Strategic Planning Analogy #555: Managing the Full Cycle

THE STORY
A friend of mine recently explained to me how his parents survived a lifetime of farming. He said their farm tended to run on a five-year cycle. In general, over that five-year span, one of the years would be extremely profitable, two would suffer big losses and two would be about break-even.

So this is what his parents did. When they had that one great year on the farm, they would shrewdly invest the windfall into the stock market. This investment would have enough of a return to get them through the four years of breakeven and losses. Then, when the next great year came again (about five years later), they’d start over again, investing the windfall in stocks to cover the next four years.

Over time, they got to be very good at stock investing. It makes you wonder if their true occupation was really farming or investing.

  

THE ANALOGY
This family was able to survive a lifetime in farming because they did not think in terms of individual years or growing seasons. Instead, they planned their business around the full five-year cycle. They knew there would be highs and lows across the five-year cycle which they did not have a lot of control over. For example, commodity prices would swing wildly and weather would change dramatically. You can compensate for a bit of this in the short term, but not most of it. Hence the highs and the lows in farming were pretty much a given.

Therefore, my friend’s parents needed a bigger plan—one that invested during the high points, so that they would have supplemental income to get through the low points.

Other businesses tend to be no different. Margins rise and fall based on all sorts of market pricing issues outside a business’ control. And, like weather, the external environment for businesses can also dramatically change. Fickle customers can abandon your business category for the next fad and cause as much damage as when the rain stops falling on the farm and goes somewhere else.

Hence, all businesses should consider their actions in terms of the full cycle. They need to reinvest the highs in order to be prepared for the lows. Unfortunately, as we will see below, not all businesses do this.

THE PRINCIPLE
The principle here is that if you try to optimize individual years rather than the full multi-year cycle, you will be on a path to destroy the business. First, if good years are optimized on their own, you end handing out the profits to all the stakeholders. That will not leave any money for the lean years. So then, the only way to optimize the lean years on their own is to cut back on everything (R&D, service, quality, etc.).

This starts the death spiral. The cutbacks in lean times make the company less viable when the good times return, so the highs get progressively smaller. Debt piles up in the lean years until it is unsustainable. None of the money ever gets reinvested for the long term, so the business gets old and unfit for the changing times. Bankruptcy is almost inevitable.

I was reminded of this principle when I saw a recent article online from Fortune. It was a list of the ten largest bankruptcies in U.S. retailing over the last few years. As I thought about this list, I realized that in a majority of these cases, the retailer failed because it did not plan for the full cycle. 

Bankruptcy usually came from a combination of:

1.     Taking out too much money in the good times (usually via a leveraged buyout)

2.     Taking on too much debt that could not be maintained when the bad times came.

3.     Was not ready when “bad weather” came (a negative change in the external environment).

4.     Did not invest the money from the good times into projects that would pay out in the future (adapting to the “new weather”).

Here are a few examples, which I’ve simplified for the sake of time.

Circuit City

Circuit City sold low margin electronics products. The margins suddenly got a lot lower when Wal-Mart and online retailers like Amazon aggressively went after the business. Circuit City did not have enough cushion to absorb the drop in prices. Then, Circuit City made matters worse in the lean times by cutting way back on sales service. It was the aggressive sales service team which was able to talk customers into buying the more profitable attachments and extended warranties for the low margin basic goods. Without the sales people to aggressively boost the margin in the shopping basket, the margins got even lower. Eventually the losses got too great to be sustainable.

Linens N Things

Linens N Things was almost identical to its competitor Bed Bath & Beyond. The only major difference was that Bed Bath and Beyond operated on a lower cost structure (a structure designed for lean times). When the lean times came, the lower cost structure allowed to Bed Bath & Beyond to still make money when Linens N Things could not. Bed Bath & Beyond became more aggressive with its coupon promotions, making it even harder for Linens N Things to compete in the lean times. Finally, Linens N Things sold out to leveraged buyout, which created a debt level that could not be maintained.

