Strategic Planning Analogy #576: How Strong is Your Foundation?

THE STORY

I think the scariest commercials on TV are sponsored by the companies that rebuild house foundations. They talk about how—if you neglect your house foundation—it will collapse and your house will be ruined. That sounds pretty scary to me.

THE ANALOGY
Businesses are like houses. They are built upon a foundation. The better that foundation, the stronger that business will be. Strategic planning is a tool to help build a strong foundation for your business.

But let’s take this deeper. Even the process of strategic planning is built upon a foundation. If the foundation behind your strategic planning is weak, it will become a weak tool in helping to build the foundation of your business. So if you want a strong business foundation, you first need a strong foundation in your strategy process.

THE PRINCIPLE
To me, the foundational assumption behind long range strategic planning is this:

“By planning, an organization can minimize its risk for failure by taking greater control over how its destiny will unfold.”

This is the foundation behind strong strategic processes. Focus your process on adhering to this foundation and the process will be strong. Focus on anything else and you may just end up wasting your time. And then, your organization’s foundation will also falter.

There are two key words in this foundation that I will focus on here: risk and control.

1) Risk

Nothing is certain in life except death and taxes. Everything else fluctuates in complex, interdependent ways. Strategies are built to be executed in such an uncertain, interconnected world. In fact, the mere exercising of your strategy will change the environment it is being executed in. 

Therefore, strategies cannot be structured in such a way as to guarantee success. There are too many variables. The best you can hope for is a reduction in the risk of failure.

As a result, a good strategic process will spend a disproportionate time focusing on those vulnerabilities where you are at greatest risk. These are chosen based on two criteria:

a) What situations will have the greatest impact on my chances for success?

b) What are the areas most uncertain in knowing how they will unfold?

If something has both high impact and high uncertainty, then it should be a key part of your strategic discussion. After all, a high impact, uncertain situation has the greatest potential for increasing your risk of failure.

Often times, these may be items that fall outside what is traditionally focused on in strategy. Yes, there is a place for mission statements, values, core competencies, goal-setting, metrics, and the like. But if you don’t spend enough time addressing the high risk issues, the other activities will not save you. You will be blindsided by a future that surprises you and you are unprepared for.

That is why scenario planning and contingency planning can be such valuable strategy tools. Scenario planning can help you discover the risky areas to focus on and contingency planning can help you prepare your responses to these risks so that you can minimize any negative impact.

This leads to a second aspect of risk. Because the environment is constantly changing, you cannot address all of your risks in a single, one-time strategy document. The world is dynamic, so the strategy process must be dynamic as well.

Notice that I keep using the word strategy PROCESS. Strategic planning should not be seen as a single annual event, but as an ongoing process which happens whenever there are decisions to be made. If you want to increase your likelihood for success, you need a strategic approach that adapts to the changes around you and helps you make the everyday choices that reduce the risk of failure.

This does not mean that your basic strategy will keep changing every day. A strategy with no lasting impact is worthless. But you may need to switch to different (well thought out in advance) contingencies as the future reveals itself.

As soon as you realize that strategic planning is about minimizing risk rather than about creating a perfect plan, you will see the folly in many strategic processes that spend way too much time trying to craft “perfection.” “Direction” is more important than “Precision” when it comes to planning. If I know my desired endpoint (i.e., direction), I will know what to do when all the changes occur: adapt so that my endpoint is still in front of me. However, if I only have a detailed roadmap as my plan with clear steps on what to do (i.e., precision), my organization can quickly become lost if the future blows up one of my steps.

Don’t waste time trying to create the perfect planning document. Instead, use that time to create the right general strategic framework (which minimizes my risk of failure).

2) Control

The second key word is “control.” Even though one cannot gain full control over the future, it is possible to increase one’s control over the future through planning. As Peter Drucker once said “The best way to predict the future is to create the future.” In other words, the more control you have over how the future is created, the less uncertainty and risk there is in the future. Therefore, one of the most important parts of good strategic planning is planning how to increase your control over how the future is created.

One thing I know for sure is that if your organization is not focused on increasing control, it will lose control to someone else who is  focused on increasing control (on creating a future that is detrimental to your organization).

This really gets down to the issue of power. The more power you have, the more control you have. And if you have both power and control, you can create strategies with less risk of failure.

Power is a relative term. To say one has power means that you have a greater ability to control the future than others who are also trying to influence how the future is created. Therefore, an analysis of power is very external in its orientation. It requires a deep understanding of all the players who can impact how the future unfolds. They may be current or future competitors, legislators, influential consumer groups, or whatever. Don’t limit your thinking here.

Your task is to figure out how to maintain your current power within this environment and increase it over time. This can include topics such as size/scale, public relations, lobbying, alliances/joint ventures, the setting of international standards, control of patents, branding, acquisitions, speed to market, and so on. You need to convince the world to march to your beat and heed to your rules (the ones which give you the advantage). Are these issues/topics part of your strategic agenda?

