, as we saw with the Casual Day stickers, an approach which motivates very well with some areas may be totally ineffective in other areas.  If I tried to motivate the entire company to meet an objective with Casual Day stickers, I’d probably get great compliance from the IT department but not from many other areas.

Therefore, tactics to motivate the larger objective need to be customized for the particular people being asked to achieve the objective.

Over the years, I have had the privilege of managing a wide variety of people.  At one extreme, I’ve managed accountants who tend to prefer predictability, rules and the comfort of routine.  On the other extreme, I’ve managed creative-artistic types who hate predictability, rules and routine. What motivated one group de-motivated the other.

I learned that I needed different motivations for all the different types of people I’ve managed over the years.  Some were motivated by money, some titles, some freedom to work on their own pet projects, and some a break from working on any projects.  So the irony is that the best way to get unified outcomes is to have diversified motivations for the inputs.

Freedom Vs. Regulation
Some experts try to frame business issues as an “either/or” argument:  either you promote freedom OR regulation.  But business life is not a unilateral process.  For major objectives, regulation is more desirable; for motivating tactics, freedom is more desirable.

So the question is not Either/OR; the question is Which/When.  In other words, which areas deserve a particular approach at what times?  Yes, freedom and regulation are both valuable tools.  A company using only one approach all the time will sub-optimize.  However, using both approaches randomly sub-optimizes as well.  Each has a place where it is appropriate and where it is not appropriate.  Great companies figure this out and use them appropriately to gain advantage.

I was reminded of this in reading an article put out recently by McKinsey and Company.  In the article, they talked about the success of an “envelope” approach to getting things done.  The envelope approach works like this.  The envelope represents the space in which the company wants to operate.  The dimensions of the envelope are rigidly defined.  You are not to act outside the dimensions of the envelope.

By contrast, great freedom was given for how an area operated within that envelope.  As long as an area of the business stayed within the envelope, there were given great latitude as to how innovate and thrive.  This envelope approach has been successful for those firms which can abandon the either/or approach and embrace which/when. 

So, using the McKinsey language, strategic objectives become the dimensions of your envelope and as long as your motivational tactics fit inside that envelope, you have great freedom to do what works best in your area.

Freedom and rigidity both have their place in business, but it is not the same place.  Rigid structure is needed to define the major strategic objectives.  This same rigid structure needs to hold for the majority of the business.  However, just because rigid universality is needed for defining the objectives does not make it appropriate for everything else.  When it comes to motivating people to deliver on that objective, usually the opposite is more appropriate.  Great freedom and diversity tends to get the best effort towards the major objective.

At that same company where I sold Casual Day stickers, our department would always have a big problem this time of the year.  We would try to plan a department Christmas party.  About half of the group wanted to make it a fancy evening affair where we would dress up and bring our spouse.  The other half wanted to make it a simple lunch catered in at the office building (no dressing up, no spouses).  The problem was compounded by the fact that each half tended to hate the preference of the other half.  So even within the same department, motivations and preferences can vary widely.  One person’s pleasure can be another person’s torture.  So be sensitive to the diversity.

Tuesday, November 27, 2012

Anticipation and Creation

By almost any measure you can think of, free-market economies are superior to the highly planned economies of socialism/communism.  Free market economies create more total wealth and do a better job of raising the general standard of living for the whole society.

Yet, for many years, I have been advocating strategic planning for businesses.  This begs the question:

If the economy in total is better off with free markets versus planned markets, then why do I believe that individual companies are better off having strategic planning?

This question is becoming more relevant based on the most recent book by Nasssim Nicholas Taleb, called “Antifragile.”  You may recall Taleb’s earlier book, “The Black Swan,” which caused quite a stir.

In Antifragile, Taleb takes a dim view of strategic planners.  His claim is that strategic planners do more harm to businesses than good in their attempt to gain control by way of rooting out the risk of randomness.  Taleb believes that the unintended consequences of these acts are to add delay, complication and inflexibility to the very business they are trying to improve.  As a result, instead of saving the business, the planning increases the risk of failure. 

