strategic planning analogy #359: Does It Fit?

THE STORY
I’m a real sucker for a great bargain. Unfortunately, not all great prices are great deals.

Take clothing, for example. I’ve seen lots of really great clearance prices over the years on clothes. Unfortunately, the clearance assortment usually leaves a lot to be desired. They almost never seem to have my exact size left in stock. Therefore, I’ve been known to buy clothing that doesn’t quite fit me exactly, just because I couldn’t resist the low price. Sometimes, I can make the clothing work. Other times, it just sits in my closet, never worn.

I may have paid a terrifically low price for the item, but it was a lousy deal because it didn’t fit and I never wore it.

THE ANALOGY
It really doesn’t matter how little I paid for the clothes. If they don’t fit, they are worthless to me. It was wasted money.

The same can be said of certain strategic initiatives. They may appear to be excellent opportunities, but if they don’t have a strategic fit with the organization, you will never reap the full benefits of that opportunity. If fact, that great so-called “opportunity” could end up destroying value for your firm because of all the time, money and energy wasted in trying to make it fit, when in fact it does not and can not. You will always be at a competitive disadvantage versus others in that space who have a greater fit with the strategic initiative.

Just as you do not want a closet full of clothes you cannot wear, you do not want a business full of initiatives where you had no strategic advantage/fit. No matter how great the opportunity looks, it has to fit to be a great opportunity for you.

THE PRINCIPLE
The principle here is that great strategies produce great cash flows over their life.

Two Factors Impacting Cash Flows
Two factors impact how much net cash a strategy will produce over its lifetime:

1) The amount of money/time/effort needed create and execute the strategy. These are the efforts which produce the INPUT for your strategy. For example, if your strategy is to become a major player in the smartphone business, you need to expend money/time/effort to design/develop your technology (hardware and software) and find a way to get the smartphone manufactured. Once this infrastructure is developed, you need a process to ensure your technology remains up-to-date and that daily operations run smoothly and efficiently. Without these inputs (a phone, software, and operations to produce them), you cannot be in the smartphone business.

2) The amount of money/time/effort needed to get customers aware of your strategy and make it easy to purchase what you are offering. These are the efforts which produce the OUTPUT for your strategy. Using modern terms, this is the concept of “monetizing” your strategy. For example, to monetize your smartphone, you need things like arrangements with the supply chain (mobile phone carriers and retailers), marketing campaigns, distribution capabilities, and a sales force. And if your business is advertising based, not only do you need a sales/marketing arm to reach end users, but also a sales/marketing arm to reach advertisers. In the case of the iPhone, Apple also needed to develop an infrastructure for developing and selling apps in order to fully monetize the strategy.

To maximize cash flow, one typically needs to keep the costs of inputs low and the net revenues from outputs high. A key way to do this is via strategic fit. Strategic fit is critical in both the inputs and the outputs. Without strategic fit, you will both expend more effort AND get less in return on your inputs as well as your outputs. And in a competitive marketplace, it is difficult to have a winning strategy when others, using strategic fit, can spend less and get more out of the same initiative.

Strategic Fit And Inputs
On the input side, strategic fit occurs when the competencies, skill sets, and infrastructure needed to get a strategic initiative up and running are similar to the competencies, skill sets and infrastructure already possessed by the firm. For example, it is easier to develop the software and hardware needed for a smartphone if you already have the engineering and technical experience to develop things like this in-house. Having brought similar technology to market in the past will put you further down the learning curve. This will make the process more efficient, more timely and more likely to succeed.

Similarly, experience in manufacturing similar products will give you an advantage in delivering the new product you have developed. You will get down the learning curve faster for everyday operations, thereby increasing the efficiencies of your input. If you can build the product using manufacturing infrastructure you already own and experienced employees who are already in place, you not only avoid the added expense of new infrastructure and new training, but you also get to spread your current infrastructure cost over more products. This makes your entire portfolio more profitable.

There was a strong strategic fit for Apple to enter the smartphone business, because it built upon the learnings, expertise and infrastructure developed for the iPod. This allowed Apple to get a quality, innovative product to market quickly and successfully. Conversely, Microsoft has been slow and far less successful in its smartphone strategy due to a poorer fit. Microsoft’s expertise and experience is more suited to developing and producing business productivity software. It knows little about designing gadgetry and is not the most savvy in understanding the consumer market.

Strategic Fit and Outputs
Outputs have a strategic fit when the necessary requirements to distribute, sell, market and monetize the strategy are similar to (or can piggy-back on) the distribution, selling, marketing and monetizing expertise/infrastructure already in place in the firm.

