Monday, January 28, 2013

StrategicPlanning Analogy #486: Turn Before You Get There

Last night, I was going to visit someone whose house I had never been to before. The directions to the house went something like this: Travel down road “X” and take a right on the last residential road before coming to the intersection with a stop sign.

At first, that sounded like pretty good directions. But then I started thinking. How am I supposed to know when I come to the last residential road prior to the stop sign? It was dark out, and there was no way of seeing if there were addition residential roads between where I was and where the stop sign was.

The only way to find out which was the last road prior to the stop sign would be to go past the road I want and go all the way to the stop sign. Then I would have to turn around and go back to the first road I find. 

I guess those directions weren't as good as I originally thought.

Knowing when it is time to turn is not always obvious. Like in the story, sometimes you have to go past your turn before you can be sure of where you should have turned.

This same dilemma can occur in business. There are times you should turn away from a business direction, because it is no longer the right strategic place to be. The business is moving towards becoming obsolete and out of touch with the changing marketplace. You need to divest.

Ideally, you’d want to turn away from the declining business before it is too late. That way, you can divest of the business more profitably and preserve your cash flow before it plummets. 

However, how can you know when the time is “just a little bit before it is too late”?  Like the story, you almost have to drive past the best time to turn and wait until you get to the point when it is too late to know exactly when “just a little before too late” occurred. 

Unfortunately, by that time, it really is too late. Unlike the road in my story (which you could turn around on), you cannot turn around time. Once time has passed, you cannot go back.

The principle here is about timing. There are optimal times to invest in a business and optimal times to divest in a business. Usually these optimal times occur just prior to a change in the inflection point on the industry lifecycle curve.  I’ve talked about this concept before, but it is worth repeating.

As you can see in the figure nearby, the best time to invest is just prior to when the market turns up (Point “A”). The reason why this is a good time to buy in is because the current trajectory is still low, so you may be able to buy in cheaply. Yet, when the trajectory soon turns, the value of the business will increase dramatically, so you make a quick gain. If you wait to buy in until after the inflection point beyond point A, the market will have already reacted to the change in direction, so you will probably have to pay a lot more to get in with little additional upside potential. All that upside is already baked into the projection, and you have to give the seller a price which includes that upside potential.

Similarly, the best times to divest are usually at Point B or Point C. These are points just prior to a downward changing inflection point. Here, the idea is to sell while buyers are still projecting a value based on the higher valuation. You sell it to them at that higher valuation, just before the valuation drops due to the coming inflection point.

Of course, the problem with this theory is the same as the problem in my story. It is difficult to know when “just before an inflection point” occurs. You almost have to witness the change in the inflection point before knowing when “just before” occurred. And by that time, it is too late.

And if you wait until it is obvious that the inflection point is near, then it is as if the inflection point has already occurred, because both sides of the negotiation will know of the certainty of the upcoming change and bake it into their projections, so you don’t get an advantage.

Ideally, you want to be far enough in advance of the change that it is not obvious to the person you are dealing with that the change is as close as it is. And being that much smarter than the person on the other side of the negotiating table is not easy to accomplish.

Why this is Important
If this is so difficult, one might say that it is not worth trying to figure it all out.  And maybe, a few decades ago, I would have agreed with you.  But in the modern economy, I don’t think we have that option anymore.

In today’s economy, most of the value created in a business no longer occurs though the annual activities recorded on the income statement or cash flow statement. Instead, most of the value is created (or destroyed) at the point when the ownership changes hands. I’ve spoken about that in more detail here and here.

Think about all the modern dot-com and social media business that are being created. Many of them never show a positive cash flow (or a cash flow large enough to justify the money invested in it). Many cannot even explain exactly what a path to profitability would look like. Yet, with every new round of private equity funding, a new value is created based on the nature of that round of funding.  The changes in ownership define the value, rather than the current income statement.

Then, when the startup goes through an IPO or sells out to a bigger public entity like Google or Facebook (think YouTube and Instagram), the really big change in value occurs.  Whether the startup lives up to that valuation is questionable (think of all the stock drops and balance sheet write-downs). But the point is that if most of the value is created or destroyed at the point of ownership change, then determining the optimal time to make that ownership change is now more crucial than ever.

How to Improve Your Odds
So how do you find those ideal points prior to inflection points before everyone else? I have three suggestions.

