Analogy #222: Square Pegs

THE STORY
There’s the old story of the square peg and the round hole. The problem is that the four points on the square peg stick out beyond the size of the round hole. As a result, no matter how hard and how long you hammer at that square peg, it will never go into that round hole.

Now the typically prescribed solution is to get rid of the square peg and find a round peg. The round peg easily fits into the round hole and can be hammered into place with just a few hits from the hammer.

Of course, this assumes that you only have three items at your disposal: a hammer, some pegs and a hole. But what if you had a fourth item—a saw.

With a saw, two more options are available. First, you can saw off the pointy sides of the square peg, so that it more closely resembles the shape of the hole. The second option would be to saw the round hole so that it more closely resembles the shape of the square peg.

THE ANALOGY
A good strategy creates a strong fit between what you are offering and what the environment needs. In classic strategic analysis, one starts by examining the environment. Based on what the environment looks like, you then create a strategy which fits that environment. For example, if the world is turning environmentally green, then it might make good sense to create a green strategy.

Relating this back to the story, if the environment looks like a round hole, then you should be creating a strategy which looks like a round peg. But what if your company is shaped more like a square peg?

A classic answer would be to replace your square peg with a round one. This sounds easy, but it is fraught with problems. First, “squareness” is what you are good at. It is your competitive advantage. Throwing it away and picking up a competency that is foreign to you (“roundness”) can be difficult. If you have to build the new competency from scratch, it can take a lot of precious time and there is no guarantee that you will succeed. Your “square” way of thinking may hurt you in your journey.

Second, if you try to get the round peg through acquisition, there can still be problems. As we’ve mentioned many times before, most acquisitions fail to provide a positive return on investment. One typically overpays for something which under-delivers relative to expectations. So you can still fail.

Third, there are others who already have wonderful round pegs. They will fill the round hole quickly before you are ready.

That’s where the saw comes in. Rather than accepting the environment as a given, we have the opportunity to alter the way the future evolves. Just as a master gardener can cause a bush to grow into a particular shape of his/her choosing, we can help shape the future. If you have a square peg, use your saw to create a square hole.

THE PRINCIPLE
The principle here has to do with preparation. Before planting a seed, the ground is prepared for it. The hard ground is broken down, the stones are removed, and the soil is fertilized. If you don’t prepare the soil, the seed won’t grow. Similarly, for your strategy to take root, the environment must be prepared for it in advance. Therefore, consider advance preparation as an integral part of your strategic plan. Improve your strategy’s potential for success by changing the environment.

This idea was made clear to me as I was reading a recent Business Week article about Cisco. Back in 2005, Cisco created the Emerging Markets Group, headed by Paul Mountford. The idea is for Mountford to spend time working with the leaders of emerging nations to help them envision the future. Part of that future includes the digital infrastructure.

Mountford tries to increase the importance of the digital infrastructure in the way these country leaders think about growing their nations and their economies. He tells them how building large digital hubs will help create jobs and make their cities more prosperous. Later, when the time comes for these leaders to put their visions into action, Cisco tries to win the business on those digital hubs.

Now Cisco doesn’t always win all the contracts. This preparation does, however, create more and better contracts to bid on. Better to get a smaller slice of a big, juicy pie than most of a meager crumb.

In other words, rather than waiting for the digital market to evolve on its own, Cisco pro-actively tries to redefine the market and chance the nature and the pace of the growth. It has taken its saw and cut a Cisco-sized hole into the future.

Another example years ago took place in the US soup business. Campbell’s had a near monopoly in soup and could have stayed content with that. However, Campbell’s realized that although it had most of the US soup business, it had only a small share of the US food business. If it could change the nation’s perception of soup, it could change the overall share for soup in the US diet.

As a result, Campbell’s embarked upon the “soup is good food” campaign. They changed the perception of soup to make it appear more wholesome and nutritious. This changed the demand profile for soup. And since Campbell’s sells most of the soup,
It gained most of the share of that increased demand. In other words Campbell’s took a saw to food demand and cut it into a shape that looked more like soup.

The beauty of this approach is that it not only makes the market more inviting for your strategy, it often makes it less inviting for competitors. The more you can shape the future to look like your peg’s particular shape, the harder it is for others to get their peg in the hole. In an extreme example, the battle between Blu-ray and HD DVD was a war to influence a preference for a standard technology. Once Blu-ray won, HD DVD had to disappear.

In addition, the more actively you control how a business ecosystem evolves, the less risk there is to your strategy. There’s a reason why some companies spend so much money lobbying governments. They want to help shape how the industry evolves and how it will be regulated. At times, it can be far more profitable to spend time and money on getting the world prepared for what you want to offer, than to try to offer what the world currently wants.

