Strategic Planning Analogy #147: Sweat is Swell

THE STORY
Thomas Edison was a very successful and prolific inventor. In his lifetime, Edison obtained 1,093 United States patents, the most issued to any individual. These included the light bulb, the phonograph and motion pictures.

Edison attributed his success to long hours of hard work. In his words, genius was “1% inspiration and 99% perspiration.” Edison worked long hours in his laboratory, quite unaware of the time. He would say, "I owe my success to the fact that I never had a clock in my workroom."

Edison was known to work for 16 hours at a stretch, to the point where he gained a reputation for never sleeping. In actuality, he would take cat naps whenever he felt the need, no matter where he was at the moment or what was going on around him. Sometimes he could be found snoozing in the middle of the day stretched out on the ground under a bush, on his workbench or on his cot located in the back of his laboratory.

In order to preserve that great Menlo Park laboratory, Henry Ford had it moved to a site in Dearborn, Michigan (you can still visit the lab there). Henry Ford wanted to make sure it exactly replicated its original condition. Each brick was numbered, so that when the bricks were reassembled, they were in the exact same order. He even transported the trash heap next to the lab where the rejected ideas were thrown out.

On October 29, 1920, when the laboratory was reopened, Henry Ford asked Thomas Edison what he thought of the relocated lab. "It's ninety-nine and a half percent perfect," Edison replied. "What's wrong?" Ford asked, concerned. "Well," Edison replied, "we never used to keep the place so clean!" Edison was too busy working to worry about cleaning.

THE ANALOGY
Lately, a lot of attention in the business press and business academics has centered around the importance of people in a firm’s success. Much is written about the need to acquire and retain the greatest talent in order to win. This is considered to be more important than ever, now that we are in a knowledge-based economy.

Thomas Edison was in the knowledge business over a century ago. He was very successful at it. It might be useful to see what his views were on talent. Yes, he had some bright and talented people around him. But the most important quality to Edison was their desire to work long and hard. He wanted people who would contribute that 99% perspiration to his inspiration.

Strategic success may indeed rest upon having the right people on board, but I’m not sure we always use the proper measurement of what the “right” person is. In many cases, “right” may have more to do with the quality of their sweat than of their intellect.

THE PRINCIPLE
The principle here is that success has more to do with output than with input. You can have a room full of geniuses pontificate on all sorts of greatness and wonderfulness, but if they cannot bring any of it to market at a competitive price, then you are wasting your time. Or, to quote Edison, “Anything that won't sell, I don't want to invent. Its sale is proof of utility, and utility is success.” Output is what pays the bills.

Therefore, when contemplating your talent strategy, keep the following four points in mind.

1) Having the Most Intelligence Does Not Lead to the Most Success
Studies have shown that the most successful entrepreneurs tend to have gotten “B” grades in school. “A” students have been found to be less successful entrepreneurs. This is because A students tend to think things through further and can visualize more of the pitfalls to any idea. As a result, they tend to be more risk adverse and not pursue an unproven idea to conclusion.

Another study found that those with abnormally high levels of intelligence tend to be lazier than the average population. The problem stems from the fact that in the formative years of their lives, these intelligent ones were able to coast through life by relying on their wits. They never had to work hard to get by. It came too easy (no perspiration). Therefore, they never developed the discipline of hard work.

Another point to consider is longevity. The costs of employee turnover are very high when you consider the rehiring costs, training costs, and loss of knowledge. Often the brightest candidates have the most options, so they leave the soonest. I heard a college coach once say that he used to try to recruit the very best athletic talent out of high school. Then he realized that the very best would opt out for the pros in their sophomore or junior year. He found that he got a better return on investment if he pursued the second tier athlete, one who would stick around and be productive for four full years.

A recruiter in the business world I know used to say that he preferred hiring people out of second tier colleges in the Midwest. He claimed these students had fewer attitudinal problems, had a better work ethic, and would stick around longer.

Therefore, seeking the brightest is not necessarily the same as seeking the best. The best can often be a notch below the brightest. The brightest may be too risk adverse, too lazy, and not stick around very long.

2) Focus Talent Efforts Proportionately to Need
Several years back, I was unemployed and using an outplacement agency. They used to have a saying that went something like this: “About 5% of people are hired through the internet and about 75% are hired through networking. Therefore, in searching for your next job, you should spend about 5% of your time on the internet and about 75% of your time networking.”

A similar principle applies to your talent strategy. If success is 1% inspiration and 99% perspiration, then maybe most of your talent strategy should be concerned with getting enough perspiration. Yes, a firm needs some very bright people. But that doesn’t mean that everyone needs to be very bright.