1. Look for Leading Indicators.  Lagging or concurrent indicators are like the stop sign in the story…by the time they tell you where the inflection point is, it is too late. What you need are leading indicators—factors which help predict future directional change. For example, in the social media, mobile, and digital worlds, future activity can be determined by the amount and quality of top tier engineers and designers flowing through the business. If many bright engineers are entering the business, better times may be ahead.  On the other hand, if engineers are leaving the company, the trend may soon be getting worse.

2. Watch how Other Ownership Changes are Affecting Valuations.  If the biggest value changes take place when firms change hands, observe how similar companies are being evaluated at their ownership changes. This may be the best way to gauge how your company would be valued at its next ownership change (if you act quickly).

3. Stick to What You Know.  The closer you stick to businesses for which you have intimate experience, the better you are at understanding the nuances in that space.  This should help you to see the more subtle changes that novices would miss and give you an advantage in understanding the inflections.

Since valuation in today’s economy is ever more dependent on what happens at the time of ownership change, it is critical to time ownership changes more precisely. This is difficult, because the best timing is usually prior to inflection points. To help find these prior moments:

1.      Look for Leading Indicators
2.      Watch How Ownership Changes are Affecting Others
3.      Stick to What You Know

If I would have had someone up in an airplane when I was looking for that house, I probably could have found my turn sooner.  The airplane could see the big picture and provide better data.  Similarly, a strategic planning department which monitors the big picture can help companies better find those ideal moments.

Wednesday, January 16, 2013

Strategic Planning Analogy #485: Unconventionality

Sometimes when my wife and I are on a road trip together, I’ll have fun by telling her that I want to race her to the destination.  Of course, that’s a silly suggestion, because we’re both in the same car.  As a result, we will both get to the destination at the same time.

I think that the very silliness of the suggestion is hilarious.  My wife thinks the very silliness of the suggestion is quite stupid.  So I laugh and she frowns.  But every once in awhile, I still bring up the suggestion when on a road trip.   

If everyone is in the same car, they will arrive at the destination at the same time.  It kind of takes the fun out of being in the race, because there is no way to get a lead over everyone else.  It makes the whole idea of racing kind of silly.

Yet, I see businesses doing this all the time.  The company will set up all kinds of goals to win and to exceed the performance of everyone else in their industry.  The goals are quite impressive.

But when you ask them how they are going to win and achieve those goals, the game plan is to operate by the traditional rules of their industry.  My response is, “How do you plan on beating everyone else if you are doing the same exact conventional activities as everyone else in the industry.”

To me, that makes as much sense as trying to win a road race by piling all the drivers into the same car.  For if everyone in the industry is playing by the same conventional rules of operation, you are in the same car—the car of conventionality.   You are running the race the same way, with the same tools, same business models, the same processes, the same strategies. 

How can you expect to pull away and win a decisive victory under those circumstances?  I don’t care how impressive your goals are.  You haven’t shown me a way to pull ahead and win.

The principle here deals with another one of my 23 laws of strategy, the Law of Unconventionality.  This law states that: “You do not achieve unconventional profitability with conventional business models.”  In other words, you do not meaningfully beat your competition if you are doing the same thing they are.  If you want unconventionally high levels of profits, you have to do unconventional things.  You have to get out of the same car of conventionality that everyone else is in and get a car of your own—a car that runs a better race.

Why Conventionality Won’t Win the Race
The problem with conventional methods is that they provide little room for differentiation.  If everyone is going after essentially the same customer in mostly the same way with basically the same offering, all the competitors will look about the same to the consumer base.  There is no natural reason for a customer to prefer one competitor over the other.

Without any meaningful natural differentiation, the only way to get an edge is by “bribing” customers with lower prices or added freebies.  Of course, the other competitors will follow, causing a downward price and profit spiral.

That is why the profitability of industries tend to drop over time and mature industries have returns which are about the same as the industry cost of capital. 

The Need to Differentiate
If there is an outlier in an industry who is beating these odds and making high levels of profits, I’ll bet you it is because they are not following the conventional rules of the industry.  They are doing something very different—playing by different rules.

