THE STORY
One time I was making a presentation to the top executives of a large corporation. I suggested that they might want to consider the acquisition of a particular retail company. I felt that this company might provide a good opportunity for them if purchased, because:
1) It would quickly and efficiently provide the corporation with a new channel of distribution.
2) It could provide a foundation for a new transformational strategy—significantly different from what the current owners were doing with the assets, and unique for the marketplace. It was an opportunity to get in on the ground floor of a revolutionary new retail concept which required this type of distribution channel.
3) Because the transformational strategy had the potential for being copied, acquiring a company that already had a national presence would provide a platform for rapid expansion, in order to claim the market before anyone else.
4) Given that the company was not implementing this transformational strategy and instead had an old positioning in the marketplace that was fairly weak, one could probably attain the assets fairly inexpensively.
It turns out that these executives I made the presentation to apparently had selective hearing. They heard the part about this potentially being a good acquisition, but seemed to miss everything else.
Here’s what they did.
1) The bought the company, but paid an outrageous premium price for the privilege. At that price, it would be difficult to get an adequate return, even if everything went right.
2) They did not implement the transformational strategy. Instead, they continued operating a variation on the old, failing strategy of the prior owners.
3) Even though it was a different channel of distribution, requiring a different approach to operating the business, the acquiring firm tended to operate it too similarly to the channel of distribution they were more familiar with.
4) The reason proposed for buying the firm was to penetrate the national market quickly with the new concept. Instead, they moved very slowly with any sort of small movement in the direction of the transformation.
As a result, the acquisition was a disaster and was eventually sold to a hedge fund at a significant loss.
THE ANALOGY
Absolutes can create easier decision-making. If something is always good or always bad, then it is easy to know what to do. Unfortunately, the answer in the business world more often than not is not “it is bad” or “it is good”, but rather “it depends.”
Take the example in the story above. Was acquiring the business a good idea or a bad idea? The answer is “it depends.” If one pays too much for the business and does little to add value to it (as this company did), then the answer to the question is that the acquisition was a bad idea. However, if it had been purchased at a more reasonable price and had been used as a launching pad to create a new transformational strategy, then the acquisition would probably have been a good idea (it is hard to say, because this path was not taken).
Business strategies often include recommendations concerning the buying or selling of assets/companies. Whether or not these strategies are successful can often depend more on the manner in which the assets are acquired/disposed of than in the original idea of doing the buying or selling. Therefore, the process of strategy should not end once recommendations are made to buy or sell an asset. To prevent selective hearing, the voice of strategy needs to continue throughout the entire process, in order to ensure that the execution is consistent with the strategic intent.
THE PRINCIPLE
The principle here is the Theory of Business Relativity. The idea is that the concept of whether an asset is good or bad is not always absolute, but can vary depending on other factors. The two factors which most impact whether an asset is good or bad are:
1) Price; and
2) Use
These are discussed in more detail below.
1) Price
Whether something is of great value depends in part on the intrinsic value within the asset. For most business assets, the intrinsic value of an asset is determined by the value of the cash flows which the asset can create for the company which owns it. However, of equal importance is the price associated with obtaining that asset. If the price one pays for the asset is far less than the intrinsic value, than the asset is very good and valuable to the firm. However, if one pays far more than the intrinsic value, then one has destroyed value and purchased a “bad” asset.
In both cases, it is the same identical asset with the same identical intrinsic value. However, the price one pays for it determines whether that is a good value or a bad value.
This principle is easy to see in stock trading recommendations. There could be a great company out there with outstanding prospects for growth and profitability. However if the price of the stock in that company has been run up too high, it could be a bad stock to buy at the going price. Conversely, there could be a very weak company out there with low profit prospects, but if the stock is priced low enough, it could be a great value to buy the stock of this “weak” company. Good or bad is only partly determined by the strength and weakness of the company’s prospects. The rest is determined by the price it takes to participate in those prospects.
So when someone asks whether a particular company is good or bad, you can say that it depends. The good news is that since intrinsic value is only part of the equation, you can have greater control in determining its total value based on your negotiating skills. If you are highly skilled in this art, you can make almost anything a good value, regardless of its intrinsic value.
With this in mind, a good strategy must first research an asset to best determine its intrinsic value. Then it must participate in the negotiation to ensure that the price of the transaction is favorable relative to the intrinsic value.
2) Use
Depending on how an asset is used, it can have a different intrinsic value. For example, let’s assume that there are two identical factories—each owned by a different company. Each company paid the same price to obtain their factory. The first company uses its factory to make a very profitable product. The second company uses its factory to make a very unprofitable product. So is this factory a good asset or a bad asset? The answer is, “it depends,” based on how it is used.
In the hands of the first company, the factory is a very good asset. It provides profits far higher than the price paid for it, because of the way it is used. In the hands of the second company, the factory is a very bad asset. It provides losses, so that the company will never get a profitable return on the investment in the factory.
Intrinsic value varies based on how the asset is used. In the original story, I felt that the company in question could be purchased at a good value, because I believed I had a better use for the assets in question than the current owners. As a result, I could afford to acquire the assets for more than the intrinsic value perceived by the current owners, but less than the intrinsic value available with my transformation strategy. That could provide a win-win on the price.
Unfortunately, the company doing the acquiring in the story paid a price about equal to the transformational intrinsic value, yet operated the business at the older, lower intrinsic value.
Therefore, it is very important to understand the strategic intent for the asset at the time of the evaluation. In addition, it is important to make sure that the asset is used in a manner consistent with the strategy, in order to create the value upon which the strategy was based.
SUMMARY
The “goodness” or “badness” of an asset’s value is only partially due to the current intrinsic value in that asset. The greater determinant of good or bad has to do with one’s strategy regarding that asset—namely how much you are willing to pay for it, and how you are planning on using it to create cash flow.
The better one’s strategy and the better the follow-through in executing that strategy, the more likely the asset will be “good” in your hands.
FINAL THOUGHTS
I worked with an executive at a different company who would ask us to go off and determine the intrinsic value of a company. We’d come back and report to him what the intrinsic value was. His response would be, “Well, if that is what the company is worth, then that is what we should pay for it.” We’d then try to explain to him that if the price he pays is equal to its intrinsic value, then he has created zero value for the company. Value is only created if you pay less than what the asset can provide in cash flow.
Showing posts with label Business. Show all posts
Showing posts with label Business. Show all posts
Saturday, June 2, 2007
Thursday, April 5, 2007
Strategy is Like Blood
The Story
When I was around twenty years old, I had to go to an oral surgeon to have my wisdom teeth pulled. After the teeth were pulled, I was told by the doctor that the gums would continue to bleed for a little while, but that it would stop shortly after I got home. Well, my gums continued to bleed for the rest of the day and continued all night. The next day I went back to the oral surgeon to get the problem resolved.
Thus began my introduction to the world of blood clotting. As it turns out, my blood does not clot like the typical person’s blood. It has difficulty clotting quickly. This problem is compounded when the bleeding is occurring in a moist place, like my mouth, where the saliva interacts with the slow process, making the clotting problem even worse. Now I understood why I had so many nosebleeds as a child.
After that problem with my wisdom teeth, I decided to look more into the chemistry behind blood clotting. As it turns out, for blood to clot, sixteen different chemical reactions must take place. And it is not a case where if you have fifteen of the chemical reactions, your blood just clots a little slower. You need all sixteen chemical reactions for clotting to occur.
It is an all or nothing type of deal. If you miss any of the chemical reactions, the entire clotting system breaks down and does not work.
The Analogy
Forming strategy is a lot like forming blood clots. Just as you need the entire 16 chemical reactions in order to get blood to clot, you often need a number of business initiatives working together in the proper order in order for a strategy to succeed. Strategy is typically not about just doing one thing right. It typically involves doing many things correctly which have a cumulative effect that cannot be achieved without the critical mass of doing all of the activities.
Wal-Mart’s strategy centers around having a low price. However, Wal-Mart does not do just one business initiative in order to achieve low prices. It is in the very fiber of everything Wal-Mart does. Some examples of the wide variety of ways in which Wal-Mart accomplishes its low cost strategy:
• Self-Distribution from its own warehouses, cutting out the middleman.
• Sophisticated computer systems that manage inventory as efficiently as possible.
• Strategic alliances and data sharing with key suppliers to help make the relationship as efficient as possible.
• Low cost building construction, no-frills headquarters.
• Low paid staff, compensated with stock.
• Minimal advertising when compared with competition.
• Everyday low pricing, which is cheaper to administrate than frequent price changes due to sales.
• Very aggressive negotiation on price with suppliers.
Wal-Mart’s ability to own a low price position comes from all over the business—systems, compensation, capital expenditures, negotiations, distribution, operations, promotion strategy, etc. Just as blood needs all 16 reactions to clot, Wal-Mart needs all of these activities and more to hold the low price position. If the only thing Wal-Mart did to build a low price strategy was put a lower price than competition on its merchandise, it would go out of business. That would be like trying to clot blood with only one chemical reaction. It doesn’t work.
Wal-Mart needs the entire system of business initiatives surrounding low costs and efficiencies, in order to profitably offer the lowest prices to its customers. They are all connected. If one of them is left out, there is a chance that competitors will use that missing initiative against Wal-Mart to narrow the cost gap, minimizing Wal-Mart’s ability to hold the low price position.
In the hyper-competitive world of today, it is often all or nothing when it comes to successfully holding a strategic position. Either you do all of the steps or you do not get to sustain the position. Just like blood.
The Principle
It’s one thing to choose a strategic position for your business and declare what it is on a piece of paper. It is quite another thing to make the words on the paper a reality in the marketplace. Just because a company declares that it is going to win with price, service, speed, customization, or whatever does not make it so. At this point, one does not have a strategy. All one has is a set of wishes.
Choosing a position is just the beginning of strategy. The next step is to create the comprehensive list of activities needed throughout the entire organization to make this position come to life. It is like creating the comprehensive list of all the chemical reactions needed to clot blood. One needs to find them all. Finally, there needs to be a process to ensure that the activities on your comprehensive take place.
Let us assume, for a moment, that your strategy’s success depends on holding a position of high service. This could affect a number of areas including:
• The quality of your service force. Have you hired the right type of people for this level of service?
• Training. Are you training your service force to adequately provide the service?
• Explaining. Does the service force know why service is so important and what type of service is expected of them?
• Compensation. Is compensation creating incentives for the right kind of behavior?
• Support. Are there adequate support materials and systems so that the service force can do its job?
• Image. Are the elements of image (appearance, business name, advertising, etc.) supporting an image of high service?
• Customer Communication. Are all the opportunities to interact with the customer offering high service (call centers, sales calls, correspondence, etc.)?
I have often seen companies implement a long list of initiatives to support a strategy and exclude any activity related to compensation. The explanation for doing so is that employees are very sensitive to changes in their compensation, and the executives to do not want to upset employees by changing how they get paid. Unfortunately, the old saying is true, that people tend to act in a way that maximizes their compensation. One can spend a great deal of time and money to build to an infrastructure to support a long list of activities. However, if compensation causes people to not want to do those activities, then all of the work on the infrastructure is worthless.
If the compensation system is creating an incentive for the wrong behavior, it can negate all of the benefits from all of the other activities. Just as leaving out one chemical reaction can keep blood from clotting, ignoring the impact of a company’s compensation program can keep an entire strategy from succeeding.
This same principle applies to many other initiatives. If you design a particular process needed in your strategy, but do not build the computer system support behind the process, the process won’t work. If you design an advertising campaign to support your strategy, but your activities do not live up to the promises of the advertising, all you are doing is accelerating the disappointment with your customers. And the list goes on.
The strategic initiatives needed to accomplish your strategy occur throughout the entire organization and affect all of the processes of your business. Therefore, it is important to get input from all over your organization when developing your strategy. Otherwise, when it is time to implement all of the initiatives to support your strategy, you may find out that the areas responsible for carrying out the various initiatives cannot perform them as needed. This will make your strategy no longer viable.
Another important element is communication. I have often seen businesses reluctant to tell their people about the initiatives required to accomplish the strategy for fear that competition would find out. However, how does one expect all of the wide variety of elements of the strategy to come together if the people responsible for carrying them out do not know about them?
A final element is coordination. To hold a strategic position, all the elements of the business need to be pointed in the direction of that strategic position. For example, if your position is based on low price, everyone needs to be doing their part to support low prices. If 20 percent of the business team is moving in a direction that emphasizes something else, like high quality or snob appeal, it will confuse your customer and hurt your ability to hold your desired low price position.
This is not to say that a company can ignore all of the attributes that are not primary to the desired position. No matter what position one chooses, one must meet minimum expectations on all relevant attributes. However, the driving force behind all aspects of the business need to be in support of the main strategy.
Summary
Strategy is a lot like blood clotting. One needs all 16 chemical reactions to make blood clot. If you are missing any one of the 16 chemical reactions, your blood won’t clot. The same is true for making sure a strategy is effective. One needs all of the business initiatives in the organization working like a chemical reaction in the direction of the strategy.
Therefore, key words to keep in mind when planning are as follows:
• Complete. Did you complete the task of not only creating a position, but also the list of what needs to be done to support the position and process for getting the list accomplished?
• Comprehensive. Is your list of tasks needed to support the position comprehensive enough to include everything required?
• Collective. Has the planning process collected input from throughout the entire organization, to ensure that the list of tasks is complete and doable?
• Communicated. Does everyone understand what is expected of them in order to build and sustain the desired strategic position?
• Compensated. Does the compensation system reward behavior in support of the strategy?
• Coordinated. Are the activities of the organization all coordinated to move in the same direction towards the desired position?
Final Thoughts
Plutonium is an interesting element. If you have only a little plutonium, it is relatively harmless. However, if you bring together enough plutonium, you can build an atomic bomb. That is where the term critical mass came from. If the mass of plutonium reaches a high enough level, it can create a huge explosion.
Similarly, if you only have a little bit of activity in your business moving in the direction of your strategy, you competition may see it as being harmless. However, if you reach a critical mass of activity, watch out! You may be able to blow your competition away.
When I was around twenty years old, I had to go to an oral surgeon to have my wisdom teeth pulled. After the teeth were pulled, I was told by the doctor that the gums would continue to bleed for a little while, but that it would stop shortly after I got home. Well, my gums continued to bleed for the rest of the day and continued all night. The next day I went back to the oral surgeon to get the problem resolved.
Thus began my introduction to the world of blood clotting. As it turns out, my blood does not clot like the typical person’s blood. It has difficulty clotting quickly. This problem is compounded when the bleeding is occurring in a moist place, like my mouth, where the saliva interacts with the slow process, making the clotting problem even worse. Now I understood why I had so many nosebleeds as a child.
After that problem with my wisdom teeth, I decided to look more into the chemistry behind blood clotting. As it turns out, for blood to clot, sixteen different chemical reactions must take place. And it is not a case where if you have fifteen of the chemical reactions, your blood just clots a little slower. You need all sixteen chemical reactions for clotting to occur.
It is an all or nothing type of deal. If you miss any of the chemical reactions, the entire clotting system breaks down and does not work.
The Analogy
Forming strategy is a lot like forming blood clots. Just as you need the entire 16 chemical reactions in order to get blood to clot, you often need a number of business initiatives working together in the proper order in order for a strategy to succeed. Strategy is typically not about just doing one thing right. It typically involves doing many things correctly which have a cumulative effect that cannot be achieved without the critical mass of doing all of the activities.
Wal-Mart’s strategy centers around having a low price. However, Wal-Mart does not do just one business initiative in order to achieve low prices. It is in the very fiber of everything Wal-Mart does. Some examples of the wide variety of ways in which Wal-Mart accomplishes its low cost strategy:
• Self-Distribution from its own warehouses, cutting out the middleman.
• Sophisticated computer systems that manage inventory as efficiently as possible.
• Strategic alliances and data sharing with key suppliers to help make the relationship as efficient as possible.
• Low cost building construction, no-frills headquarters.
• Low paid staff, compensated with stock.
• Minimal advertising when compared with competition.
• Everyday low pricing, which is cheaper to administrate than frequent price changes due to sales.
• Very aggressive negotiation on price with suppliers.
Wal-Mart’s ability to own a low price position comes from all over the business—systems, compensation, capital expenditures, negotiations, distribution, operations, promotion strategy, etc. Just as blood needs all 16 reactions to clot, Wal-Mart needs all of these activities and more to hold the low price position. If the only thing Wal-Mart did to build a low price strategy was put a lower price than competition on its merchandise, it would go out of business. That would be like trying to clot blood with only one chemical reaction. It doesn’t work.
Wal-Mart needs the entire system of business initiatives surrounding low costs and efficiencies, in order to profitably offer the lowest prices to its customers. They are all connected. If one of them is left out, there is a chance that competitors will use that missing initiative against Wal-Mart to narrow the cost gap, minimizing Wal-Mart’s ability to hold the low price position.