This is a valid concern.  I have seen examples where this type of result has occurred.  For example, in the name of reducing risk by sharing knowledge and expertise, large shared services organizations are built.  These shared services organizations, if structured improperly, can add delay, complication and inflexibility to a business.  In two instances I am personally aware of, these negative results were so severe that the shared service organizations were dismantled.

So we cannot just dismiss the argument posed in this book.  We need an answer to the question.

One of the main reasons why a free economy is superior to a planned economy is due to the concept Joseph Schumpeter referred to as creative destruction.  The general idea of creative destruction is that great improvements to the economy do not come from proactively tweaking the status quo.  Instead, they come from allowing the status quo to die and be replaced by something far superior.  Only by freely allowing marketplace churn—letting old business models be destroyed by new business models—does the market make great leaps forward.

And the beauty is that, when left free of excessive planning, the market will do this creative destruction all by itself.  It is when we try to interfere and protect the status quo that we hinder the ability of the marketplace to make great strides. 

In a macro sense, allowing creative destruction has much merit.  But business leaders live in a micro world.  Their primary role is not the health of the total economy, but the health of their business.  Freely allowing their business to be destroyed in the name of Creative Destruction will not win them any praise from their stakeholders (shareholders, lenders, employees, etc.).  No, these stakeholders want the business leaders to cause their businesses to survive and thrive regardless of what is happening in the macro economy.

I believe that the best way to do this is via planning (we’ll discuss how to do this further below).

In his excellent book “Good Strategy/Bad Strategy,” Richard Rumelt makes the case that most of what is practiced today in the name of strategy is truly awful.  Worse than just poor execution of good processes, Rumelt believes that much of what is called strategy today is not strategy at all.  It is just terrible actions which hurt businesses. 

I suppose Rumelt would agree with many of the points made by Taleb.  In the name of strategy, a lot of negative activity is taking place.  But that is no reason to abandon strategic planning.

That would be like saying that just because some doctors conduct malpractice, we should abandon the science of medicine.  Or, because some reporters distort the facts, we should ban all news organizations.    

No, the proper response would be to eliminate the bad practices and promote good, healthy planning which works in concert with creative destruction rather than against it.
My first rule of strategy is this:  “ALL strategic initiatives eventually fail.”  My second rule of strategy is this:  “You are not an exception to rule #1.  YOUR strategic initiative will eventually fail.”

The primary reason why strategic initiatives eventually fail has a lot to do with the forces of creative destruction.  The environment in which you conduct business keeps changing.  What was the best thing to do in one environment is usually not be the best thing to do in a different environment. As the environment changes, your original strategic initiative becomes less relevant.  If you do not change, eventually your strategic initiative becomes irrelevant and you die—destroyed by creative destruction.

But here is where my rule #3 comes in: “Just because strategic initiatives die does not mean that your company has to die.  As long as you continually abandon failed strategic initiatives and replace them with relevant initiatives, the company will outlast any individual strategic initiative.”

The idea here is that good strategic planning is not primarily about trying to preserve the status quo or reduce the risk within the status quo.  It is about preparing yourself to prosper in a world where the status quo changes.

Hence, two of the most important words in good strategic planning are ANTICIPATION and CREATION.

Yes, the environment is changing.  But the change is rarely random.  There is logic behind the change.  The impact of an aging population can be roughly predicted.  The impact of business life cycles can be roughly predicted.  Advances in technology can be roughly predicted (like Moore’s Law).  As a result, the future environment should not be a complete surprise.  It can be ANTICIPATED.  And if something can be anticipated, then it can be prepared for.  And that is a key role for good strategy—to help companies better anticipate the changing environment in which they must prosper (and find ways to best exploit what is anticipated).