Southwest Airlines has superior profits over conventional airlines because it doesn’t play by conventional airline rules.  It runs a point to point system with different rules on seating, ticketing (won’t use other ticketing sites online), baggage, fuel purchasing, employee relations and host of different things.  By playing by different rules, it has a lower cost structure and an offering which is superior to a significant sector of the population.

Geico made a splash in the insurance industry by running against the conventional approach of selling insurance personally through a huge network of insurance agents.  Instead, they put the money into advertising and call centers and cut out the agent fee, putting that money into other benefits.

Ashley Furniture gets higher than average returns for furniture retailers by direct sourcing much of its furniture from low cost countries and bypassing the branded furniture manufacturers which the conventional furniture retailers use.

Amancio Ortega became the third richest person in the world by re-writing the rules of the fashion industry.  Instead of running the business around a handful of fashion seasons each year, he built a system based on continuous replenishment.  This system supports his Zara stores in a new way, called “fast fashion,” which is very profitable, because it is a much more productive use of capital and inventory than the conventional fashion operators.

Apple became one of the highest valued companies by avoiding the conventional approach of specializing in either hardware, software or distribution and build an integrated, closed system.  It also changed the rules by focusing on elegance rather than just functionality.

Differentiation Breaks the Bribery Trap
When you do things differently, you give yourself a natural edge.  Either you create cost savings the competition cannot copy so that you can profitably underprice them, or you create superior preference so that customers are willing to pay more for your offering.  Either way, you get to zoom past the conventional operators in the race to profits.

Apple has had long lines of people waiting to full price for their integrated offerings, because many consumers thought their different approach made it worth the effort to get one. 

Because Zara sells through its offerings so quickly and replaces them with something different, people learn that it is useless to wait for items to go on sale.  You have to buy it at full price right away.  And because of their different cost structure, Zara’s full price is still a good deal relative to conventional operators.

The Limitations of Bechmarking
This is why benchmarking is only of limited value.  It helps you to understand how others do things, but it doesn’t tell you how to do things differently from everyone else.

If you are falling behind in the race, benchmarking can help you find a way to get into the car of conventionality.  At least then you are no worse than average and can ride with the rest of the conventional operators.

Or, if you see someone breaking away from the pack, benchmarking can help you figure out how to get inside their car.  For example, others like H&M and Forever 21 have copied much of Zara’s business model, which is starting to make that the “new conventional” model.

But benchmarking won’t tell you how to become the next Southwest, Geico, Apple or Zara.

Sources of Differentiation
There are lots of ways to become unconventional.  It can be done by going after a different customer base, offering a different bundle of benefits, offering a radically different way to solve an old problem, changing how a solution is delivered, changing how an offering is paid for, and so on.  There is not enough room in this blog for all the creative ways to break the mold.  Look for your creative way and you’ll be pleased with the results.

If you run your business the same way as everyone else in the industry, you will never break away from the pack.  You will be stuck in a world lacking differentiation—and the added profits which come from differentiation.  Only unconventional approaches lead to unconventional returns.

A popular old circus act was to have dozens and dozens of clowns pile out of a tiny car.  If you stick to doing things the conventional way, you are like one of those clowns stuffed into the car of conventionality.  And those clowns get laughed at.  Do you want to be laughed at?  If not, get a car of your own.

Friday, January 11, 2013

Strategic Planning Analogy #484: Adoption Curves

I knew someone who lived in Latin America back in the days when inflation was regularly 2,000 to 3,000% per year.  He told me that back then a popular occupation was to be a profession line-stander.  What these people did was stand in line outside of a store before it opened.  Then, once the store opened, they quickly bought a bunch of goods for the person who paid them to stand in line for them.

Why were so many people willing to pay others to shop for them?  The extremely high inflation rates made it a great economic investment.  When inflation is over 3000%, you want to convert your money into goods as soon as possible, because every moment you waited made your money far less valuable.  Even waiting a day or two to shop would significantly diminish how much you could buy with that money.

Therefore, if you were too busy to shop immediately after getting paid, it was worthwhile to pay someone to shop for you, because the cost of paying the line-stander was less than the value loss in the currency by waiting until you could get around to shopping for yourself.

So being at the front of the line was important when paying cash in that society.  However, what if you were paying credit in a hyper inflation environment?  Well, then you’d want to be last in line, because the longer you waited to pay, the less valuable was the money used to pay off the earlier debt.

