Thursday, November 13, 2014

Strategic Planning Analogy #541: Necessary for Whom?

I was in a business meeting recently where we somehow got on the topic of Southwest Airlines. I was explaining how Southwest had been so much more profitable than most other airlines for decades because of its unique business model, which in part included the avoidance of the hub and spoke model used by most of its competition.

Someone in the meeting objected to the praise of Southwest. He countered that the traveling world needs a hub and spoke business model. Since the hub and spoke model is necessary, it is not proper to praise a company which avoids this necessity.

In my mind, my reaction was “Necessary for whom?” Is it necessary for some business travelers? Yes. Is it necessary for Southwest? Absolutely not.

Two of the key aspects of strategy are determining WHERE to compete and HOW to compete. Answer these concerns properly and success is more likely. Answer them wrong and success is nearly impossible.

One method businesses use to determine where and how to compete is by looking for necessity of demand. After all, if something is viewed as a necessity and demanded by a large sector of society, it must be a good place to be, right?

Just look at the illegal drug business. The junkies feel that getting their next fix of the drug is the most necessary thing they must do. And the suppliers of those illegal drugs make a lot of money off that perceived necessity.

The problem is that there is not a strong correlation between necessity of demand and profitability. It worked in the illegal drug business. It didn’t work so well for those satisfying the necessity of hub and spoke in the airline business.

Southwest chose its “where to compete” principally in the lower price, non-business portion of the airlines industry. Southwest chose its “how to compete” by doing a number of things differently, including the elimination of the hub and spoke model. These were very profitable choices for Southwest.

In fact, it was a more profitable choice than going after the demands of the business traveler, even though the demand for business travel is higher (and presumably more necessary) than for non-business travel.

Just because something out there in the marketplace is a necessity does not mean that you have an obligation to provide it. Like Southwest, it may be better to avoid it.

The Southwest example illustrates a common situation in business. This is the principle that the highest profits are often found by avoiding the highest demand. This may seem counterintuitive at first, but there is logic behind this point of view.

Why High Demand Items Are Often Not Very Profitable to Supply
There are many factors which tend to lower the profitability of serving many high-demand segments. The first is that high demand segments tend to attract a lot of competition. Businesses like to flock to where the big sales potential lies. But when too many companies are fighting for those sales, the profitability of those sales plummet. Price wars suck the desirability out of those sales. You may be able to get a much higher return going after smaller, less competitive markets.

A second problem is that high demand necessities tend to attract a lot of government regulation. Food and health care are high demand necessities. Many governments get involved in significant regulation how those necessities are supplied. This often takes a lot of the profitability out of the system.

Just look at the results when communism gets involved in the necessity of supplying food. They impose all sorts of regulations and price controls. They often insert themselves into owing a lot of the food businesses. The net result is that businesses pull away and consumers are stuck with shortages and long lines.

A third problem is that high demand needs pull in the masses. And the masses do not always have a lot of discretionary income. They cannot afford to pay as much for their demands as other, smaller segments. You cannot charge more than they are able or willing to pay, no matter how much it costs you to serve them. Just look at the automobile industry. Those selling cars to the masses tend not to do as well as those selling cars in luxury or high performance segments. Customers in the luxury and high performance segments are willing and able to pay a lot more for their cars, making them more profitable, even if the segments are smaller than the mass segment. That's the reason why Tesla decided to start by targeting the high performance end of the electric car business.

When you try to appeal to the masses, you often end up with “average” offerings. Unfortunately, there will always be competitors who specialize in targeting the smaller niches. The specialists will offer items that are cheaper, or of higher quality, or of higher prestige, or of higher functionality. These more profitable niches will eat away at your mass market, leaving you with some of the less profitable middle ground. This is what Southwest did when it specialized in the profitable low price, non-business segment (and firms like Virgin Airlines and Net Jets at the high end), leaving the other airlines fighting over the unprofitable middle.

Fourth, high demand areas are often in fairly mature businesses. Mature and aging businesses, by their very nature, tend not to be as profitable as businesses in their younger, faster growing stage. Look at Procter & Gamble. They completely divested out of the food business (an extremely high demand business). Why? Because it did not have high prospects for future growth and profitability. It was too mature.

Instead, P&G has been pouring money into beauty care. You can say that food is a necessity and beauty care is a more discretionary luxury (less necessary). Yet, beauty care is where P&G have better prospects for growth and profitability. P&G is doing a great job of choosing where and how to compete, even if it means walking away from a lot of high demand products. 

