Strategic Planning Analogy #279: Trends Change, Not People

THE STORY
When I was a teen, my observations were that young people drank Coke and older people drank coffee. Now, decades later, it seems that it is the younger crowd that is patronizing the coffee shops and drinking the coffee in large quantities. If anyone is drinking a Coke, it tends to be an older person.

The same with hair color. When I was a teen, I observed that if there was a woman with bright blonde hair, she tended to be a relatively young adult. Older women had more subdued colors. Now, decades later, it seems that the bright blond colors are on the older women and the younger women use more subtle highlighting.

It’s as if all of the rules I learned as a teen no longer apply.

THE ANALOGY
The problem with the rules I came up with as a teen was that I was linking a trend to an age. In other words, I believed that when people reached a certain age, they should act a certain way.

Instead, I should have linked a trend based on date of birth. In other words, people born at a certain time have a particular characteristic they will carry on throughout adulthood. The next generation is not bound by the old trend and so they start their own, which they carry on throughout their adulthood.

It isn’t so much that people’s beverage preferences change completely as they get older. It’s that the “cool” drink in the formative years changes from generation to generation. Depending on that was “cool” to drink at that formative age, that became the beverage of choice you carried with you as you aged.

A couple of generations ago, that cool drink was Coke. Now, it’s some fancy form of coffee (or maybe an energy drink). I suppose in another generation or two, young people will find something else “cool” and it will be the old folks who drink the fancy coffees (who are those same people who picked up the coffee habit when they were young and when coffee was cool).

This concept has been particularly true with beer brands over the ages. A particular beer brand is cool when drinkers are starting out, and they tend to stick with that brand through the rest of their life. The next generation chooses another “cool” beer brand and sticks with it. And so on.

So what does this imply for strategy? Strategies try to find the ideal place for your firm in the future. To find that ideal place in the future, it is important to first have an accurate view of the future.

As you try to imagine that future world, you can fall into the trap I did as a teen and incorrectly assume that younger generations will revert back to the behavior of the prior generation when they get older. I had thought that young people would always prefer Coke and old people would always prefer coffee, no matter when you were born. That was an incorrect assumption.

A better way to predict the future is to look at how each generation forms its habits in those formative years, and use that as a guide for how each generation will adapt to the future.

THE PRINCIPLE
The principle here is that trends change faster than people change. The next revolution in behavior tends to start with the generation still forming its life-long habits. Those who already have long-ingrained habits change far more slowly. As each new generation arrives, there is the opportunity to create a new trend, even if the older folks hesitate to participate.

This principle should lead to the following concepts.

1. Don’t look to the older people of today to predict how the older people of tomorrow will be
Back in the 1980s, I remember reading predictions about shopping behavior. At that time, the older people were shopping Sears, while the younger adults preferred shopping discount stores and specialty stores. Some prognosticators at that time were predicting that when the younger customers became old, they would switch store preferences to Sears, since that seems to be what older people do.

Well, here we are at the point when those younger shoppers from the 1980s are older. And guess what…they did not automatically start switching over to shopping Sears. Sears’ customer count continues to drop.

Those prognosticators in the 1980s made the mistake I did as a teen and associated behavior with an age rather than with when you were born. Sears is losing customers because the ones who were in their formative years when Sears was cool are dying. The next generation stayed with the same basic habits they formed back in the 1980s. They didn’t say they needed to switch to Sears when they got old because “that’s what old people are supposed to do.” Instead, they said, “Sears is the store for my parents, not me.”

Buick has been trying for years to get young people to embrace their brand. Unfortunately, Buick tends to be associated with a much older generation and it is hard to dislodge that image.

For young people, Buick is not the cool brand of their generation. And when today’s young generation gets old, I doubt they will suddenly switch to driving Buicks. They won’t think that “Old people drive Buicks, so now that I am old, I should drive a Buick.” No, unless something dramatic happens, Buick’s fate appears tied to an earlier generation and its best years will die as that older generation dies.

The same is true for newspapers. For awhile, many newspaper folks were not afraid of the internet because they thought that as the young adults got older, they would become more like their parents and switch from the internet to the newspaper. You don’t hear those comments much anymore, as people realize the new generation is never switching to paper for their news as their parents have habitually done.