A&P

A&P is an example of a supermarket company that could not keep up with the changing weather. It had old stores, run the old way, with old union contracts. When the good times were there, A&P did not reinvest and modernize or build a lot of stores in the growing markets. Instead, it took the profits out of the stores. That left A&P with the oldest stores in the oldest neighborhoods without the changes needed for the modern grocery business. When the bad times came, A&P kept cutting back. But due to their old union contracts, they were forced to first lay off the younger, less expensive (and more productive) employees. This left them with even higher costs relative to competition. It’s hard to survive when you have a combination of the most outdated offerings and the highest cost structure.

Sbarro

Sbarro had most of their pizza restaurants in malls. They thrived in the good times by taking advantage of the traffic already created by the mall. Unfortunately, the weather changed. Malls became far less popular. Mall traffic dropped significantly. Eating in malls dropped significantly. Sbarro did not have a business model designed to draw its own traffic or survive on lower traffic. So when the mall traffic dried up, it was like when a farmer’s land dries up…profits evaporate. It didn’t help that Sbarro had also gone through a leveraged buyout, which drained them of the extra cash needed for lean times.

Blockbuster and Borders

Blockbuster and Borders were two retailers who sold tangible media (Blockbuster: movies; Borders: Books). The digital revolution changed their weather. When movies and books became digital, customers did not need brick and mortar stores any more. Plus, the price of digital movies and books were so low, that Blockbuster and Borders couldn’t compete on price. These company's failures wasn’t inevitable. Others invested to adapt to the new weather of the digital world. Blockbuster and Borders, however, did not make those heavy investments in a timely manner. Hence, they failed. They, like A&P, did not do like my friend’s parents and invest during the good times. You cannot live off the investments you do not make. And without investments into the new, you become obsolete.

Quicksilver

Quicksilver is a retailer specializing in clothing and gear for the surfing culture. Teens paid a premium to shop at Quicksilver because appearing to be part of the surfing culture made you look cool. But then the weather changed. Cool transferred from surfing culture to smartphone culture. The Apple store was now the cool destination. Money that used to go to clothes went to technology. The clothes still bought tended to come from cheaper stores, like H&M, because the money you saved on clothing could be used to buy more cool technology. Quicksilver could not adapt its cost structure and merchandising for these leaner times.

SUMMARY
Business life is not a straight line of consistency. Instead, there are periods of ups and downs. Many of the ups and downs are influenced by external factors that are not completely under your control.

Therefore, if you want your company to last over the long haul, it must be built in such a way as to survive the entire cycle of good times and bad times. That means, that in the good times, you should:

1. Put some money aside for the bad times.
2. Invest some money in things that will improve your relevancy as markets evolve.
3. Not let your cost structure rise to levels that can only be supported in good times.

Then, in the bad times:

1. Live off some of the money set aside in the good times rather than destroy your offering (and image) through overly excessive cost cutting.
2. If it looks like the weather has changed permanently for the worse, be ready to make radical moves to become relevant again. Don’t just try to wait it out if it looks like business is not ever coming back to your business model. In the best case scenario, you would have started investing in these changes back when times were still good.

FINAL THOUGHTS
To be a good farmer, my friend’s parents had to know more than just how to farm. They also had to be good investors. Similarly, good businesses cannot just be managed by people who only know how to operate the current business model. They also have to know how to invest in what will replace the current business model.

Strategic Planning Analogy #534: You’re Older Than You Feel

THE STORY
According to a study reported in the Psychonomic Bulletin and Review in 2006, adults tend to feel younger than their chronological age. Beginning around age 25, people start reporting a sense that they don’t feel as old as they really are.

The gap between their subjective and chronological age continually increases between age 25 and 40. By the time adults are 40, most adults report feeling about 20% younger than they really are. This 20% gap tends to remain for most of the remainder of their years.

So if we are “only as old as we feel,” then I guess we’re not that old.