It takes time to proper influence a marketplace. Mountford often spends years working with government officials to dream and envision before any project comes out of it. It can take years to change one’s perception about soup. But the rewards can be great. That is why a long-term perspective can be so valuable. It gives you time to saw the hole that will reap the greatest rewards.

If all you do is react to what is in front of you, then you will never play to your strengths. Your fate will be determined by the world, which does not have your best interests at heard. However, if you take time to mold the future into what is best for you, good times are ahead.

SUMMARY
Strategy is about trying to create a fit between what the market wants and what you have to offer. In classic marketing, the emphasis is usually on creating internal adjustments in what you offer so that you are more in tune with the environment. However, it can often be more desirable to spend that effort on changing the environment to be more in tune with what you do best. How much time do you spend trying to influence the marketplace versus having the marketplace influence you?

FINAL THOUGHTS
If you don’t have a saw, make friends with someone who does. I worked with a furniture retailer that wanted to define high-end furniture shopping to be what they offered. It did not have enough influence on its own to do this. As a result, the retailer spent a lot of time wooing the local garden club. The garden club was very influential in helping define what cultured high-end people did in that market. By directly capturing the approval of the garden club, the retailer indirectly cut a hole in the high-end furniture space that was just their size.

Strategic Planning Analogy #128: Talk Your Ear Off

THE STORY
Well, I’m back from my vacation. I spent a week in rural northern Ontario. The locals told me that my wife and I were up there during the off-season—after the warm weather activities and before the snow-related activities.

There were many ways to tell it was the off season. First, the resort was nearly empty. Second, about half of the tourist attractions were closed. Third, about five times when we went to a restaurant to eat, we were the only patrons in the restaurant. At first that seemed kind of creepy, but we got used to it.

Initially, we thought this would make it hard to fill up the days. However, we soon found out that it didn’t take much to fill the day. Everywhere we went we would run into locals who would want to talk to us as long as we were willing to listen. Sometimes, they could talk on for hours at a time. If we hadn’t walked away a couple of times, we’d probably still be talking to some of these people.

The funny thing was that these locals would tell us they liked living up in the rural areas because they didn’t like being around a lot of people. They said they liked the solitude. Yet, whenever someone showed up (local or otherwise), they would end up talking up a storm to each other. One guy told us he took walks on trails that weren’t near his home, because if he went on a trail close by he would end up seeing someone he knew on the trail and spend his time talking rather than exercising.

Then I thought about all the people I know who love the hustle and bustle of the big cities with all the people. These urban folks don’t mind all the people, yet they rarely strike up a conversation with people they meet on the street. So the people who craved solitude seemed more willing to break that solitude with conversation than the ones who like to be surrounded by people.

THE ANALOGY
It seems a bit ironic that even though these people preferred the solitude, the fewer the people in the area, the more likely they wanted to break the solitude by talking to anyone—even strangers. Yet those more comfortable being around lots of people seemed less likely to talk to them.

Apparently, we tend to place more value on the things that are the most rare. If people are rare, we value their company more. If people are plentiful, we tend to value each individual less.

Business seems to work in the same way. Value is not necessarily based on the intrinsic worth of the item. Instead, it is based on the relationship of the worth to its supply. Even if it is not worth all that much under normal circumstances, if the item becomes extremely rare, then its value suddenly increases. Therefore, when developing strategies, one must not evaluate items in isolation, but rather in relation to their supply in the marketplace.

THE PRINCIPLE
The principle here is “supply and demand.” The more supply relative to demand, the less the value. The less the supply relative to demand, the higher the value. At first, this would seem to be a simple principle. Nothing new here…we’ve heard this before. However, how many times have we failed to include supply and demand in our strategic toolkit of actions?

On October 31, 2007 the Wall Street Journal wrote an article about GM. They explained a new strategy taking place at GM. In the past, whenever GM had a hot-selling car, they would ramp up production. Their logic was that they should manufacture more of the items that were selling well.

Unfortunately, it is difficult to fine-tune production rates to demand in a timely manner. Inevitably what would happen was that GM’s rate of production would eventually outstrip demand, causing a glut in supply for the car in demand. To sell down the glut, they would have to discount the price heavily. This would take all the profit out of the hot-selling vehicle. This is what happened to the GM HHR vehicle.

By contrast, the latest hot vehicle at GM is the Buick Enclave. However this time GM did not ramp up the production much on the Enclave. Instead they intentionally kept the supply of the vehicle small.