This is not to say that older people never change their behavior. They do. However, those changes are not because they say “I’ve gotten old now, so I have to start acting like my parents did.” Instead, the changes tend to occur because:

a) Their relative discretionary time versus discretionary money changes over their lifetime (we act differently when we are time rich and cash poor versus when we are time poor and cash rich).

b) Their physical abilities change (older people have poorer vision, weaker stomachs, and are less mobile—perhaps no longer able to drive themselves).

c) Even though they may not be trend-setters, older people will switch to the new if it is found to be vastly superior (for example, the elderly eventually saw the benefit of the internet for their lives). In this case, they are not changing to be more like their parents, but to be more like their children.

2. Don’t look to the younger people of today to predict how the younger people of tomorrow will be
Each generation has its own defining moments. Those who grew up in the depression of the 1930s had a different outlook from those who grew up in the prosperous 1950s versus those who grew up in the turbulent 1960s, versus those who grew up in the materialistic 1980s, versus those who are growing up in the current age of terrorism.

Times change; technology advances. A person who has been tapping on a computer keyboard since the age of three sees technology a lot differently from one who first typed on a computer in their 20s. The “cool” behavior of one generation becomes “the weird stuff my parent’s did” to the next generation.

“Cool” communication has morphed from email to IM to texting to tweeting. We’ve moved the core cool internet page from portals to search engines to social network sites. The cool thing of tomorrow may not even be invented yet. So don’t assume today’s definition of cool will last.

It’s difficult to stay relevant and cool for each new generation. MTV has had to reinvent itself many times over in order to have its brand still be relevant to each young generation (and it appears to be losing the battle). Perhaps a better approach is to emulate Pepsi, who adds new brands to its portfolio in order to be relevant to each new generation, from Pepsi to Mountain Dew to Gatorade to SoBe.

Therefore, when envisioning the future, assume some behavior patterns which do not yet even exist. Better yet, try to create that next cool thing.

SUMMARY
Behavior patterns tend to follow generations. Therefore, it is often a mistake to use one generation’s patterns in order to predict a different generation’s patterns.

FINAL THOUGHTS
All of this change is good, because it provides a competitive advantage to those who know how to exploit it. If things never changed, we’d all still be shopping Sears.

Strategic Planning Analogy #252: The Price is Wrong

THE STORY
Back in the 1990s, the warehouse industry was starting to explode. Firms like Costco and Sam’s Club were growing like crazy, taking market share away from traditional supermarkets.

I worked for a traditional food retailer who believed that the clubs were getting an unfair advantage. The belief was that traditional supermarkets were paying full-price to the manufacturers for product.

By contrast, it was believed that the clubs were getting preferential pricing. The manufacturers were spending extra money to bundle their products into larger “club packs.” Yet even though the manufacturers took on extra costs to make these club packs, the clubs were paying less money for their product.

The rationale? The club business was seen by the manufacturers as a small incremental business. As a result, they were only charged for the incremental additional cost to serve them. The core expenses for development and infrastructure were only passed on to the core supermarket customers. At least that’s what they thought at the company where I worked. And they didn’t like the idea of subsidizing the manufacturer so that the clubs could get a cost break.

To test the theory, we opened up some warehouse clubs of our own. That way, we would be able to see the actual types of prices being charged to the clubs. If we could prove the theory, we were going to make a big stink about it.

Well, the manufacturers figured out what we were up to, so most manufacturers either refused to deal with us or they offered the identical deal that they were giving to our supermarkets. Soon thereafter, we had to shut down the experiment.

Of course, it didn’t take long for consumers to see the lower prices in the clubs.

What’s happened since then? Well the combined sales of Costco and Sam’s Club are now over $115 billion. Traditional supermarkets have lost a ton of market share. Clubs really aren’t incremental business any more.

THE ANALOGY
A key part of strategy has to do with pricing. What is the best pricing strategy? Price too low and you forego potential income. Price too high and sales may vaporize.