This idea of building strategies which increase control was a key point of focus in my previous blog, seen here.

This is one of the key advantages of the Blue Ocean strategy. If you focus on building a strategy in a place where there aren’t any rules yet, you have a better shot of gaining control over how those rules are written. There is often a better shot at creating the future if you go to a place where there is not an entrenched competitor who already has control (provided you enter the blue ocean with power).

How much of your strategic process is focused on internal issues versus trying to gain control of the eternal environment? My guess is that your process probably needs to increase the time spent on gaining external control.

SUMMARY
One’s foundational philosophy behind strategic planning will determine the type of planning process you adopt. I believe that the foundational philosophy that creates the best strategic planning process is this:

“By planning, an organization can minimize its risk for failure by taking greater control over how its destiny will unfold.”

This foundation will lead to a greater focus on the external issues of minimizing risk and controlling power. And that has the greatest return on your strategic efforts.

FINAL THOUGHTS
Some say that planning is no longer valuable because the world is changing too quickly. Well, if your strategic process is focused on the wrong foundation, that statement is true. However, if your strategic foundation is focused on minimizing risk, increasing control, and long-term destiny, then it is more important than ever.

Strategic Planning Analogy #516: Avoiding Driveways

THE STORY
My wife and I disagree on which types of roads are safer. I think expressways are safer. She thinks city roads are safer.

My logic goes like this: Accidents happen when the unexpected happens (like someone turning off or entering the street) or when change occurs (like a change in speed). By that reasoning, on a city road every driveway, every parking lot entrance/exit, every intersection, every stop sign, every traffic light is a place where an accident can happen, because they are potential sources for the unexpected or change. So, in a few miles of city driving, you may drive past literally thousands of these potentially dangerous locations.

By contrast, on an expressway, I only have to worry about the few cars immediately surrounding me and the rare entrance/exit ramp. That’s a lot fewer potential accident triggers.

My wife’s logic is simpler. The higher the speed, the more dangerous the accident, so drive on slower roads to be safer.

THE ANALOGY
Business strategies can take you on many journeys, including acquisitions, joint ventures, start-ups, brand extensions, new geographies, new customers, and so on. And statistics show that most of these actions end up as failures. There is no safe alternative—acquisitions, joint ventures, start-ups and other business changes all are statistically more likely to fail than succeed.  

It’s like driving when you know that you are more likely to have an accident than not. It’s enough to make one hesitant to get in the car.

But if you don’t get in the car, you will never reach your strategic destination. And because of all the changes in the environment, the status quo will eventually become obsolete. Therefore standing still is not an option, either. It too will eventually be a failure—a horrible accident.

So the business strategy dilemma is similar to the one in the story: What is the safest route to take to avoid terrible accidents?

THE PRINCIPLE
The principle here is that tactics like acquisitions, start-ups, joint ventures, and diversifications are not by themselves the salvation of your company. In fact, they statistically increase your risk for failure. Instead of being your salvation, they are merely tools—and dangerous ones at that. To be successful, one needs a strategy for how to use these tools—a path which optimally avoids most of the accidents which often accompany these tools.

So which path should one take:

1. My wife’s approach (go slow in the city to avoid the biggest accidents);
2. My approach (go fast on the expressways which avoid the uncertainties which increase accidents by avoiding driveways and intersections);
3. Or a combination of paths?

Going Slow

Applying my wife’s advice, the answer would be to go slow. In some cases, that is good advice. Remember, the strategic goal is not to be the first to arrive, but the first to succeed. A strong and savvy follower is often more successful than the reckless trailblazer. As the old saying goes in US westerns, it is the advance scout who gets hit with the most arrows.

For example, Coke did not invent diet cola or cola in cans or caffeine-free cola or sports beverages or pretty much any other beverage innovation in the last 50 years. Yet, Coca Cola is a leader or strong player in just about any non-alcoholic beverage segment currently in existence. Why? Coke is a great fast-follower. By building superiority in distribution, points of customer contact and marketing, Coke can overcome the small innovators over the long haul. Coke lets everyone else take all the risks and then—once a successful innovation becomes apparent—they swoop in and eventually take over. They let other, faster people have all the accidents.

There are several effective tools in the “go slow” approach, like stage-gating and real options. The basic idea is to chop up a grand goal into smaller sub-goals. You aim for the nearest sub-goal. Depending on the success of that early effort, you will make changes in subsequent sub-goals or perhaps halt the project completely. This keeps all your accidents small.

A similar approach is doing a lot of beta-testing. Rather than speeding as fast as possible down a path, you pause to consumer-test the concept and make adjustments based upon the tests. Amazon is famous for doing a lot of testing.

However, the “go slow” approach often has its limits. Sometimes, the dynamics of the market do not provide the luxury of going slow. Faster competitors can get too much of a first-mover advantage (not all of us have as much power to overcome as Coke).

And even the “go slow” approach can eventually require big moves into big acquisitions, big joint ventures, big divestitures and the like. So even though you have eliminated some of the potential accidents, there can be many more that the go slow approach cannot avoid. So going slow it may be part of the solution, but it is not the whole answer.