In the hyper-competitive world of today, it is often all or nothing when it comes to successfully holding a strategic position. Either you do all of the steps or you do not get to sustain the position. Just like blood.
The Principle
It’s one thing to choose a strategic position for your business and declare what it is on a piece of paper. It is quite another thing to make the words on the paper a reality in the marketplace. Just because a company declares that it is going to win with price, service, speed, customization, or whatever does not make it so. At this point, one does not have a strategy. All one has is a set of wishes.
Choosing a position is just the beginning of strategy. The next step is to create the comprehensive list of activities needed throughout the entire organization to make this position come to life. It is like creating the comprehensive list of all the chemical reactions needed to clot blood. One needs to find them all. Finally, there needs to be a process to ensure that the activities on your comprehensive take place.
Let us assume, for a moment, that your strategy’s success depends on holding a position of high service. This could affect a number of areas including:
• The quality of your service force. Have you hired the right type of people for this level of service?
• Training. Are you training your service force to adequately provide the service?
• Explaining. Does the service force know why service is so important and what type of service is expected of them?
• Compensation. Is compensation creating incentives for the right kind of behavior?
• Support. Are there adequate support materials and systems so that the service force can do its job?
• Image. Are the elements of image (appearance, business name, advertising, etc.) supporting an image of high service?
• Customer Communication. Are all the opportunities to interact with the customer offering high service (call centers, sales calls, correspondence, etc.)?
I have often seen companies implement a long list of initiatives to support a strategy and exclude any activity related to compensation. The explanation for doing so is that employees are very sensitive to changes in their compensation, and the executives to do not want to upset employees by changing how they get paid. Unfortunately, the old saying is true, that people tend to act in a way that maximizes their compensation. One can spend a great deal of time and money to build to an infrastructure to support a long list of activities. However, if compensation causes people to not want to do those activities, then all of the work on the infrastructure is worthless.
If the compensation system is creating an incentive for the wrong behavior, it can negate all of the benefits from all of the other activities. Just as leaving out one chemical reaction can keep blood from clotting, ignoring the impact of a company’s compensation program can keep an entire strategy from succeeding.
This same principle applies to many other initiatives. If you design a particular process needed in your strategy, but do not build the computer system support behind the process, the process won’t work. If you design an advertising campaign to support your strategy, but your activities do not live up to the promises of the advertising, all you are doing is accelerating the disappointment with your customers. And the list goes on.
The strategic initiatives needed to accomplish your strategy occur throughout the entire organization and affect all of the processes of your business. Therefore, it is important to get input from all over your organization when developing your strategy. Otherwise, when it is time to implement all of the initiatives to support your strategy, you may find out that the areas responsible for carrying out the various initiatives cannot perform them as needed. This will make your strategy no longer viable.
Another important element is communication. I have often seen businesses reluctant to tell their people about the initiatives required to accomplish the strategy for fear that competition would find out. However, how does one expect all of the wide variety of elements of the strategy to come together if the people responsible for carrying them out do not know about them?
A final element is coordination. To hold a strategic position, all the elements of the business need to be pointed in the direction of that strategic position. For example, if your position is based on low price, everyone needs to be doing their part to support low prices. If 20 percent of the business team is moving in a direction that emphasizes something else, like high quality or snob appeal, it will confuse your customer and hurt your ability to hold your desired low price position.
This is not to say that a company can ignore all of the attributes that are not primary to the desired position. No matter what position one chooses, one must meet minimum expectations on all relevant attributes. However, the driving force behind all aspects of the business need to be in support of the main strategy.
Summary
Strategy is a lot like blood clotting. One needs all 16 chemical reactions to make blood clot. If you are missing any one of the 16 chemical reactions, your blood won’t clot. The same is true for making sure a strategy is effective. One needs all of the business initiatives in the organization working like a chemical reaction in the direction of the strategy.
Therefore, key words to keep in mind when planning are as follows:
• Complete. Did you complete the task of not only creating a position, but also the list of what needs to be done to support the position and process for getting the list accomplished?
• Comprehensive. Is your list of tasks needed to support the position comprehensive enough to include everything required?
• Collective. Has the planning process collected input from throughout the entire organization, to ensure that the list of tasks is complete and doable?
• Communicated. Does everyone understand what is expected of them in order to build and sustain the desired strategic position?
• Compensated. Does the compensation system reward behavior in support of the strategy?
• Coordinated. Are the activities of the organization all coordinated to move in the same direction towards the desired position?
Final Thoughts
Plutonium is an interesting element. If you have only a little plutonium, it is relatively harmless. However, if you bring together enough plutonium, you can build an atomic bomb. That is where the term critical mass came from. If the mass of plutonium reaches a high enough level, it can create a huge explosion.
Similarly, if you only have a little bit of activity in your business moving in the direction of your strategy, you competition may see it as being harmless. However, if you reach a critical mass of activity, watch out! You may be able to blow your competition away.
Tuesday, February 20, 2007
Fire Your Owner
THE STORY
My finance teacher in college was a brand new professor. He had just finished his PhD and made the transition from being the student directly to being the teacher. He had no meaningful real-life experience in finance (nor any meaningful real-life experience at teaching for that matter, either).
This professor was not much older than I was at the time, which was relatively young. Yet when he taught, he spoke as if he had generations of experience and seemed to enjoy telling his students how most everyone in the business world was misguided.
He hated it when a company would introduce a new product, or diversify into new lines of business (to mitigate risk), or change a strategy to adapt to a changing world. In his mind, every business should be required to sell only one product, and sell it in only one way…forever.
What was his reasoning behind this? He believed that the investing shareholders should have ultimate power. If investors like the one product and the one way it is sold, then they can support it by buying shares in the company. If they don’t like the product or the way it is sold, then they can sell their shares in the company (or never invest in it in the first place). The good would get rewarded and the bad would get punished—by the investors.
Whenever a company changed its portfolio or its strategy, he felt it was interfering with his ability to control the company with his ownership. After all, what if the company came up with two products—one he liked and one he didn’t? Now he could no longer support one with his shares and deny the other by not buying shares. This made him very angry.
And if a company had the wrong strategy, he didn’t want it to change, because then the company would be doing something he couldn’t control. Instead, he would prefer that the company kept the bad strategy, so he could sell his shares in that firm and re-invest them into a company that already had the better strategy.
He did not care if a company lived or died. He would just continue to move his money and invest it in the best location at that particular moment
By contrast, Warren Buffet seems to have taken an opposite approach to investment and done quite well with it. I suspect that Mr. Buffet has done much better in investing than my college professor did.
THE ANALOGY
Although most investors are not as blunt as this professor, many act as if they believe what he is saying is true. They have no sense of loyalty or desire to help a business thrive over the long haul. They just want to move their money around to wherever the success is at the moment. What motivates their personal success often is at odds with what is in the best interests of an individual company’s long term success. For them to win, the company often has to fail.
When devising strategies, it is important to consider the desires of your owner. After all, these are the people who pay your salaries and can get you fired. But sometimes you have to take a stand and not do exactly as they desire. Giving them exactly what they desire may end up not giving them what they really need…an economic engine that produces cash flow for a long time.
Warren Buffet understands the big picture and realizes that the best returns usually come from long-term investing in companies that know how to adapt and survive. When the investor’s success depends on the company having long-term success, then usually both sides win. But if the investor’s best interests are not the same as the company’s, then one or both sides tends to lose.
THE PRINCIPLE
Over the past couple of blogs we have been talking about the concept of “who is my customer”. We have seen that you can use different strategic approaches to choose which type of customer you want to serve. You can serve the people who pay the money, the people who use the service, the people who influence the people who use the service, and even the people that may eventually buy your company.
There is another type of customer we haven’t talked about much. That would be the current owner, be it a corporate headquarters (if you work in a division), a board of directors, an active shareholder, or a venture capitalist (if you are a start up), or something similar.
In general, it is a good idea to make this “customer” happy. They are the boss. At the very least, you cannot ignore them. However, sometimes the best path to making them happy is to do something other than they want. It can be a tricky business to disobey a boss, so we must be careful when doing so. The following are a few principles to help determine when to do so.
1) Move in the Direction of the Greater Good
Sometimes a division of a corporation is asked to embark on a strategy which sub-optimizes the individual division, but optimizes the good of the greater corporation. In this case, the path would not be to disobey and try to maximize your individual business, but to act for the greater good of the entire corporation. To ensure that this happens, the division should be rewarded based on its impact on the greater good.
2) Don’t Move in the Direction of Illegal or Immoral Activity
The phrase, “But my boss made me do it,” does not stand up well in court. You always have the option of quitting.
3) The Owner is the Tie-breaker in differences of Opinion
Sometimes people just come to different conclusions. It’s okay to express your differences to the boss, but in the end, their opinion is the one that matters.
4) When the Owner’s goal is clearly not in the best interest of the company, consider firing the owner as your customer.
If a shareholder is making unreasonable demands that will line their pockets with money but bankrupt the company, perhaps you need to look for ways to “fire” your owner. In other words, try to change the profile of the type of investors that invest in you. Try to cultivate more Warren Buffet type of owners, rather than owners like my old college professor. If you stand your ground and fight for the long-term health of your company, you should naturally attract the investors who are looking for that type of business and discourage the investment by other types of investors.
As a general rule, if you manage for the long-run, you tend to build a strong track record of growing cash flow, which leads to a successful stock price. However, if you just focus on short-term tricks to inflate today’s stock price, you may end up being a poor investment over time. So to make owners happy with growing stock prices, you sometimes have to ignore the stock price and focus on the business. Hence the irony that in order to make an owner happy, you sometimes have to focus on something other than trying to make the owner happy. Their happiness is a byproduct of good strategy, rather than making their happiness become the strategy.
SUMMARY
Although it is important to make the owners happy, sometimes the best way to do so is to focus on something else—namely making the business strong. If the owners do not see the wisdom in this, either try to get a different type of owner or go work somewhere else.
FINAL THOUGHTS
The world is a lot more complicated than what I can describe in a short blog. I don’t want to come off sounding as naïve as my old professor. But at the same time, I think leaders need to do some genuine leading every once in awhile and not just be a puppet of the owners.
My finance teacher in college was a brand new professor. He had just finished his PhD and made the transition from being the student directly to being the teacher. He had no meaningful real-life experience in finance (nor any meaningful real-life experience at teaching for that matter, either).
This professor was not much older than I was at the time, which was relatively young. Yet when he taught, he spoke as if he had generations of experience and seemed to enjoy telling his students how most everyone in the business world was misguided.
He hated it when a company would introduce a new product, or diversify into new lines of business (to mitigate risk), or change a strategy to adapt to a changing world. In his mind, every business should be required to sell only one product, and sell it in only one way…forever.
What was his reasoning behind this? He believed that the investing shareholders should have ultimate power. If investors like the one product and the one way it is sold, then they can support it by buying shares in the company. If they don’t like the product or the way it is sold, then they can sell their shares in the company (or never invest in it in the first place). The good would get rewarded and the bad would get punished—by the investors.
Whenever a company changed its portfolio or its strategy, he felt it was interfering with his ability to control the company with his ownership. After all, what if the company came up with two products—one he liked and one he didn’t? Now he could no longer support one with his shares and deny the other by not buying shares. This made him very angry.
And if a company had the wrong strategy, he didn’t want it to change, because then the company would be doing something he couldn’t control. Instead, he would prefer that the company kept the bad strategy, so he could sell his shares in that firm and re-invest them into a company that already had the better strategy.
He did not care if a company lived or died. He would just continue to move his money and invest it in the best location at that particular moment
By contrast, Warren Buffet seems to have taken an opposite approach to investment and done quite well with it. I suspect that Mr. Buffet has done much better in investing than my college professor did.
THE ANALOGY
Although most investors are not as blunt as this professor, many act as if they believe what he is saying is true. They have no sense of loyalty or desire to help a business thrive over the long haul. They just want to move their money around to wherever the success is at the moment. What motivates their personal success often is at odds with what is in the best interests of an individual company’s long term success. For them to win, the company often has to fail.
When devising strategies, it is important to consider the desires of your owner. After all, these are the people who pay your salaries and can get you fired. But sometimes you have to take a stand and not do exactly as they desire. Giving them exactly what they desire may end up not giving them what they really need…an economic engine that produces cash flow for a long time.
Warren Buffet understands the big picture and realizes that the best returns usually come from long-term investing in companies that know how to adapt and survive. When the investor’s success depends on the company having long-term success, then usually both sides win. But if the investor’s best interests are not the same as the company’s, then one or both sides tends to lose.
THE PRINCIPLE
Over the past couple of blogs we have been talking about the concept of “who is my customer”. We have seen that you can use different strategic approaches to choose which type of customer you want to serve. You can serve the people who pay the money, the people who use the service, the people who influence the people who use the service, and even the people that may eventually buy your company.
There is another type of customer we haven’t talked about much. That would be the current owner, be it a corporate headquarters (if you work in a division), a board of directors, an active shareholder, or a venture capitalist (if you are a start up), or something similar.
In general, it is a good idea to make this “customer” happy. They are the boss. At the very least, you cannot ignore them. However, sometimes the best path to making them happy is to do something other than they want. It can be a tricky business to disobey a boss, so we must be careful when doing so. The following are a few principles to help determine when to do so.
1) Move in the Direction of the Greater Good
Sometimes a division of a corporation is asked to embark on a strategy which sub-optimizes the individual division, but optimizes the good of the greater corporation. In this case, the path would not be to disobey and try to maximize your individual business, but to act for the greater good of the entire corporation. To ensure that this happens, the division should be rewarded based on its impact on the greater good.
2) Don’t Move in the Direction of Illegal or Immoral Activity
The phrase, “But my boss made me do it,” does not stand up well in court. You always have the option of quitting.
3) The Owner is the Tie-breaker in differences of Opinion
Sometimes people just come to different conclusions. It’s okay to express your differences to the boss, but in the end, their opinion is the one that matters.
4) When the Owner’s goal is clearly not in the best interest of the company, consider firing the owner as your customer.
If a shareholder is making unreasonable demands that will line their pockets with money but bankrupt the company, perhaps you need to look for ways to “fire” your owner. In other words, try to change the profile of the type of investors that invest in you. Try to cultivate more Warren Buffet type of owners, rather than owners like my old college professor. If you stand your ground and fight for the long-term health of your company, you should naturally attract the investors who are looking for that type of business and discourage the investment by other types of investors.
As a general rule, if you manage for the long-run, you tend to build a strong track record of growing cash flow, which leads to a successful stock price. However, if you just focus on short-term tricks to inflate today’s stock price, you may end up being a poor investment over time. So to make owners happy with growing stock prices, you sometimes have to ignore the stock price and focus on the business. Hence the irony that in order to make an owner happy, you sometimes have to focus on something other than trying to make the owner happy. Their happiness is a byproduct of good strategy, rather than making their happiness become the strategy.
SUMMARY
Although it is important to make the owners happy, sometimes the best way to do so is to focus on something else—namely making the business strong. If the owners do not see the wisdom in this, either try to get a different type of owner or go work somewhere else.
FINAL THOUGHTS
The world is a lot more complicated than what I can describe in a short blog. I don’t want to come off sounding as naïve as my old professor. But at the same time, I think leaders need to do some genuine leading every once in awhile and not just be a puppet of the owners.
Monday, February 19, 2007
We Can All Act Like Sports Franchise Owners
THE STORY
Back in 2001, Howard Schultz and 57 partners bought the Seattle Sonics professional basketball franchise for $200 million. During the time that Howard Schultz owned the Seattle Sonics, the team suffered annual losses. It is claimed that while Schultz owned the team, the combined operating losses were $60 million.
Yet, in spite of being a business that showed no signs of making a profit, Schultz and his partners sold the Seattle Sonic team in 2006 for $350 million. That is $150 million more than what they paid for the team and $90 more than they paid if you subtract the annual losses. In fact, they supposedly turned down an offer of $425 million (more than twice what they paid for the team) from Larry Ellison, CEO of Oracle, because he wanted to move the team away from Seattle.
This is not a fluke price. In 2004, the New Jersey Nets basketball franchise sold for $300 million and the Cleveland Cavaliers basketball team (and its arena) were sold in 2005 for $375 million.
Willamette Management Associates is an expert in the area of sports franchise valuation. One of their representatives says that it is very difficult to use income flows as a means of evaluating sports franchises. To quote a 2002 paper they wrote on the topic,
“The discounted cash flow method is often used in the valuation of sports franchise intangible assets. However, it may be difficult to use this method in the valuation of the sports business enterprise. This is because many sports franchises either earn negative income or do not generate sufficient income to support the prices paid in actual team sales.”
So it appears that even though the business itself can be a perpetual money loser, in the world of sports franchises that does not mean it is a bad investment. According to the Seattle Times, the annual rate of return on the investment of Howard Schultz and his partners, when you consider the selling price and other factors, was probably around 10.6%. That’s a pretty good return for investing in something that loses money.