This had two positive impacts. First, by not flooding the market with Enclaves, people did not tire of the vehicle through over exposure. The difficulty in getting the Enclave helped to make the car even hotter to own. There is more status in owning that which is difficult to attain. Second, by not building so many, GM was able to sell the Enclave at full sticker price, which increased the profitability on each unit sold.

The strategy used by GM regarding supply had a direct impact on profitability—to hurt the profits of the HHR and help the profits of the Enclave. Even though they didn’t change the vehicles themselves, GM changed supply—and that changed the profits.

Just as the limited supply made people more important in rural Ontario to locals (even though the locals claimed to not liking to be around lots of people), the Enclave’s value was heightened based on limited supply.

This principle is also very important in the fashion industry. When production is limited so that only the elite few can get it, the fashion stays hot. Once supply is opened up and “everyone” can have one, the fashion allure is lost and the entire fashion brand suffers. It is a fine line that many of the high end fashion brands are now walking in trying to increase the breadth of demand for their brands. If they go too far, the brand will lose its cache and will be abandoned by its core customer.

Remember, the goal of most strategies is not to maximize sales, but to maximize profits over the long haul. Many times, the relentless pursuit of additional incremental sales can actually reduce total profitability, because of some combination of the following:

1) Too much margin needs to be given up to create the additional sales. This margin loss may not only impact the incremental items sold, but reduce profits on other units which could have sold at a higher price if fewer were made.

2) The brand image/status is destroyed through over exposure and future brand efforts fail as a result.

3) To get the additional sales, additional investments needed for production capacity or marketing create a negative return in investment on these sales.

4) Due to the efforts of getting new customers, the more loyal and more profitable customer base could receive less attention, causing them to leave and take their business where they feel more important.

Fewer sales can actually be more profitable, because it keeps supply and demand in a more profitable balance.

Studies have shown that, regardless of industry, most of a company’s profits come from about 15-25% of the customers and that about a half of one’s customers are currently unprofitable to serve. Perhaps if one quits trying to get all of those extra customers and spends more time trying to satisfy the 15-25% best customers they already own, one may be better off.

Therefore, when designing your strategy, don’t let the lure of sales cause you to make strategic decisions which destroy profitability. Sales are nice, but profits are better.

SUMMARY
Value is often influenced greatly by the laws of supply and demand. Supply and demand is something your company can have some influence over, if incorporated into the strategy. Therefore, controlling supply and demand should be a part of the strategic goals.

FINAL THOUGHTS
Just because the people in rural Ontario wanted to talk more did not mean that they were more gifted in the art of conversation. The conversations weren’t special or the words more exciting. The length had more to do with the desire to talk (based on the rarity of people to talk to) rather than the value of the words spoken. The same was true with the Buick Enclave. GM didn’t raise the value by improving the vehicle. It was not made more special. It was the same vehicle it was before. They just increase the desire through controlling supply.

Dullness is a Virtue

THE STORY
A friend of mine and I used to get into heated arguments about which one of us lead the duller life. We each thought we were pretty dull and so we would spend hours off and on for months trying to make our case as to why we each thought we lived duller lives than the other person. Come to think of it, I guess we would both have to be living pretty dull lives, if we wasted so much time on such a silly argument.

Every once in awhile, my friend would feel like he had finally come up the definitive point—the one that would unquestioningly prove that he was significantly duller than me. He would get excited and start saying things like:

“See, I win! You lose! I am the dullest person in the world! You’re not! I win! I win!”

After he got all of that enthusiasm out of his system, I would calmly reply:

“You’ve just said that you won a big contest. You claim to have won the dullest person in the world award. Well, that makes you a pretty exciting person, because now you are a big contest winner. I guess that disqualifies you from being the dullest person.”

After that, the whole argument would start all over again.

THE ANALOGY
Usually people are drawn to excitement like moths to a flame. If all the exciting and cool people have an ipod, then we want one too. We want to be where the action is. Dullness is something we usually try to avoid.

The same is true in business. Businesses seem to want to be where the action is. If all the cool companies are into Six Sigma, then we want our company to do it too. If the exciting companies are all diversifying to building HDTV’s, then we want to have a division building them as well.

The logic is simple. If this is a hot space that customers are flocking to, then there must be a lot of money here. Therefore, if I get to the hot space, then I will make a lot of money, too.

Yes, a handful of people make money in exiting areas. Most, however, lose a lot of money. The problem is that exciting areas are often among the most competitive. With all those companies flocking in to do business, the cut-throat competition chokes out the profitability.

In contrast, some of the most profitable places to be are pretty dull. If you want to make money, quite often dullness is a virtue. Getting excited over being the dullest company in the world might not be such a bad thing, after all.