For example, the Apple iPad can take advantage of all of the expertise and infrastructure already in place to distribute, sell and monetize the iPod and the iPhone. Apple already has the needed relationships with the retailers and the phone carriers. They already have the apps infrastructure in place. Apple can use the same sales force and distribution infrastructure. They already know how to successfully market cool new technology to the target audience. This cuts out a lot of time and costs, as well as improving efficiency and effectiveness.

Contrast this to the experience Dell had in adopting its strategy from selling computers to business to selling computers to consumers. At first, you would think this to be a reasonable fit. Further examination says otherwise, particularly as it relates to outputs. Selling to consumers is quite different than selling to business. You need a different type of sales force, with a different type of sales pitch. You need different channels of distribution. You need a different product mix (less desktops, more laptops). You need a different marketing appeal (based on different attributes) which uses different advertising media. There are different after sales service expectations, since consumers don’t have their own IT departments. You need to be “cool.”

By not having expertise in all of these outputs to the consumer market, Dell was at a competitive disadvantage to HP/Compaq. HP/Compaq had a greater strategic fit in the consumer space, so they won the strategy battle in computers. HP/Compaq could move faster and more efficiently in the consumer space, giving them the edge over Dell.

Remember, even if you have a superior product, your strategy can still fail if the competition has a superior way to get their product sold. Just ask anyone who has tried to win against Frito-Lay in salty snacks in the US. It is almost irrelevant how good your snack is. Frito-Lay has such a lock on the distribution channels that you cannot get adequate access to the customer at the point of sale. Even a giant like Anheuser Busch had to abandon their strategic initiative into salty snacks (Eagle Snacks) in failure because of its disadvantage to Frito-Lay in snack distribution. Anheuser Busch could not transfer its beer distribution expertise, so there ended up being little fit on outputs.

Overcoming A Lack of Strategic Fit
Given the importance of strategic fit, companies try to find ways to quickly overcome a lack of strategic fit. There are two ways to do so. First, one can seek fit via acquisitions. The logic is that if you do not have a strong strategic fit within your company, then buy a company that already has that strategic fit. That way, your firm will have the strategic fit once the acquired company is assimilated.

Although this approach can sometimes work, it has two big drawbacks. First, you typically have to pay a large premium to acquire a company with the desirable knowledge and infrastructure needed for entering a hot new opportunity. You end up paying so much for the business that nearly all of the financial benefit goes to the seller, rather than the buyer. Unless this expertise and infrastructure is very scarce, others will also have this fit. And if the others already had the fit in-house, they will have attained it at a far lower cost than your acquisition, putting you at a competitive disadvantage.

Second, the expertise and infrastructure in the acquired company is only useful if it can be integrated into the new strategy. Transfer of expertise is always difficult, but it is more difficult when done via acquisition.

The alternative to acquisition is outsourcing. The idea is that if you do not have the fit, then outsource that work to someone who already has the fit. The problem here is that you can lose any competitive advantage. If everyone can outsource to the same experts, then you cannot gain an edge on anyone else using the same source.

Sony used to be very strong in conventional tube televisions because of its proprietary expertise in manufacturing. However, with the new TV screen technology, all the manufacturers are basically outsourcing the key manufacturing to the same few third-party manufacturers. Sony is sourcing from the same place as everyone else. Now, Best Buy can go direct to the same third-party manufacturers and build a comparable TV, cutting out Sony and keeping more of the profits.

In global automobile manufacturing, a lot of the parts were outsourced to manufacturers in China. Now, the Chinese want to become world players with their own automobile brands. They can rely on the local outsourcers to provide them the same quality parts as the established brands. And because the manufacturer and outsourced firms are both Chinese, they have some added synergies unavailable to global firms.

Therefore, don’t think of acquisitions and outsourcing as magic bullets that automatically achieve strategic fit and strategic advantage. There are significant risks involved. It is better if your strategy can rely on expertise and infrastructure that you (and only you) already have in place.

SUMMARY
To win in a competitive environment, it helps to have a strategic advantage. An excellent source of advantage is strategic fit. The closer the fit between a new strategic initiative and your core expertise and infrastructure, the more likely you will have an advantage. Strategic fit not only applies to what is needed to develop/create a product/service, but also what is needed to monetize that product/service. Therefore, when choosing a strategy, look for options with a strong strategic fit in both areas. If the fit is not there, do not assume that acquisitions and outsourcing can automatically fill the gap and make you a success.

FINAL THOUGHTS
There are a lot of exciting new growth opportunities out there. But if they don’t fit, they won’t be exciting growth opportunities for you. Don’t follow the crowd and chase the latest hot idea. Look for the unique opportunity which fits who you are and is hard for others to copy because it doesn’t fit them. Wear the clothes that fit and you will always look good.