Why I would even argue that unusual Black Swans (events which have never before occurred) can be anticipated.  Sure, we won’t know the exact nature of the next potential disaster, be it a tsunami, earthquake, nuclear meltdown, housing crisis or whatever.  But bad, unusual things cycle through on a fairly regular basis.  And the best strategic response to negative black swans often doesn’t vary much.  There are only so many ways a black swan can impact the environment, no matter what it is.  Through the anticipative act of scenario planning, one can have a set of pre-planned responses which will work for almost any black swan.

However, even stronger than anticipation is CREATION.  Creative destruction occurs when a company reinvents the rules in a way which renders the status quo obsolete.  Those who are early masters of the new status quo typically gain disproportionate benefits.  Creative destruction has to be created by someone.  It may as well be you.  After all, isn’t it better to destroy someone else’s status quo than to have someone else destroy your status quo?

As Peter Drucker put it, “The best way to predict the future is to create the future.”  Therefore, good strategic planning looks at ways to reinvent business models—to create the next cycle of creative destruction.  In essence, the planning process is not used to preserve the status quo, but to become a leader in controlling how the status quo will be destroyed.

This is somewhat similar to the Blue Ocean approach to strategy.  The idea is to use planning to look for new, uncontested spots in the marketplace.  In other words, instead of trying to win in the highly competitive red ocean of the status quo, create your own new status quo (the blue ocean).

Strategic planning as a source for anticipation and creation might even be an approach that both Rumelt and Taleb would find acceptable.

Even though highly planned economies tend to be inferior to a more free-market economy, that doesn’t mean that planning is a worthless activity for individual companies.  Planning is worthwhile for individual companies, because it provides a means for them to survive the forces of creative destruction—either through anticipation or creation.   However, not all processes labeled “planning” focus on anticipation and creation.  Some focus on trying to preserve the status quo.   In a world where all strategic initiatives eventually fail, that second approach is not a recipe for long-term success.

The best planning looks forwards, not backwards.  As hockey great Wayne Gretzky put it, skate to where the puck is going to be, not to where it has been.  Anticipation drove his actions.  You should be driven by the same thing.

Tuesday, November 20, 2012

Strategic Planning Analogy #477: Waiting for Avocados

There’s a story about the early days of the Chipotle Mexican Grill restaurants.  They had a winning formula which looked poised for rapid growth.  McDonald’s invested in the company in the 1990’s, because they could see the huge growth potential as well.

But there was this little green mush getting in the way, called guacamole.  As the story was told, guacamole was only a minor item on the menu, but a significant roadblock to rapid growth.  The key ingredient in guacamole is avocado.  Avocados are not a particularly widely grown crop.  The acreage devoted to avocado trees in the US at the time was very small.  If Chipotle Mexican Grill was going to hit their growth targets, there would have to be a lot more avocado orchards than currently existed.

But there were three problems.  First, you cannot just plant an avocado pit into the ground and get a tree full of avocados.  Avocado trees grown from seed tend to be barren of fruit.  To get the tree to grow avocados, you need to graft branches of fruit-bearing trees onto the seedling.  That takes a lot of time and effort.

Second, even after the tree is sprouted and grafted, it can take from 5 to 12 years before the tree starts to bear fruit.  So even if Chipotle got an immediate increase in avocado orchards, it would be many, many years before it would impact their ability to make guacamole.

Third, farmers needed to be convinced that demand for avocados would skyrocket before they would make such a commitment to increasing the crop.  Why should they believe that this small restaurant chain of a few dozen outlets (primarily in Colorado) would have enough growth to absorb all of the extra avocado output?  If Chipotle doesn’t follow through on its growth plans, they’d be stuck with crops they couldn’t sell at a profit.  And for the first 5 to 12 years, the farmers wouldn’t have anything to sell from those trees to anybody.

Eventually the folks at Chipotle convinced farmers to increase the output of avocados.  And now, about a dozen years later, Chipotle is selling a lot of guacamole in their more than 1,300 restaurants.  Chipotle claims that on an average day they go through 97,000 pounds of avocados (or about 44,000 kg).  That’s over 17,000 tons of avocados in a year.