A key part of pricing struggle comes when you are pricing your product into two different distribution channels, like clubs versus supermarkets. Manufacturers in the early years appeared to give the clubs a price advantage by treating them as incremental business that only needed to cover incremental costs.

Of course, when you give one channel the advantage, you are creating a market dynamic which favors one channel over the other. Market share shifts will follow. In the long run, that can be a problem, because if the core business shrinks too much, there is nobody left to cover all of the core costs. Incremental pricing won’t pay all the bills.

THE PRINCIPLE
The principle here has to do with understanding the long-term consequences of incremental pricing. This is particularly important in this digital age. The incremental cost of adding a digital component to a core business is virtually free. Adding a digital news component to a newspaper company adds virtually no incremental costs. Adding a digital sales channel for selling songs adds virtually no additional costs to the recording label. Adding a digital sales channel to a travel agency adds virtually no additional costs. And so it goes in the digital world.

The problem comes when these new digital channels are priced out at the incremental cost added by that channel. Since the added costs are virtually free, one can charge virtually nothing and still appear to be putting extra profit on the bottom line.

Of course, this only works if the core business can still absorb the core costs. Although a digital newspaper may be virtually free to produce if you have a healthy newspaper to cover the core costs, what happens if the paper version of the newspaper goes away? That news-gathering organization is very expensive. Somebody has to pay for it. If you give away the digital version, it cannot absorb these costs.

This is a real problem today. Large newspapers like Denver’s Rocky Mountain News and the Seattle PI are gone. The Detroit newspapers only home deliver a couple of days a week. Tons of smaller papers have or will soon be calling it quits. There are rumors that even big papers like the Boston Globe and San Francisco Chronicle may soon cease to print newspapers.

It used to be that newspapers had one of the largest profit margins around. Traditionally, the most profitable part of the newspaper was the classified section. Digital sites like Monster.com took away the job classifieds and other sites took away the car classifieds. Others, like Craig’s List and EBAY took away a lot of the rest.

Then the younger generations stopped buying the papers and got their news off the internet for free. So the newspapers lost their most profitable advertising and a big chunk of their customers. And when newspapers lost a generation of customers, they became less desirable for other advertisers. Suddenly, papers like the Seattle PI were losing $14 million per year.

The same thing is happening in the entertainment industry. With the sales of CDs vaporizing, there is not enough money coming in to pay the bills in the music industry. The small, incremental prices for music (often free) on the internet are not making up the difference. People are scrambling to find a new business model. Although there is no consensus on what that new model will be, there is an agreement that the profitability of the entire music ecosystem has permanently shrunk and there is a lot less money to share with all the players.

Digital travel sites were priced so low that the traditional travel agent industry is virtually gone.

So, what can we learn from this?

RULE #1: Price Favoritism Eventually Leads to Market Share Favoritism If one channel is given a pricing advantage, it will eventually get a market share advantage. The channel that only pays the incremental cost gets an advantage. It can price cheaper in the marketplace, because it isn’t burdened with its fare share of the non-incremental costs.

Consumers tend to prefer paying less rather than paying more, so market share shifts to the one with the pricing advantage, be that wholesale clubs, digital news, digital music, digital travel, and so on. It might not happen overnight, but it will happen.

As the subsidized product gains share from the non-subsidized channel, eventually the whole idea of incrementalism becomes invalid. The subsidized product is now too large to be just incremental business. It is becoming the new core. Conversely, the old core business is no longer large enough to cover the core costs.

RULE #2: Once a Low Price Has Been Established as the Norm, It Gets Sticky
Now, one has a problem. Expectations have been set. People expect digital products to be essentially free. This expectation becomes sticky in the mind of the customer. They are resistant to start paying a lot more for something that they used to get for a lot less.

Therefore, it is extremely difficult to raise prices to cover the core costs once the lower incremental price has been set. As a result, supermarkets are going away, newspapers are going away, travel agents are going away, and so on. The business model is broken and it is very difficult to fix.

The solution?

1. Consider the potential long-term market share shifts when pricing to a new channel. Ask what happens when this little side business becomes the main business. Does the model still work?

2. Try to work early in the conversion to set the pricing expectations for the new channel, since it is difficult to change expectations after they are set.