Strategic Planning Analogy #263: Living in Fear

THE STORY
I knew a woman who was very curious. She liked to read all the time. One of her favorite topics to read about was the dangers and threats which could beset the world. She became an expert in understanding all the potential dangers—everything from the dangers which could beset a women walking alone in a parking garage to the dangers to the entire planet from the thinning of the ozone layer.

The more she read about potential dangers, the more fearful she became. She eventually became afraid that all of the potential dangers had a high likelihood of happening—to her. She became increasing afraid to leave the house. Her fear for the entire health of the planet (and her inability to stop every threat) became so intense that she was prescribed medicine in order to cope.

Over time, the fear so gripped her that she could no longer function in the outside world. She was a true sufferer of agoraphobia—and it was so sad to see.

THE ANALOGY
Although it is not a bad idea to become informed about potential risks, too much fear about those risks can be very detrimental. As we saw in the story, excessive fear over potential threats can be paralyzing. Too much fear leads to an inability to act and move ahead. The fear can trap us in our homes.

Business is all about taking risks. As they say, “No Risk, no Reward.” Of course that doesn’t mean we should ignore all warning signs of risk and dive into a situation blindly. That almost always leads to disaster. The recent economic collapse, for example, was due to not properly understanding the risks of the complex financial products which were introduced. Financial institutions dove too deep into these risky ventures—blind to the extent of the risk—and it almost collapsed the entire economy.

One of the key roles of strategic planning is to provide knowledge and insight so that the risks are minimized. Better, less risky moves can be made based on the discipline of strategic analysis—a solid understanding of the environment. Strategic planning makes you smarter so that you can act smarter.

However, even with the use of strategic planning, the risks do not go entirely away. If you wait until all the facts are in, it will be too late to take the lead. The market dynamics will already be set in concrete and not have room for your late entry. Therefore, there will always be an element of the unknown in every good strategy.

The key is to not become paralyzed with fear. Instead, the goal is to make risk your friend.

THE PRINCIPLE
The principle here is that risk is not to be avoided, but rather to be exploited. Don’t be like my friend who was so fear stricken that she was afraid to leave the house. To win, you have to take your business out into the marketplace and aggressively fight for success. Even in tough economic times, one cannot just hunker down in the bunker in fear and wait it out.

Market share changes hands all the time—especially when times get tough. Customers are more willing to reconsider their habitual buying patterns when their economic condition worsens. Therefore, tough times are not times to hide in your house, because your share is more vulnerable than ever. Of course, the share of your competitor is also vulnerable, so you have an opportunity to gain if you go out and act smartly.

Taking calculated risks into uncharted territory can be one of your best friends, because:

a. It allows you to get a head start in an area which is relatively uncontested (like the Blue Ocean Strategy).
b. It allows you to write the rules in your favor.
c. It increases your chance of being the leader and reaping most of the rewards.

Of course, not all ventures into new space are successful. So how can we improve our chances of success within this uncertainty? Here are four suggestions.

1. Plan the Entire Chain
Successful ventures are based on successful business models. In today’s increasingly sophisticated marketplace, it is not enough just to create a cool product. To make money, one needs to plan and control the entire value chain around it. Your business model strategy must include a way to get the rest of the value chain to work in your favor. Otherwise it can work against you.

Compare, for example, Sony versus Apply. Sony has concentrated on making cool devices. Apple has concentrated on making cool business systems—devices, apps, stores and so on.

Apple realized that a cool device can quickly become a commodity—a piece of hardware that gets the profit margin kicked out of it if you do not control the selling process downstream. Therefore, Apple has tightly controlled its retail distribution.

Second, Apple knew that if the cool applications shift to another device, nobody will want the Apple device, because what customers really want is the ability to get to the cool apps. As a result, Apple did its best to become THE place for the cool apps programmers to programming for.

Finally, devices get purchased infrequently, whereas the apps get purchased all the time. Apple knew if it was not getting a cut of the apps business, it was losing out on where most of the ongoing value in the business model was being made. Therefore, Apple made sure it was THE place for purchasing the apps, so that it could get a cut of the sales.

By planning the entire value chain, Apple was able to ensure that the value chain continued to flow through Apple and did not get diverted somewhere else. This this thoroughness and control significantly increased Apple’s ability at being a success in risky new ventures like the ipod and the iphone.

By contrast, Sony’s recent ventures aimed at cool devices only have not been as successful. They have recently suffered a large loss. Sony’s cool devices are not cool enough on their own to create a secure business model. By not controlling distribution downstream or applications upstream, Sony is more vulnerable to being bypassed in the value chain. By not having the compelling stickiness of a tight value chain, Sony has to cut prices in order to create preference, which hurts margins.