Even little things can become big things if you grow large enough.

Some issues can be resolved quickly.  Others take more time.  Avocados are an issue which takes years to adjust.  If you want a lot of avocados in 10 years, you have to start planning for them right now.  Even though avocados were a minor part of the entire menu, they became a major concern when plotting restaurant growth.

A similar situation can happen in many other businesses.  Small items can make a mess out of carefully crafted long-range plans because they cannot be adjusted fast enough to accommodate the plan.  This is particularly true if one ignores the slow changing issue until the last minute.

Therefore, when planning the big picture, you also need to look at the small picture.  You need to find those little “avocados” that can destroy the big picture if you did not start adjusting them soon enough.

The principle here is that a large strategy can only move as fast as its slowest component.  Therefore, if you want to move quickly, you need to find where the slowest components are and find ways to speed them up. 

Not Just Avocados
This applies to a lot more than just avocados.  The US version of the Mars candy bar was originally designed with hazel nuts.  However, Mars was not proactive in getting a grip on the small, slow-adjusting hazelnut market.  As a result, the supply and pricing of hazelnuts was erratic.   It was destroying the elaborate growth plans for the US version of the Mars Bar.  As a result, after introducing the candy bar to the market, Mars changed the formula from hazelnuts to almonds.  The almond market was larger, more stable and could more quickly adjust to the growth requirements of the Mars Bar.   

Of course, using almonds made the Mars Bar less distinctive in the market place and probably made the strategy less successful than originally planned.  But at least it kept the brand alive (at least until 2002).

Another story was less successful.  Back in the 1970s General Mills came out with a cereal called Buc Wheats.  It was sort of like corm flakes except made from buckwheat.  Like avocados and hazelnuts, the buckwheat supply was small and slow adjusting.  General Mills never fully got control in the supply of this ingredient.  As a result, even though the cereal was in high demand, they ceased production.  All because they didn’t do like Chipotle and put early effort behind shoring up the weak link in the strategy.

Not Just Food
This principle also applies to non-food issues.  Many industries, like mining and pharmaceuticals have very long lead times before an investment becomes productive.  I worked with a mining company who understood the long lead times and had already done the hard, slow work to find and secure a replacement site for a mine.  That way, they were prepared for when the current mine was no longer viable and could continue operations uninterrupted.  Had they waited until the first mine was nearly depleted before looking for a replacement, there is a good chance they would have spent years without any mining output (like waiting for avocado trees to reach fruit-bearing years). 

Lately, there has been a large movement in both the mining and pharmaceutical industries to shift strategies more towards acquisitions.  But that’s what you have to do when your efforts to build a pipeline of new products fails and you still want to grow.  You have to buy someone else’s pipeline.  And when you have to buy the pipeline, a big chunk of the profits from that growth are given to the person you bought the pipeline from.

A great example of a company who really understands this principle is  In the early days of e-commerce there were a lot of companies that wanted to become a huge player in this space.  Nearly all of them quickly disappeared. is one of the few left standing from those days and it is standing strong.

Why?  Amazon understood that to become a massively successful e-commerce firm for the long haul, it would need a lot of capabilities that are time consuming or expensive to develop.  There were a number of “avocados” they had to deal with, like search capabilities, recommendation engines, one-step check-outs, big-data algorithms, efficient distribution centers, and so on.  Amazon worked very hard in the beginning to master these skills, knowing they would pay long-term dividends. 

With an avocado tree, you don’t get any fruit for many years, but once you reach fruit-bearing years, you get a big crop every year.  Similarly, Amazon did not produce any meaningful profits for a long time because they were putting all the money into growing their avocado trees.  Now those trees are bearing fruit year after year after year.  Not only is Amazon benefitting from those plantings, but they are becoming an outsourcer of choice for other ecommerce firms who did not prepare in advance to plant their own avocado tree infrastructure.