Avoiding Driveways

So that leads to my go fast approach on the expressways. Accidents are minimized on the expressway because many of the causes for accidents are taken away—driveways, intersections, stop signs and traffic lights.

The business equivalent to avoiding driveways is to look at where the inherent risks are in each business tactic and then try to eliminate them. For example, key sources of accidents in joint ventures come from items like divergent objectives, conflicts between core businesses and the joint venture, governance issues, power issues and so on. The more you can eliminate these sources of accidents up front, the fewer the accidents. These are joint venture equivalents to driveways, intersections and stop signs. The more you can specifically eliminate risks in these areas, the less likely your joint venture will have an accident.

Similarly, in acquisitions many of the risks have to do with things like over-evaluating synergies, paying too much, poorly integrating the two companies, dealing with divergent corporate cultures, underestimating negative customer reactions, and so on. If you can eliminate these sources of accidents, your acquisition is more likely to be successful.

The folks at McKinsey did research and discovered that the companies which are most likely to avoid accidents in acquisitions are the ones who do a lot of acquisition and have built core competencies in how to do acquisitions well. In other words, the successful acquirers have enough experience to know where all the driveways and intersections are and have competencies in finding paths to avoid them (their expressways).

So the idea here is to first understand the key sources of risk in whatever tactical tool your choose. Then, take a path of implementation which avoids these sources of risk (Better yet, make understanding and avoiding core competencies of the firm).

For example, don’t even try to do a joint venture with someone who has a radically conflicting strategic agenda. That’s like driving the wrong way on a one-way road. You are just begging for an accident. Instead, take the expressway where that intersection doesn’t even exist.

A Combination

In reality, a combination of the two approaches can often work best. Don’t be so hasty that you take needless risks. Taking time out for stage-gating or beta testing can be very prudent. On the other hand, large, gutsy moves may eventually be required to reach a better tomorrow. Rather than delay them too long, move forward quickly, but smartly by proactively avoiding specific areas which are most likely to increase the risk of a failure/accident.

SUMMARY
Tactics like acquisitions, start-ups, joint ventures, and diversifications are not by themselves the salvation of your company. Instead, they are necessary, but dangerous tools which increase one’s risk of failure if used improperly. To improve one’s likelihood of success with these tools, consider the following:

1. Before rushing full speed ahead, take time to de-risk the overall strategy. Consider additional tools like stage-gating, real options, and beta-testing to make sure your ultimate goal is correct.
2. Consider building competencies which can make you a great fast-follower towards good strategic goals “proven” by riskier firms.
3. When implementing tools like acquisitions to reach the goal, understand the risks inherent to the particular tool. Then specifically address those risks prior to acting, so that those risks can be avoided.
4. Consider building core competencies in handling these tools before using them.

FINAL THOUGHTS
So, in a way, I guess my wife and I are both a bit right in our approaches to safe driving.

Strategic Planning Analogy #381: Strategy Backstop

THE STORY
Back when my son was young, we lived next door to a city park. Many times we would walk over to that park to play a little “two-man baseball.”

In two-man baseball, you only have two positions—a pitcher and a batter. The problem occurred when the batter would hit the ball out into the outfield. Since there was nobody in the outfield to catch the ball, the pitcher would have to run out there and try to find the ball in the tall grass. And since there was nobody in the infield to throw the ball to, the pitcher would have to run the ball back to the infield.

Unfortunately, running out to the outfield and back was usually longer than the distance to run the bases. Therefore, any ball hit into the outfield usually scored a home run.

Fortunately, neither of us was all that good at hitting the ball, so that problem wasn’t as bad as it could have been. Instead, we had a different problem. We would swing the bat and usually miss. Since we didn’t have a catcher, the ball would continue to zoom past the batter.

Fortunately, there was a backstop fence behind home plate. Any ball that went past the batter would hit the backstop fence and stop, making it easy to retrieve.

What we really needed was another backstop fence behind the pitcher. The way, any ball hit towards the outfield would be intercepted by the fence and drop down by the pitcher.

THE ANALOGY
The purpose of the backstop fence in baseball is to stop bad pitches and bad hits from flying away into a space where they do not belong, protecting spectators from injury. In the business world, bad things can happen as well. Therefore, businesses look for their own form of backstops—ways to minimize any negative implications when things go wrong.

A lot of research has been done lately into the science of risk. What these studies have found out is that humans tend to put a lot more weight on the negative consequences of a decision and a lot less weight on the positive upside of a decision. In other words, humans tend to make decisions more around the principle of minimizing loss than in trying to maximize gain. It takes an awful lot of positive upside to get us to accept a little bit of downside.

The mathematicians and statisticians will tell us that this is “irrational” behavior. They would say that as long as the upside is only slightly higher than the downside, a “rational” person should move forward.