In many prior blogs, I have talked about the need for focus. It is extremely difficult to be successful when a company is moving in hundreds of different directions at once. Success comes from narrowing the focus to only a few great initiatives at a time. Once you use the brilliance of the genius corps to set the agenda for focus, the priority shifts to getting the agenda accomplished. That takes a different type of individual…the perspiration expert. And guess what, you need more of the perspiration experts than the agenda setting geniuses.

3) “Followership” is Also Important
Business literature likes to talk about the importance of leadership. “Followership” is also important. Most organizations need a lot more followers than leaders. Shouldn’t we be concerned with getting the best followers at least as much as we are concerned with getting the best leaders?

One time, I was in charge of putting on an off-site meeting for business leaders. It was taking place in an old structure in the back-woods, with a slow-working heating system. These business leaders were used to leading. So at the beginning of the day, when the heating system hadn’t quite gotten up to temperature yet, these cold leaders would lead by turning up the thermostat all the way. Eventually, the slow working heating system would react and then the room would be way too hot. So then the leaders would turn the thermostat all the way down and the room would eventually be too cold again.

On multiple occasions, these leaders were told to leave the thermostat alone, and if they would just be patient, the room would get to the right temperature. But these leaders were not used to following, so all week long they would take the initiative to fiddle with the thermostat, making the room temperature alternate between too cold and too hot.

If these leaders could not even follow such a simple instruction, how well do you think they would follow on other issues where they might have to sacrifice some of the power in their silo for the good of the entire organization? Yes, even leaders need to be skilled in following.

4) Believers are Better than Mercenaries
In a previous blog, I talked about how employees who believe in the purpose and vision of the firm are more productive than people who only work for a paycheck (see “Soulless Capitalism”). Firms can often be like professional sports teams working under a salary cap. The sports team cannot afford to hire the best at each position and still fit under the salary cap.

Similarly, if you hire people who are only there for the money, you cannot afford your team. It is probably better to get a second tier person who passionately believes in what you are doing than some genius hot-shot whose incremental benefit will be eaten up in whatever additional perks you have to pay to keep them.

SUMMARY
Assembling the right team is very important to strategic success. But the right team is not necessarily the smartest team. The right team has the proper balance of inspiration and perspiration, with a greater emphasis on perspiration—the ability to get the work done which leads to output.

FINAL THOUGHTS
Every so often in the music industry, people will try to put together a “supergroup” band made up of the best musicians available. These supergroup bands rarely last long. All of their egos get in the way and they cannot work well together as a band. Don’t make the same mistake with your business. Just because the individual pieces look good does not mean you will have successful output when they come together. Build a team that perspires well together.

Strategic Planning Analogy #146: Keep on Truckin’

THE STORY
Once upon a time, there was a rapidly growing business that needed to expand its trucking capacity quickly. Therefore, its head of transportation called three different trucking firms to see if they could help. He told all three of them that the first company to get a truck to his warehouse would get the contract for all of this new ongoing business.

The gentleman at the first trucking company was delighted to get the call. “That’s wonderful news,” he said. “I could use the cash. I’ve just started looking for some new customers. My business has really been slow lately. Of course some of that could be because maintenance problems on my old fleet caused a couple of my trucks to drive off the road and crash into a ditch. Without those trucks, I can’t make deliveries. However, as soon as I can convince the banks to loan me some money and get the trucks out of the ditch and get them repaired, I’ll send them to your warehouse.”

The woman at the second trucking company had a different response to the call. “Business was pretty good last quarter,” she said, “so I locked up all the trucks and sent the drivers off for a long vacation. It might take me awhile to find a driver.”

This head of the second trucking company was not too concerned about getting the business, because she was expecting in a couple of weeks for an old client to renew his large contract. What she didn’t know was that at that very moment the banks were foreclosing on that client and putting him out of business.

When the third trucking company got the call, the owner said, “No problem. Although we’re keeping busy, I’ve already got a driver on the road looking for additional business. I just need to redirect his route slightly, and he’ll be at your place in no time.

Guess who got the business?

THE ANALOGY
Future growth can often come from a different place than where current business is coming from. It could be a new product, a new service, a new customer, a new business model, and so on. In the story, the new growth for the trucking firms could come from this new potential customer.

All three companies took a different approach to future growth.

The first firm waited until it was at a crisis point before looking for growth. It didn’t start looking for new business until the old business had already gone away and put him in a financial pinch. It was his own fault that he was in a crisis, because he had mismanaged maintenance until his old trucks no longer functioned properly. It’s hard to be a growing trucking company without working trucks.