3. Look for ways to reinvent the core, so that it can still be supported. This may require a whole new business model, where costs may need to be shared with competition, or revenues may need to come from new sources (like advertisers).

4. If the business model looks like it could be in serious trouble due the channel shift, sell out early. The folks who sold out of the newspaper business a few years ago were the smart ones.

SUMMARY
When new distribution channels show up, keep in mind that your near-term decisions on how to price to that channel can have serious long-term consequences. Think out the whole scenario before making a hasty pricing decision just on incremental costs.

FINAL THOUGHTS
Many young cartoonists have recently given up their profession. Newspapers cannot afford to take on new, unproven cartoons. The new cartoons are all over the internet for free. Without an income, these cartoons are disappearing. And that’s not funny.

Mighty Canoes

THE STORY
From the late 1700s into the early 1800s, one of the most strategic locations in North America was the Straights of Mackinac. Located between the Upper and Lower Peninsulas of Michigan, this narrow waterway connects two of the great lakes—Lake Michigan and Lake Huron. It is also not very far from the mouth of Lake Superior. Whoever controlled the Straights of Mackinac controlled the lucrative fur trade, which brought great wealth to whomever was in charge.

To ensure control of the straights, a fort was built on Mackinac Island, located just to the east of the straights. For a time, the British controlled the fort, but after the American Revolutionary war of 1776, it was given to the Americans. The key feature of the fort was the wall of cannons on the south side. These cannons were strong and powerful—able to shoot cannon balls long distances towards attacking war ships, which would by necessity need to approach from the south.

This defensive wall of cannons gave the Americans so much confidence that there did not appear to be a great need to fortify the fort with many soldiers. Only about 60 were deemed necessary. After all, the ships would be blasted away by the cannons before reaching shore, so hand to hand combat seemed remote.

When the War of 1812 was declared, the British saw this as their opportunity to retake Fort Mackinac and regain control of the fur trade. Enlisting the help of their Native Indian allies and some of the fur trappers, the British used mostly canoes to quietly paddle their way to the north side of the island in the middle of the night. They dragged a small cannon onto shore and up the hill towards the fort.

At daybreak, the British fired a single warning shot from the cannon, awakening the American soldiers. The Americans found themselves in quite a predicament. First, their defensive cannons were on the wrong side of the fort. Second, even if they could quickly move them to the other side, they would be worthless, because the cannons were designed to shoot far out into the water, not down the side of the hill. Third, the Americans were well outnumbered by the British, the Indians and the trappers.

As a result, the American commander Porter Hanks surrendered the island to the British without firing a single shot.

THE ANALOGY
Be it armies or businesses, we all tend to fortify our defenses at the point where we believe we are most vulnerable to attack. In the case of the Straights of Mackinac, if an army of warships were to come, they would most likely come up through Lake Huron from the more populated areas to the south. Hence, the fort was built to defend that type of an attack. Thinking like an army, they assumed their primary enemy would be an army just like them—someone who would use warships.

Indians and trappers, however, do not have war ships. They use canoes. As the Indians and trappers were gathering in the region to join up with the British preparing for the attack, they did not appear to be a threat. Indians and trappers canoed through the area all the time. They were not soldiers.

Although a warship cannot attack Mackinac Island from the north, canoes can. Because the Americans were only prepared for a conventional attack by like-minded soldiers, they were unprepared for a northerly attack from what appeared to be harmless canoes. Instead, they turned out to be mighty canoes.

This same problem often happens in business. Our best laid strategic defenses turn out to be worthless because they prepare us for the wrong type of war.

THE PRINCIPLE
The problem here is that we tend to look in the wrong direction when it comes time to create a strategic defense. The problem is twofold:

1) Looking Backward Rather Than Forward
2) Looking Inward Rather than Outward

Each of these will be looked at separately and then shown how they worked together to hinder a recent battle in the business world.

1) Looking Backward Rather than Forward
There is a tendency to believe that the next strategic battle will be fought in a similar manner to the battles of the past. The expectation is that relatively similar weapons will be used and that relatively similar tactics will be used. Therefore, when preparing a defense, there is a tendency to prepare to do a better job against what we have seen in the past. In other words, our preparation makes us ready to win a war that is already over.