THE ANALOGY
At the end of the day, the basic goal of capitalism is to find good returns on investment. As the story above illustrates, it is possible to get very good returns on investment on businesses that provide little to no profitability on an annual basis. The return on investment for the Seattle Sonics did not come from the operating earnings, but rather from the selling price.
Now you may be thinking that such opportunities occur only in the world of sports. However, recent trends seem to be indicating that this trend is creeping ever more into the rest of the business world. Just look at some of the prices that hedge funds have been paying recently for businesses that are not very prosperous. Even businesses that lose money are being snapped up at relatively high prices by these hedge funds.
When devising business strategies, there appears to be a strategic option to consider running a business not to necessarily make money through earnings, but rather to gain virtually all of the profits at the point when the property is sold. This is called the “build to flip” strategy.
THE PRINCIPLE
The build to flip strategy takes a different perspective on the question “who is my customer.” Instead of seeing the customer as being the person who pays you for your goods or services, this strategic alternative sees the customer as the person you eventually sell the business to. Taking the adage “please the customer” to heart, the build to flip companies run their business more to make an eventual buyer of the firm happy rather than to make the business operation’s customers happy.
For example, during the dot com bubble of the 1990s, many start-ups had as their strategy the goal of eventually selling the business to Cisco Systems. Cisco had a policy that they would only buy firms located in one of three areas—Silicon Valley, Austin Texas, or the Research Triangle in North Carolina. The reason was that it was too difficult to manage the Cisco empire if all the subsidiaries were scattered all over the place.
Start-up companies knew this policy, so if their goal was to eventually be bought out by Cisco, they knew that they had to locate the business in one of these three areas, even if it was inconvenient to them or to their operating customers. After all, they saw Cisco as their ultimate customer, and if that is what Cisco wanted, then that is what they did.
I personally saw this principle in action when I was in the grocery business. A number of independent grocers, when they got near retirement age, wanted to sell their businesses. These grocers knew how the large supermarket chains thought when considering the purchase of an independent grocer. Large grocery chains believed that it was easier to take a store with high volumes and leverage the volume into higher profitability than it was to take a low volume store and increase its volume. In fact, these chains would prefer to purchase a high volume store that lost money over a low volume store with modest profits, because they believed the high volume store had more upside potential.
Knowing this, the independent grocer thinking of retiring would for a year or two abandon the idea of making a profit and focus all of the strategic effort on doing whatever it took to increase sales volume. They would do this even if the tactic made little economic sense in the long run or even if the tactic was unsustainable in the long run. After all, the eventual buyer of the business wanted to buy sales volume and typically set its purchase price on a multiple of sales. So to give the “customer” what they wanted, the independent grocer would raise the sales volume, regardless of the consequences.
Once the sales volume from these tactics started to peak, the independent grocer would sell the company to the supermarket chain. This strategy would make the independent grocer wealthier than if they had run the business as normal prior to the sale. So as you can see, the idea of getting a good return when losing money is not just a principle for sports franchises.
Even on a smaller level, I have seen this policy used in the real estate business. It is not uncommon for someone to own property on the far outskirts of a city. The owner of the property knows that if they wait a few years, the city will grow out to where his land is. At that time, it will become very profitable to sell the land to a developer. To sell now would bring a lesser return. So what do you do with the property in the mean time, while waiting for the city to grow in this direction?
Well, you don’t want to put a lot of capital into the land, because you are going to only hold it a short time. Since you do not know how the eventual new owner will want to use the property, you don’t want to use the property in such a way that would limit the flexibility of the new owner to do what they want. So what do many of them do?
They put a miniature golf course on the property. The cost to do so is very low, and it leaves a lot of flexibility for the next owner, since a miniature golf course can be easily removed, leaving the land ready for just about any use. The golf course does not have to make a lot of money. Even if it helps cover just a portion of the interest on the real estate, it is beneficial. After all, the goal is to make most of the return on the sale of the land, not the operation of the miniature golf course.
If you are trying to sell a company, there are many decisions that you might make differently if you look at a potential buyer of the firm as the true customer. For example, if you know that potential buyers of the company prefer to operate on particular computer platforms, you may want to run your business on that platform as well, even if it is not your personal preference.
Instead of spending a lot of time making calls on operating business prospects, you may want to divert more energy to speaking at seminars or in getting articles published in places where potential buyers of the company will get exposed to you in a favorable light. The idea is to make it a priority to think about ways to make your company appear more valuable to a potential buyer of the company.
There is something to be learned from running your business as if it were a sports franchise.
SUMMARY
There is more than one way to get a good return on your investment. One way is to focus on getting nearly all of your return at the point in which you sell the company (the build to flip strategy). This tends to be the way that sports franchises have worked for decades and it appears to be an increasingly viable strategy outside the sports world. This is especially true given all of the hedge fund money out there looking for companies to buy. In this strategy, the idea is to look at the eventual buyer of the firm as your true customer and to make decisions based on how it would please this eventual buyer.
FINAL THOUGHTS
If it is true that the majority of the profits of a business strategy could come at the point at which the company is sold, then it must also be true that a lot of the value in the acquiring company could be destroyed if it purchases companies unwisely. Making most of your value by purchasing properly (rather than selling properly) is another way to build a strategy.
Back in 2001, Howard Schultz and 57 partners bought the Seattle Sonics professional basketball franchise for $200 million. During the time that Howard Schultz owned the Seattle Sonics, the team suffered annual losses. It is claimed that while Schultz owned the team, the combined operating losses were $60 million.
Yet, in spite of being a business that showed no signs of making a profit, Schultz and his partners sold the Seattle Sonic team in 2006 for $350 million. That is $150 million more than what they paid for the team and $90 more than they paid if you subtract the annual losses. In fact, they supposedly turned down an offer of $425 million (more than twice what they paid for the team) from Larry Ellison, CEO of Oracle, because he wanted to move the team away from Seattle.
This is not a fluke price. In 2004, the New Jersey Nets basketball franchise sold for $300 million and the Cleveland Cavaliers basketball team (and its arena) were sold in 2005 for $375 million.
Willamette Management Associates is an expert in the area of sports franchise valuation. One of their representatives says that it is very difficult to use income flows as a means of evaluating sports franchises. To quote a 2002 paper they wrote on the topic,
“The discounted cash flow method is often used in the valuation of sports franchise intangible assets. However, it may be difficult to use this method in the valuation of the sports business enterprise. This is because many sports franchises either earn negative income or do not generate sufficient income to support the prices paid in actual team sales.”
So it appears that even though the business itself can be a perpetual money loser, in the world of sports franchises that does not mean it is a bad investment. According to the Seattle Times, the annual rate of return on the investment of Howard Schultz and his partners, when you consider the selling price and other factors, was probably around 10.6%. That’s a pretty good return for investing in something that loses money.
THE ANALOGY
At the end of the day, the basic goal of capitalism is to find good returns on investment. As the story above illustrates, it is possible to get very good returns on investment on businesses that provide little to no profitability on an annual basis. The return on investment for the Seattle Sonics did not come from the operating earnings, but rather from the selling price.
Now you may be thinking that such opportunities occur only in the world of sports. However, recent trends seem to be indicating that this trend is creeping ever more into the rest of the business world. Just look at some of the prices that hedge funds have been paying recently for businesses that are not very prosperous. Even businesses that lose money are being snapped up at relatively high prices by these hedge funds.
When devising business strategies, there appears to be a strategic option to consider running a business not to necessarily make money through earnings, but rather to gain virtually all of the profits at the point when the property is sold. This is called the “build to flip” strategy.
THE PRINCIPLE
The build to flip strategy takes a different perspective on the question “who is my customer.” Instead of seeing the customer as being the person who pays you for your goods or services, this strategic alternative sees the customer as the person you eventually sell the business to. Taking the adage “please the customer” to heart, the build to flip companies run their business more to make an eventual buyer of the firm happy rather than to make the business operation’s customers happy.
For example, during the dot com bubble of the 1990s, many start-ups had as their strategy the goal of eventually selling the business to Cisco Systems. Cisco had a policy that they would only buy firms located in one of three areas—Silicon Valley, Austin Texas, or the Research Triangle in North Carolina. The reason was that it was too difficult to manage the Cisco empire if all the subsidiaries were scattered all over the place.
Start-up companies knew this policy, so if their goal was to eventually be bought out by Cisco, they knew that they had to locate the business in one of these three areas, even if it was inconvenient to them or to their operating customers. After all, they saw Cisco as their ultimate customer, and if that is what Cisco wanted, then that is what they did.
I personally saw this principle in action when I was in the grocery business. A number of independent grocers, when they got near retirement age, wanted to sell their businesses. These grocers knew how the large supermarket chains thought when considering the purchase of an independent grocer. Large grocery chains believed that it was easier to take a store with high volumes and leverage the volume into higher profitability than it was to take a low volume store and increase its volume. In fact, these chains would prefer to purchase a high volume store that lost money over a low volume store with modest profits, because they believed the high volume store had more upside potential.
Knowing this, the independent grocer thinking of retiring would for a year or two abandon the idea of making a profit and focus all of the strategic effort on doing whatever it took to increase sales volume. They would do this even if the tactic made little economic sense in the long run or even if the tactic was unsustainable in the long run. After all, the eventual buyer of the business wanted to buy sales volume and typically set its purchase price on a multiple of sales. So to give the “customer” what they wanted, the independent grocer would raise the sales volume, regardless of the consequences.
Once the sales volume from these tactics started to peak, the independent grocer would sell the company to the supermarket chain. This strategy would make the independent grocer wealthier than if they had run the business as normal prior to the sale. So as you can see, the idea of getting a good return when losing money is not just a principle for sports franchises.
Even on a smaller level, I have seen this policy used in the real estate business. It is not uncommon for someone to own property on the far outskirts of a city. The owner of the property knows that if they wait a few years, the city will grow out to where his land is. At that time, it will become very profitable to sell the land to a developer. To sell now would bring a lesser return. So what do you do with the property in the mean time, while waiting for the city to grow in this direction?
Well, you don’t want to put a lot of capital into the land, because you are going to only hold it a short time. Since you do not know how the eventual new owner will want to use the property, you don’t want to use the property in such a way that would limit the flexibility of the new owner to do what they want. So what do many of them do?
They put a miniature golf course on the property. The cost to do so is very low, and it leaves a lot of flexibility for the next owner, since a miniature golf course can be easily removed, leaving the land ready for just about any use. The golf course does not have to make a lot of money. Even if it helps cover just a portion of the interest on the real estate, it is beneficial. After all, the goal is to make most of the return on the sale of the land, not the operation of the miniature golf course.
If you are trying to sell a company, there are many decisions that you might make differently if you look at a potential buyer of the firm as the true customer. For example, if you know that potential buyers of the company prefer to operate on particular computer platforms, you may want to run your business on that platform as well, even if it is not your personal preference.
Instead of spending a lot of time making calls on operating business prospects, you may want to divert more energy to speaking at seminars or in getting articles published in places where potential buyers of the company will get exposed to you in a favorable light. The idea is to make it a priority to think about ways to make your company appear more valuable to a potential buyer of the company.
There is something to be learned from running your business as if it were a sports franchise.
SUMMARY
There is more than one way to get a good return on your investment. One way is to focus on getting nearly all of your return at the point in which you sell the company (the build to flip strategy). This tends to be the way that sports franchises have worked for decades and it appears to be an increasingly viable strategy outside the sports world. This is especially true given all of the hedge fund money out there looking for companies to buy. In this strategy, the idea is to look at the eventual buyer of the firm as your true customer and to make decisions based on how it would please this eventual buyer.
FINAL THOUGHTS
If it is true that the majority of the profits of a business strategy could come at the point at which the company is sold, then it must also be true that a lot of the value in the acquiring company could be destroyed if it purchases companies unwisely. Making most of your value by purchasing properly (rather than selling properly) is another way to build a strategy.
Sunday, February 18, 2007
Who is My Customer
THE STORY
Pity the poor woman who just took a marketing management job at a medical device company. She had never worked in the industry before. She was given the project of working with their latest product—a device that used an entirely new way to cure a disease. After a meeting to demonstrate the device to her, the closing words of her boss to her was “Now go out and market this thing.”
At first, she walked away from the meeting rather confident, since she had been in marketing for some time. But then she started the think, “Go out and market this to whom? Who is my customer?”
Her first thought was that the customer is the patient using the device. Therefore, her marketing should focus on how painless and how quickly the device works.
Then she thought that perhaps the customer is the doctor who prescribes the procedure. If the doctor doesn’t want to prescribe it, then in many ways it really doesn’t matter what the customer wants. If the doctor is the primary customer, then the marketing focus would have to also address issues such as whether insurance companies will readily pay for the procedure and whether it increases the risk of malpractice.
Most of these devices will end up in hospitals, so maybe the focus should be on hospital procurement executives. They will want a marketing presentation that looks at the financial cash flows and revenue streams.
Then she considered whether the insurance company is the primary customer. After all, they are the ones paying the money once the device is used. If they don’t want to pay, the device won’t get used. If they are the primary customer, then the key marketing issue must focus on cost effectiveness relative to other treatment options.
And what about the government? They get to approve the diseases for which this device can be used as treatment. They impact how Medicare will treat this device. There are powerful political lobbies from the companies who sell the products currently used to treat this disease who will use the government to help protect their status quo. Therefore, perhaps the marketing needs to focus on lobbying.
At this point, the marketing executive was very confused and wondering if she could still get her old job back.
THE ANALOGY
There are many different types of decisions that go into getting a product sold. As we saw in the story above, the decision-makers who affected sales of the device included:
· Product Users (Patient)
· Product Prescribers/Advisors (Doctors)
· Product Investors/Determine Access (Hospitals)
· Product Usage Payers (Insurance Companies)
· Product Regulators/Inluencers (Government)
For some products, those decisions are made by a small handful of people who are in charge of multiple roles. Sometimes, as in the story above, there are a great number of constituents who all play separate roles in the decision-making.
This complexity provides opportunities to create strategic advantage via the types of strategic approaches one takes to these various constituents or the type of decisions you want constituents to make.
THE PRINCIPLE
There are two basic ways to gain strategic advantage in the complexities associated with how a product is purchased:
1) Focus on a different aspect of the complexity than the competition; or
2) Redefine the roles of the players in the decision-making process.
Allow me to give a simple example of how this works. Let’s say you sell children’s breakfast cereal. The child is the user and an influencer in the purchase, but the parent is the advisor/prescriber and the person who pays for it. Principle #1—focus on a different aspect of the complexity—would work something like this: If all of the competition is focusing their efforts on getting the child to demand the product from the parent, perhaps you can create a strategic advantage by focusing on getting the parent to override the child’s demands and buy the product for reasons that please the parent, such as nutrition. A third approach could be that instead of spending most of the marketing money on the child or the parent, the money is spent on buying better shelf space and pricing promotions with the supermarket company (who influence access and pricing).
The second principle—redefine the roles—could work something like this: You repackage the cereal into individual snack sizes and put them into vending machines where the children hang out. Now, the parent is no longer defined as the purchaser, but the child is, who buys the snacks on his or her own out of the vending machine. The access is no longer defined as the store, but as a machine.
You can also see this taking place in the world of broadcast entertainment. Looking at principle #1, you can focus on either trying to get content pleasing to the audience (the users) or content pleasing to the advertisers (the payers). In many cases, the same strategic move can please both: if you draw a large audience (such as the Superbowl) you can have many willing to pay large sums for the right to advertise.
This, however, is not always the case. Sometimes one can draw a large audience with controversy, and many advertisers do not want to be connected with controversy. Take, for example, Fox television’s attempt in November to broadcast the OJ Simpson story “If I did it, Here’s How it Happened.” No matter how popular, no advertiser wanted to be associated with the story, so the network did not air it.
Other times, advertisers can demand that they not only get advertising via commercials, but product placements into the show’s content. Take, for example, the ever-present coke beverages located by the judges of American Idol. This is all about pleasing the advertising customer rather than the viewing customer. So depending on which customer you want to focus on, one can come up with different strategic approaches for the types of entertainment one broadcasts.
Looking at principle #2, broadcast entertainers can also redefine the roles. For example, many entertainment programs now ask the audience to vote with their cell phone. This is a huge money-making opportunity, which now makes the viewer also a payer. A new trend is to make the audience also the creator of some of the content, such as with YouTube, or some of the commercials on Superbowl XLI. In the case of controversy, if the audience demand is large enough, one can use pay-per-view to get the audience to pay for things that advertisers shy away from.
In the new digital economy, business models are starting to look more like the broadcast entertainment model, where users get content for free and advertisers pay for space on the screen. But again, there may be opportunities for a strategic advantage based on how one focuses on the complexities of the business model. One can take limited resources and focus on getting the absolute best content or one can take limited resources and focus on building the most efficient online advertising model. One can redefine roles and get the users to pay for the content. And I’m sure that there will be many new models to evolve that we haven’t seen yet.