But consider how risk can impact the career of a business decision maker. If the person makes a decision which turns out badly, they could lose their job. If they make a decision which turns out well, often nothing happens, since that is what was expected. Only when an outcome is outstandingly positive well beyond earlier optimistic expectations does a career get rewarded. Why take on the risk of getting fired unless there is enough upside to provide the chance for personal reward?

I think this explains why scientists find us fearful of a little loss and desiring a huge gain in order to offset the risk. But regardless of whether or not this behavior is “rational,” it is reality, so we need to work with it.

Therefore, if we want a company to embrace a strategy, we need to make sure the leaders feel comfortable about the risk. And that means that the potential downside needs to appear a lot smaller than the potential upside. And one of the key ways to do this is by putting a lot of “backstops” into your strategic plan.

THE PRINCIPLE
The principle here is that strategy is not just about trying to move a company forward. It is also about trying to prevent a company from moving backward. If you ignore the fears of moving backward, you will never get the company to embrace your plan to move forward.

Strategies usually involve change. And with change comes the risk of something going wrong. And when something goes wrong, the negative consequences can be huge. Not only can the company move backwards, but so can people’s careers. This creates fear about adopting the strategy.

Just as backstops in baseball stop balls from taking a dangerous trajectory, strategy backstops try to stop the negative consequences when something goes wrong.while implementing strategic change. By helping to minimize negative consequences, the strategy becomes more desirable to management.

Strategy backstops tend to fall into two categories: Control (Ownership) and Controls (Exit Ramps).

1) Control (Ownership)
For a strategy to succeed, a number of things have to happen to the company’s advantage—a lot of decisions have to go your way. The more other people control those decisions, the more likely they will decide in a manner which is not in your favor. Their strategic agendas may not be the same as yours; in fact, their aims may be the opposite of yours. Therefore, if you want to minimize the risk of decisions going against you, it helps to control as many points where decision-making takes place as possible.

For example, think about access to critical supplies for your business model. If you want to ensure timely access to a sufficient amount of those supplies, you may want to exert more control over your suppliers. Perhaps you need to acquire your supplier in order to ensure that your strategic concerns are their top priority. Perhaps you need to renegotiate your supply agreement.

It appears that Apple is switching suppliers for its memory chips from Samsung to TSMC. Although there are many reasons for doing so, one reason appears to be because Samsung makes devices which directly compete with Apple devices. As a result, Samsung’s strategic goals with their chip supply may diverge at times from Apple’s. By switching to TSMC, Apple should have more control over its chip supplier.

This principle not only works upstream with suppliers but also downstream with distribution channels. Coke and Pepsi have been acquiring their bottlers. The reason is because Coke and Pepsi see the value in increasing the control over how their products are distributed. This is particularly true for the faster-growing non-traditional beverages, where Pepsi and Coke had less contractual control over the bottlers. The ownership created a backstop for strategies around these newer beverages.

Of course, the more of the process you own, the greater are your share of the losses if the process goes badly. Therefore, sometimes a good backstop is to give up some of the ownership. By not having 100% of the ownership, you do not have 100% of the losses.

This is common in Hollywood, where movie ventures are funded by multiple motion picture companies. The risk is shared amongst them. There are lots of ways to structure joint ventures and strategic alliances so that the burden of potential loss is shared, creating a backstop.

Franchising is another example. Franchisees put up the investment capital and take on the risk of the franchisee failing. Ironically, even though the franchisor is giving up ownership to the franchisee, the franchisor is in some ways actually gaining more control. Because the franchisee has a greater vested interest in making the venture a success, they are more likely to help the strategy succeed than a mere employee. So with franchising, you lower your share of any loss while simultaneously increasing the motivation of the operator to make the venture a success. Now that’s a good backstop.

2) Controls (Exit Ramps)
One big bet can look a lot riskier than a many small bets. Therefore, one way to reduce perceived risk is by dicing up one big decision into a lot of small decisions. The more opportunities you have to make decisions, the more opportunities you have to opt out or modify the approach early, before the losses get too large.

Think of it as being like two different expressways. One has exits every fifty miles; the other has exits every mile. If you accidentally find yourself going in the wrong direction on the first expressway, you have to go fifty miles before you can make a correction. On the second expressway, you are never more than a mile from being able to make a course correction. The more exit ramps you put into your strategy, the sooner you can correct course (before the losses become huge).

There are many processes to do this, such as stage gating or real options. The general principles work something like this. First, you develop key success indicators—metrics which help you tell whether or not you are on the right course. These are your controls, like a GPS on the dashboard on your car. Second, you develop a process where there are many opportunities to assess your progress. These are like building lots of exit ramps.

Then you monitor your controls. If the controls say you are off course, you make a correction at your next exit ramp.

What are examples of exit ramps? If you are a retailer, instead of signing up for a twenty year lease, you can sign up for a five year lease with three five year renewal options. That gives you more opportunities to walk away if the store is not performing. If you are in the oil drilling business, instead of buying a property where you think there may be oil, do a short lease to test for oil, with an option to buy later. Design contracts with lots of clauses for opting out if key measures are not met.