THE ANALOGY
Perception is a powerful thing. If we feel younger than we actually are, then we will act younger than perhaps we should. This could lead to foolish behavior and get us a trip to the emergency room at the hospital.

I dare say that the same phenomenon can occur in the business world. I think a lot of executives feel that their company (or business model) is not as old as it really is.

There’s this sense that maturity doesn’t apply to their business. They feel like their industry is still young and growing and that their company is still a growing youngster, too.

But let’s face it. Businesses and industries have life cycles, just like humans. They may start out young and growing, but eventually they reach maturity and then decline. You may not always feel like your company is progressing through these life stages, but it is. And it is probably further along on this path than you think.

The problem is when you manage your company based on the way you feel about its age rather than what its age really is. Each stage of a business’ life requires a different type of strategy. If your company has reached maturity and you still feel like you are in your growth phase, you will be using the wrong strategy. And just as adults when not acting their chronological age can do foolish things that get them into the hospital, managers who do not manage to their business’ actual life stage age can get their companies into serious difficulties.

THE PRINCIPLE
The principle here is that although the growth phase of an industry may appear to be the most fun and most desirable, the truth of the matter is that in most mature economies, most of the industries are mature as well. Therefore, most of us should be focusing on mature industry strategies.

IBIS World Data

This was really brought home to me when I was looking at a report produced by IBIS World. IBIS World produces reports on a wide variety of industries. To give a perspective, each report shows where that industry fits on the industry life cycle. They do this with a comparative scatter plot showing where about 700 industries fit on the life cycle path. I’ve put a sample of one of these charts in this blog.

As you can see in this chart, the largest number of industry dots are in the mature phase. And although the later growth phase gets the next largest number of dots, the decline phase is not all that far behind. Early growth has the fewest number of dots.

This chart shows just how old most industries are. Mature and decline together dominate the landscape.

The Disconnect

Yet when one looks at business literature and strategic discussions, it seems that the topic of growth dominates. There appears to be a disconnect between the reality of maturity and the desire to act as if maturity has not yet occurred.  Just as our society is preoccupied with youth culture, our businesses are preoccupied with younger business stages.

We may feel younger, but the disconnect between that perception and reality can get us in trouble. Talking like we are in the growth phase or acting like we are in the growth phase does not alter the reality that for many of you, you are already in the mature or declining phase. And by not acting your age, you could be doing your business a disservice.

The Downside of Not Acting Your Age

Here is a list of the major negative consequences from managing to growth when you should be managing for maturity.

1.     Overinvesting in the industry: Because you over-estimate the growth and life expectancy of your industry, you tend to value investment opportunities within the industry as higher than they really are.  This leads to paying too much for bad deals. Hence, you destroy value by overinvesting in areas where the returns will never cover the cost of capital.

2.     Working too hard to grow the top line: If you think there’s still a lot of growth in the industry, then you will have high expectations for what your own growth should be within that industry. However, in maturity, those high growth expectations may be quite unrealistic. Therefore, the only way to hit those high sales goals is to start a price war rampage in order to steal sales from the other mature competitors. This destroys the profit margin for you and the entire industry. If competitors follow your downward pricing, you may not end up with any additional business—just lower margins. But even if competition does not follow you in this downward spiral and you get some of their sales, you may still end up as less profitable because of how you destroyed the margins in order to get the business.

3.     Under-investing in future business models:  If you think there is still a lot of growth and vitality in the current business, then you will see little incentive to investigate or invest in the next big thing that will make your status quo obsolete. The problem is that your business model’s obsolescence is probably a lot closer than you think. By ignoring that, you will be unprepared for when that day comes. You will end up like Kodak, who saw their entire world fall apart because they delayed making the transition from analog film to digital imaging until it was too late. For more on Kodak, look here.

So, as you can see, acting as if your business is younger than it really is is not a small issue. At best, it will cause you to destroy value. At worst it will cause you to destroy the company.

A Better Approach

To avoid these negative consequences, consider the following:

1.     Continually monitor your life cycle using objective tools: Don’t rely on your feelings. They can deceive you. Use objective tools to monitor your path through the business life cycles.