In retailing, some firms are redefining their role from being influencers and access points to becoming the manufacturer of the products they sell. Similarly, manufacturers are starting to go direct to the user with their own stores. In other words, instead of focusing on the store as their customer, the manufacturer is going direct to the user as their customer.
The beauty is that because there is no one single best way to go to market, there are opportunities to gain an advantage by taking a new strategic approach. The problem is that if you do not think more open-mindedly about different ways to define customers and the other stakeholders, you will always be left behind and copying others.
SUMMARY
Answering the question “Who is my customer?” is not as obvious as it first appears. Often, there are many stakeholders involved in completing a purchase, including users, influencers, access points, payers, regulators, etc. In a sense, they are all your customer. Yet given one’s constraints of money and time, one cannot always give high attention to all of them. By thinking outside the conventional box, one can redesign the business model amongst these players, either by:
1) Altering who gets focused on (i.e, who becomes the primary customer)
2) Altering the roles played by the various stakeholders, which might even lead to adding new players or eliminating some of the former players from the decision-making process.
How you manage these decisions can have a major influence on how you design your business model and how you design your marketing program.
FINAL THOUGHTS
Another stakeholder or constituent whom we did not address is the firm that you may eventually intend to sell your company to. That’s the big cash buyer. A little focus on them as your customer could go a long way to getting the deal to happen. But this topic will be covered in more depth in another blog.
Pity the poor woman who just took a marketing management job at a medical device company. She had never worked in the industry before. She was given the project of working with their latest product—a device that used an entirely new way to cure a disease. After a meeting to demonstrate the device to her, the closing words of her boss to her was “Now go out and market this thing.”
At first, she walked away from the meeting rather confident, since she had been in marketing for some time. But then she started the think, “Go out and market this to whom? Who is my customer?”
Her first thought was that the customer is the patient using the device. Therefore, her marketing should focus on how painless and how quickly the device works.
Then she thought that perhaps the customer is the doctor who prescribes the procedure. If the doctor doesn’t want to prescribe it, then in many ways it really doesn’t matter what the customer wants. If the doctor is the primary customer, then the marketing focus would have to also address issues such as whether insurance companies will readily pay for the procedure and whether it increases the risk of malpractice.
Most of these devices will end up in hospitals, so maybe the focus should be on hospital procurement executives. They will want a marketing presentation that looks at the financial cash flows and revenue streams.
Then she considered whether the insurance company is the primary customer. After all, they are the ones paying the money once the device is used. If they don’t want to pay, the device won’t get used. If they are the primary customer, then the key marketing issue must focus on cost effectiveness relative to other treatment options.
And what about the government? They get to approve the diseases for which this device can be used as treatment. They impact how Medicare will treat this device. There are powerful political lobbies from the companies who sell the products currently used to treat this disease who will use the government to help protect their status quo. Therefore, perhaps the marketing needs to focus on lobbying.
At this point, the marketing executive was very confused and wondering if she could still get her old job back.
THE ANALOGY
There are many different types of decisions that go into getting a product sold. As we saw in the story above, the decision-makers who affected sales of the device included:
· Product Users (Patient)
· Product Prescribers/Advisors (Doctors)
· Product Investors/Determine Access (Hospitals)
· Product Usage Payers (Insurance Companies)
· Product Regulators/Inluencers (Government)
For some products, those decisions are made by a small handful of people who are in charge of multiple roles. Sometimes, as in the story above, there are a great number of constituents who all play separate roles in the decision-making.
This complexity provides opportunities to create strategic advantage via the types of strategic approaches one takes to these various constituents or the type of decisions you want constituents to make.
THE PRINCIPLE
There are two basic ways to gain strategic advantage in the complexities associated with how a product is purchased:
1) Focus on a different aspect of the complexity than the competition; or
2) Redefine the roles of the players in the decision-making process.
Allow me to give a simple example of how this works. Let’s say you sell children’s breakfast cereal. The child is the user and an influencer in the purchase, but the parent is the advisor/prescriber and the person who pays for it. Principle #1—focus on a different aspect of the complexity—would work something like this: If all of the competition is focusing their efforts on getting the child to demand the product from the parent, perhaps you can create a strategic advantage by focusing on getting the parent to override the child’s demands and buy the product for reasons that please the parent, such as nutrition. A third approach could be that instead of spending most of the marketing money on the child or the parent, the money is spent on buying better shelf space and pricing promotions with the supermarket company (who influence access and pricing).
The second principle—redefine the roles—could work something like this: You repackage the cereal into individual snack sizes and put them into vending machines where the children hang out. Now, the parent is no longer defined as the purchaser, but the child is, who buys the snacks on his or her own out of the vending machine. The access is no longer defined as the store, but as a machine.
You can also see this taking place in the world of broadcast entertainment. Looking at principle #1, you can focus on either trying to get content pleasing to the audience (the users) or content pleasing to the advertisers (the payers). In many cases, the same strategic move can please both: if you draw a large audience (such as the Superbowl) you can have many willing to pay large sums for the right to advertise.
This, however, is not always the case. Sometimes one can draw a large audience with controversy, and many advertisers do not want to be connected with controversy. Take, for example, Fox television’s attempt in November to broadcast the OJ Simpson story “If I did it, Here’s How it Happened.” No matter how popular, no advertiser wanted to be associated with the story, so the network did not air it.
Other times, advertisers can demand that they not only get advertising via commercials, but product placements into the show’s content. Take, for example, the ever-present coke beverages located by the judges of American Idol. This is all about pleasing the advertising customer rather than the viewing customer. So depending on which customer you want to focus on, one can come up with different strategic approaches for the types of entertainment one broadcasts.
Looking at principle #2, broadcast entertainers can also redefine the roles. For example, many entertainment programs now ask the audience to vote with their cell phone. This is a huge money-making opportunity, which now makes the viewer also a payer. A new trend is to make the audience also the creator of some of the content, such as with YouTube, or some of the commercials on Superbowl XLI. In the case of controversy, if the audience demand is large enough, one can use pay-per-view to get the audience to pay for things that advertisers shy away from.
In the new digital economy, business models are starting to look more like the broadcast entertainment model, where users get content for free and advertisers pay for space on the screen. But again, there may be opportunities for a strategic advantage based on how one focuses on the complexities of the business model. One can take limited resources and focus on getting the absolute best content or one can take limited resources and focus on building the most efficient online advertising model. One can redefine roles and get the users to pay for the content. And I’m sure that there will be many new models to evolve that we haven’t seen yet.
In retailing, some firms are redefining their role from being influencers and access points to becoming the manufacturer of the products they sell. Similarly, manufacturers are starting to go direct to the user with their own stores. In other words, instead of focusing on the store as their customer, the manufacturer is going direct to the user as their customer.
The beauty is that because there is no one single best way to go to market, there are opportunities to gain an advantage by taking a new strategic approach. The problem is that if you do not think more open-mindedly about different ways to define customers and the other stakeholders, you will always be left behind and copying others.
SUMMARY
Answering the question “Who is my customer?” is not as obvious as it first appears. Often, there are many stakeholders involved in completing a purchase, including users, influencers, access points, payers, regulators, etc. In a sense, they are all your customer. Yet given one’s constraints of money and time, one cannot always give high attention to all of them. By thinking outside the conventional box, one can redesign the business model amongst these players, either by:
1) Altering who gets focused on (i.e, who becomes the primary customer)
2) Altering the roles played by the various stakeholders, which might even lead to adding new players or eliminating some of the former players from the decision-making process.
How you manage these decisions can have a major influence on how you design your business model and how you design your marketing program.
FINAL THOUGHTS
Another stakeholder or constituent whom we did not address is the firm that you may eventually intend to sell your company to. That’s the big cash buyer. A little focus on them as your customer could go a long way to getting the deal to happen. But this topic will be covered in more depth in another blog.
Friday, February 16, 2007
If You Can Open the Door, So Can Others
The Story
There is a situation I have seen repeated over and over again in the business world, especially in the airlines industry. To protect the people who have fallen into this trap over the years, I will tell a generic version of the story.
Bob sees himself as an entrepreneur skilled at finding opportunities in relatively mature businesses, by getting aggressive and shaking up the status quo. Bob looks at the airline industry and says to himself, “Here is an industry I can shake up in my favor.”
Bob leases some airplanes and starts his bold plan. He notices that some routes are more profitable for the established airlines than others—routes where airlines charge abnormally higher than average fees. Bob puts his planes on these routes and charges ticket prices significantly below the established airlines. This plan gives Bob two strategic benefits:
1. Consumer Benefit: He is making a low price statement to the consumers on the routes where he can get the largest price savings impact with the least impact to his bottom line.
2. Competitive Benefit: He is disproportionately taking away the routes with the greatest source of income from the established airlines, making it hardest for them to finance a retaliation.
Sure, Bob will lose large sums of money at first with his plan. In the long run, though, Bob is confident that he will knock some of the weaker airlines out of business and have the market restabilize with his company having a meaningful market share. At that point, Bob will be able to raise prices and start reaping a respectable return on his investment. Bob thinks he’s a strategic genius.
For awhile, Bob’s plan works very well. He disrupts the status quo and gains market share. Bob continues to add routes and gain public favor with his “too good to be true” low prices. Weaker airlines are in retreat. The losses pile up at Bob’s company, but Bob assures himself that a new stability is just around the corner. Soon, he will have achieved his desired market strength, allowing him the power to raise fares to a profitable level.
Just as Bob predicted, that time of new stability arises. Weaker players have left the industry. Bob’s market share is strong. Bob raises his prices. Then he puts his feet up on his desk, relaxes, and says, “My job is done. I have won the game.”
What Bob doesn’t know is that on the other side of town there is an entrepreneur named Jane who also likes to make money by shaking up established industries. At about the same time Bob is putting his feet up on the desk, Jane is looking at the newly stabilized airlines industry and says, “Here is an industry I can shake up in my favor.”
Jane utilizes a strategy similar to Bob’s and upsets the pricing stability with her “too good to be true” low prices. Bob has to respond by putting his prices back to the old unprofitable levels. Eventually Bob goes out of business and Jane survives. Then Jane takes advantage of the new restabilization of the industry by raising her prices.
At about this time, Lee is looking at the airlines industry, saying, “Here is an industry I can shake up in my favor.” And the cycle repeats itself yet again.
The Analogy
Strategies are based on assumptions. If you choose the wrong assumptions, your strategy will likely fail. There is a failed assumption I like to call “The Last One Through the Door” assumption. This assumption rarely leads to long-term strategic success. With “The Last One Through the Door” assumption, businesses assume that they can enter an industry, buy market share by offering prices or features below cost, and then get their profits later when the market restabilizes and they can raise prices.
The problem with this approach is that it only works if nobody comes behind you and destabilizes all over again. In other words, for this strategy to succeed, the path you took to enter the industry must be a door that you can lock behind you, so that nobody else can enter in the same way you did. You have to be “the last one through the door.”
Unfortunately, if you are able to find a way to open the door, others will often find a way to open that door as well. This is what happened to Bob, whose strategy failed because he could not keep Jane from later entering through the same door that Bob used. Jane fell to the same fate when Lee opened the door behind her.
Bob made a terrible error in his strategic planning. His plan’s success was based on his ability to achieve long-term stability in the airlines industry, long enough to recoup his early losses and provide a respectable return on his investments. This was a bad assumption, because it was based on the false assumption that he would be the last one through the door.
Bob may not have even realized that his strategy depended on being able to lock the door behind him. He probably thought that once he restabilized the market, the war was over. Bob believed that he was the final victor and his enemies were vanquished. If indeed the war is over, there is no need to look back at the door behind you.
However, in business, the war is never entirely over. You may win battles, like Bob did, but new battles are always on the horizon. New enemies crop up where you least expect them. The peace of market stability may never be achieved. All because Bob couldn’t lock the door behind himself.
The Principle
The first rule of strategy, according to Harvard Professor Michael Porter, is to make sure you are competing in an industry that has profits. Some industries are inherently less profitable than others. In some industries, none of the companies make an acceptable return on investment. What good is it to build a strategy to win in an industry where even the winners cannot make a good return on their investment?
What makes an entire industry relatively unprofitable? Usually, it is a result of low barriers to entry. In other words, it is easy for new players to enter the industry. If new players can continually enter an industry, then it will be under constant churn and never achieve the kind of stability required for profitability. These are typically industries to avoid.
For example, the trucking industry is a relatively unprofitable industry. This is because it is easy for an independent to lease a few trucks and start upsetting the industry. By comparison, look at how profitable Microsoft is. That is because there are high barriers to creating a new operating system for PCs that could successfully compete against Microsoft. The best strategies are those where you can get into an industry early, like Microsoft, and then be able to lock the door behind you with high barriers to entry.
Therefore, when building your strategy, keep the following principals in mind:
1. Never forget the fact that if it is relatively easy for you to enter an industry, then it is probably relatively easy for others to enter that same industry. This could be an indication that the industry may never stabilize at a level of adequate profitability. It is usually better to find an industry where it is difficult for you to enter and impossible for others to enter, than to find an industry that is easy for you and anyone else to enter.
2. Once you enter an industry, try to find ways to lock the door behind you. Look for ways to redefine the industry so that others can no longer take the path you did. Find ways to increase the barriers to entry.
3. Don’t ever assume that permanent stability can be reached in an industry. There is always enough change in the external environment to eventually make it possible for another company to find a new way to disrupt it, either through new technology, new processes, or by taking advantage of changes in customer needs and desires. Even if you can effectively lock the door that got you in, others may find new doors to get in. There is never a time when you can say “the war is over,” put your feet up on the desk, and stop having to compete.
4. If temporary advantages are what made you initially successful, don’t assume that you will continue to be as successful once those temporary advantages disappear. When customer loyalty is tied to a tactic your company cannot sustain, like unusually low introductory prices that are below cost, don’t expect your customers to automatically remain loyal to you when that tactic is abandoned. If they are only loyal because of your ridiculously low prices, they may leave when you raise them to more normal levels. Make sure you are providing enough consumer benefits so that once the temporary tactics are lifted, you are still providing a superior value in some form.
Summary
The first rule in strategy is to make sure the industries you participate in make money. Otherwise, winning may lead to an unprofitable prize. Industry profits are usually linked to high barriers to entry. If the barriers to entry are too low, there will be constant competitive churning and instability, which typically leads to unprofitable price wars. Therefore, when building a strategy based upon entering a new industry, keep the following principles in mind:
There is a situation I have seen repeated over and over again in the business world, especially in the airlines industry. To protect the people who have fallen into this trap over the years, I will tell a generic version of the story.
Bob sees himself as an entrepreneur skilled at finding opportunities in relatively mature businesses, by getting aggressive and shaking up the status quo. Bob looks at the airline industry and says to himself, “Here is an industry I can shake up in my favor.”
Bob leases some airplanes and starts his bold plan. He notices that some routes are more profitable for the established airlines than others—routes where airlines charge abnormally higher than average fees. Bob puts his planes on these routes and charges ticket prices significantly below the established airlines. This plan gives Bob two strategic benefits:
1. Consumer Benefit: He is making a low price statement to the consumers on the routes where he can get the largest price savings impact with the least impact to his bottom line.
2. Competitive Benefit: He is disproportionately taking away the routes with the greatest source of income from the established airlines, making it hardest for them to finance a retaliation.
Sure, Bob will lose large sums of money at first with his plan. In the long run, though, Bob is confident that he will knock some of the weaker airlines out of business and have the market restabilize with his company having a meaningful market share. At that point, Bob will be able to raise prices and start reaping a respectable return on his investment. Bob thinks he’s a strategic genius.
For awhile, Bob’s plan works very well. He disrupts the status quo and gains market share. Bob continues to add routes and gain public favor with his “too good to be true” low prices. Weaker airlines are in retreat. The losses pile up at Bob’s company, but Bob assures himself that a new stability is just around the corner. Soon, he will have achieved his desired market strength, allowing him the power to raise fares to a profitable level.
Just as Bob predicted, that time of new stability arises. Weaker players have left the industry. Bob’s market share is strong. Bob raises his prices. Then he puts his feet up on his desk, relaxes, and says, “My job is done. I have won the game.”
What Bob doesn’t know is that on the other side of town there is an entrepreneur named Jane who also likes to make money by shaking up established industries. At about the same time Bob is putting his feet up on the desk, Jane is looking at the newly stabilized airlines industry and says, “Here is an industry I can shake up in my favor.”
Jane utilizes a strategy similar to Bob’s and upsets the pricing stability with her “too good to be true” low prices. Bob has to respond by putting his prices back to the old unprofitable levels. Eventually Bob goes out of business and Jane survives. Then Jane takes advantage of the new restabilization of the industry by raising her prices.
At about this time, Lee is looking at the airlines industry, saying, “Here is an industry I can shake up in my favor.” And the cycle repeats itself yet again.