Choose Wisely
As a business, you have choices. Strategy is about helping you make better choices. Those choices need to consider more than just the size or necessity of demand. They also need to look at the profitability within that demand. Smaller segments can often be better strategic choices.

In most businesses, there is no law that says that you have to target unprofitable segments. Even if you think that a particular function is necessary to make the world work, that doesn’t mean you have to serve it. It’s okay to walk away from some businesses and leave it to someone else.

Others may have business models better suited to those situations. Keep in mind that when P&G has been divesting all of its non-desired businesses, it has been finding buyers for those businesses. Many of those buyers are companies who do things differently from P&G and are better suited for wringing value out of mature, slow growth businesses.

Is There a Moral Obligation?
There may indeed be some moral issues here. Is it right to only serve the profitable rich and ignore the masses? Can we ignore the poor because they are unprofitable? Businesses work within a society and they have some obligations to that society. But they also have obligations to shareholders, debt holders and employees.

If businesses choose to or are forced to take on bad business models, this is bad for everyone. If they cannot make an adequate return, employees lose their jobs, and equity/debt holders don’t get a return. More importantly, the companies don’t make any profits which can be used for charity or for taxes to governments to help solve these issues.

Strong, healthy businesses are in a better position to provide jobs and provide funding for social issues. Then the question turns from business models to social accountability.

Strategy is ultimately about making choices, such as where and how to compete. These few strategic choices can have a bigger impact on business success than almost any other thing you do. Choosing what not to do is usually more important than choosing what you do. And some of the things you should not be doing are perhaps serving large “high necessity” demands. It’s okay to walk away from them and go in a direction better suited to who you are.

When you look at large, mass oriented businesses, there are usually only a small handful of winners (often only one or two). The rest struggle to stay alive. If you are not the winner in that mass space, it is usually better to walk away and switch to leading in a smaller segment. And that’s okay.

Friday, November 7, 2014

Strategic Planning Analogy #540: Three Novelists

Consider three types of novelists.

The first author wrote a great novel once. He liked the book so much that he would rewrite the same book every year. A few parts might be added and subtracted each year and maybe a couple of sections would be updated. But essentially it was the same story. He is currently working on the tenth edition of this book, ten years after the first edition. He is so busy with these updates that he hasn’t had time to ever write a second novel.

The second novelist was all over the map. Each new novel went in an entirely new direction with entirely new characters and subject matters. The writing styles and topics would vary so much between novels that there was no guarantee that if you liked one book that you would like another. And it was difficult to get used to all the new characters all the time.

The third novelist wrote a mystery series. The lead character detective was the same in all the books, surrounded by a familiar cast of characters. Although the style was familiar in each book, the plots in each book in the series had enough novelty to keep them unique and interesting. Over time, the lead detective came to be thought of like a familiar old friend to the readers, who anxiously waited to hear about his next adventure.

So which author do you think sold the most books?

Strategists are a lot like novelists, except instead of writing novels, we write strategic plans. And I have seen all three of the types of authors mentioned above in strategic plan writing.

The first type of author is often found in companies with a rigid, but unimaginative annual planning process. Every year, they go through the same boring process. Each business unit submits what they want to do, which is essentially the status quo. Then all the “same as ususal” business unit plans are rolled up together, creating a broad affirmation of the status quo.  Although it may appear as if the annual process is creating a new plan every year, it is really just slightly re-editing the same plan, year after year after year. We’ll call this the “One Book” approach to strategy.

The second type of author is like companies who switch their strategic planning personnel a lot or use a lot of different strategy consultants. As each new author of the strategy walks into the role, they try to put their unique stamp on the process to prove their worth. As a result, each new strategic plan is a radically different approach, totally unconnected to the plans of the past. The company’s role in each plan is so different, that it is hard to imagine that it is the same character. We’ll call this the “Annual Reinvention” approach.

The third type of strategy author (who is like the one who wrote the mystery series) falls somewhere in between the first two. Unlike the Annual Reinvention approach, there is the continuity between each successive plan. It builds on the character’s past and works with its habitual strengths and weaknesses. Yet, unlike the One Book approach, each plan is a new story for the new reality being confronted. We’ll call this the “Series” approach.

And just as novelists who write series tend to sell the most books, strategists who take a “Series” approach tend to have the most successful strategies.