Sure, all of these exit ramps may cost you a little bit more, reducing upside potential a little. On the other hand, they reduce the downside risk by a lot. And, in the end, minimizing the downside seems to be more desirable than maximizing the upside.

SUMMARY
If you want people to embrace your strategy, then you had better understand the psychology behind risk. In general, downside potential is weighed far more than upside potential. Therefore, people are more likely to embrace your strategy if there are lots of backstops embedded in the plan to minimize risk. Common backstops include increasing control of key decision points and increasing the number of opportunities to opt out or modify the decision (like stage gating or real options programs).

FINAL THOUGHTS
Since most decision makers want a high upside to compensate for any downside, if you cannot reduce the downside through backstops, then look for ways to increase the upside. For example, Disney tries to leverage its investments into as many selling opportunities as possible. A successful Disney movie can be leveraged into lots of toy sales, amusement park rides, Broadway plays, TV shows, licensing agreements and so on. All of these add-ons make the downside risk on that movie venture appear less threatening.

Strategic Planning Analogy #289: Basic Training

THE STORY
Many people have stories about the terrible ordeal they went through in Army basic training (also known as Boot Camp). They tell about how the Sergeants yelled at them unceasingly and how the Sergeants tried to punish and humiliate them in front of the others.

When my son went through basic training, it was relatively painless. The Sergeants pretty much left him alone. I asked him how he was able to do that. His response:

“I quickly found out that there were two groups of people that got picked on. One group was the laggards, who were having trouble keeping up with the rest. They were yelled at to get them to work harder.

“The second group was those who excelled much better than average. They were yelled at to break their egos. The ones in the middle were pretty much ignored. So I tried to be in that anonymous middle at everything we did.”

Leave it to the army to make “aiming for average” a virtue.

THE ANALOGY
One of the key factors to consider in business decisions is risk. Typically, we try to develop strategies that minimize risk (relative to the reward). Even if we cannot eliminate risk, we try to find ways to manage it so that we are best prepared to withstand it.

My son found a way to minimize/manage the risk of punishment and humiliation in the army. He noticed that the risk increased the further he varied from normal, average behavior, either in a positive or negative direction. By hiding in the middle, with the masses, he could avoid a lot of that punishment and humiliation.

This same principle is true in the business world. As we will see later in this blog, many of the most dangerous risks to your business are at the points where you are the most unlike your peers. There is more safety in the anonymous middle.

THE PRINCIPLE
The principle here is that we need to keep a careful eye on those points in our strategy where were stand out from the crowd, because that can often be the source of some of our greatest risks.

Think, for a moment, about the recent financial crisis. At first, the US government thought that the crisis would only impact the outliers who were overly aggressive in the problem mortgages. Therefore, the government was willing to let Lehman Brothers fail, because it was thought to be a rare outlier. However, once it was determined that the financial crisis was going to devastate the anonymous middle of the financial world, the US government put into action a massive bailout program to try to save as many as possible.

By staying in the middle, the risk was minimized. They got a bailout. But Lehman, by appearing to be a little more aggressive, was allowed to fail.

Or let’s suppose that most of the companies in your industry are headquartered in Country A. You are unusual in that you are headquartered in Country B. In your industry, there are many transactions between Country A and Country B. As the currency exchange rate between the two countries vary, it impacts those inter-country transactions.

For the majority, who are all headquartered in Country A, the currency risk is relatively small. Since they all have the same problem, they can adjust fees to compensate and still make about the same amount of money and still be competitive with all the others headquartered there. However, because you are headquartered in Country B, the exchange rates have the opposite impact on your business. When you adjust, you are out of sync with everyone else—sometimes for the good, sometimes for the bad. Your difference in location increases your exchange risk relative to your competition.

In October of 2009, McKinsey & Company released a paper on managing risk. One of the points made in that paper was that some of the largest risks to your business [what they call risk cascades] come at the point where you are the most different from your competition. To quote the paper:

“Companies are particularly vulnerable to this type of risk cascade when their currency exposures, supply bases, or cost structures differ from those of their rivals. In fact, all differences in business models create the potential for a competitive risk exposure, favorable or unfavorable.”

This creates an interesting dilemma. Most of the writings on strategy emphasize the benefits of differentiation. They explain that it is what makes you different that provides the opportunity to become superior in some way to some segment. To quote Michael Porter, “Strategy is about making choices, trade-offs; it's about deliberately choosing to be different.” I talked about this in greater detail in an earlier blog.

Yet, this same benefit from differentiation also increases your risk. My son avoided risk in army basic training by avoiding differentiation. Yet we, as strategists, know that this is not an option for us if we want to excel.

That is why the McKinsey article goes on to say, “The point isn’t that a company should imitate its competitors, but rather that it should think about the risks it implicitly assumes when its strategy departs from theirs.”

You may currently be taking comfort in the elaborate and sophisticated strategy you have put in place. However, a small detail, such as being located in the wrong country, could create a currency risk that puts that entire strategy in jeopardy.