As the story illustrates, sometimes there can be great benefits to being first in line to get something.  Other times the benefits may flow to those at the back of the line.  This same idea applies to business strategy.  Under some circumstances it makes strategic sense to be a leader in adopting new ideas, new technologies, and new business models.  Under other circumstances, it makes sense to be closer to the back of the line.  And being in the middle tends not to get much of any advantage at all.

At first this may seem counter-intuitive.  After all, the normal consumer adoption curve typically looks like a bell-shaped curve.  There are a few early adopters, a few late adopters, and most people adopt somewhere in-between.

However, when it comes to strategic adoption rates for businesses, I think the preferred curve may look more like the inverted bell curve seen in the world of hyperinflation, with most of the advantages coming at either end, and little to be gained by adopting in the middle.

The principle here is that the timing of when you make a strategic move may be almost as important as what the move is.  In most cases, early adoption is best.  In many cases later adoption makes sense.  Being in the middle rarely is the best strategic move.

When Early Adoption Makes Sense
There are three times when it makes strategic sense to be at the front of the line.  These are each discussed below.

1) Establishing a Strategic Position
A strategic position is the benefit where you want to win in the marketplace.  And almost without exception, there is value to being one of the first to stake out that position.  Why?  If you are the first, you are going after uncontested territory.  There is nobody there who already owns the position, so you can just claim it for yourself...unchallenged.  You can defines the rules in that space to be in your favor.  You become the first to come to mind when the position is thought of.  You are the “expert.”

Consider the opposite, where you try to win at a position which someone else has already claimed and won. The only way you can win is to unseat the current winner.  That effort can be extremely difficult, costly and time consuming…and usually still fails.  The early leader in grabbing a strategic position has so many advantages that they can enjoy success for a long time, even if they do not have the best offering.

That’s why Al Ries and Jack Trout, the experts in positioning, made their first law of marketing the Law of Leadership, which says “It’s better to be first than it is to be better.”

2) Gaining a Temporary Edge
There is a lot of imitation in business.  If someone comes up with an idea that gives them an advantage, others will copy it.  As a result, most advantages are temporary.  Therefore, you have two choices:  You can be at the front of the line on that innovation and get the temporary advantage until others catch up; OR you can wait to do the innovation later. 

If you wait, you get no advantage in the marketplace when you invest in the innovation, since the early adopters already took it.  All you are doing is erasing your market disadvantage so that you can regain parity with the early adopters. 

If it costs roughly the same to adopt an innovation early or late, then all the advantage goes to the early adopter.  This is because every firm will eventually have to make about the same investment in order to stay relevant, so the costs are the same.  But only the early investor gets the advantage in the marketplace.  The rest have a disadvantage at first and only parity later.  So be at the front of the line if it is an advantage which pretty much everyone will have to adopt eventually.

An example could be something like free on-line delivery.  The first to offer it get the advantage, become known for it, and build a loyal sales advantage.  The latecomers are eventually forced into offering free on-line delivery to stem their sales losses to the early movers.  But it does not result in huge market share gains for the latecomers, because those lured by free delivery are already satisfied by the early adopters of the policy.  There is little incentive to switch to the latecomer’s parity offering.  I speak more about this principle in an earlier blog.

3) The Guinea Pig
Sometimes the inventor of a new process or new technology has trouble achieving the critical mass of customers needed to make their product an industry standard.  In this B2B world, it is often to the inventor’s advantage to incent some companies to become their guinea pig.  In other words, if the inventing company essentially “pays” some potential customers to be test cases for their product, then they can build the critical mass that gets others to follow.

This is why brands in the fashion world give free samples to the tastemakers and celebrities which the masses like to copy.  For if the tastemakers and celebrities wear the fashion, then others will follow, making it worthwhile to give those leaders the items for free.

This can also happen for businesses which are opinion-leaders in their industry.  If you are willing to be an early adopter for these businesses desperate to create a critical mass of demand, you may get the product for free, or get other incentives to pay for training costs or costs of conversion.  Look at the great financial deal Nokia got from Microsoft to be one of the first to adopt the Microsoft smartphone software. The latecomers would not get all of those incentives.  They would have to pay full price for the item.  Hence,the early guinea pig gains an advantage over the latecomers.