And Amazon hasn’t stopped.  Recent profits were depressed because of the massive spending Amazon was doing to expand internationally.  But Amazon knows that a half-hearted effort will fail.  It needs to really invest big into slow returning infrastructure.  Otherwise it won’t have enough avocados (infrastructure) to handle the growth plan.

And Amazon did not wait until the demise of analog media to work on its replacement.  It made the early investment in Kindle so that it was ready and strong with a replacement when the current stream of profits dry up.

Lessons Learned
So what can we learn from all of this?

  1. Make sure you understand what is needed to make your growth plan succeed (from yourself and from your supply chain).
  2. Put special effort around those issues which require more time and attention in order to not derail your growth plan.
  3. Don’t wait until a need arises before trying to resolve it.  Anticipate what you need and prepare in advance to be sure it is already established when needed.
  4. Be willing to invest in slow-returning areas if they help build long-term enduing strength.   

Most strategies involve growth.  And growth both requires and causes change to the status quo. If you do not anticipate and prepare for the type of change needed to make your growth strategy a success, your strategy will most likely fail.  Since that preparation can take a lot of time and effort, start working on it early in the process.  Otherwise, you may not be prepared in time.  Then, your well-crafted strategy will become a worthless piece of paper.

I guess what I’m asking for is “Patient Greed”—an understanding that you might become a lot wealthier in the long run if you are patient enough to invest early in the right slow-returning activities.  Unfortunately, greed and patience rarely seem to go together.  Greedy people rarely want to wait for the avocados to grow.  But if you are able to put these two qualities together, you will gain a competitive advantage.

Tuesday, November 13, 2012

Strategic Planning Analogy #476: Passion for What

Back in the late 1990s, I went to a seminar at the annual Consumer Electronics Show in Las Vegas.  There was a panel of experts talking about the future of connected consumer homes.

Most of the “panel of experts” were the geekiest of geeks, the nerdiest of nerds.  They each seemed to live in homes with about a half dozen satellite dishes on them and about four different sets of connectivity wires running through their houses.  They had all sorts of bizarre homemade networking devices trying to connect all their computers.  And they were predicting that eventually all consumers would have homes as geeky as theirs.

The audience was almost as geeky as the panel and were nodding their heads in approval.  That is, until the last panel member began to speak.

The last member was not geeky or nerdy.  He was a consumer marketer.  He had done consumer research and found that the average person would not put up with all of that geeky stuff.  The audience started to boo him walked out in disapproval.

Well, here we are, about 15 years later.  None of the geeky predictions came to pass and the marketer was right. 

The members of the so-called “panel of experts” were extremists in their enthusiasm for consumer electronics and technology.  It was their passion.   They knew all the jargon.  They were willing to devote all their spare time to learning the obscure technology behind it.  They could build their own computers and program them to do specialized tasks.

In other words, they were not normal.

These people mistakenly believed that eventually everyone else would have the same level of passion as they did for all this geeky stuff.  In other words, they felt that eventually, their odd behavior would become normal.  It did not.

As it turns out, the panel member who best understood the future of the connected home had no passion for the subject.  His expertise was in listening to the customer, who was saying something entirely different.

I’ve been around a lot of companies who are looking for passionate employees.  I’ve seen a lot of job advertisements looking to hire people with passion for the products the company was selling.  The rationale is that employees who are passionate about the product are better employees.

But is that really true?

That panel of experts was so passionate for their business that the members were blind to the fact that they were outliers in society.  They were so abnormal that they couldn’t understand normal people.  And normal people are the customers.  As a result, they completely missed the mark on helping businesses in the industry prepare for the future.

Instead, it was the one panel member who was not biased by personal passion (the marketer), who could accurately hear the customer and give sound advice.

This excessive passion can be particularly messy for strategic planners.  If they are too passionate for the business they are in, they can become biased extremists who are blind to the realities of normal people.  As a result, their strategic recommendations can be way off the mark and hurt the companies they work for. 