Therefore, when looking for points of risk vulnerabilities, don’t just focus on the grand design of your strategy. Look for the little details where you stand out from the anonymous middle.

Perhaps you are a little more labor intensive, or a little more capital intensive, or you rely on a different set of suppliers. Whatever it is, that little difference puts you at odds with the rest of the industry. That means that when there are corresponding market shifts in labor costs/availability, capital costs/availability or supplier costs/availability, you are effected more than the rest of the market, because you have more at stake.

If you are in the anonymous middle, you adjust similarly with everyone else on these issues and get by. You might even get a bailout. But if you are an outlier, watch out, because that difference can radically decrease your competitiveness when changes occur.

It is impossible to keep track of every issue that could possibly impact your business. There aren’t enough hours in the day. As a result, you need to prioritize. Near the top of that priority list should be the issues which arise out of the points of difference in your strategy.

SUMMARY
Although differentiation is a key aspect of a great strategy, it is also a key source of risk. Since we do not have the option of avoiding differentiation in strategy, we do not have the option of avoiding the added risk inherent in that point of differentiation. Therefore, a business’ risk-assessment process should prioritize a focus on the risk factors closely associated with their points of differentiation.

FINAL THOUGHTS
Although it is true that there is “safety in numbers,” it is also true that nothing great ever happens unless you go against the crowds. Hence, risk cannot be avoided if you seek greatness. So rather than avoid it, accept it and manage it.

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.

Hometown Bias

THE STORY
At the height of the popularity of the Dave Matthews Band, I saw a documentary about the history of the band. The documentary makers went back to where the band started in Charlottesville, Virginia. They interviewed some of the people who remembered the early beginnings of the Dave Matthews Band.

One of the people they interviewed was a guy who used to hang out at the first little local clubs where the band played. This guy blurted out, “I knew from the very beginning that eventually the Dave Matthews Band would become hugely famous” (or something like that).

My first reaction upon hearing him was, “My, this guy has a good sense about what music will sell in this country.” Then, I started to think, “I’ll bet that every little garage band that ever started playing in some local bars had some adoring fans who said, “I just know that some day this band will become hugely famous.”

Although every one of these local bands probably had fans who “knew” they would become famous, in reality over 90% go nowhere. That Dave Matthews fan in the documentary wasn’t an astute judge of success. He just happened to be lucky enough to be living in a place that had a local band that was one of the rare groups to actually become famous.

Some of us aren’t as fortunate. Back in the 1970s when I was in college, I enjoyed the music of a local Michigan band called the Whiz Kids. Pat McCaffrey, the leader of the duo, was a highly talented musician. He would simultaneously play the bass using the bass pedals on an organ, while playing keyboards with his left hand and playing a saxophone with his right hand. It was a sight to behold. I “just knew” that the Whiz Kids would eventually become famous.

Well, it didn’t turn out that way. The Whiz Kids never broke into the big-time like Dave Matthews. I went on the internet recently to see if I could find out whatever happened to the Whiz Kids. I found out that on October 9th of 2007, Pat McCaffrey and the Whiz Kids will be performing the after dinner music at the 38th Annual Conference of the “Excess/Surplus Lines Claims Association.” It will be at the Hyatt Grand Champions Resort near Palm Springs. It was nice to see that Pat was still earning a living in music some 30 years later, but I don’t think the “Excess/Surplus Lines Claims Association” conference is the same as the types of gigs the Dave Matthew Band gets.

THE ANALOGY
Strategies are used in businesses in order to help them determine where to place their “bets” on the future. Businesses have limited money, people & time, and they want to invest these limited resources where they believe they will get the best return.

As a result, the strategic process is often used to help find where the next big success will be. They are looking for strategies that will be “winners” for the company. Trying to pick the next winning strategy is similar to trying to predict who the next great band will be.

Just as over 90% of all those local bands never make it to the big time, around 90% of new business ventures never live up to expectations and destroy shareholder value. Every company believes they are betting on the next “Dave Matthews” type of business venture, when in reality, it is more like a “Whiz Kids” outcome (or worse).

In spite of the terrible odds, companies continue to try to pick winners. Take Kraft, for example. In recent years, they have spent a fortune on a huge number of new products and innovations, most of which were duds. The real money comes from things invented long ago, like Oreo cookies (which have been around since 1912) and Miracle Whip (a recipe they bought during the depression of the 1930s for about $300).

THE PRINCIPLE
The principle here is “the hometown bias.” We tend to have a sense of pride around our home-grown ideas and strategies, just as the locals have a sense of pride for their home-grown bands. Just as it is easy to imagine how our local band could become famous, we can imagine how our home-grown ideas can hit the big-time.

This bias can blind us to reality. I spent some time as a radio DJ. It gave me the opportunity to listen to a great deal of music. I tried to analyze the situation to try to see if there were any common factors which caused some of those bands to become a big hit and why some went nowhere. I discovered that sometimes highly talented musicians made it big, and sometimes they didn’t. Similarly, sometimes marginally talented bands made it and sometimes they didn’t. I couldn’t find much of any correlation for factors which created success.