Sir Howard Stringer, head of Sony, has seen the error of this narrow focus and is in the process of transforming Sony to think more holistically about the entire value chain. So, success in new ventures goes up if you plan out the entire value chain—to build a system which is biased in your direction and makes all the players better off if they play by your rules.

2. Look for Superior Solutions
A lot of businesses get excited by a new venture when it uses the latest and greatest technology. The mindset tends to be that “if it uses the latest technology, it has to be better, so the business model should succeed.” The problem is that most people don’t care about how up-to-date the technology is. What they really want is a superior solution to a problem. Sometimes, the latest technology does not improve the ability to solve a problem. Sometimes it even makes it worse.

Take internet grocery shopping, for example. Nearly every venture into this space has been a miserable failure. Is it because they did not use the latest technology? No, it’s because internet grocery shopping is an inferior way to shop.

They claimed that internet grocery shopping would be more convenient. However, how convenient is it really when you consider that:

a) You have to sit at home for a 4 hour delivery window (which is a longer time than it takes to shop).
b) If they are out of stock on an item you want, either they may make a substitution you don’t like or they will not supply the item, leaving you with only half the ingredients needed for a meal. Is that convenient?
c) The ordering process on line is less enjoyable than shopping, and unless you like eating the same food every week, it is still time consuming.

On top of that, a lot of the things a customer does for free when shopping the store (picking out the items, checking them out, taking them home) now are done by labor that must be paid if you buy off the internet. This makes the internet process a lot less efficient and the groceries a lot more expensive. As it turns out, the minor bit of convenience is not seen as enough to justify the higher prices the new internet grocery model needs to earn a profit. So the business model fails. The moral? Just because a model uses newer technology does not automatically make it better. Only go after ventures which truly have a significant advantage over the status quo in solving the customer’s real problem.

3. Narrow the funnel quickly
Although there are risks to putting all your eggs in one basket, there are also risks to trying to venture into too many different directions at the same time. The solution? Don’t be afraid of looking at a lot of potential new ventures early in the process. This increases your chance of finding a real winner. However, quickly determine which ones have the best shot of success and stop the funding on the rest. One of the biggest drains occurs when one delays halting support for the losers. The longer you wait, the worse it gets.

4. Experiment and Adapt
Ultimate successes rarely end up looking like the original vision. They tend to morph along the way as you learn. Therefore, rather than working in the lab alone until the original vision is perfected, do some early experimentation. Let beta models out into the marketplace. Get input along the way from your customers. Be willing to flex and adapt. This increases the likelihood that the final product is what the market really wants.

SUMMARY
Even though new ventures pose risks, that is not a reason to hide and resist venturing into new areas. The idea is to use a strategic planning process which minimizes the likelihood that the risks will hurt you. This includes ideas such as planning the entire value chain, planning for superior solutions, narrowing the funnel quickly, and experimentation/adapting.

FINAL THOUGHTS
If you do the types of activities mentioned in this blog, risk moves from being an enemy to being a friend, because it gives you an edge over the competitors who do not follow this advice.

Analogy #157: Skin Shedding

THE STORY
Back when I was in High School, one of my best friends had a collection of snakes. It seemed like those things were shedding their skin all the time. In fact, snakes shed their skin about 3 to 8 times a year, depending on age, species and feeding habits.

Skin shedding is an important part of the life of a snake. Without the shedding, the snake could not grow. In addition, skin shedding is the means by which snakes get rid of any parasites on their body.

The shedding process starts with a period of inactivity. During this time, the eyes of the snake will become a dull, bluish-white color. This is because there is a thin layer of skin covering the eyes which must also be shed. As this layer over the eyes gets ready to be shed, the snake has difficulty seeing. Without adequate vision, snakes at this time can become unpredictable and aggressive.

Also during this early process, the new underlying skin gets a chance to toughen up a bit. Once the new skin is ready, the snake rubs its nose on something to cut the old skin open. Then the snake wiggles out of the old skin all at once. If the snake is healthy, the skin will come off in a single piece.

After shedding the skin the snakes go back to normal activities, like eating. Some of my friend’s snakes preferred to eat live food, so he would have live mice and baby chicks around. Once they ate enough of them, the shedding process would start all over again.

ANALOGY
The strategic planning process is a lot like snakes shedding their skin. Businesses can be burdened with old activities, old business units or old strategies which need to be shed. The way that snakes shed their skin can teach us much about how businesses should shed their skin.