2.     Act Your Age: If you are in maturity, then use the appropriate strategies for maturity such as:

a.      Moving the focus from top-line growth to process efficiency and cost control.

b.     Focus on reaping the maximum return from prior industry investments rather than creating new ones.

c.      Consider shifting emphasis to pockets where maturity is further away, such as emerging nations.

d.     Examine the relative merits of consolidating the industry versus selling out to someone else who wants to consolidate the industry.

e.      Invest in the next big thing that will replace the status quo.

I love what I see in the packaged food industry. P&G realized that its corporate culture and business model were optimized for growth industries. P&G also realized that its food products portfolio had moved on to maturity. Therefore, it sold its mature food businesses to other companies, like Pinnacle Foods. It was a win-win. It freed up money so that P&G could invest in growing industries like health and beauty. And, since Pinnacle Foods has a corporate culture designed to excel in mature businesses, the food businesses were under better management.

In fact, it worked so well that P&G is considering a more massive divestiture of brands.

SUMMARY
The business world is a dynamic place, where new business models replace the old. As a result, businesses do not stay in the growth phase forever. Maturity and decline occur. Unfortunately, many business leaders think their business model is younger than it really is. This leads them to manage for growth when they should be managing for maturity. By using the wrong strategies (growth strategies instead of mature strategies), these leaders destroy value. The better move is to align your strategy with the reality of where your business model lies in its life cycle.

FINAL THOUGHTS
You can use this disconnect to your advantage. If you know that your business is in maturity or decline and someone else still thinks it is in its growth phase, you can sell your business to them for more than you think it is worth.

Strategic Planning Analogy #529: Stick to Your Stage

THE STORY
I read a story recently about how John Breck introduced shampoo to the United States back around 1930. Before then, people used some form of soap to wash their hair. But John Breck showed how to use a pH-balanced detergent which more easily rinsed away from the hair and left the hair and scalp in better condition.

I was shocked to learn how recently shampoo, as we know it today, was invented. I started thinking about all those generations of people in the past who have not had the simple benefit of shampoo.

I guess there was a reason why royalty in the past liked to wear those big crowns on their heads and why the ancient pharaohs of Egypt shaved their heads. As royalty, they did not want to be seen with dirty hair.  

THE ANALOGY
Shampoo is not the only common everyday consumer good that was invented relatively recently. Nearly all common consumer goods which fill our supermarkets are less than 100 years old. In fact, Uneeda Biscuits is considered to be the first broadly advertised branded food product. That happened in 1898. Before that, most food items were sold to grocers unbranded in bulk barrels—put into a plain brown bag for the customer by the local grocer.

Even self-service supermarkets, themselves, have only been around since abut the 1930s. They had to wait until all these products, like Breck Shampoo, were invented and branded so that consumers could choose items on their own.

You could say that a century ago, branded consumer products were the internet economy of their time. They were inventing whole new categories of products, like shampoo. They were changing the way people lived and spent their time and money. A radical transformation was going on in a burgeoning new industry. New trails were being blazed and new concepts were being invented (like couponing, which really didn’t begin to take off until all these branded products came about).

This was the era in which consumer product firms like Proctor & Gamble really grew into the huge and successful businesses they are. They were the masters of inventing new categories and inventing ways to market them to create incredibly large businesses which did not exist before (you could say that disposable diapers were like the Facebook of their day).

These consumer product companies understood how to use chemists and other scientists to invent major breakthroughs in performance (not unlike how companies in the digital economy use engineers). They blazed trails in new distribution and marketing channels, just as the digital economy did with marketing on the internet and smartphones.

Yes, less than 100 years ago, the big consumer branded product companies were Googles, Linkedins and Apples of their time.

But now look at those branded consumables found in supermarkets. Right next to them is a store brand that is just as good and costs a lot less. Sales growth is virtually non-existent. The old marketing tricks don’t move the sales needle much. It’s a very mature business driven mostly by cost control and price wars.