Worse yet, since his business was still in shambles, he couldn’t absorb any growth. Until he could fix his maintenance issues and repair his trucks, he was going to continue to lose more of his current business and not be able to attract new business. He waited until the cash ran out before fixing the problem, and he can’t fix the problem without cash.

The second firm wasn’t even looking for growth. The owner was so confident that the old business would continue that she locked up the resources. She had extra capacity of trucks and drivers which could have been used for new business, but she didn’t apply them to look for growth. Unfortunately, old business does not last forever, and she would soon learn that the old business was going away, leaving her with nothing.

The third firm was proactively looking for growth while the business was still doing well. Because he was doing well, he could afford to have someone out looking for growth. And since he had someone already out there and prepared for future business, it was a simple matter to quickly absorb that growth.

In the business world, companies tend to fall into one of three categories, similar to these three companies. Either they:

1) Wait until the model is broken before seeking growth.

2) Assume that the old model will last forever, so they do not worry about looking elsewhere for growth. (Of course, no business model lasts forever. Therefore eventually that model will break and then these people move to category #1.)

3) Start looking for the business model of the future while the current model is still strong enough to support the cost of the search.

Similar to the story, it is typically the third type of company which is in the best position to take advantage of future opportunities when they appear. As the old saying goes, “It is easier to steer a moving semi-truck than one that is standing still.” The third company had its trucks moving, so it could more easily steer them towards the future.

THE PRINCIPLE
The dual principles here are that:

1) The first one to lock up the future usually wins; and
2) If you want to be the first to find the future, you have to be out there actively looking for it today.

These principles are briefly outlined below:

1) The first one to lock up the future usually wins
Much has been written by Al Ries and Jack Trout about the importance of being the first to lock up the next big thing in the minds of the customer. The first firm to lock up the future becomes the brand most associated with the future. It therefore becomes the brand which gets the largest share of the customers looking for that next big thing. The first firm to own the next big thing also gets to define what it is and how the business model works. And guess what, they define it in a way which most benefits themselves.

By contrast. the imitators, the followers, the me-too’s and the laggards rarely get as much credit for their actions into the new arena. That credit has already been given to the leader. And guess what, most people would rather associate themselves with winners and leaders than with followers. Therefore, the one who wins the space first has a great advantage.

2) If you want to be the first to find the future, you have to be out there actively looking for it today.
This leads to the second principle. If you want to be the first to own the future, you have to be looking for it before it comes to pass. If you wait until it becomes a reality, then you are—by definition—not first.

Even if the current business model is still working well, that is no excuse for not looking ahead. As pointed out in a previous blog, the current business model tends to become obsolete a lot faster than we think (see “The Room is Smaller Than You Think”). Therefore, one cannot just sit back and relax, counting on the current momentum to carry you through.

Just as the current model tends to fall apart faster than one thinks, the time to replace the model tends to take longer than one thinks. In a recent article by Booz-Allen (“A Blueprint for Strategic Leadership”, 1/10/2008), the authors claim that it typically takes a company five to seven years to reposition or transform itself. Therefore, if you want a smooth transition, from a successful current business model to a successful future business model, you need a five to seven year head start on making the transition.

As we saw in our story, the first two trucking firms did not start looking in advance. The first firm waited until the old model was broken. At that point, its cash flow was not strong enough to sustain the time it would take to transform it fleet. The second firm had fallen into the trap of thinking it had more time with the old model than it really did, so it wasted resources which it could have been effectively applied to seeking the future.

It was the third firm which was successful. While still doing well in the old model, it was diverting some of its profits to finding the new model. It had no idea at the time where the new business would come from, but it was devoting an effort to seek it. This gave it the ability to both discover and reach the future first.

It takes time and money to reach the future. Waiting to act takes away your time and often allows your company to fall into a weaker financial position. As a result, someone else will get there first and reap the benefits instead of you.

SUMMARY
All business models eventually fail. If you do not want your company to fail along with the business model, then you need to proactively be seeking the next big thing while the current model is still strong enough to support you during the transition period.

FINAL THOUGHTS
Louis Pasteur one said that “Chance favors the prepared mind.” It may appear from the outside that the one who successfully finds the future first was just lucky. But in reality, it is not mere luck. It is the one who is preparing by proactively seeking the future now who usually finds it first.

It’s hard to find things when you are not looking. If you are busy looking, you will find things you didn’t even know existed. Keep your semi moving forward and you will see where to turn.

Strategic Planning Analogy #145: Top Management Commitment

THE STORY
One time I was sitting in a meeting listening to a woman describing the way she wanted us all to accomplish a particular project. At one point in her speech, she mentioned that the project would fail unless we had top management commitment.