1) Without Shedding, A Snake Cannot Grow
Old practices, old businesses and old strategies can hold a business back. Often times, the best path to growth is by taking a new direction, by doing something a little different. Unless we are willing to shed ourselves from the past and embrace the new skin, we cannot grow the business to its optimal potential. So businesses must also shed in order to grow.

2) Shedding Helps Get Rid of Parasites
There are many things that can keep a business down: obsolete practices, toxic cultures, nagging cash drainers which should no longer be a part of the portfolio, and so on. These are like parasites to the company, robbing the company of its resources while providing nothing in return. Sometimes, the only way to get rid of these parasites is to make a clean break with the past.

3) The Old Skin does not come off until the New Skin is ready
It’s one thing for a business to rid itself of parasites and other hindrances to growth. However, if there is not a replacement strategy in place and ready to go, a company is stuck. New sources of cash flow need to be developed while the old sources of cash are still in place to fund/support it. Once the new sources have started to prove themselves, you can then shed the old businesses.

4) The Eyes get cloudy before the Shedding Occurs
When moving into new directions, the future appears a bit more cloudy. You cannot rely as much on your past history. When blazing new trails, there aren’t any maps to rely on. Yet, just because the future is not completely clear, this is no excuse to hold back. In fact, it is just the opposite. It is during the times of environmental change, when vision less unclear, that strategic change is of even greater importance. Cloudiness is a sign that the methods of the past may no longer be appropriate and that it is time to shed.

5) The Skin is shed all at once
Often times, a complete break with the past is needed in order to capture the growth of the future. It’s hard to move forward if you keep looking backwards. To eliminate distractions, a full shedding may be required. It’s a competitive world out there. In the race to the future, competitors who are unencumbered by the past can often capture leadership in the future faster than someone who is only half-shed and trying to live in both worlds.

THE PRINCIPLE
The principle here is that the strategic planning process can be an integral part of the shedding process. It can help you to know when it is time to shed the past and can help you find which skin to wear in the future.

GE is a great example of a company which knows how to shed its skin. Over the years, GE has entered all sorts of new businesses, like entertainment, financing and energy. At the same time, GE has exited a whole lot of industries, particularly in basic manufacturing. Planning helps GE manage the continual shedding of old businesses, and the putting on of the skin of new businesses. It helps in staging the timing—knowing when to shed, when to expand.

For example, when GE got into plastics, it was a new growth industry with plenty of opportunity to add value. Now plastics has become more of a commodity (where value is harder to add), so GE is getting out.

Someone who was naturally gifted in this area was Charles Lazarus. He made a highly successful career out of knowing when to shed his skin.

Back in the 1940s, he took over the family business—a used bicycle shop. To grow sales, he decided to consider adding new products to the mix. Charles Lazarus noticed that right after World War II, the soldiers were settling down and having babies. Therefore, he decided to exploit the trend by adding baby furniture to the store mix. Based on the initial success, he made the bold move. He shed the skin of the bicycle shop and devoted the entire store to baby furniture.

In 1948, Lazarus renamed the store the National Baby Shop (bold ambitions for a one-store operation). Business was much better, but Lazarus wanted to grow even more. He noticed that cribs are not a big repeat business. He wanted to sell things that brought customers back more frequently. His customers often asked if he sold toys. Therefore, he added toys to the mix. It was a hit.

In the 1950s, Lazarus saw that the self-service supermarket format was growing rapidly, replacing the old full-service grocer. He thought that this self-service superstore concept was the future of retailing, and could be applied to other items besides food. Based on this observation and the success of the toys in his store, Lazarus decided to shed his skin again. In 1954, he shed the furniture skin and the full-service skin by opening an all toy store which was set up like a supermarket. He called it Children’s Supermart.

As he was growing the concept, he opened a store in a location where he could only have a small sign. Therefore, to keep the letters in the sign large, he shortened the name of the store to Toys R Us.

After building the chain up to four stores, he sold the operations in 1966 to Interstate Stores for $7.5 million. Interstate Stores was a conglomeration of discount department stores operating principally under the names of White Front and Topps.

Unfortunately, Interstate Stores got into financial difficulties and declared bankruptcy in 1974. Lazarus saw another opportunity to shed skin. He convinced the authorities to put him in charge of the bankruptcy. He shed the skin of the discount department stores and decided to dedicate the company to toy superstores. This was a bold move given that this was such a small part of the original company.

However, in 1978, Interstate Stores came out of bankruptcy and changed its name to Toys R Us. Sales were only around $300 million at the time. However, by growing rapidly, sales reached $4.8 billion by 1990, the year Lazarus retired as CEO. That’s pretty good considering he started the baby furniture portion of the bicycle shop with an investment of only $5,000.