Consumer branded products are not at all anymore like the digital economy. And I suspect that at some point in the future, the digital economy will look a lot like the consumer branded goods industry today—very mature and without much growth. And it may happen sooner than many people think, just as I was surprised how soon shampoo went from a new category to extreme maturity.

THE PRINCIPLE
The principle here is that industries go through life cycles. There’s the introduction stage, followed by rapid growth, maturity and decline. Each stage has its own challenges—the keys to success and the skills required to win vary by stage as well.

Two Strategic Choices

As a business, you can choose one of two strategies:

1. Stick with your industry (become and industry expert) and ride the industry through its stages.
2. Stick with the business stage you are good at operating in and change your portfolio so as to stay in that stage of the life-cycle.

Looking at history, it seems that the second option is the best. General Electric has been so successful for so long because it keeps changing its portfolio. It gets out of businesses that are maturing and reinvests in newer industries that can take advantage of its corporate strengths. Proctor and Gamble has succeeded by getting out of the mature industries it helped develop and reinvest in industries (like beauty care and health care) where it’s traditional skills are still valuable.

And today, we see a lot of “serial entrepreneurs”—people who are great at the start-up stage of a business. As soon as their business leaves the start-up stage, they sell it and work on their next start-up. They succeed because they stick to the stage of business they have mastered.

It’s easy to understand why the second option is preferable. It’s hard to change one’s nature and instincts. As industries move from one lifecycle stage to the next, what is required to win is different. You have to radically change your business model and culture to adapt to the change. Most companies find it difficult enough to excel when dealing with relative stability. It becomes exceedingly difficult to excel when moving into a phase where all the rules for success are changing.

So stick with what you know—and the most important thing you know (most likely) is how to operate in a particular life stage, not the particulars about your industry.

If your company stays with your industry, your company’s life cycle will follow the industry lifecycle. You’ll decline along with the industry. Is that what you want?

It all happens faster than you think

The second option is not without its own risks, though. The trick is knowing when is the right time to make the shift—to exit one industry and enter another. If you get the timing wrong, you miss out on a lion’s share of the value creation.

One point to keep in mind is that industries move through their stages a lot quicker than we usually think. When you are in the middle of the day to day within an industry, you can sometimes lose sight of the bigger external factors that about to shake your industry into the next phase. From the inside, today looks a lot like yesterday, and tomorrow looks like it will be a lot like today. So we get lulled into thinking things are moving slowly.

But then, one day, everything seems to change. It only surprises us because we didn’t keep a closer eye on what’s happening outside the industry—where the disruptions start.

Experts tell us that industry lifecycles are getting ever shorter; the transitions come ever sooner. While I am a bit surprised about how fast consumer branded products went from invention to complete maturity, that process occurred far more slowly than what is happening today.

Back in the early 2000s, I was working with Best Buy and was trying to convince them to look for a “post retail” strategy. My concern was that the traditional retail industry was going to get extremely mature relatively quickly and if they wanted to continue to be a growth company, they would need to think beyond retail.

Best Buy thought they had a lot of time, so they didn’t act. And now, only about a decade later, Best Buy finds itself struggling because its retail foundation is in maturity (or maybe even the beginnings of decline). This just goes to show how fast this change can sneak up on you if you are not watching carefully.

So to play the second strategy, one needs to keep one eye focused on the external environment, in order to know when the times are about to change.

SUMMARY
Businesses have two strategic choices:

1. Stick with your industry (become and industry expert) and ride the industry through its stages.
2. Stick with the business stage you are good at operating in and change your portfolio so as to stay in that stage of the life-cycle.

In most cases, the second option is more likely to lead to lasting success. However, to make the second option really successful, you have to get your timing right on knowing when to shift your portfolio. That requires keeping an eye outside your industry—where the disruptions which cause your industry to shift occur.

FINAL THOUGHTS
Google is not content to think its current business foundation will be a growth industry forever. They keep investing in places where they think the next growth may come. You should