The principle here is that an individual annual plan is not an isolated event, but one book within a series. Or, to use another metaphor, it is like a single screen shot from the middle of a movie. If you keep repeating the same screen shot for the entire movie, you have a lousy movie (like the “One Book” approach). Similarly, if you radically change the plot of the movie for each successive screen shot, you have a lousy movie (like the “Annual Reinvention” approach). Great movie scenes build from what came before and point to the changes ahead (like the “Series” approach). So when writing your individual plans, think like a series writer.

The Problems with the One Book Approach
The biggest problem with the one book approach is that it assumes a static environment—no changes. If you assume the future will be just like the past, then what worked in the past will also work in the future. Therefore, continuation of the status quo makes sense; reissuing the same basic plan every year makes sense.

However, we all know that the future will not be identical to the past. There are too many elements of change to allow history to continue as before. Change can come from a multitude of sources, from inside the business to inside the industry to outside the industry. Changing government administrations, changing technologies, changing competitive landscapes, changing economic conditions, changing customer moods, and a host of other areas all serve to alter the marketplace in which you compete.

Therefore, the same strategy book from 10 years ago will not work today, even if you update it a bit each year. A continuation of the status quo will lead to ruin.

The role of the strategist has to be more than just a scribe who takes the status quo words from each business unit and just writes them down verbatim into the annual plan. No, the strategist needs to add value to the process by:

  1. Helping the business units see how the future is going to be different from the past.
  2. Helping the business units discover the best ways to adapt to the new future.
  3. Helping the corporation see big picture of how all the individual business units line up against the changing future, creating a need to alter the business unit portfolio. In a changing future, the best role for a particular business unit may be to shut it down (no longer relevant), and that type of advice will rarely come from the business unit itself when submitting its plan.
The Problems with the Annual Reinvention Approach
The opposite approach from one book—the total strategic reinvention—isn’t much better. It creates a whole lot of action, but it never leads to very much benefit, because the direction of the action changes every year.

A key part of strategy is positioning. To win in the marketplace, you have to stand for something—your position. Winning such a position takes time and consistency. If you keep changing your position each year to something radically different, then you really end up standing for nothing.

When you change who you want to be all the time, your employees get confused about what you stand for, so they don’t know what to do. Worse yet, your employees may take the attitude that “this too shall pass” so they will ignore the latest strategic initiative. After all, why work hard on implementing something if you know that next year the company will want to implement something else? Neither confusion nor apathy in the employee ranks creates an effective strategy implementation program.

And then there are the customers. If your customers get confused about what you stand for, they will never know if you are the right solution for their problem. It is like the author who radically changes her style from book to book. You never know if the next book will fit your preferences.

It takes time to build the competencies and capabilities necessary to pull off a strategy. If you keep changing the strategy, your competencies and capabilities will never be at optimal levels for the strategy of the moment. By contrast, if you keep a relatively consistent direction over many years, you can develop competencies and capabilities which will make you best at delivering your position and blow away the competition.

The Benefits of the Series Approach
The series approach takes the best from each extreme while eliminating the worst. First, it understands that a company has a heritage, a past, a preconceived reputation in the marketplace. You are not working from a blank slate each year. You are building on what came before. This has an impact on what the best future path should be. Like the mystery series of novels, you have the same lead detective in each book, and the prior novels in the series impact what you can effectively do with the character in future novels. Yes, the character can change and grow up, but too many radical changes from book to book ruin the series.

So continuity is important. Build from past strengths. Ignoring your strategic heritage while looking forward is a dangerous path.

On the other hand, the series approach doesn’t re-write the same plot each year. It understands that the marketplace is continually changing, so you need a new story line to adapt to the change. It is the idea of being able to adapt what already makes you great to the new realities of the future.

Just as each murder in the mystery series requires a different solution, each year has its own strategic problems to solve. The variety in plots keeps the individual story in each book in the series fresh and relevant. Yet each solution relies on the historic strengths of the recurring detective. The same should be true of your strategic plans.

Strategic plans are like novels. And the best strategic plans tend to be like individual novels within a series. First, they provide continuity between the stories in order to take advantage of the past and build competencies and capabilities for the future. Second, each novel’s story is different, because times change.

I’m currently helping a company with its new five-year strategic plan, and the starting off point is its prior five-year plan. You have to look backwards before you can look forwards.