His success was due to understanding the marketplace and knowing when to completely shed his skin, from bicycles to baby furniture to toys (and from full service to self-service). Although it was intuitive to Charles Lazarus, many of the rest of us could benefit from a more disciplined approach through strategic planning.

SUMMARY
Just as snakes need to shed their skin in order to grow, businesses periodically need to shed themselves of their past in order to grow. Times change, requiring businesses to change. To effective adapt to this change, there must be a willingness to shed all of the old skin and wholeheartedly embrace the future.

FINAL THOUGHTS
The technical term for the shedding of skins like snakes is “ecdysis.” This is from the Greek word meaning “to strip off.” As it turns out, some exotic nightclub dancers have taken to this term and refer to themselves as an “ecdysiast” on their resumes (it sounds classier than saying you were a stripper). For different reasons, perhaps we should be referring to ourselves as ecdysiasts as well.

Strategic Planning Analogy #154: Gaps & Plugs Part 2

THE STORY
Many people find themselves in a situation where they need to lose weight. Since a lack of discipline is often the reason why they got into this problem in the first place, usually they are not looking for a disciplined approach to solve the problem.

Instead, many of these people look for a simple one-step solution for losing weight. For example, they may buy an exercise machine and expect that to solve all of their problems. The problem with just doing exercise alone is that:

1) It can make you hungrier, so you end up eating more and not lose weight.
2) It can put undesired muscle bulk on the body, so you don’t lose weight.
3) If you discontinue the exercise, the muscle bulk can turn to fat.

Then there are the various starvation diets. If you do that alone,

1) Your body will adjust and slow down its metabolism, so the reduction in calories becomes less effective.
2) Eventually you have to come off the starvation diet, and because your metabolism has slowed down, you gain weight faster.

Experts agree that the best method to lose weight is a balanced, disciplined approach, combining modest reductions in eating with modest increases in exercise. Not only is this more effective, it is more sustainable over the long haul.

THE ANALOGY
Just as people want to lose weight, companies want to gain sales and profits. As we saw in the prior blog (part 1), undisciplined extreme approaches in a singular direction rarely lead to sustained growth.

Instead, just like weight loss works best with modest modifications to both diet and exercise, planning for growth works best with modest modifications to both current businesses and new ventures.

THE PRINCIPLE
The principle here is that instead of putting all of your growth bets on one big “home run,” it is usually better to string along a lot of base hits, both in shoring up the current business as well as experimenting with new ventures. Here are three rules to keep in mind when taking this type of balanced approach.

Rule #1: If you want different results, you need to do things differently
On the old TV show “Third Rock From the Sun,” Harry Solomon was watching a Road Runner cartoon on TV. Harry turns to Tommy and says that he knows that the latest trick of the Coyote is going to work to capture the Road Runner. Tommy reminds Harry that he has already seen this cartoon and that it did not work when he saw it last time. To this, Harry says something to the effect of, “Yes, but this trick is too ingenious not to work eventually.”

There’s an old saying that the definition of an insane person is one who continues to do the same thing and expects different results. Harry was under this same delusion in thinking that if the Coyote did the same thing over and over, eventually the cartoon would have a different result.

As silly as this sounds, some strategic planning processes aren’t much different. They plan an ambitious goal for a current operating division—something that the division has never come close to achieving in the past. Then they do nothing different and are surprised when the goal is not met.

If you want a different result, then you need to do different activities. Planning is more than just planning goals. It is about planning activities. The key question to ask is “What are you going to do differently in the current division in order to achieve a different (and much better) outcome?”

The strategic plan should not just map out results. It needs to map out the new processes and approaches which will be used to achieve these new results. Premeditated forethought into how to re-engineer the current business is needed to provide the catalyst for improvement. Otherwise, people will tend to return to the comfort of the status quo, which produces status quo outcomes. When the change is articulated into the plan, it is more likely to occur, because it is more likely to be measured.

Rule #2: If you want to be in the right place at the right time, be in lots of places
Because the current business is more familiar, it is easier to articulate the specifics of change into the plan. However, when moving into new ventures, there are more unknowns. Predetermining all the specifics can be premature (and potentially destructive) because the likelihood of guessing wrong is high.

Therefore, it is usually safer, particularly in the early stages, to make a lot of small bets in new ventures. Many experiments will help educate the company on the best eventual path. As Thomas Edison used to say, the benefit of doing lots of experiments is that you learn what doesn’t work. Then you can concentrate on the things which do work.

In other words, if you want to be in the right place in picking new ventures, first put yourself in a lot of places. This doesn’t mean that you should just randomly pick things to experiment on. Every experiment should be consistent with the over-arching strategy and should try leverage current strengths. But that still leaves lots of opportunity.