At that point, a number of people in the audience simultaneously let out a strange sounding groan. It didn’t seem like they had practiced this in advance. It seemed jointly spontaneous.

Afterwards, I noticed that all of the people who groaned were working for the same large business consulting firm. When the meeting was over, I asked one of them why they all had groaned.

I was told that it was a response to hearing the term “top management commitment.” They had been trained to groan whenever the term came up, in order to discourage its use. Their point was that top management commitment is essential to all major projects, so one was not shedding any light when it was said to be essential to a particular project. Pointing out a given was did not deserve to be listened to.

I still thought it was a bit pompous for them to groan like that, but then I remembered that they were consultants.

THE ANALOGY
Top management commitment is indeed important to the success of many business ventures. I googled the phrase “top management commitment” and got over 60,000 hits. These hits claimed that top management commitment is essential for business initiatives as diverse as:

- Improving Quality
- Improving Safety
- Accomplishing Environmental Initiatives
- Getting More Diversity in the Workplace
- ERP projects
- Changing Technology Platforms
- Improving One’s Export Business
- Getting Six Sigma in Place
- Putting together a Knowledge Management Program

I suppose that if I kept reading all of the references, I would have found that “top management commitment” is the cure for bad breath and bunions as well.

And, of course, there were references to the fact that top management commitment is essential for successfully accomplishing business strategy. Even though it can be a critical component to strategic success, I have not mentioned it in any of my approximately 150 blogs on strategic planning. The reason is because I still remember those groans and I don’t want anyone groaning at me.

THE PRINCIPLE
Employees tend to commit to the same things which they see top management committed to. I guess that’s why top managers are called leaders. Wherever they direct their commitment, the rest of the organization follows their lead. This is why it is a given that top management commitment is essential for major projects.

It is impossible for top management to intensely commit to every aspect of the business all the time. There is just too much going on. In order to be effective, management needs to narrow the focus to a smaller set of key activities. That is why one of the most important principles of strategy has to do with focus.

You cannot give employees a list of the top 200 most important initiatives for the next year and expect all 200 of them to all be executed flawlessly. Their attention will be diverted and diluted in too many directions. Excellent execution requires a narrow focus that commits to only a few things at a time. Great leadership is in knowing which few things to focus on at a particular time and in rallying the organization to follow your committed focus.

This could also be used as the definition of great strategy.

A lot of times when people talk about strategic planning, they can get all wrapped up in the process of the planning. Time is spent drafting fancy documents like Vision Statements, Mission Statements, Goals and Objectives, Internal Strengths & Weaknesses, Reports on the External Environment or Competition, and so on. Then there is time spent in various offsite planning meetings with inspirational speakers and breakout work sessions. Finally, there can be large notebooks and/or Powerpoint presentations which sum it all up.

Now there can be important benefits from all of this activity, but at the end of the day the key strategic planning question is this: What are the few things that top management should focus their commitment on?

This is such a critical question because, as we have seen, companies tend to move in the direction where top management commits their focus. In practical terms, this means that top management commitment is in fact the driver of strategic execution. What you focus on defines your strategy.

At this point, it can almost become irrelevant what all of those vision statements, mission statements and other such strategic planning outcomes were. You can see this by asking yourself this question: If all of that strategic planning work said to go in one direction, but top management commitment was focused in a different direction, which way would the company go? You guessed it; they would follow the commitment instead of the process.

The purpose of all that strategic planning process work is not to have fancy documents and well run meetings. Instead, the purpose of strategic planning is to discover the most important issues to focus on, and convince the leadership to commit to these issues as their primary focus. Anything else is secondary at best.

So when you are developing your strategic planning process, make sure that the purpose of all that activity is to:

1) Learn what should be focused on;
2) Inspire management to commit to the focus; and
3) Follow-up to ensure that people do not get off the focus

SUMMARY
Successful strategic planning is not about doing as much strategic planning stuff as you can. It isn’t a long checklist of activities to check off like a grocery shopping list. Just doing the process should not be the goal. Instead, strategic planning is to be a means to greater end—to properly focus the commitment of top management. If that goal is not accomplished, then all of that planning process stuff is a waste of time.

FINAL THOUGHTS
I have a Dilbert coffee cup. On one side of the cup it describes what a company is like without strategic planning. It shows the telephone ringing and Dilbert not having a clue of what to do. On the other side of the cup it describes what a company is like that has strategic planning. It shows Dilbert boldly picking up the phone and telling the person on the other end of the phone “We don’t do that.”

This is a very important point. If the goal of strategic planning is to create focus, then the byproduct of that focus is knowing what not to focus on. It helps us boldly say "no" to the activities which are not consistent with the focus.