I think the Australian band Skyhooks (one of the bands I heard as a DJ and didn’t make it) put it well in one of their songs. They said that the successful bands find a “million dollar riff” (a lucky twist of music that tickles the ear).

Now I’m not implying that business success is all luck. But it is true that sometimes just as there are only small nuances between a dud riff and a million dollar riff, there are small nuances between a huge strategic success and a dud.

Here are some tips to help avoid some of the duds of strategy:

1) Be aware of the hometown bias.
Realize that there are more Whiz Kids than Dave Matthew Bands and that local pride can blind us to giving too much credit to our homegrown ideas. Stand back and look at it with a more critical eye. If your bias does not let you look at it critically, then use unbiased research to help you see how the concept will be seen in the real world.

2) Realize that pride and egos can distort our judgment.
Examine your options with a dispassionate eye. Although it may hurt our egos for a time, it is okay to stop a pet project if it is starting to look like a dud. Pulling the plug early can often be a very smart thing. It’s not an admission of failure, but rather an avoidance of a bigger failure later.

3) Sweat the Details.
Because the difference between huge success and huge failure in music can hinge on the nuance of a riff, it is really important to sweat the details. Great ideas are important, but great execution can often be even more important. Designing and selling digital music players was a great idea. A lot of companies dove into the business. Yet most of these companies have failed to catch on, in spite of it being a great idea. Ipods did catch on, however. One of the reasons they succeeded with that same idea when others didn’t was because Apple did a better job of sweating the details. They spent more time mastering the nuances of the business.

4) Spread your Bets.
In the music industry, even though the music labels had experts with the “golden ear” who had a good sense about what music would sell well, they were still often wrong. As a result, the music label would hedge their bets by investing in a large number of bands. The logic was that even if nine out of the ten guesses were wrong, the tenth would be so profitable that it would more than make up for the losses on the other nine. Similarly, businesses need to use tactics to reduce the risk, like:

a) Don’t put all your hopes into a single idea. Have multiple experiments going on all the time. That way, you stand a better chance of hitting the idea that makes you a winner.

b) Stage your investments. Don’t bet the whole thing at once. Invest in the idea in stages. If a stage fails, then you can back out before you’ve invested everything. If a stage succeeds, you can ramp up.

5) Understand that your idea will not be executed in a vacuum.
Eventually, your idea will need to be executed out in the marketplace, where competition will try to minimize your success (for more on this, see the blog, “Bombs Start Wars”). To avoid future disasters out in the marketplace, ask yourself these questions:

a) Does my idea provide a superior enough solution in the marketplace for a consumer problem to cause people to switch from their current solution alternative to mine?

b) If the big, powerful competitors also decide to enter this space, do I have what it takes to beat them in head-to-head competition?

SUMMARY
Most new ideas fail. Don’t let egos or homegrown pride cause to you to back a bad idea. Be willing to do what is necessary up-front to reduce the bias and what is necessary later to pull the plug early if the idea does not pan out.

FINAL THOUGHTS
Good decision making requires looking at an issue both rationally and emotionally. Although we need to eliminate emotional biases that blind us to reality, we do not want to eliminate emotions entirely from our thinking. After all, our customers use emotions to make their purchases.

Reducing the Risk

THE STORY
I used to work for a company which did a miserable job of managing the 401K savings accounts of its employees.

Every year the company went through the same ritual. First, they would tell the employees how poorly the money had been invested over the past year. It was always a return well below the average return which the rest of the market received.

Then they would announce that because of the horrible return, the company was changing to a different investment firm to manage the 401K account. The new 401 K managers were chosen based on having one of the highest returns over the past year (far higher than the returns the company received with the prior money managers).

Of course, after having such a banner year in the prior year, the new money managers would have a slump the following year (the year we switched our money to them). So after a year of suffering through their slump, they’d repeat the process all over again and hire yet another new management firm for the 401k. We were perpetually one year too late in benefiting from the good year of an investment company.

THE ANALOGY
A major reason for doing strategy is to improve one’s risk. The idea is that if one takes time to think and plan strategically, it should decrease the risk of encountering problems (because you are better prepared and aware of potential pitfalls in advance) and increase the likelihood of success (by discovering high potential options). When dealing with risk, one needs to grasp the big picture.

The people who were deciding who should manage the 401 K accounts in the story above seemed to be missing the big picture. They would choose the financial managers based on a very short time horizon—typically looking at a track record of only a year or two. And then they would only keep the management firm for a year or two.

Investments tend to be cyclical, with high years and low years. Over the long haul, some investors are able to do better than average, but even the good investors can occasionally have a bad year or two. Similarly, poor investors can sometimes have a rare good year if they are lucky. If you only look at a short track record, and only keep an investment firm for a short period of time, you are more likely to:

1) Choose a poor investor who just finished a rare lucky year; and
2) Not get the full benefit of a good investor, because you may have only stayed with them during their rare unlucky year.