One of the strengths of Google is its constant experimenting into related businesses. Most don’t pan out, but by doing so, they find the few nuggets which pay off big. They put themselves in a lot of places in order to eventually be in the right place.

Rule #3: If you want the right experiments to move to the next level, don’t predetermine expectations.
One of the most critical elements in experimentation is knowing when an experiment is not working and needs to be dropped. Quite often, there is a tendency to continue to waste resources long after the project should have been dropped.

As we discussed in the prior blog, there is a hesitancy to drop a project if a company is already psychologically attached to it due to prior expectations of success. The pressure to fulfill those expectations can make us throw good money after bad and keep bad projects alive.

Therefore, in the early stages, do not assign quantifiable expected goals for an experiment. For example, don’t start six experiments and say from the start that you expect all six to each place a million dollars of profit on the bottom line next year. At that point, you have declared them to no longer be experiments. They are now projects that must be completed in order to achieve that predetermined goal. It is almost impossible to pull the plug on them now, even if they are bad, because expectations have been set under the presumption that it must succeed and make $1 million.

A better approach would have been to say that we don’t know which of the six experiments will work, but somewhere in here is a multi-million dollar success story. That way, if one of the experiments does not appear successful, it is easier to drop it early, when losses are small.

SUMMARY
Setting ambitious goals is often a good early step in planning. However, trying to get all of the extra performance from a single source can be quite risky. It is usually better to take a balanced approach, looking for gains from both current business and new ventures. For current businesses, focus on new ways to do things, since the old ways produce the old results. For new ventures, experiment in the early phases on multiple ideas, and then prudently stop investing in the experiments which do not work.

FINAL THOUGHTS
Another quick way to lose weight is through amputation, but I don’t recommend it. The side effects are worse than the benefits. Similarly, a quick way to gain sales in a business is to make a big acquisition. Since most big acquisitions end up destroying value, I would think long and hard before making that choice. Lots of sales growth isn’t worth much if it destroys profits.

Strategic Planning Analogy #153: Gaps & Plugs Part 1

THE STORY
Although Wal-Mart is on the leading edge of technology today, this was not always the case. Back in the early 1960s, when Wal-Mart was first starting out, its systems were very crude.

The accounting system consisted of a bunch of pigeon holes on the wall of the office—one pigeonhole per store. The paperwork for each store would then be stuffed into its appropriate pigeonhole. Once a month, the paper would be taken out of the holes and Sam Walton and Wanda Wiseman would close the books.

Not wanting to waste a lot of time doing paperwork, Sam Walton came up with a way to really speed up closing the books. He called it the ESP method. This is how Sam Walton explained the method in his autobiography:

“It’s a pretty basic method: if you can’t make your books balance, you take however much they’re off by and enter it under the heading ESP, which stands for Error Some Place.”

THE ANALOGY
Sam Walton used a simple plug to make his books balance. The plug was needed because Sam did not know how else to bridge the gap in his books.

A similar situation often occurs in strategic planning. First, one comes up with ambitious goals for the company. Then the core business is examined to see if it can achieve the ambitious goal. Many times, the core business appears to fall short of the goal. This creates a “planning gap.”

The question then is how to plug this strategy gap. One approach is to just make-up a line in the plans and stick the gap there, sort of like what Sam Walton did with his accounting books. Perhaps instead of calling it ESP, we could call it USP—Unknown Source of Profits.

Unfortunately, just as Sam had no idea what caused his accounting error, this method will give you no idea for how to fill your strategy gap. Your strategic goal in this case has no real connection to your planning activities. Therefore, it should be no surprise that when plugging your goal in this manner, you usually fall short of hitting the goal. The unknown source of profits becomes an unfound source of profits.

THE PRINCIPLE
In general, there are two places to look when trying to fill this gap—current operations and new ventures. The main principle here is that “putting all of your eggs into one basket,” be it current operations or a new venture, is typically sub-optimal. Instead, a more balanced approach between the two is normally more successful.

In this blog, we will examine some of the pitfalls associated with the extremes—either looking to get it all from current operations or all from new ventures. In the next blog, we will look at how a more balanced approach can often be better.

1) Too much Dependence on the Core can Start a Death Spiral
Ambitious goals are not bad, per se. In the book Built to Last, the authors say that successful companies tend to have “Big Hairy Audacious Goals,” called BHAGs.

If a goal is big, hairy and audacious, then it must by definition expect more than what one would naturally receive from current operations run similar to how they are run today. Therefore, by definition, BHAGs create a planning gap with current operations.