The Analogy
Strategies are based on assumptions. If you choose the wrong assumptions, your strategy will likely fail. There is a failed assumption I like to call “The Last One Through the Door” assumption. This assumption rarely leads to long-term strategic success. With “The Last One Through the Door” assumption, businesses assume that they can enter an industry, buy market share by offering prices or features below cost, and then get their profits later when the market restabilizes and they can raise prices.
The problem with this approach is that it only works if nobody comes behind you and destabilizes all over again. In other words, for this strategy to succeed, the path you took to enter the industry must be a door that you can lock behind you, so that nobody else can enter in the same way you did. You have to be “the last one through the door.”
Unfortunately, if you are able to find a way to open the door, others will often find a way to open that door as well. This is what happened to Bob, whose strategy failed because he could not keep Jane from later entering through the same door that Bob used. Jane fell to the same fate when Lee opened the door behind her.
Bob made a terrible error in his strategic planning. His plan’s success was based on his ability to achieve long-term stability in the airlines industry, long enough to recoup his early losses and provide a respectable return on his investments. This was a bad assumption, because it was based on the false assumption that he would be the last one through the door.
Bob may not have even realized that his strategy depended on being able to lock the door behind him. He probably thought that once he restabilized the market, the war was over. Bob believed that he was the final victor and his enemies were vanquished. If indeed the war is over, there is no need to look back at the door behind you.
However, in business, the war is never entirely over. You may win battles, like Bob did, but new battles are always on the horizon. New enemies crop up where you least expect them. The peace of market stability may never be achieved. All because Bob couldn’t lock the door behind himself.
The Principle
The first rule of strategy, according to Harvard Professor Michael Porter, is to make sure you are competing in an industry that has profits. Some industries are inherently less profitable than others. In some industries, none of the companies make an acceptable return on investment. What good is it to build a strategy to win in an industry where even the winners cannot make a good return on their investment?
What makes an entire industry relatively unprofitable? Usually, it is a result of low barriers to entry. In other words, it is easy for new players to enter the industry. If new players can continually enter an industry, then it will be under constant churn and never achieve the kind of stability required for profitability. These are typically industries to avoid.
For example, the trucking industry is a relatively unprofitable industry. This is because it is easy for an independent to lease a few trucks and start upsetting the industry. By comparison, look at how profitable Microsoft is. That is because there are high barriers to creating a new operating system for PCs that could successfully compete against Microsoft. The best strategies are those where you can get into an industry early, like Microsoft, and then be able to lock the door behind you with high barriers to entry.
Therefore, when building your strategy, keep the following principals in mind:
1. Never forget the fact that if it is relatively easy for you to enter an industry, then it is probably relatively easy for others to enter that same industry. This could be an indication that the industry may never stabilize at a level of adequate profitability. It is usually better to find an industry where it is difficult for you to enter and impossible for others to enter, than to find an industry that is easy for you and anyone else to enter.
2. Once you enter an industry, try to find ways to lock the door behind you. Look for ways to redefine the industry so that others can no longer take the path you did. Find ways to increase the barriers to entry.
3. Don’t ever assume that permanent stability can be reached in an industry. There is always enough change in the external environment to eventually make it possible for another company to find a new way to disrupt it, either through new technology, new processes, or by taking advantage of changes in customer needs and desires. Even if you can effectively lock the door that got you in, others may find new doors to get in. There is never a time when you can say “the war is over,” put your feet up on the desk, and stop having to compete.
4. If temporary advantages are what made you initially successful, don’t assume that you will continue to be as successful once those temporary advantages disappear. When customer loyalty is tied to a tactic your company cannot sustain, like unusually low introductory prices that are below cost, don’t expect your customers to automatically remain loyal to you when that tactic is abandoned. If they are only loyal because of your ridiculously low prices, they may leave when you raise them to more normal levels. Make sure you are providing enough consumer benefits so that once the temporary tactics are lifted, you are still providing a superior value in some form.
Summary
The first rule in strategy is to make sure the industries you participate in make money. Otherwise, winning may lead to an unprofitable prize. Industry profits are usually linked to high barriers to entry. If the barriers to entry are too low, there will be constant competitive churning and instability, which typically leads to unprofitable price wars. Therefore, when building a strategy based upon entering a new industry, keep the following principles in mind:
- Never forget the fact that if it is relatively easy for you to enter an industry, then it is probably relatively easy for others to enter that same industry and create instability.
- Once you enter an industry, try to find ways to lock the door behind you.
- Don’t ever assume that permanent stability can be reached in an industry.
- If temporary advantages are what made you initially successful in entering an industry, don’t assume that you will continue to be as successful once those temporary advantages disappear.
Final Thoughts
In your quest for growth, you may find yourself looking for ways to enter new industries. Keep in mind that while you are doing that, other firms looking for growth may be trying to find ways to enter your industry. While you are keeping one eye looking out to find new doors to enter, keep your other eye looking in to make sure your doors are locked.
Thursday, February 15, 2007
Going in Circles
THE STORY
There once was an important executive at an amusement park. He needed to get an urgent message to someone at the other end of the park, so he gave the letter to one of his subordinates and said, “Quick, get on this horse and hand deliver the message to the man at the other end of the amusement park.”
So the man got on the horse that the man pointed to, just as he was ordered to do. Unfortunately, this was a wooden horse on the park’s merry-go-round. The merry-go-round went around in circles a couple of times and dropped of the subordinate at the same location as where he started. This made the important executive furious. He yelled, “What’s the matter with you? I thought I told you to deliver this letter to the other end of the park. Give me back the letter.”
So then the executive gave the letter to another one of his subordinates and gave her the same message—get on a particular horse and hand deliver the message to the man at the other end of the amusement park. So the second subordinate got on the merry-go-round horse, went around in circles a couple of times and she ended up where she started, still holding the letter.
Again, the executive was furious, so he gave the letter to a third associate and gave him the same message. He got on the merry-go-round and had the same result. This lead the executive to give the same orders to a succession of other subordinates—all leading to the same disappointing result.
Finally, a thought occurred to the executive as to why he was having so many problems delivering the letter. “I finally know what’s wrong,” said the executive. “The problem is that nobody knows how to ride horses any more.”
THE ANALOGY
Over time, businesses will hit periods of difficulty. The old ways suddenly seem less effective. The business is no longer appears to be going anywhere, just like the merry-go-round horses don’t seem to be going anywhere. There is lots of activity, but no forward progress. All that activity just seems to make you go in unproductive circles, like the merry-go-round. Just as in the story, your difficulties prevent you from completing your business's mission.
In times of trouble, many executives resort to changing the person in charge of the mission. The thinking is that the reason the mission is failing is because the person in charge of the mission is incapable or unqualified for the task. Therefore, if you put someone new in charge, the problem will get fixed. This was the thought pattern of the man in the story. He kept thinking that if he could just put the right subordinate in charge of the mission, he or she would succeed.
Unfortunately, the problem was not the person in charge, but rather the business model chosen for the mission. No matter who was put in charge, no one was going to get to the other side of the park by using a merry-go-round horse. Rather than changing leaders, the executive should have been changing horses…finding a different kind of horse that is capable of getting to the other side of the park.
The same is true in business. Quite often the only path to success is not in changing leaders, but in changing the business model. That is where strategy comes in—to tell you when to change horses and which type of horse to change to. The sad part of the story was that the executive never caught on to this truth. He kept thinking that if he switched leaders long enough, he would eventually find one that could ride the merry-go-round horse to the other side of the park.
THE PRINCIPLE
The principle here revolves around degrees of control. Typically, the more control you have over your destiny, the more successful your future will be. Studies have shown that in most cases, strategic decisions impact your destiny than more than the person in currently in charge of the strategy. The leaders have less control of their destiny than most people think. They’re freedom to act is constrained by the strategy they inherit.
Years ago, I went to a retailing seminar where the professor said that the ultimate success of companies (and particularly retailers) can only be affected about 20 to 30% by the leader. The other 70 to 80% is determined by major strategic decisions made long ago. You can see this when you replace a bad store manager with a good store manager. Yes, the store will have better performance under the better store manager, but rarely will the results move by more than 20%. Earlier strategic decisions account for the rest of the performance:
If the brand reputation is terrible and your business model is uncompetitive, there is not much that a new leader can do in the near term to make a huge difference. He or she has inherited a wooden horse strategy that won’t make it to the other end of the park. Even a good manager can do only so much when given a mission based on an obsolete business model.
Often times you will see someone leave a successful company and go to lead a less successful company. The person frequently brings others from the more successful company to help him or her. Yet, despite their past success, they do not turn around the less successful company. The reason is because people alone are not enough. There is a reason why that company was less successful in the first place. Frequently, it is because it has an inferior strategy. Until the strategy is changed, there is only so much the new management can do. Making the merry-go-round go faster will not get you any closer to the other end of the park. Similarly, working harder at executing an obsolete or inferior strategy will not lead to great success.
Yes, sometimes current management has done such a poor job of executing a good strategy that new management can make a meaningful difference by just improving the execution. However, if you’ve changed the management two or three times and things are still looking bad, it may be time to concentrate on changing horses rather than changing riders.
February seems to be the time when you see a lot of changes in retail management. Financial results for the year are coming in, and if they are bad, there is often a change in management. Just yesterday I saw seven press releases announcing top level management changes at large retail companies.
The buzz in retail circles in recent months has been that the strategy of the Gap stores is so obsolete that it didn’t really matter who they chose to run the company. Some even speculated that the Gap would have a hard time finding qualified new executives, because no one would want it. In an article in the Wall Street Journal entitled “Gap Needs a CEO, and Many Qualify; Will Any Apply?” dated January 24th, 2007, it says:
“The job pays well and has plenty of perks. There's just one hitch: You have to be the next chief executive officer of Gap Inc. The successor to former Gap CEO Paul Pressler, who resigned Monday, must contend with unpopular products, falling sales and profits, anxious investors, problematic store leases, fleeing executives, and rivals gobbling market share. There's also an influential founding family that might balk at a restructuring the CEO might favor -- all or any of which might give a contender pause. No simple solutions are at hand.”
That sounds a bit like a wooden merry-go-round horse to me.
SUMMARY
New management can do only so much to change a troubled company if the trouble is due to having an obsolete or inferior strategy. Until the strategy is changed, the impact of having a succession of new management every year or two will do little to improve the circumstances. Management can only impact about 20-30% of performance. The rest comes from strategic decisions. Doesn’t it make sense to concentrate more on areas which impact 75% of performance than on areas that impact only 25% of performance?
FINAL THOUGHTS
There’s an old saying that the definition of an insane person is someone who keeps repeating the same bad behavior over and over again in hopes of getting a different result. Dare I say more?
There once was an important executive at an amusement park. He needed to get an urgent message to someone at the other end of the park, so he gave the letter to one of his subordinates and said, “Quick, get on this horse and hand deliver the message to the man at the other end of the amusement park.”
So the man got on the horse that the man pointed to, just as he was ordered to do. Unfortunately, this was a wooden horse on the park’s merry-go-round. The merry-go-round went around in circles a couple of times and dropped of the subordinate at the same location as where he started. This made the important executive furious. He yelled, “What’s the matter with you? I thought I told you to deliver this letter to the other end of the park. Give me back the letter.”
So then the executive gave the letter to another one of his subordinates and gave her the same message—get on a particular horse and hand deliver the message to the man at the other end of the amusement park. So the second subordinate got on the merry-go-round horse, went around in circles a couple of times and she ended up where she started, still holding the letter.
Again, the executive was furious, so he gave the letter to a third associate and gave him the same message. He got on the merry-go-round and had the same result. This lead the executive to give the same orders to a succession of other subordinates—all leading to the same disappointing result.
Finally, a thought occurred to the executive as to why he was having so many problems delivering the letter. “I finally know what’s wrong,” said the executive. “The problem is that nobody knows how to ride horses any more.”
THE ANALOGY
Over time, businesses will hit periods of difficulty. The old ways suddenly seem less effective. The business is no longer appears to be going anywhere, just like the merry-go-round horses don’t seem to be going anywhere. There is lots of activity, but no forward progress. All that activity just seems to make you go in unproductive circles, like the merry-go-round. Just as in the story, your difficulties prevent you from completing your business's mission.
In times of trouble, many executives resort to changing the person in charge of the mission. The thinking is that the reason the mission is failing is because the person in charge of the mission is incapable or unqualified for the task. Therefore, if you put someone new in charge, the problem will get fixed. This was the thought pattern of the man in the story. He kept thinking that if he could just put the right subordinate in charge of the mission, he or she would succeed.
Unfortunately, the problem was not the person in charge, but rather the business model chosen for the mission. No matter who was put in charge, no one was going to get to the other side of the park by using a merry-go-round horse. Rather than changing leaders, the executive should have been changing horses…finding a different kind of horse that is capable of getting to the other side of the park.
The same is true in business. Quite often the only path to success is not in changing leaders, but in changing the business model. That is where strategy comes in—to tell you when to change horses and which type of horse to change to. The sad part of the story was that the executive never caught on to this truth. He kept thinking that if he switched leaders long enough, he would eventually find one that could ride the merry-go-round horse to the other side of the park.
THE PRINCIPLE
The principle here revolves around degrees of control. Typically, the more control you have over your destiny, the more successful your future will be. Studies have shown that in most cases, strategic decisions impact your destiny than more than the person in currently in charge of the strategy. The leaders have less control of their destiny than most people think. They’re freedom to act is constrained by the strategy they inherit.
Years ago, I went to a retailing seminar where the professor said that the ultimate success of companies (and particularly retailers) can only be affected about 20 to 30% by the leader. The other 70 to 80% is determined by major strategic decisions made long ago. You can see this when you replace a bad store manager with a good store manager. Yes, the store will have better performance under the better store manager, but rarely will the results move by more than 20%. Earlier strategic decisions account for the rest of the performance:
- How you’ve managed the brand image.
- Your particular business model (price, product, service levels, etc.)
- How you’ve positioned yourself versus competition
If the brand reputation is terrible and your business model is uncompetitive, there is not much that a new leader can do in the near term to make a huge difference. He or she has inherited a wooden horse strategy that won’t make it to the other end of the park. Even a good manager can do only so much when given a mission based on an obsolete business model.
Often times you will see someone leave a successful company and go to lead a less successful company. The person frequently brings others from the more successful company to help him or her. Yet, despite their past success, they do not turn around the less successful company. The reason is because people alone are not enough. There is a reason why that company was less successful in the first place. Frequently, it is because it has an inferior strategy. Until the strategy is changed, there is only so much the new management can do. Making the merry-go-round go faster will not get you any closer to the other end of the park. Similarly, working harder at executing an obsolete or inferior strategy will not lead to great success.
Yes, sometimes current management has done such a poor job of executing a good strategy that new management can make a meaningful difference by just improving the execution. However, if you’ve changed the management two or three times and things are still looking bad, it may be time to concentrate on changing horses rather than changing riders.
February seems to be the time when you see a lot of changes in retail management. Financial results for the year are coming in, and if they are bad, there is often a change in management. Just yesterday I saw seven press releases announcing top level management changes at large retail companies.
The buzz in retail circles in recent months has been that the strategy of the Gap stores is so obsolete that it didn’t really matter who they chose to run the company. Some even speculated that the Gap would have a hard time finding qualified new executives, because no one would want it. In an article in the Wall Street Journal entitled “Gap Needs a CEO, and Many Qualify; Will Any Apply?” dated January 24th, 2007, it says:
“The job pays well and has plenty of perks. There's just one hitch: You have to be the next chief executive officer of Gap Inc. The successor to former Gap CEO Paul Pressler, who resigned Monday, must contend with unpopular products, falling sales and profits, anxious investors, problematic store leases, fleeing executives, and rivals gobbling market share. There's also an influential founding family that might balk at a restructuring the CEO might favor -- all or any of which might give a contender pause. No simple solutions are at hand.”
That sounds a bit like a wooden merry-go-round horse to me.
SUMMARY
New management can do only so much to change a troubled company if the trouble is due to having an obsolete or inferior strategy. Until the strategy is changed, the impact of having a succession of new management every year or two will do little to improve the circumstances. Management can only impact about 20-30% of performance. The rest comes from strategic decisions. Doesn’t it make sense to concentrate more on areas which impact 75% of performance than on areas that impact only 25% of performance?
FINAL THOUGHTS
There’s an old saying that the definition of an insane person is someone who keeps repeating the same bad behavior over and over again in hopes of getting a different result. Dare I say more?
Wednesday, February 14, 2007
This Candy Melts in Your Hand
THE STORY
Once there was a young boy who loved chocolate. He was very happy, because at this moment he had a fist full of chocolates. He was joyfully walking down the street until he walked past a chocolate shop. There, something caught his eye and caused him to stop.
In the display window of the shop was a gigantic glass jar of chocolates—more than enough to satisfy him and all his friends. Next to the jar was a sign which read: “Free Samples. Help Yourself.” That sign certainly got the boy’s attention.