THE PRINCIPLE
The principle here is supply and demand. As long as there is more demand than supply, it is relatively easy to make a profit, provided you have what is in short supply. Conversely, if there is more supply than demand, it becomes a buyers market and prices plummet. Take for example the HDTV industry. It seemed like the hot and exciting place to be. Consumer demand was rising quickly. With a growing market that large, how could you lose?

Well apparently, you can lose a lot. So many people jumped into manufacturing and selling HDTVs that it became a glutted market. You could even buy HDTVs at gas stations and supermarkets. Prices during the most recent Christmas season on HDTVs got so low that everyone started losing money on them. Sure, the customers were happy. It was the hot and exciting product to own, and they got it at a cheap price. The manufacturers and retailers, however, reported poor financials for the Christmas season due to the low prices.

In today’s business environment, information is easy to obtain; money is easy to obtain; manufacturing capabilities are easy to obtain. As a result, when something gets hot, everyone quickly knows about it and has the means to attempt to exploit the trend very quickly. Before you know it, the market is glutted and profits disappear.

While everyone was losing money on the HDTV’s who was making the money? It was the relatively dull people who got paid to install the TVs and make sure they worked. The glamour may have been in the TVs, but the money was in the duller manual work behind the scenes, like the Geek Squad.

This pattern has repeated itself many times. During the dot com boom, everyone rushed to where the excitement was—setting up cool web sites. Most of these companies lasted only a short period of time, never really earning any money and closing their doors once the venture capital money ran out. But who made money? It was Cisco Systems, the dull company that made the dull server boxes that were hidden in a room that nobody saw. All of these loser dot com companies bought lots of servers, making Cisco very profitable.

EBAY created excitement in the on-line auction business. It seemed like the cool place to be, because money was actually changing hands on the site. Customers were excited, so businesses got excited as well. Many companies tried to build their own on-line auction businesses and get in on the coolness of EBAY. After losing a lot of money, they all seemed to disappear. Who’s making money now? It is the dull little franchises, who make money helping people get their products onto EBAY and then help ship the products to the buyer. The low tech guys are making money while the glamorous high tech folks were losing their shirts.

Speaking of franchising, I once went to a seminar on franchising. The keynote speaker was someone who made a lot of money with his franchise. He said that when he first started looking into various franchise options, he was drawn to things that looked interesting or exciting. Quickly, he discovered that some of the best franchises were in areas that were pretty dull and unglamorous. He bought a franchise in janitorial services for office buildings and made a fortune. His advice to people in the seminar was not to go with what looked appealing, but go with the dull stuff—because that is where the money is. Fewer people want to do the duller and more mundane stuff, leaving more profit opportunities for the people who get into the business.

A lot of people seem to think it is cool to own an airline. The city where I live, Columbus, Ohio, is excited because the city formed a joint venture to run a commuter airline. Do we really want our mayors running airlines? But it is the exciting thing, and people are flocking to it. Yet it appears that long-term profits are very illusive in that industry. One place where making money seems to be occurring is in the relatively dull business of selling tasty meals for passengers to take on planes, now that the airlines have cut back on meals to try to make money.

Some of the most profitable retailers run some of the dullest stores—places like Wal-Mart and Walgreens. In the big malls, I don’t always see a lot of people carrying bags from the exciting fashion retailers. I do, however, usually see a lot of people consuming relatively dull stuff like hot pretzels and big cookies. Similarly, I was recently at a cool street art fair in Breckenridge Colorado. Not much artwork seemed to be selling, but the relatively dull stuff at the food concession stands nearby seemed to be doing a brisk business.

So next time you are looking for a new strategic alternative, don’t follow the pack to be in the center of the hot spot. It’s usually just a little too hot and you will likely get burned. Instead, stay on the periphery doing the relatively dull things that support the companies in the center. You get to stay warm, and you can stick around a lot longer without getting burned. Remember, dullness is a virtue.

SUMMARY
The laws of supply and demand have not been repealed. Quite the contrary. With the freer flow of information and money these days, it has never been easier for supply to chase demand. As a result, hot spaces get congested very quickly, making profits in the exciting spaces very difficult. Instead, it appears that the smart money should go into the duller businesses in the background, where you can create larger margins supporting the glamour industries.

FINAL THOUGHTS
Of course, the problem is that once everyone starts figuring out that the dull places are where the money is, they cease to be dull and start becoming exciting. Then everyone starts rushing in and destroying the profits. As in all strategic pursuits, you cannot stand still. You have to keep pushing the envelop of dullness.