One way to fill the planning gap is to place nearly all of the expectations for filling the gap on current operations, even though by definition BHAGs stretch beyond the capacity of current operations. In other words, once the current patterns of expectations are trended out, they are adjusted to become exceedingly aggressive—far more than just stretch goals. For example:

a) Sales growth goals could be raised significantly above historical trends;
b) Cost cutting goals could place expense expectations well below anything ever done before;
c) Performance is expected to improve even though capital spending is curtailed.

Under this scenario, the implications to the company tend to follow one or more of these patterns:

a) Internal Decline: Employees figure out that the goals are unrealistic/unattainable and that they will now have a miserable time being yelled at and no longer get any bonuses. The good people will start to leave the company and the rest will be demoralized. The balance of employees’ time could move from trying to make improvements to trying to “cover one’s ass” and deflect the blame to someone else. Instead of performance getting better, performance will get worse.

b) External Decline: In order to hit the extraordinary near-term goals, the long-term viability will be threatened. For example, to hit unrealistic sales goals, promises may be made that cannot be fulfilled. To hit unrealistic expense goals, customer service could suffer. Lack of proper investment could eventually make your internal processes obsolete. For a short period of time, these tactics could work, but in the long run, they will ruin your future potential. Customers will eventually realize you do not live up to your promises, have lousy service and are obsolete. They will take their business elsewhere.

These two types of decline can put a company into a “Death Spiral.” It works as follows: over time, demoralized employees and defecting customers hurt performance. As a result, the planning gap between ambitious goals and shrinking results gets even larger. With a bigger gap, the pressure increases on the core business, causing even more internal and external decline. Every year it gets worse until the whole thing blows up.

2) Too much Dependence on New Ventures can Start a Money Pit
Although putting all the burden for filling the gap on the current business can lead to a death spiral, it is also potentially dangerous to put all of the burden on new ventures. One of the big problems with new ventures is that they tend to be at least partly outside our range of expertise. Without that expertise, we do not know what a realistic expectation should be for new ventures. Not knowing all the potential pitfalls, there is a tendency to set these goals unrealistically too high.

This can lead to one or more of the following issues:

a) Distorting One’s Risk Profile:
There are two ways this can increase the riskiness of your firm. First, if one wants big rewards quickly, there is a tendency to gravitate towards riskier investments (risk=rewards). Second, to find big results quickly, one tends to focus on fewer, larger ventures rather than a lot of smaller ones. By focusing on fewer, larger new ventures, the likelihood of failure increases, since most new ventures fail and you don’t have a large pipeline of options.

Technically speaking, if your risk profile goes up, then your key stakeholders should demand an even higher return on investment, since they want to be compensated for taking the added risk. This places even more pressure on looking for even bigger near-term returns. Even if you do not increase your return hurdle rate due to extra riskiness, it should be done. Otherwise you may approve projects at the lower rate which would not pass the test at the more accurate higher rate.

b) Hesitancy to Pull Back if News is Bad:
With all the pressure to find a success with a few big new ventures, there is pressure to be overly optimistic in expectations on these ventures. Revenues tend to be estimated on the high range and costs tend to be estimated on the low range. When reality starts setting in—and prospects do not look as bright—there is pressure to keep plodding along anyway. Too much has already been invested, people are expecting a success, there is little else in the pipeline to replace it, and your career may be damaged if you admit failure. As a result, bad ventures tend to live on longer than they should.

c) Throwing Money at the Problem:
When prospects start looking bad and you still want to succeed, a common response is to throw more money at the problem. Since this is a new venture, you may not have a lot of internal expertise to rely on…all you have is money. The hope is that if you throw more good money after bad, something good will turn out. It rarely does, so then you try an additional round of throwing money at the problem.

d) Current Business Envy:
With all of the attention and glamour given to the new venture, those working on the current business could feel left out and jealous. All the good people may shift over to the glamour side of the business, which hurts current business performance. Or, to keep them working on the current business, you may need to throw some additional money in their direction.

As a result of these four possible results, a focus on trying to get too big of a return too quickly on too few new projects can create a money pit—a place where you keep throwing money, but see little in return.

SUMMARY
Setting ambitious goals is often a good early step in planning. However, if you have no idea of how to achieve those goals, you will most likely not achieve them. In general, there are two sources for filling the gap between current trends and an ambitious goal—current operations and new ventures.

As we saw in this blog, too much reliance on only one of these sources will tend to lead to problems, so the goal is still not met. In the next blog, we will see that a more balanced approach tends to be more successful.

FINAL THOUGHTS
Studies have shown that smaller, consistent increases in performance improve stock prices more than large promises which are never realized. Too much blind ambition can be a hindrance.