There was a problem, however. The boy would need both of his hands to lift the lid off of the chocolate jar. Because one of his fists was full of chocolates, he could not lift the lid off the jar. The boy thought about setting down his chocolates so that he could lift the lid, but he was afraid to, for fear of losing the chocolates he already had. As a result, he just kept walking down the street, happy for still having those original chocolates in his hand.
Unfortunately, it was very hot that day. Soon, the boy’s chocolate began to melt. It oozed out from between his fingers and dripped to the ground. When he opened his hands, all he had left was a little bit of chocolate smeared on his fingers. This made the boy unhappy.
But then he remembered the gigantic jar at the chocolate shop. “I’ll just go back to the chocolate shop and get some from the jar,” he thought to himself. However, by the time he got back to the chocolate shop, all of the chocolate was already taken. There was nothing left. This made the boy exceedingly unhappy, because now he didn’t get any chocolate to eat that day.
THE ANALOGY
The business world is full of change. Change causes old products/business models to become obsolete and new products/business models to take their place. The trick of strategy is in knowing when it is time to abandon the old and when to embrace the new.
In the story, the boy did not make those decisions very well. He held onto his old chocolates far longer than he should have (until they melted away and he received no benefit). He also waited too long before embracing the new, larger prize of the giant jar of chocolates (he waited until everyone else got there first and took the prize). His dilemma was that he couldn’t figure out how he could have both at the same time. Therefore, he kept the smaller prize (which he already had) instead of letting go so that he could reach for the greater prize.
As odd as that decision sounds, it is the same conclusion that many businesses take. They hold on to the older, smaller business model (which they know & are comfortable with) and miss out on getting the bigger prize of taking claim of the next business model. Then, when the current business model melts away into obsolescence, they are left with nothing, because the competition has already staked a dominant position in the new space, leaving nothing but an empty jar.
THE PRINCIPLE
The principle we are talking about is fear of cannibalization. It is the fear that if I go after a new business opportunity, it will require letting go of a current business model that is quite profitable, because the new opportunity grows at the expense of the old opportunity. Not wanting to destroy the business model that is currently providing huge profits, the companies decide not to invest in the new model.
There have been numerous examples of this phenomenon throughout time:
1) Back in 1973, Ford Motor Company invented the Minivan, but they did not introduce it to the marketplace for fear that it would cannibalize the profitable sales of their station wagons. When some of the people who worked on the project moved to Chrysler, they introduced the minivan there. As a result, station wagons became obsolete and Ford has never become a major force in minivans.
2) In the late 1980s, supercenters were starting to evolve in the United States. K Mart wanted to be part of the movement, but it did not want to cannibalize its K Mart store sales. Therefore, when it built its American Fare supercenters, it did not put in the types of merchandise found in a K Mart. Instead it combined convenience driven food with high end apparel and durable hardlines like major appliances. The experiment failed and K Mart was never able to recover from it and compete in supercenters.
3) In the late 1990s, Kodak was slow and reluctant to make a big push into digital imaging because of fear of cannibalizing its powerful position in traditional photography. Kodak’s efforts did not save the core photography business and by dragging its feet, it never got a strong position in digital imaging. Now the company is struggling to find a reason for existing in today’s marketplace.
4) In the 2000s, the traditional record labels were reluctant to pursue digital music for fear of cannibalizing the traditional CD market. It took an outsider like Apple to take the market by storm. Until very recently, EMI continued to ignore the inevitability of the fact that digital music was making CDs and the traditional label business model obsolete. Now many bands are ignoring the labels completely and gaining success on their own through downloads made popular on sites like YouTube and MySpace.
5) The latest example I heard of was the recent complaint that the US mobile phone companies, such as T-Mobile, Verizon and AT&T, are resisting the movement into mobile voice over IP (MVoIP) for fear of cannibalizing their current voice business. My guess is that eventually people will flock to MVoIP and the winners will not be the traditional players in the space today.
In every case, the companies above clung on tightly to the chocolates they had and refused to reach boldly with two hands for the next prize. As a result, the chocolates they thought they had eventually oozed away into nearly nothing, while others got the next prize from the big jar before these companies were willing to go after it.
In the end, these companies did not prevent cannibalization of their products. All they did was help determine who would have the honor of doing the cannibalizing. And they decided to let someone else do it. As long as the business is being replaced anyway, one should at least try to benefit from the situation by cannibalizing one’s self. But alas, many companies do not do so.
Why does this fear of cannibalization cause poor decision-making? It is because a one has to significantly increase short-term risk in order to make the leap. Most business hierarchies have so many layers to go through in order to get approval, that conservatism wins out and the known, less risky cash flow (at least in the near-term) nearly always wins. Consider the obstacles facing someone promoting the leap to the new model:
1) The capital is already invested in the old model. It is a sunk cost. To transfer to the new business model, new capital is required. That’s riskier and in the short-run reduces return on investment.
2) The old model has a known cash flow. The new model is harder to predict, making it riskier and harder to defend.
3) Executives often think “I can reap the rewards of the old model today and get big bonuses. If I invest in the new model, it can lower today’s profits near-term (hurting my bonus) and not show profits until later (after I’ve moved on, so the successor to my position gets the bonus).”
4) The new business model may require new skills and processes which the current group has not mastered. That could result in lack of success in transferring to the new skills, and may put the current team out of work, to be replaced by people with different skills. Why risk a career over that?
As you can see, both personal goals and near-term corporate goals lead one to conclude that making the leap early is very risky and may not benefit my personal situation. Hence, the fear wins out and the company ends up losing out.
SUMMARY
Change is inevitable. Ignoring change and clinging to the past does not make change go away. The cash flows from the old business models cannot be saved by ignoring the future. In the end, new businesses cannibalize old businesses. Rather than resist, it is better to take advantage of the change and get in early, so that you can get the most out of what happens next.
This has been the pattern at Wal-Mart. In the beginning, Sam Walton was in the variety store business. When he saw that discount stores had the potential to make variety stores obsolete, he quickly jumped into the discount store business and created Wal-Mart stores. Then, when he noticed that supercenters had the potential to make discount stores obsolete, he quickly jumped in with Wal-Mart Supercenters. The others, who stayed in the variety store business, are all gone. Most of those who stayed in the discount store business are gone. Wal-Mart is still here and as big and as profitable as ever, because they did not fear cannibalization.
FINAL THOUGHTS
Often times, the winners with the new business model are outsiders who were not a part of the former business model (such as Apple was to the record labels). These outsiders do not fear cannibalization, because they had nothing to be cannibalized. Sometimes, the only way to remain an insider is to think like an outsider.
Once there was a young boy who loved chocolate. He was very happy, because at this moment he had a fist full of chocolates. He was joyfully walking down the street until he walked past a chocolate shop. There, something caught his eye and caused him to stop.
In the display window of the shop was a gigantic glass jar of chocolates—more than enough to satisfy him and all his friends. Next to the jar was a sign which read: “Free Samples. Help Yourself.” That sign certainly got the boy’s attention.
There was a problem, however. The boy would need both of his hands to lift the lid off of the chocolate jar. Because one of his fists was full of chocolates, he could not lift the lid off the jar. The boy thought about setting down his chocolates so that he could lift the lid, but he was afraid to, for fear of losing the chocolates he already had. As a result, he just kept walking down the street, happy for still having those original chocolates in his hand.
Unfortunately, it was very hot that day. Soon, the boy’s chocolate began to melt. It oozed out from between his fingers and dripped to the ground. When he opened his hands, all he had left was a little bit of chocolate smeared on his fingers. This made the boy unhappy.
But then he remembered the gigantic jar at the chocolate shop. “I’ll just go back to the chocolate shop and get some from the jar,” he thought to himself. However, by the time he got back to the chocolate shop, all of the chocolate was already taken. There was nothing left. This made the boy exceedingly unhappy, because now he didn’t get any chocolate to eat that day.
THE ANALOGY
The business world is full of change. Change causes old products/business models to become obsolete and new products/business models to take their place. The trick of strategy is in knowing when it is time to abandon the old and when to embrace the new.
In the story, the boy did not make those decisions very well. He held onto his old chocolates far longer than he should have (until they melted away and he received no benefit). He also waited too long before embracing the new, larger prize of the giant jar of chocolates (he waited until everyone else got there first and took the prize). His dilemma was that he couldn’t figure out how he could have both at the same time. Therefore, he kept the smaller prize (which he already had) instead of letting go so that he could reach for the greater prize.
As odd as that decision sounds, it is the same conclusion that many businesses take. They hold on to the older, smaller business model (which they know & are comfortable with) and miss out on getting the bigger prize of taking claim of the next business model. Then, when the current business model melts away into obsolescence, they are left with nothing, because the competition has already staked a dominant position in the new space, leaving nothing but an empty jar.
THE PRINCIPLE
The principle we are talking about is fear of cannibalization. It is the fear that if I go after a new business opportunity, it will require letting go of a current business model that is quite profitable, because the new opportunity grows at the expense of the old opportunity. Not wanting to destroy the business model that is currently providing huge profits, the companies decide not to invest in the new model.
There have been numerous examples of this phenomenon throughout time:
1) Back in 1973, Ford Motor Company invented the Minivan, but they did not introduce it to the marketplace for fear that it would cannibalize the profitable sales of their station wagons. When some of the people who worked on the project moved to Chrysler, they introduced the minivan there. As a result, station wagons became obsolete and Ford has never become a major force in minivans.
2) In the late 1980s, supercenters were starting to evolve in the United States. K Mart wanted to be part of the movement, but it did not want to cannibalize its K Mart store sales. Therefore, when it built its American Fare supercenters, it did not put in the types of merchandise found in a K Mart. Instead it combined convenience driven food with high end apparel and durable hardlines like major appliances. The experiment failed and K Mart was never able to recover from it and compete in supercenters.
3) In the late 1990s, Kodak was slow and reluctant to make a big push into digital imaging because of fear of cannibalizing its powerful position in traditional photography. Kodak’s efforts did not save the core photography business and by dragging its feet, it never got a strong position in digital imaging. Now the company is struggling to find a reason for existing in today’s marketplace.
4) In the 2000s, the traditional record labels were reluctant to pursue digital music for fear of cannibalizing the traditional CD market. It took an outsider like Apple to take the market by storm. Until very recently, EMI continued to ignore the inevitability of the fact that digital music was making CDs and the traditional label business model obsolete. Now many bands are ignoring the labels completely and gaining success on their own through downloads made popular on sites like YouTube and MySpace.
5) The latest example I heard of was the recent complaint that the US mobile phone companies, such as T-Mobile, Verizon and AT&T, are resisting the movement into mobile voice over IP (MVoIP) for fear of cannibalizing their current voice business. My guess is that eventually people will flock to MVoIP and the winners will not be the traditional players in the space today.
In every case, the companies above clung on tightly to the chocolates they had and refused to reach boldly with two hands for the next prize. As a result, the chocolates they thought they had eventually oozed away into nearly nothing, while others got the next prize from the big jar before these companies were willing to go after it.
In the end, these companies did not prevent cannibalization of their products. All they did was help determine who would have the honor of doing the cannibalizing. And they decided to let someone else do it. As long as the business is being replaced anyway, one should at least try to benefit from the situation by cannibalizing one’s self. But alas, many companies do not do so.
Why does this fear of cannibalization cause poor decision-making? It is because a one has to significantly increase short-term risk in order to make the leap. Most business hierarchies have so many layers to go through in order to get approval, that conservatism wins out and the known, less risky cash flow (at least in the near-term) nearly always wins. Consider the obstacles facing someone promoting the leap to the new model:
1) The capital is already invested in the old model. It is a sunk cost. To transfer to the new business model, new capital is required. That’s riskier and in the short-run reduces return on investment.
2) The old model has a known cash flow. The new model is harder to predict, making it riskier and harder to defend.
3) Executives often think “I can reap the rewards of the old model today and get big bonuses. If I invest in the new model, it can lower today’s profits near-term (hurting my bonus) and not show profits until later (after I’ve moved on, so the successor to my position gets the bonus).”
4) The new business model may require new skills and processes which the current group has not mastered. That could result in lack of success in transferring to the new skills, and may put the current team out of work, to be replaced by people with different skills. Why risk a career over that?
As you can see, both personal goals and near-term corporate goals lead one to conclude that making the leap early is very risky and may not benefit my personal situation. Hence, the fear wins out and the company ends up losing out.
SUMMARY
Change is inevitable. Ignoring change and clinging to the past does not make change go away. The cash flows from the old business models cannot be saved by ignoring the future. In the end, new businesses cannibalize old businesses. Rather than resist, it is better to take advantage of the change and get in early, so that you can get the most out of what happens next.
This has been the pattern at Wal-Mart. In the beginning, Sam Walton was in the variety store business. When he saw that discount stores had the potential to make variety stores obsolete, he quickly jumped into the discount store business and created Wal-Mart stores. Then, when he noticed that supercenters had the potential to make discount stores obsolete, he quickly jumped in with Wal-Mart Supercenters. The others, who stayed in the variety store business, are all gone. Most of those who stayed in the discount store business are gone. Wal-Mart is still here and as big and as profitable as ever, because they did not fear cannibalization.
FINAL THOUGHTS
Often times, the winners with the new business model are outsiders who were not a part of the former business model (such as Apple was to the record labels). These outsiders do not fear cannibalization, because they had nothing to be cannibalized. Sometimes, the only way to remain an insider is to think like an outsider.
Tuesday, February 13, 2007
Everyone is an Elvis Impersonator
The Story
Making predictions into the future can be a tricky business. To help reduce error and make predictions more accurate, businesses have relied on the science of mathematics. Using complex mathematical formulas, even the smallest of historical trends can be projected into a “mathematically plausible” future.
Unfortunately, mathematics can only go so far in creating a plausible future. Back in the 1970s, a mathematician made an observation regarding the rapid growth in Elvis Pressley impersonators. After Elvis had died, a large number of singers started dressing up like Elvis and performing the old Elvis tunes before audiences. This form of entertainment quickly became very popular. Elvis impersonating became a large, successful business. As a result, there was an extremely rapid rise in the number of people becoming Elvis impersonators.
Using sophisticated mathematical formulas, this mathematician took the historically rapid rise in Elvis impersonators that occurred shortly after Elvis’ death in the 1970s and made a projection: If this growth in Elvis impersonators were to continue at the same rate into the future as had occurred in the past, every human being on the planet would eventually become an Elvis impersonator sometime around the year 2025.
Well, here we are, about thirty years later, and the last time I checked, none of the people I know are Elvis impersonators (or at least none of them admit it). The mathematical formulas may have been correct, but the prediction was wrong.
The Analogy
The goal of strategic planning is to proactively create a more desirable future state for your business. To build a winning position in the future, it is useful to understand the type of future environment you are designing a winning position for. Therefore, good strategic planning begins by trying to understand the future.
Many different tools and techniques are used to try to understand what the future environment might look like. Although these techniques may use different mathematical formulas, most of the techniques rely on taking historical trends and projecting some sort of continuation of these trends into the future. This was the technique used by the mathematician mentioned above to predict the future of Elvis impersonization.
Unfortunately, historical trendlines of the past are rarely continued at the same exact pace forever into the future. That is why we are not all Elvis impersonators today. The rate of growth in Elvis impersonators quickly slowed down considerably and eventually started to decline.
The point at which a trendline or curve changes its rate of growth is called an inflection point (see figure below). If you misunderstand the timing and magnitude of inflection points, your predictions of the future will be as inaccurate as the projection that we would all become Elvis impersonators.
The Principle
I have seen many executives make terrible strategic mistakes because they failed to take into account inflection points in their analysis of the future. When times are good, they assume that times will always be good. They project the growth of today into growth forever. Huge investments are made in adding manufacturing capacity for anticipated growth. About the time the new factories start producing products, the growth in demand for the product has already slowed. Huge inventories are built up that cannot be sold. It turns out the product was only a short-term fad and the company goes bankrupt.
There are several forces that cause inflections to occur:
1. Competitive Reactions
2. Natural Limits
3. Cycles and Pendulums
4. Discontinuities
5. Influence
These are briefly discussed below.
1. Competitive Reactions
If you are being successful in the marketplace, assume that competition will respond to blunt your success. Remember, if you are gaining market share, that means that someone else is losing market share. Those who are losing share will do whatever they can to stop the loss. This typically slows down your growth.
Even if your success is based on creating an entirely new market, expect a reaction. After all, there are so few truly new growth businesses out there. When companies see them, they all want to get a piece of the action. So even if the new market continues to grow rapidly, your participation in that growth may slow down due to increased competition in that space. For more information on competitive reactions, see the blog entitled Bombs Start Wars.
2. Natural Limits
Growth cannot go on forever, because there are natural limits to growth. For example, to be a successful Elvis impersonator, you need to have a large enough audience willing to pay to see you perform. If everyone was an Elvis impersonator, there would be nobody in the audience. Hence, Elvis impersonation is limited by the size of the audience willing to pay to hear a performance. So one needs to understand how limited the preference is for your product or service.