When Late Adoption Makes Sense
There are also times when it is better to be nearer the end of the line.

1) Evolving Industry Standards
When there are a variety of conflicting technologies fighting to become the industry standard, it may make sense to wait until one better understands which technology will become the industry standard.  That way, you are less likely to invest in the wrong technology and then need to make a second investment in whichever technology ultimately became the standard.  This is especially important if you are a small player who does not have enough clout to influence which technology wins and not enough money to make the investment twice.

If the technology impacts your interaction with all the players in your supply chain, there may be little advantage to being first if the rest of the people you deal with in the supply chain are waiting until they see which technology wins.  The real advantage only comes when everyone is on the same page.  It may be better to wait to see what your key partners adopt before making your choice.

2) Price Deflation 
Some technologies and business systems are very expensive when they first come out and have their prices drop dramatically over time.  This would be a sort of high price deflation, the opposite of the high inflation in the Latin America story.  In the case of high deflation, there can be high incentives to wait.  If you wait long enough, you can get the same thing as the early adopters, but much cheaper.  That cost gap may be more than enough to compensate for entering the business a little later.

Not only might the later product version be cheaper to buy, but cheaper to operate.  The technology might go from difficult installation to “plug and play.”  So purchase cost, installation cost and ongoing maintenance/operating costs could benefit from waiting.

3) Avoiding Mistakes
Not all innovations turn out as originally promised.  They may bomb in the marketplace or need significant tweaking.  Sometimes, it pays to let others do all the difficult and expensive work of experimenting and testing.  Then, only once the formula for success is figured out, pounce on the marketplace with the winning formula.

This type of waiting is especially useful to market leaders who have significant influence on their supply chain.  For example, Coca Cola has rarely ever been the first with any innovations in their industry.  They were not the first to put soda in cans.  They were not the first to create a diet soda.  They were not the first with energy drinks.  What Coke likes to do is let others waste their time, money and effort on experimenting.  Then, once the right answer is known, Coke jumps in.  And because of Coke’s marketplace clout, they usually overcome the later start and overtake the innovator…and save all the innovation expense.

Strategy is more than just knowing what to do…it is knowing when to do it.  Often the best strategic moves come to early adopters.  However, sometimes it makes more sense to wait.  The proper timing depends on issues like the riskiness of the innovation, expected price changes over time (up or down) and your relative market position.  There is no obvious answer for everyone in every situation.  So you have to figure it out, just like most other strategic issues.

Before getting in line, decide where in the line you want to be.

Monday, January 7, 2013

Strategic Planning Analogy #483: Execution

Let’s say that you are the coach of a sports team.  Your biggest game of the season is coming up, so you devise a masterful plan beforehand on how to win the game.  After writing up the plan, you become very proud and say to yourself, “This is a brilliant strategy.”

Yet, when it is just before game time, you tell the players on your team, “Each of you go out there and individually do whatever you think is right.”  So that is what the players do during the game.

And I’m sure you know what the result would be.  There is no coordination among the players or agreement about what to do.  As a result, they suffer a terrible loss.

There is a reason why sports teams have coaches and why those coaches develop game plans.  Without the coach and the game plan, the players on the team would play in a random, uncoordinated fashion.  They would have no success.  Yes, they may all individually be great athletes, but if they are not executing a common strategy, they will fail.

To win in sports, you need more than just great athletes.  You need a plan to win and a coordinated execution of that plan.  For example, a great pass is only “great” if there is someone who knows it’s coming and is in the right place and ready to receive it.  And that only happens if it is planned and practiced.

As the saying goes, there is no “I” in TEAM.  It is about working a common plan together.

This may sound obvious for sports teams, but it appears to be less obvious in the business world.  There is a great movement to “empower” the people on the front lines of business.  The idea is to just give them the proper tools and get out of the way.  Let them do whatever they think is right.

Sure, the gang up at headquarters may have some fancy strategic plan enshrined in some book or Powerpoint deck.  But if the people on the front lines aren’t aware of the plan, or not trained in what the plan means for them, or are told to just “do whatever you think is right,” then that plan is worthless.  You become just like the coach in the story who designs a great strategy but doesn’t use it while the game is being played.  That type of planning is worthless.