Had the company taken a broader view and either looked at a longer historical track record, or stayed with the current manager over a longer period, they could have mitigated the risk of low performance by smoothing out the occasional lows with the more frequent highs.

Strategists need to take a longer or broader view to improve their risk profile as well.

THE PRINCIPLE
There are four key principles to understand when using strategic planning to improve your risk profile:

1) Risk = Reward
2) Risk is Minimized When Bundled at Same Time
3) Risk is Minimized When Stabilized Over Time
4) Risk is Minimized With Pruning

These are discussed in detail below.

1) Risk = Reward
The first thing to keep in mind is that the roll of strategy is not to eliminate risk. As the old saying goes, “Risk = Reward.” If you want to achieve outstanding rewards, you have to take some calculated risks. The goal of strategy is not to eliminate risk, but manage risk.

The only way to totally eliminate risk is to stay with the certainty of the status quo and make no investments. Unfortunately, this lack of risk leads to the absolute certainty that your company will die when the status quo eventually gets replaced by the next big thing.

To truly grow and have above average returns, one must make investments into unproven territory. If you wait until all the facts are known, others will invest before you and reap the rewards of the fast mover. By waiting until an industry is mature and well-defined, you will perpetually suffer from the mediocre returns inherent in mature businesses.

The role of strategic planning is to help your ventures into the unknown become less risky, by increasing what you know. First, strategic environmental analyses can help you understand how the marketplace is evolving. By knowing how the marketplace is evolving, you can better understand which new ventures are most in tune with that environment.

Second, by examining opportunities strategically, it is easier to understand which new ventures are inherently the least risky. Finally, by having a strategic plan which helps you build up core competencies, you can better determine which opportunities fit the strengths you have been developing. The more strengths you have that fit the needs of the new opportunity, the better you will be able to succeed in that venture, regardless of its inherent riskiness.

2) Risk is Minimized When Bundled at Same Time
If you put all of your eggs in one basket, your total risk is the same as the risk of the individual project. However, if you invest in a handful of new ventures, your total risk is less than the risks of the individual projects. When doing a bundle of ventures at the same time, the likelihood increases that you will find a winner within the bundle. Provided you get out of the losers soon enough and properly feed the winners, the likelihood of total success goes up significantly over the long haul.

Remember, the goal is not to make every individual investment a winner. The goal is to properly manage both the good and the bad in a manner that best optimizes the performance of the total corporation. Strategic planning can help you manage this ever-evolving portfolio.

3) Risk is Minimized When Stabilized Over Time
As we saw in the story about the 401K managers, if you keep changing management all the time, one increases the likelihood of have a string of bad performance. The same can be true in managing your strategy. Changing one’s strategic direction too often usually serves to hurt performance.

If you change your strategy for a given business investment too often, it can alienate your customers. They can become confused about what your brand stands for. If you are wishy-washy about what you stand for and keep changing your approach, the customers will be wishy-washy about their loyalty to you. Different strategies may require different competencies, which makes it difficult to develop any expertise. How can customers believe you are an expert, if you keep changing your expertise?

Sometimes, different strategies appeal to different customers. For example, if some customers prefer an everyday low price strategy. Others prefer a more promotional pricing environment. If you switch from one pricing strategy to the other, you could end up alienating your current customers and not pull in the other type of customers who prefer your new pricing position.

In retailing, I know from experience that every time one significantly changes the sales floor, there is an initial negative reaction from the confusion it causes. Constant change will turn of the retail customer.

It is a shame that the average tenure for a CMO is now under two years and that advertising agency changes have become such a frequent event. These changes make it hard to create the continuity which leads to strength and clarity with the customer.

Sometimes, the best action with a business is to do nothing and just let it build momentum from having a stable strategic platform.

4) Risk is Minimized With Pruning
Just as a grape vine can only produce the optimal number of grapes if it is regularly pruned, companies can only produce optimal results if the portfolio is regularly pruned. Yes, stability is important for an individual investment, but for the portfolio, it is often beneficial to add and subtract investments on a regular basis. Some firms are great at start-ups but not at running mature businesses. For these firms, it may make sense to prune out businesses when they reach maturity. Similarly, some businesses are great at turnarounds, but cannot add much value to an already successful investment. These firms may need to prune out businesses once they have successfully turned them around. By sticking to what one does best, one minimizes the risk of staying in businesses that no longer fit one’s strengths.

In addition, not all investments in the bundle will succeed. It is important to know when it is time to pull the plug on the losers.

SUMMARY
Risk is an inherent part of creating business success. By utilizing strategic analyses and by understanding your strategic strengths, you can increase the chance of success within these risks.

FINAL THOUGHTS
If the only thing you add to an investment is money, then you do not provide very much to ensuring the success of the investment. However, if you add to that strategic insights and strategic synergies, risk goes down and likelihood of success goes up.