There are other natural limits as well, like finances. Customers have only so much money to spend, and you cannot get over 100% of the available money. There are also limits on the availability of natural resources. For example, I heard someone do the math on what would happen if everyone in China started drinking one extra can of beer per day or one extra hamburger per day. There is not enough grain in the world to meet that kind of demand.
Therefore, one of the initial steps in any strategic plan should be an analysis of the potential limits to the size of your market. If you significantly over- or under-estimate the market size, you may end up making the wrong strategic choices.
3. Cycles and Pendulums
Life tends to operate in cycles. For a while, something may be in fashion. Then it goes out of fashion. Later, it comes back into fashion. This applies to more than just high fashion apparel. Take automobiles, for example. Sometimes, economy cars are more in fashion, sometimes luxury cars are more in fashion. Sometimes trucks, minivans or sport utility vehicles are more in fashion. This is why many companies have a strategy that includes a portfolio of products and services. That way, they can more easily shift with the changing cycles and fashions.
Other times, patterns look more like a pendulum. For example, opinions may grow increasingly more liberal until people see the flaws in liberal extremism, so they start swinging the pendulum back towards conservatism. Then, when they see the flaws in conservative extremism, the pendulum moves towards liberalism, and so on.
Some cycles can be very long and their patterns cannot be detected if you only look at trends from the last couple of years. For example, in economics, there are some who believe in the Kondratiev long wave economic cycle, which takes approximately 50 years to complete. In human behavior, there has been some research around a pattern that repeats itself every four generations. This cycle has been traced back to the late 1500s, with the same pattern of four successive generational types happening over and over again (For more on this subject, see the writings of William Strauss and Neil Howe, including their books “The Fourth Turning” and “Generations” or visit the webpage www.timepage.org/time.html). If you understand these cycles, you can do a better job of predicting what might happen next, even if it is not a direct continuation of the trends of the recent past.
Making predictions into the future can be a tricky business. To help reduce error and make predictions more accurate, businesses have relied on the science of mathematics. Using complex mathematical formulas, even the smallest of historical trends can be projected into a “mathematically plausible” future.
Unfortunately, mathematics can only go so far in creating a plausible future. Back in the 1970s, a mathematician made an observation regarding the rapid growth in Elvis Pressley impersonators. After Elvis had died, a large number of singers started dressing up like Elvis and performing the old Elvis tunes before audiences. This form of entertainment quickly became very popular. Elvis impersonating became a large, successful business. As a result, there was an extremely rapid rise in the number of people becoming Elvis impersonators.
Using sophisticated mathematical formulas, this mathematician took the historically rapid rise in Elvis impersonators that occurred shortly after Elvis’ death in the 1970s and made a projection: If this growth in Elvis impersonators were to continue at the same rate into the future as had occurred in the past, every human being on the planet would eventually become an Elvis impersonator sometime around the year 2025.
Well, here we are, about thirty years later, and the last time I checked, none of the people I know are Elvis impersonators (or at least none of them admit it). The mathematical formulas may have been correct, but the prediction was wrong.
The Analogy
The goal of strategic planning is to proactively create a more desirable future state for your business. To build a winning position in the future, it is useful to understand the type of future environment you are designing a winning position for. Therefore, good strategic planning begins by trying to understand the future.
Many different tools and techniques are used to try to understand what the future environment might look like. Although these techniques may use different mathematical formulas, most of the techniques rely on taking historical trends and projecting some sort of continuation of these trends into the future. This was the technique used by the mathematician mentioned above to predict the future of Elvis impersonization.
Unfortunately, historical trendlines of the past are rarely continued at the same exact pace forever into the future. That is why we are not all Elvis impersonators today. The rate of growth in Elvis impersonators quickly slowed down considerably and eventually started to decline.
The point at which a trendline or curve changes its rate of growth is called an inflection point (see figure below). If you misunderstand the timing and magnitude of inflection points, your predictions of the future will be as inaccurate as the projection that we would all become Elvis impersonators.
The Principle
I have seen many executives make terrible strategic mistakes because they failed to take into account inflection points in their analysis of the future. When times are good, they assume that times will always be good. They project the growth of today into growth forever. Huge investments are made in adding manufacturing capacity for anticipated growth. About the time the new factories start producing products, the growth in demand for the product has already slowed. Huge inventories are built up that cannot be sold. It turns out the product was only a short-term fad and the company goes bankrupt.
There are several forces that cause inflections to occur:
1. Competitive Reactions
2. Natural Limits
3. Cycles and Pendulums
4. Discontinuities
5. Influence
These are briefly discussed below.
1. Competitive Reactions
If you are being successful in the marketplace, assume that competition will respond to blunt your success. Remember, if you are gaining market share, that means that someone else is losing market share. Those who are losing share will do whatever they can to stop the loss. This typically slows down your growth.
Even if your success is based on creating an entirely new market, expect a reaction. After all, there are so few truly new growth businesses out there. When companies see them, they all want to get a piece of the action. So even if the new market continues to grow rapidly, your participation in that growth may slow down due to increased competition in that space. For more information on competitive reactions, see the blog entitled Bombs Start Wars.
2. Natural Limits
Growth cannot go on forever, because there are natural limits to growth. For example, to be a successful Elvis impersonator, you need to have a large enough audience willing to pay to see you perform. If everyone was an Elvis impersonator, there would be nobody in the audience. Hence, Elvis impersonation is limited by the size of the audience willing to pay to hear a performance. So one needs to understand how limited the preference is for your product or service.
There are other natural limits as well, like finances. Customers have only so much money to spend, and you cannot get over 100% of the available money. There are also limits on the availability of natural resources. For example, I heard someone do the math on what would happen if everyone in China started drinking one extra can of beer per day or one extra hamburger per day. There is not enough grain in the world to meet that kind of demand.
Therefore, one of the initial steps in any strategic plan should be an analysis of the potential limits to the size of your market. If you significantly over- or under-estimate the market size, you may end up making the wrong strategic choices.
3. Cycles and Pendulums
Life tends to operate in cycles. For a while, something may be in fashion. Then it goes out of fashion. Later, it comes back into fashion. This applies to more than just high fashion apparel. Take automobiles, for example. Sometimes, economy cars are more in fashion, sometimes luxury cars are more in fashion. Sometimes trucks, minivans or sport utility vehicles are more in fashion. This is why many companies have a strategy that includes a portfolio of products and services. That way, they can more easily shift with the changing cycles and fashions.
Other times, patterns look more like a pendulum. For example, opinions may grow increasingly more liberal until people see the flaws in liberal extremism, so they start swinging the pendulum back towards conservatism. Then, when they see the flaws in conservative extremism, the pendulum moves towards liberalism, and so on.
Some cycles can be very long and their patterns cannot be detected if you only look at trends from the last couple of years. For example, in economics, there are some who believe in the Kondratiev long wave economic cycle, which takes approximately 50 years to complete. In human behavior, there has been some research around a pattern that repeats itself every four generations. This cycle has been traced back to the late 1500s, with the same pattern of four successive generational types happening over and over again (For more on this subject, see the writings of William Strauss and Neil Howe, including their books “The Fourth Turning” and “Generations” or visit the webpage www.timepage.org/time.html). If you understand these cycles, you can do a better job of predicting what might happen next, even if it is not a direct continuation of the trends of the recent past.
4. Discontinuities
Sometimes, dramatic changes just happen which have little to do with the past. Some are discontinuities we can create by ignoring conventional wisdom and trying something radically different. For example, conventional wisdom for almost 100 years said that to sell photographic cameras, you needed to emphasize durability, reliability and quality. Then, all of the sudden, disposable one-use cameras came on the market that never talked about durability, but instead stressed convenience. These disposable cameras are now a significant portion of the photography business. Another discontinuity was getting North Americans, who were used to getting drinking water for virtually free, to start paying for it by the bottle.
Other discontinuities are caused by unusual outside circumstances. For example, an event like the terrorist attack on the United States on September 11, 2001 suddenly changed a number of businesses, such as the airlines industry. Although these types of discontinuities may be difficult to predict, it is sometimes useful in strategy to look at a variety of potential scenarios, so that if one of the scenarios were to suddenly occur, you would be ready to react quickly.
5. Influence
Businesses do not have to just sit back idly and wait for the future to come. Often times, a company has the opportunity to influence how the future will evolve. You may be able to help determine the next fashion cycle. You may be able to influence factors that affect natural limits. You may be able to prepare yourself to optimize in the next phase in a longer cycle and maybe even hasten the advance to the next phase. You can create the next great discontinuity in your business. You can create scenarios to anticipate a variety of potential futures, so that you are prepared in advance for a number of potential outcomes.
As you can see, strategic planning can be very useful in helping you cope with an uncertain future by:
- Helping you to know in which direction to use influence to modify the future to your advantage.
- Helping you to see a larger cycle, so that you can anticipate the next phase and find the path get there ahead of the competition.
- Helping you to envision many potential futures, so that whatever happens in the future, you will have a well thought out strategy for that situation. Strategies thought out patiently in advance tend to be better than hasty reactions when discontinuities first appear.
Summary
One of the main goals of strategic planning is to proactively create a more desirable future state for your business. To do this properly, one must have a reasonable expectation of what that future will look like. Although it is impossible to achieve complete accuracy about what the future will be, it is a safe bet to assume that the future will not be just an identical continuation of the trends of the past. Trends change, due to a number of factors, like:
1. Competitive Reactions
2. Natural Limits
3. Cycles and Pendulums
4. Discontinuities
5. Influence
It is important to include these factors in your predictions of the future. Otherwise, you will end up with predictions as ridiculous as the one that claims we will all become Elvis impersonators.
Final Thoughts
Some people say that because the future is unknown and that recent trends cannot predict what will happen next, planning for the future is a waste of time. Just live for maximizing today and worry about tomorrow when it comes.
I say just the opposite. Because the future is unknown and unpredictable, you have an opportunity to alter the course of how the future unfolds. The beauty of the future is that it is far enough away that you have time to influence in part how it will look. If you take the time to plan properly, you can create a much better position for your business. It is precisely because of the uncertainty that one needs to plan. If the future were entirely knowable, you could not influence the outcome and planning would be meaningless.
Because the future is not obvious, you can obtain a competitive edge if you spend more time trying to understand and influence it than your competition. Uncertainty makes the value of planning increase, not decrease.
Monday, February 12, 2007
What's A Few Seconds Among Friends
THE STORY
Once there were three physicists. They were standing next to a tall skyscraper. Suddenly, a loud voice came from above, shouting, “Watch out! I’m going to jump!” The physicists looked up and saw a man standing on a ledge of the skyscraper looking like he is about to jump.
One physicist turned to the others and remarked, “I wonder how long it would take for the man on the ledge to hit the ground after he jumps.” This started a heated debate. The following comments were made by the physicists:
“Well, speed equals mass times acceleration, so if we can determine the exact mass of the man on the ledge and the exact height of the building, we could get an answer. Maybe if I go to the city records, I can find a blueprint showing the exact building height. While I’m doing that, perhaps one of you could kindly ask the man what his mass is.”
“That’s all well and good, but I think the weather will affect your calculation. It is very humid and windy today. This will alter the speed. I need to check with the weather bureau for precise conditions.”
“And don’t forget about that coat he’s wearing. It is a big trench coat. I suspect that when he jumps, the coat will fill up with air and act like a parachute, slowing him down. Perhaps I should run a few models on my computer with various coat-billowing scenarios.”
So all three physicists went off and did serious and extensive research on the problem. When they finally got back together again at the base of the skyscraper, they all had come to different conclusions. One predicted 5.34 seconds, one predicted 6.02 seconds and the third predicted 6.53 seconds. This started another series of arguments as to who was right and why the others’ analyses were flawed.
Finally, one of them said, “The only way that we’ll ever know is through experimentation. Let’s time how long it takes the man on the roof to hit the ground after he jumps.” They all agreed, but when they looked up, the man was no longer on the ledge.
As it turns out, while they were out doing research, the man on the ledge jumped and hit the ground in 5.7 seconds. Police and the ambulance service had already taken care of the problem before the physicists got back. Unaware of what happened, the physicists turned their attention to ponder another problem—why the sidewalk by the skyscraper was so dirty.
THE ANALOGY
Sometimes, in our attempt to precisely understand a problem, we get caught up in the research and the minutia, missing the big picture. The big picture in the story was that a man was contemplating a jump to his death. The physicists had the opportunity to try to stop the tragedy. They could have tried to talk him out of it. Or they could have called some experts to come in to help. Or they could have tried to find a net to cushion his fall. Instead, they wasted time trying to get more precision on the phenomenon.
In the end, it doesn’t really matter if the man hits the ground in 4 seconds, 5 seconds or 6 seconds. In the end, what matters is that a tragedy was about to occur and they did nothing to stop it.
This same thing happens in strategic planning. People can spend months (or maybe years) trying to make the forecasts of the future as accurate as possible. While all of the time is spent on gaining this extra precision, the world keeps moving forward. By the time one reaches the conclusion, it may already be too late to take any action. The phenomenon one is trying to predict may already occur, and you are unprepared with a strategy for dealing with it.
You can see this in rapidly changing environments, like digital entertainment and mobile phones. By the time the market settles down and you can accurately predict the outcome, it will be too late to develop and implement any sort of strategy to become a major player in that area. The rules will already be in place and the consumers will have already made their choices of who is going to win. You may have accuracy on your side, but the competition will have the profits.
THE PRINCIPLE
Precision can make us feel more comfortable. After all, isn’t it risky to act with less than perfect information? Even if you cannot achieve perfect information, isn’t it true that the more precise and accurate your findings, the better off you are? Not exactly. There are many reasons why the pursuit of added accuracy can be detrimental to your strategic health:
1) Nobody knows exactly how the future will unfold. There are too many variables. At some point, further research will not help get you any closer to understanding the future. You just have to make some educated guesses.
2) Speed can often be very critical. Windows of opportunity can shut quickly. Others can get the advantage quickly if your retaliation is slow. Time spent in search of excessive precision can be time not spent in timely action.
3) In your search for details, you can lose sight of the big picture. You might even end up looking for precision in the wrong direction. It’s like the old saying of understanding a tree but losing sight of the whole forest.
4) Precision can give the illusion of knowing more about an uncertain future than you really know. It can give you the false confidence to move forward boldly, without giving any further scrutiny to your situation.
So, if too much precision is potentially dangerous and no knowledge is dangerous, what is a person to do? The answer is to substitute precision with assessment. Assessment involves knowing three things:
1) DIRECTION: Which direction are the trends heading? Higher or lower; bigger or smaller; better or worse; stronger or weaker? This can apply to consumer beliefs/behavior trends, competitive trends, technology trends, economic trends, etc.
2) MAGNITUDE: How far is it going in that direction? Big or Really Big; a Little Better or Much Better; a Little Stronger or Quite a Bit Stronger?
3) SPEED: Is the trend moving in the direction to this magnitude quickly or slowly? How soon will the trend manifest itself?
The key in the whole analysis game is to research until you are reasonably sure that further research would not make a major difference in what you choose to do. Then stop the research and do what you choose to do. In most cases, if you know the direction, magnitude and speed of the trends around you, then you know enough to do the right thing.
In the story, it was irrelevant whether the jump from the skyscraper would take 5, 6, or 7 seconds. No matter how many seconds it took, the key facts were already known:
1) Direction: Is the trend going Up or Down?
2) Magnitude: Is it happening a little or a lot?
3) Speed: Is it happening quickly or slowly?
In most cases, this will let you know enough to get your company moving in the right strategic direction (and save a lot of precious time).
FINAL THOUGHTS
The physicists were so busy gathering data that they didn’t even know that the terrible event actually occurred. The clean up was so quick that all they saw was a dirty sidewalk. If you miss out on acting timely due to busyness, your business will quickly disappear as well, leaving little more than a little smudge in the memory of time.
Once there were three physicists. They were standing next to a tall skyscraper. Suddenly, a loud voice came from above, shouting, “Watch out! I’m going to jump!” The physicists looked up and saw a man standing on a ledge of the skyscraper looking like he is about to jump.
One physicist turned to the others and remarked, “I wonder how long it would take for the man on the ledge to hit the ground after he jumps.” This started a heated debate. The following comments were made by the physicists:
“Well, speed equals mass times acceleration, so if we can determine the exact mass of the man on the ledge and the exact height of the building, we could get an answer. Maybe if I go to the city records, I can find a blueprint showing the exact building height. While I’m doing that, perhaps one of you could kindly ask the man what his mass is.”
“That’s all well and good, but I think the weather will affect your calculation. It is very humid and windy today. This will alter the speed. I need to check with the weather bureau for precise conditions.”
“And don’t forget about that coat he’s wearing. It is a big trench coat. I suspect that when he jumps, the coat will fill up with air and act like a parachute, slowing him down. Perhaps I should run a few models on my computer with various coat-billowing scenarios.”