Yet this worthless approach seems to go on quite often in the business world.  Those designing the strategy and those executing the strategy rarely interact.  They may talk about the strategy once a year at an off-site location nowhere near where the actions of the business actually takes place.  Yet, the rest of the year, when the daily execution of decisions takes place, the topic of the strategy is rarely ever brought up.  This creates a disconnect between what the company says and what the company does.

And you know what?  It is what you do on a daily basis out in the marketplace which determines your success, not what is dreamt up back at headquarters.  So if you want to win, you need the team to be playing the game you designed beforehand.

The principle here is that the real strategy is not what you say, but what you do.  What you say is just an idea.  By itself, it has no value, no impact on one’s success.  Instead, it is what you do which impacts your success, because it is the only thing that gets played out in the marketplace where the battle is fought.

Therefore, if you want to win, you need three things:

  1. A winning game plan (a great strategic plan).
  2. A team capable of executing the plan (the right skills, infrastructure, investments, competencies, supply chain connections, etc.).
  3. A team that has been coached so that they have the knowledge, ability and desire to execute the plan while the game is being played. 

We’ve talked a lot about the first two points, so we will focus the rest of the blog on point #3. 

You cannot execute what you do not know.  If a player does not know what is expected of them, it should not be a surprise when they do not do what you want.  If the only people who know the strategic plans are the executives on the sidelines, then don’t be surprised when those on the front lines of the business do things contrary to the strategy.

Yes, you may have great, caring, action-oriented people in your company who want to the right thing.  But if there is no consensus on what is right, then they will all be doing different things—none of them evil per se, but none of them coordinated to build upon each other to deliver the plan.

Therefore, make sure everyone knows what the plan is.  You probably even want your customers to know what the plan is, so that they can hold your people accountable to it.  Heck, why not tell the whole world, including your competitors what your plan is.  If it’s a well designed strategy and your people are executing it well, it shouldn’t matter.

Vince Lombardi, the great coach of the Green Bay Packers in the 1960s, said that he wanted his teams to execute so well, that even if the opposing team knew exactly what you were going to do, they still couldn’t stop you.

Wells Fargo has created success with a superbly executed plan to win via cross-selling.  Now it’s one thing to say “we will win via cross-selling.”  It’s another thing to have a sophisticated plan executed everywhere in the organization to pull it off.  As Wells Fargo CEO John Stumpf put it recently, “We could leave our strategic plan on an airplane and it wouldn’t matter.  It’s all about execution.”

So don’t be afraid to tell the whole world your strategy, especially the people who have to execute the strategy.  And do it often. 

And do it specifically.  In sports, each player not only needs to know the overall game plan, but the specific game plan for their position.  Have you told everyone what is expected of them as their part of the game plan?  Do you even know what each person’s part is in executing the plan?  Shame on you if you haven’t broken down the strategy to a level where people can see where they fit in.  Don’t assume people will figure it out on their own.

Knowing what is expected does not automatically imply that you can flawlessly execute the plan.  That is why sports teams practice between games.  Through instruction, training, repetition and feedback, the players become better at their role.  That way, when game time comes, they are better able to execute the plan.

This same principle applies to business.  Don’t just tell people what is expected.  Help train them so that they can better execute on what is expected.  How many businesses have employee training programs specifically developed around strategic goals and objectives?  You’d fire a sports coach who didn’t train his team to execute the plan.  Why should we settle for less in business?

Every day, there are dozens, if not hundreds of decisions being made by each person in the organization.  Are each of these decisions helping to promote the strategic intent or are they moving in a different direction?  The strategic coaches cannot be there when every one of these decisions are being made, so the coaches need to train everyone so that it becomes a natural reflex to decide in the direction of what’s right for the strategy.  Have some training sessions where you go through common situations, to help everyone see what the best decisions for action are.  

Finally, one needs people on the team who want to execute the plan.  You need team players who buy into the culture, buy into the objectives, and buy into the general strategic approach for achieving those objectives.  Effective leadership can help build up that desire. 

Unfortunately, we’ve all seen great athletes who are not team players.  They tend to hurt, rather than help performance.  Are you willing to deal properly with those who don’t have the desire to be a team player? 

But What About Improvising and Adjusting?
Now we all know that the future is uncertain.  Things will happen that we did not anticipate.  But that is not an excuse to stop planning and stop trying to connect execution to plans.