The principle here is that it is often better to hire people who have passion for their individual job skill than passion for the business where they apply that skill.  In other words, if you are in the green energy business, it is better to hire an accountant who is passionate about accounting than one who is passionate about green energy. 

There are many reasons why I believe this:

1. Improper Bias
In the story, we saw that the people with excessive passion had a biased and distorted view of the world.  Their extremism blinded them to what normal people are like.  They rejected consumer research (the facts), because it did not line up with their distorted, passionate viewpoint.  As a result, they became useless in helping companies address the needs of normal people.

I’ve seen this occur in multiple companies, where passionate extremist employees would promote all sorts of crazy ideas and bad strategies based on the notion that they found it appealing to their own passions.  Their rational was, “I would like that, so everyone else should like it, too.”

Unfortunately, the ultra-passionate segment of most businesses is quite small.  There are not enough of them to support these ideas.  Just because abnormally passionate people like something does not mean that normal people would also like it. 

And when you fill a company with passionate extremists, they start thinking that they are closer to normal than they really are, because all of their co-workers share the same biased extreme.  This leads to bad forecasts, bad strategies, and bad results.

Think about the battery-powered automotive industry.  Many of the companies were filled with employees who loved the idea of electric cars and thought everyone else should love them too.  So they came up with business models that were far too optimistic and now many of these businesses are going bankrupt.

2. The Charitable Cause Phenomenon
Although there are some great charitable organizations out there, I’d have to say that some of the worst-run businesses I’ve ever seen are charitable organizations.  Why?  Usually it is because the people running the business have more passion for the cause than for their individual job. 

They want to be a part of the cause, so they will do whatever job they can get to become a part of it.  That often means doing jobs for which they are not the most qualified.  Yes, passion can make up for some skill inadequacies, but often not enough to make many of them truly productive.  Just because their heart is in the right place doesn’t mean they are best qualified to get their job done.

Organizations need a lot of different skill-sets, from as mundane as janitorial or data entry to as sophisticated as a strategist, CEO, CIO, or COO, etc.  If people do not have lots of skills or passion for their individual task, then that task will not get done well.  If enough tasks don’t get done well, then the entire organization starts to fall apart.

That is why I like people’s primary passion to be around their assigned task, rather than the business.  That way, the people are happily excelling on that which they are assigned to do, because that is their love and passion.

3.  The Stockholm Syndrome
The Stockholm Syndrome is based on studies which show that people captured by terrorists will, over time, tend to become more sympathetic to the views of their captors. If normal people can start feeling more like the radical extremists who captured and tortured them, then I think normal people can start feeling good about the businesses which capture the bulk of their waking hours.

In other words, if you take a great accountant and put him or her into a green energy company, most over time will become more sympathetic to the green energy cause.  It is a natural consequence.

However, I don’t think the opposite is necessarily true.  If I take someone who loves green energy and is only moderately interested in accounting and put them into a green energy company, I don’t think they become a lot more passionate about being an accountant. 

Therefore, hire people who are passionate about their task, and you can train them to care about the business.  This will work out better than hiring people who love the business and then try to get them to love their individual job.

That’s why you commonly hear people in service businesses say that they look for people who love giving service (their job) and then train them in their business.  This works a lot better than finding people intimately in love with the business but have no desire to serve.

Great strategies rely on great insight and great execution.  Great insight and execution often are at odds with people who are excessively passionate about the business they are in.  First, their excessive passion biases them so they cannot see the realities of the normal world.  Therefore, their insights are inaccurately biased and subject to failure.  Second, people who are doing jobs based on their passion for the business rather than a passion for their job are not the best at doing their job, so execution suffers.  A better approach is to fill your business with people who are passionate for the skills of their individual task.  They will execute well on more accurate assessments of reality.

I have been a strategist at many companies where I did not have an excessive passion for the products being sold.  And I was proud of that.  I would tell people that this kept me from becoming too biased based on personal distortions.   I was forced to listen to the customer.  Second, my passion was for doing strategy, so they would get great strategies (and isn’t that what they hired me for in the first place?).