So all three physicists went off and did serious and extensive research on the problem. When they finally got back together again at the base of the skyscraper, they all had come to different conclusions. One predicted 5.34 seconds, one predicted 6.02 seconds and the third predicted 6.53 seconds. This started another series of arguments as to who was right and why the others’ analyses were flawed.
Finally, one of them said, “The only way that we’ll ever know is through experimentation. Let’s time how long it takes the man on the roof to hit the ground after he jumps.” They all agreed, but when they looked up, the man was no longer on the ledge.
As it turns out, while they were out doing research, the man on the ledge jumped and hit the ground in 5.7 seconds. Police and the ambulance service had already taken care of the problem before the physicists got back. Unaware of what happened, the physicists turned their attention to ponder another problem—why the sidewalk by the skyscraper was so dirty.
THE ANALOGY
Sometimes, in our attempt to precisely understand a problem, we get caught up in the research and the minutia, missing the big picture. The big picture in the story was that a man was contemplating a jump to his death. The physicists had the opportunity to try to stop the tragedy. They could have tried to talk him out of it. Or they could have called some experts to come in to help. Or they could have tried to find a net to cushion his fall. Instead, they wasted time trying to get more precision on the phenomenon.
In the end, it doesn’t really matter if the man hits the ground in 4 seconds, 5 seconds or 6 seconds. In the end, what matters is that a tragedy was about to occur and they did nothing to stop it.
This same thing happens in strategic planning. People can spend months (or maybe years) trying to make the forecasts of the future as accurate as possible. While all of the time is spent on gaining this extra precision, the world keeps moving forward. By the time one reaches the conclusion, it may already be too late to take any action. The phenomenon one is trying to predict may already occur, and you are unprepared with a strategy for dealing with it.
You can see this in rapidly changing environments, like digital entertainment and mobile phones. By the time the market settles down and you can accurately predict the outcome, it will be too late to develop and implement any sort of strategy to become a major player in that area. The rules will already be in place and the consumers will have already made their choices of who is going to win. You may have accuracy on your side, but the competition will have the profits.
THE PRINCIPLE
Precision can make us feel more comfortable. After all, isn’t it risky to act with less than perfect information? Even if you cannot achieve perfect information, isn’t it true that the more precise and accurate your findings, the better off you are? Not exactly. There are many reasons why the pursuit of added accuracy can be detrimental to your strategic health:
1) Nobody knows exactly how the future will unfold. There are too many variables. At some point, further research will not help get you any closer to understanding the future. You just have to make some educated guesses.
2) Speed can often be very critical. Windows of opportunity can shut quickly. Others can get the advantage quickly if your retaliation is slow. Time spent in search of excessive precision can be time not spent in timely action.
3) In your search for details, you can lose sight of the big picture. You might even end up looking for precision in the wrong direction. It’s like the old saying of understanding a tree but losing sight of the whole forest.
4) Precision can give the illusion of knowing more about an uncertain future than you really know. It can give you the false confidence to move forward boldly, without giving any further scrutiny to your situation.
So, if too much precision is potentially dangerous and no knowledge is dangerous, what is a person to do? The answer is to substitute precision with assessment. Assessment involves knowing three things:
1) DIRECTION: Which direction are the trends heading? Higher or lower; bigger or smaller; better or worse; stronger or weaker? This can apply to consumer beliefs/behavior trends, competitive trends, technology trends, economic trends, etc.
2) MAGNITUDE: How far is it going in that direction? Big or Really Big; a Little Better or Much Better; a Little Stronger or Quite a Bit Stronger?
3) SPEED: Is the trend moving in the direction to this magnitude quickly or slowly? How soon will the trend manifest itself?
The key in the whole analysis game is to research until you are reasonably sure that further research would not make a major difference in what you choose to do. Then stop the research and do what you choose to do. In most cases, if you know the direction, magnitude and speed of the trends around you, then you know enough to do the right thing.
In the story, it was irrelevant whether the jump from the skyscraper would take 5, 6, or 7 seconds. No matter how many seconds it took, the key facts were already known:
- Direction: A movement towards injury—a bad direction.
- Magnitude: Very High, Very Severe—nearly certain death.
- Speed: The likelihood is that it will happen very soon, and when it happens, the event will occur very quickly.
That was enough knowledge to take action to prevent the man from jumping. One didn’t need to research the building height, weather conditions, or the air resistance of a coat. One needed to act immediately.
This is also true in business. If you can quickly assess the direction, magnitude and speed of what is going on around you, then you can move forward. In fact, if you continued on and built a big fat binder full of numbers to three decimal points, it is unlikely that your conclusion would meaningfully be any different than if you had stopped when you knew the direction, magnitude and speed.
SUMMARY
When in need of a strategic decision, before diving into a lengthy research project with lots of precision, ask yourself three questions:
1) Direction: Is the trend going Up or Down?
2) Magnitude: Is it happening a little or a lot?
3) Speed: Is it happening quickly or slowly?
In most cases, this will let you know enough to get your company moving in the right strategic direction (and save a lot of precious time).
FINAL THOUGHTS
The physicists were so busy gathering data that they didn’t even know that the terrible event actually occurred. The clean up was so quick that all they saw was a dirty sidewalk. If you miss out on acting timely due to busyness, your business will quickly disappear as well, leaving little more than a little smudge in the memory of time.
Saturday, February 10, 2007
Home Field Dis-Advantage
The Story
Businesses often use sports analogies to describe business strategy. One aspect of sports is the concept of “home field advantage.” Home field advantage refers to the fact that sports teams are more likely to win games played at their own field or court than they do playing at the opponent’s field. Let us see how this principle applies to the business world in the following story.
I knew a retailer that had a very successful retail concept, which had been expanded to a large section of the United States. Virtually everywhere the retailer built these stores, it quickly gained significant market share and became very profitable. There was one significant exception to this pattern. When the retailer expanded into one particular city in the United States, it ran across a competitor that it could not beat. In fact, the stores the retailer built in this city did so poorly that they were quickly closed.
This rival competitor was a much smaller company with far fewer resources. Yet this smaller competitor was starting to expand into the area held by my retail friend. Given the overlapping expansion plans for both companies, it was becoming obvious that these two competitors were destined to compete again in the future.
This left my retail friend with a choice:
The first choice would be like playing a sports game at home, while the second option would be like playing an away game.
My retail friend used to be a professional sports athlete. Relying on his sports background, he chose the option of playing the game at home and let the competitor come into his stronghold. His figuring was that, like in sports, he was more likely to win on his home territory, so this was the better place to have the contest.
What my retail friend failed to realize was that the competitor had increased prices in its own retail stronghold in order to fund the battle against my friend. This competitor started attacking some of my friend’s most profitable markets with a small handful of stores. Although I’m sure those new stores were not very profitable for the competitor, they wiped out a larger amount of profitability for my friend, since he had more stores in the market and these were some of his most profitable stores.
With some of his most profitable markets in shambles, my friend’s overall chain results were noticeably down. Not wanting to disappoint his shareholders with bad results, he started raising the prices in his remaining markets to cover the losses in the contested markets. All that served to do was make those uncontested markets less competitive and even more vulnerable for attack. Since the competitor was still making good profits in his stronghold markets, he was able to fund an increase in attacks. All the while, he was getting stronger, while my friend was getting weaker.
To make a long story short, in the years since this competitive battle began, my friend has had to retreat to the point where virtually the only place where the business makes money anymore is in the original home city. By contrast, the competitor is much larger, much stronger, and competes over a much larger territory. It looks like the home field advantage was not much of an advantage after all.
The Analogy
Although there are many parallels between sports and business, the battles are not identical. The analogy between sports and business breaks down because business is not played one game at a time. In team sports:
By contrast, in the business world:
As a result, many of the reasons why home field advantage works in the sports world do not work in the business world. In fact, the opposite is often true—there is often a home field dis-advantage.
As we saw in the story above, my friend tried to move the business battle to where he thought he would have home field advantage. As a result of that decision, he ended up losing the overall battle against this competitor. The disadvantages of “playing the game at home” where one already has a strong position are as follows:
Businesses often use sports analogies to describe business strategy. One aspect of sports is the concept of “home field advantage.” Home field advantage refers to the fact that sports teams are more likely to win games played at their own field or court than they do playing at the opponent’s field. Let us see how this principle applies to the business world in the following story.
I knew a retailer that had a very successful retail concept, which had been expanded to a large section of the United States. Virtually everywhere the retailer built these stores, it quickly gained significant market share and became very profitable. There was one significant exception to this pattern. When the retailer expanded into one particular city in the United States, it ran across a competitor that it could not beat. In fact, the stores the retailer built in this city did so poorly that they were quickly closed.
This rival competitor was a much smaller company with far fewer resources. Yet this smaller competitor was starting to expand into the area held by my retail friend. Given the overlapping expansion plans for both companies, it was becoming obvious that these two competitors were destined to compete again in the future.
This left my retail friend with a choice:
- Does he allow the competitor to come into his geographic stronghold and fight the battle here; or
- Does he aggressively go into the stronghold of the competitor and fight the battle there?
The first choice would be like playing a sports game at home, while the second option would be like playing an away game.
My retail friend used to be a professional sports athlete. Relying on his sports background, he chose the option of playing the game at home and let the competitor come into his stronghold. His figuring was that, like in sports, he was more likely to win on his home territory, so this was the better place to have the contest.
What my retail friend failed to realize was that the competitor had increased prices in its own retail stronghold in order to fund the battle against my friend. This competitor started attacking some of my friend’s most profitable markets with a small handful of stores. Although I’m sure those new stores were not very profitable for the competitor, they wiped out a larger amount of profitability for my friend, since he had more stores in the market and these were some of his most profitable stores.
With some of his most profitable markets in shambles, my friend’s overall chain results were noticeably down. Not wanting to disappoint his shareholders with bad results, he started raising the prices in his remaining markets to cover the losses in the contested markets. All that served to do was make those uncontested markets less competitive and even more vulnerable for attack. Since the competitor was still making good profits in his stronghold markets, he was able to fund an increase in attacks. All the while, he was getting stronger, while my friend was getting weaker.
To make a long story short, in the years since this competitive battle began, my friend has had to retreat to the point where virtually the only place where the business makes money anymore is in the original home city. By contrast, the competitor is much larger, much stronger, and competes over a much larger territory. It looks like the home field advantage was not much of an advantage after all.
The Analogy
Although there are many parallels between sports and business, the battles are not identical. The analogy between sports and business breaks down because business is not played one game at a time. In team sports:
- The entire contest takes place at a single location against a single opponent.
- The entire battle typically falls within the confines of a timed event. When the time runs out, the team with the most points wins.
- After the game is over, the next game is played as if that last game never occurred. The points do not carry over. You both start out the next game tied at 0-0.
By contrast, in the business world:
- The business plays in multiple locations at the same time against multiple opponents. Resources can be moved between battles in the middle of the battle.
- The battle does not end when time runs out. It either ends when one side is so devastated that it gives up, or when both sides find a way to peacefully co-exist.
- After the battle is over, the strengths and weaknesses continue into the next game. If you ended the last battle in weakness, you start the next battle in weakness.
As a result, many of the reasons why home field advantage works in the sports world do not work in the business world. In fact, the opposite is often true—there is often a home field dis-advantage.
As we saw in the story above, my friend tried to move the business battle to where he thought he would have home field advantage. As a result of that decision, he ended up losing the overall battle against this competitor. The disadvantages of “playing the game at home” where one already has a strong position are as follows:
- In business, if you win a game at home, you are no better off than when you began. You have only defended to achieve what you already had. In fact, even if you win, you may be further behind than when you started, because of the resources spent to defend your position. However, if you lose at home, it is a real and major loss of a profitable portion of your business that does not come back once the contest is over. Hence, there is little upside and a big downside to playing at home where you are strong.
- A loss at home in the business world leaves you in a weakened position when the contest is over. The loss permanently reduces one’s available resources to use in the next battle. Unlike sports, the loss carries over in the next game, making it harder to win future games. Even if you win a battle at home, it does not necessarily make you any stronger against the next opponent. You just stay even. Hence, a loss at home creates the potential for a long-term downward spiral across many battles, whereas a win just helps you maintain the status quo.
The opposite occurs when a business “plays an away game” in the heart of where the opponent is strongest. If you win, you gain greatly—you have gained a stronghold in a new area as well as greatly weakened an opponent. You have moved the balance of power more in your favor by adding new profit opportunities for yourself while taking profit opportunities away from your opponent. If you lose, most of what you have lost is just the opportunity to gain more ground.
Most importantly, by moving the battle to the opponent’s stronghold, you keep the battle from attacking your most profitable markets while you attack your opponents most profitable markets. It is easier for you to fund the battle when your core markets are protected, while it is harder for your opponent to fund that same battle when their core is under attack.
The Principle
In the business world, there are many ways in which you can have the option of either playing a home game or an away game. A home game is where you are relatively stronger. An away game is where your competition is relatively stronger. That strength can be in many categories. It could be a geographical strength, where in international business competition, you are stronger in some countries than in others. It could be a product category strength, where you have higher market shares in some categories than in others. It could also be a technology strength, a distribution channel strength, or a consumer demographic strength.
When developing strategy, you often have the choice of determining whether your competitive struggles take place predominantly at your position of strength or at the position of your competitor’s strength. Often, our initial reaction is to always set the battle to take place at our position of greatest strength. We think this will automatically give us “home field advantage.”
However, as we saw in the story above, home field can often be a disadvantage. There may be many times when it makes more sense to make the competitive battle an away game. There are two times when away games make more sense in the business world:
- When I am very large and resourceful while my competitor is much smaller with fewer total resources.
- When I am much smaller with fewer resources and my competitor is very large and resourceful.
In the first instance, the analogy would be like siege warfare. In siege warfare, an army with large resources would surround the castle of its enemy, cutting off its access to any resources beyond the castle. In a process of attrition, the larger force with the greater resources would outlast the weaker force in the castle, who eventually runs out of food and must surrender or starve.
Even though the “home team” in the castle is stronger in that particular area of business than the attacker, the attacker can draw upon resources from other businesses where it is overall much stronger. The strategy for the attacker becomes total resources against total resources, rather than weakness against strength in this particular area of business.
Relating this to the story mentioned at the beginning of this chapter, my friend could have attacked the stronghold “castle” market of the smaller competitor and outlasted him because my friend had far more resources. In a war of attrition, the competitor would have run out of resources first in defending its territory. The added benefit for my friend would have been that if he had held siege to the competitor’s castle, the competitor would have been unable to fund attacks into my friend’s territory. Unfortunately, he did not do this.
In the second example, the analogy would be guerrilla warfare. The strategic goal of guerrilla warfare is to make small, quick attacks on your stronger enemy—in their territory—in such a way that the damage to the opponent is greater than the damage to yourself. Over time, such attacks will gradually make the guerrilla stronger, while gradually making his opponent weaker. In time, the balance of power would change, and the formerly weaker guerrilla becomes the stronger of the two.
The assumption here is that, even if you are relatively weaker, you have some uniqueness in your overall strategic position so that you can win some of the guerrilla skirmishes. For example, even though you are smaller, you may be faster, more personalized, or provide better service. If you are both smaller and have no unique benefits to bring to bear, then it doesn’t matter what you do. You will lose no matter what you do.
Guerrilla warfare was the tactic the competitor effectively used against my friend in the story above. It worked well and my friend lost the overall battle.
Summary
Business strategy is often similar to sports strategy. However, not all sports analogies apply well to business. In particular, the idea of “home field advantage” in sports is often “home field dis-advantage” in the business world. When designing a business strategy, it can frequently make sense to move the location of the competitive battle away from your position of strength into your competitor’s position of strength.
If you are still having trouble seeing the benefit of playing an away game, here is something to consider. Over the last century, there have been numerous large, successful, established companies that eventually lost out to a small upstart firm. In almost every case, there was a point in time when the established company had enough relative power that they could have played an away game against the upstart and weakened it to the point where it would never have gained enough clout to eventually win.
A key part of strategy is determining who the next upstart is who might have the power to eventually beat you, and then playing an away game against them early, which keeps them from ever becoming meaningful in the marketplace. For example, in the early 1970’s, K Mart was one of the strongest and most powerful retailers on the planet. At that time, there was a small upstart retailer called Wal-Mart that was starting to grow out of it rural base. K Mart could have played an away game against Wal-Mart at that time in those rural markets and won. Instead, it chose not to do so. Today, K Mart is in bankruptcy and Wal-Mart is the largest retailer on the planet.
Final Thoughts
The irony of the story above was the fact that the basic idea of the home field dis-advantage was pointed out to my friend before he made his choice. He was told that the ideal strategy was to fight the battle at the opponent’s stronghold. His response was, “Don’t give me a strategy. Just tell me how to make money.”
When you play your business as an away game, you will suffer some financial loss at first. Your opponent, however, should suffer an even greater loss. In the long-run, this strategy will usually create much more wealth, even if there is a little pain at the beginning. To quote a famous sports adage, “No pain, no gain.”
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