Sport events have the same problems.  Unexpected things happen.  Perhaps a key player is injured, or the opposition is stronger than you anticipated.  That doesn’t mean teams abandon planning and play randomly. 

No, instead sports teams make adjustments to the plan.  They don’t totally abandon their macro plan, because they are stuck with the players and the training they already have.  But mid-game they adjust the plan to make it more suitable for the game of the moment.  And if they were trained well, they have practiced some alternatives for just such occasions.

The same is true for business.  It is okay to adjust the plays mid-game (adjust, not completely throw away).  And if you have practices various scenarios in advance, you are ready to adjust quickly when the scenario changes.

Finally, the idea of empowerment is not a totally bad concept.  In fact, it is mostly a good concept, especially when things are changing.  But it needs to be empowerment bounded by strategic intent.  In other words, one is free to improvise as long as it is consistent with the overall strategic imperatives for that individual.  The sports analogy would be that a player can adjust their play as long as it is consistent with the game plan for their particular position on the team. 

And the more you train and practice the strategy, the better that improvisation will be.

Your real strategy is not what you say, but what you do.  Therefore, any strategic planning process needs to emphasize strategic execution—doing the things which move the strategy forward.  In order to accomplish this, one needs to do three things: 

  1. Have a great plan.
  2. Have a team capable of executing the plan.
  3. Have a team that has been coached so that they have the knowledge, ability and desire to execute the plan while the game is being played. 

This requires making sure everyone knows the plan (and their part in it), is trained to do what is needed to execute the plan, and has the desire to play their part.

How often do your strategy people ever get out in the field to see the game in action?  You wouldn’t dream of leaving the coaches at home when a sports team goes out to play a game.  Is it any less wrong to never let the business strategists be at the game in the marketplace?

Wednesday, January 2, 2013

Strategic Planning Analogy #482: Owning Vs. Driving

In automobile racing, the drivers get all the glory.  They are the heroes; the ones who get in all the photos and are adored by the race car fans.

Yet are the drivers really all that special?  Most are mere employees of large race car companies.  They don’t own the car they drive in the races.  Heck, they don’t even own the clothes they wear while driving.  Both the clothing and the cars are covered with decals and logos of the company sponsors who invest in these large racing enterprises.

Winning in car races requires more than just drivers.  There are the car designers, the pit crew, and a whole host of others.  Yet the glory goes to the one driving the car.

In an episode of The Simpsons, there was a child’s race of coasting “soapbox derby” cars down a hill.  While all the boys were clamoring to be the drivers, one of the coaster car designers lamented, “It’s all in the design.  The drivers are basically ballast in these cars.”  Yet the drivers get the glory.

The drivers don’t own anything but they get all the glory.  That’s because, to most fans, it’s not who owns the car that is important, but who drives it. 

A similar idea applies to all businesses.  Many business leaders seem possessed with the idea that their company has to own a lot of things.  They are constantly involved in a wide variety of acquisitions and other M&A activity.  They focus on building a portfolio of owned businesses.

Yet is ownership really all that important?  In auto racing, the glory goes to the one who drives the car, not the one who owns it.  Similarly, as long as your company is driving the way an industry works, does it really need to own that many pieces of the industry?

The key is not ownership, but control.  And as long as you are in control (behind the steering wheel), you can have as many people putting their logos and decals on the venture as they want.  Because it is the driver who gets the biggest prize.

The principle here has to do with control.  Those who control how an industry or business ecosystem works control how the money flows.  So a business with more control can make more of the money flow to themselves.  

Increasing ownership does not necessarily lead to increasing control and increasing profitability.  In fact, as we will see later, increased ownership can actually reduce control and profitability.

There are many alternatives to ownership, including alliances, joint ventures, partnering, outsourcing, buying on the open market, and a host of contractual arrangements.  These can often lead to greater control and greater profitability than ownership.  If you do these types of arrangements properly, you can be in the driver’s seat for the industry—and get the glory (and the biggest prize).

Problems With Transfer Pricing
Ownership can destroy control and profitability in many ways.  First, there is the problem of transfer pricing.  As an item moves through the pipeline—from raw material to the hands of the ultimate consumer—there are numerous places to transfer ownership, from the extractor to the part supplier to the assembler/manufacturer to the distributor to the retailer to the consumer. 