History is shown that each new major war is fought with a different type of weapon and a completely different set of tactics. These render defenses prepared for fighting wars the old way obsolete and relatively useless.

For example, after World War I, France spent a considerable amount of time and money preparing a strong defense against any future attack by Germany. It was designed under the assumption that Germany would attack the second time the same way they did the first time—with slow, protracted, stationary battles. France was confident that if Germany tried the WWI tactics again, they would fail against the French defense. However, in WWII, Germany used a new mobile “blitzkrieg” approach for which the French were not prepared. The French defense proved to be worthless.

The Americans at Fort Mackinac expected a warship attack, because that was the traditional approach of the past. They were not prepared for a new type of war using canoes.

Rather than looking backwards in time to find our inspiration for strategic defenses, we need to look forward and anticipate how the next battle might look, and how it will be different from past battles. That is why a key component of strategic planning involves spending time trying to envision potential future scenarios, to answer questions, like:

A. What the future environment will be like?
B. How consumer needs and desires will evolve?
C. What non-tradition opportunities and threats could crop up which better fit the future environment?
D. What will it take to win in that future world?

One thing we probably count on is the fact that what worked in the past will not work in the future. Therefore, we need to prepare ourselves for new types of battles with new types of tools. Just as the Americans at Mackinac should not have rested in the confidence that the big cannons would always protect them, businesses should not rest in the fact that the tools which worked for them in the past will always for them in the future.

2) Looking Inward Rather than Outward
The American soldiers made the mistake of thinking that their enemy would be a lot like them—professional soldiers trained to fight traditional battles. Instead, they got Indians and fur trappers. Businesses do the same thing in thinking that our enemies will be similar to us.

If you are the cola leader, like Coke, you may see the enemy as another cola, like Pepsi cola and prepare to win the cola wars. Instead, the new enemy is sports drinks, fortified beverages, energy drinks and the like. Pepsi caught on to seeing the potential new enemy as being a non-cola sooner than Coke and has reaped the benefits.

In many cases, the most potent enemy does not look like us at all. Rather than looking inward at our own narrowly defined industry to find enemies, we need to look outside our industry. Strategic thinking can help us find the new enemies lurking outside our traditional industry, ready to gobble up our market share.

Newspapers Vs. the Internet
For most of the second half of the 20th century, newspapers in the United States had a virtual monopoly in their home market. They were strong; they were powerful. They were confident that nobody was going to be able to start up a new newspaper that would cause any serious damage to their near-monopoly. Owing the local newspaper was like owning the big cannon, ready to take on anyone who wanted to build a rival newspaper.

Then, at the end of the 20th century, the internet started to get used by people other than scientists and researchers. To the powerful newspapers, the internet looked like little canoes going by—no big threat. After all, we’re in the newspaper business. The internet is not a newspaper…not even close. Who would ever place an ad on something like that?

Eventually, the internet became a very viable information source. It used new tactics that were foreign to the newspapers:

1) Fresh news available 24 hours a day.
2) Ability to interact with the news and other readers of the news real-time, using Web 2.0 technology
3) Customize the news so that you only get the news you wanted
4) Combine news from multiple sources
5) Make the news available for free

These young internet upstarts did not act like newspaper people. What’s the matter with them.

Well, now the newspapers are fighting for their lives against the digital world. Because they looked backwards to the past (this is how the news had been done and will always be done) and they looked inward at the newspaper industry (instead of looking outside for threats), they caught on to what was happening too late. The mighty canoes of the internet are winning the war.

SUMMARY
A good strategic defense needs to be based on looking forward (at what the new tactics for success will be) and outward (at players who are not a part of your traditional industry). Strategic planning is a process which helps one look forward and outward.

FINAL THOUGHTS
Of course, traditional internet players cannot sit back and think they’ve won the war any more than the newspapers before them. New threats, new tactics, new players will show up to threaten them as well. For example, will mobile phones change the rules so that the money is made at the carrier level instead of at the content level? Will users take over the content and leave out the internet content players? And so on…