At each point along this chain a transfer price is negotiated.  Those with power control who benefits the most from how the transfer price is negotiated.  For example, Walmart is a very powerful part of many pipelines. When manufacturers sell to Walmart, I’m sure the Walmart does much better on the transfer price than do the manufacturers or other retailers negotiating with those same manufacturers.

A problem can frequently occur, however, if a company owns too many parts of that pipeline.  If they forward and backward integrate significantly through acquisition, they can end up owning most of the transfer points.  In essence, the company ends up negotiating with itself.  Therefore, the fully integrated company cannot use control, power and leverage to extract above average returns through transfer pricing.  After all, if you own both sides of the negotiating table, if one side wins and the other loses, you are no further ahead in total, because you own the winner and  the loser in the negotiation.  In other words, the extra ownership reduces your control over how the money flows in transfer pricing.

Problems With Alienation
The mere fact that you own an additional piece of the supply chain can destroy the value of what you have purchased due to the reaction of others.  For example, let’s assume you buy one of your suppliers—someone who was a supplier to you as well as some of your competitors.  Those competitors, who were happy to purchase from that supplier before you owned it, may no longer want to use the supplier after you own it, because they don’t want to give business to their competition.

For example, when Walmart purchased McLane Distribution, it thought it would gain knowledge of fast moving consumer good distribution in groceries.  What they failed to consider was how many convenience store customers would drop McLane as their supplier because they didn’t want to help Walmart.  Walmart had to sell McLane in order for McLane to keep its customers.  So, by owning McLane, Walmart destroyed McLane’s power to control its other customers.

Problems With Focus
The more diversified your ownership, the less focused one tends to be.  It takes considerable effort to be state-of-the-art at everything all the time.  There are more opportunities to slip up.  However, if you keep your sphere of ownership smaller, you can specialize at being the very best in a narrow focus.

There are reasons why people outsource things like payroll and IT and other back-office functions to specialists.  That way, they know that there is someone whose whole livelihood is based on being the very best in that area doing the work for them.  Specialization makes those outsourcing firms more powerful and it allows their customers to focus on the areas more critical to their success.  It is a win win.

Nike and Apple
Nike and Apple are two firms which avoid a preoccupation with ownership and instead preoccupy themselves with control.  In both cases, Nike and Apple focus on only two areas—design (business model and product design) and consumer image.  Pretty much everything else is outsourced (including the making of the products).  Nike and Apple own the key drivers for their whole ecosystems.  It puts them in a powerful position to drive how the rest of the entire ecosystem operates, even though they don’t own it.  And both are doing well.

Apple is able to focus in on what matters and leave the rest to the other experts.  And because it is the driver, it negotiates tough deals.  Just ask anyone in media who has had to deal with Apple.  By contrast, Sony tried to own everything—from design to manufacturing to even trying to own the media.  The added ownership worked against Sony.  They lost focus and could not win the battle on transfer pricing.  Worse yet, even though it owned most of the parts, Sony did not build as integrated a business model as Apple.  So Apple—owning fewer of the parts—created a superior integrated model.  Apple was like the race car driver—they didn’t own the car, but they made it go in the right direction because it was their hands on the wheel.  And now, Apple is very profitable and Sony is struggling.

The key implication of all this is that ownership should not be the automatic default option when looking at how to gain an element for one’s strategy.  In fact, there are so many reasons why other alternatives may be superior that acquisition may need to be the option of last resort.  Ownership may need to become the exception, not the rule.

Before jumping to the conclusion of ownership, check to see if there are ways to gain control without the need to own.  Find a way to drive someone else’s car and steal the glory.

And finally, instead of focusing on how to do M&A deals, focus on how to do non-ownership deals in such a way they you get to be the driver.

When developing strategies, one often finds a need to add certain elements in order to succeed.  But just because you need them does not mean that you have to own them.  It only means that you have to control them.  And in many cases, you gain more control and more profitability if you do not own them.  Therefore, do not automatically default to acquisition as the way to get what you need.

A read a study recently which looked at businesses and their level of successes with acquisition, partnerships and building from scratch.  Their conclusion was that acquisition tended to produce the least amount of success when compared to building or partnering.  Their conclusion was to only acquire when building or partnering didn’t make sense.  That sounds logical to me.