Strategic Planning Analogy #144: Last One Standing Gets the Bill

THE STORY
Let’s assume for a moment that you are invited to a lavish dinner party. Not only that, the invitation says you are the guest of honor.

You show up for the dinner and find it to be more lavish than your wildest dreams. The crowd is huge. The entertainment is extravagant, with numerous famous performers. There is more food than you have ever seen before, and it is of the highest gourmet quality.

Everyone at the dinner keeps telling you how great you are. In fact, they are so generous in their praise that they say they are willing to surrender to your greatness.

Things are going fantastically; you cannot be happier. Then suddenly—in a flash—everyone disappears. You are quickly left alone, the last person standing…at least for a moment. Then the owner of the establishment appears.

The owner of the establishment says, “Here is the bill for dinner party, payable immediately.”

You look at the bill in shock. It is more money than you could ever afford to pay in your lifetime, let alone pay immediately. You turn to the owner and say, “But I was the guest of honor. I shouldn’t have to pay this.”

But the owner replies, “I heard everyone surrender their obligations to you. Besides, you are the only one left. Who else is there to give the bill to?”

Not long after that, you get another invitation—an invitation to stay in debtor’s prison until you can pay off the bill for the dinner party. And attendance is mandatory.

THE ANALOGY
Sometimes being the last person standing is less of a victory than it at first seems. You may have outlasted everyone else, but it may just mean that you are the only one left to pay all of the bills.

Most industries go through life cycles, starting with incubation, followed by rapid growth, maturity and then decline. Usually during the maturity phase, the industry starts to consolidate. First, the bigger players begin to acquire all of the smaller players. Then the bigger players start acquiring each other. Eventually there are only one or two major players left.

At first, the survivors of consolidation feel like the guest of honor in the story above. If you are one of the survivors, then you must be better and smarter than the rest, right? Every time you acquired someone else, the acquired companies had to surrender their power to you, which felt grand. Everything seemed to be going your way and it felt like a great party.

Unfortunately, the party eventually ends. The maturity phase of the industry lifecycle moves to the decline phase. You paid a high price to acquire all of those firms (probably with a lot of debt), and now the declining market cannot support your infrastructure. Industry profit margins are shrinking and sales are in decline. There is nobody left to sell your business to, since you are the only one left in the business (and outsiders won’t invest in a declining industry unless you are willing to sell out at a great loss). And now the bill arrives to pay back all of that debt used to finance the consolidation…and the bill is more than you can afford.

By contrast, the firms who sold out early received a premium price for their business. They may have lost out in the industry survival game, but they came out ahead in their return on investment. They were able to leave the party flush with cash and escape before the bills came due.

THE PRINCIPLE
The principle here is that retreat can often be a better strategic option than victory. There is a price to be paid for victory, and sometimes the price is too high. Selling out early in the consolidation phase is often a better option than trying to hang on.

Study after study has shown that most acquisitions fail to provide an adequate return on investment. In other words, companies pay more for acquisitions than they end up being worth. There tend to be a handful of reasons for this:

1) Overestimation of External Potential.
Acquirers often assume that the market potential is greater than what eventually develops. In reality, the growth phase ends sooner than expected or the decline phase is larger than expected. As mentioned in a previous blog, if businesses feel threatened by a new growth vehicle, they will retaliate, and blunt the growth rate of the threat (see the blog “Bombs Start Wars”).

Whenever I have seen early projections of the potential of a new industry, the estimates are almost always way too large. Remember the early days of internet retailing, when the “experts” were projecting the doom of the traditional retailer and how the dotcom retail specialists were going to rule the world? Well now, many years later, the volume of retail done on the internet is well short of those projections and it is the sites owned by traditional retailers which tend to be succeeding better than the dotcom specialists. Amazon has never lived up to the potential inherent in its early high stock price.

Overestimating external market potential will create a tendency to pay too much for companies during the consolidation phase.

2) Overestimation of Internal Consolidation Potential
Just as overestimation of external factors can make a company pay too much, so can overestimation of internal factors. Usually somewhere in the calculation of the value of an acquisition is an estimation of the synergies in combining the companies. The synergistic benefits include factors like:

a) Elimination of redundancies in costs between the two firms.
b) Economies of scale in combining sales volume
c) Added leverage in the supply chain, which is assumed to provide greater control over one’s ability to influence levels of profitability.

When synergies such as these are overestimated, then one is likely to pay too much for the acquisition. And guess what…studies have shown that synergies are often overestimated. Savings and influence are rarely as great as estimated. Integration is usually messier and costlier than projected.

3) Egos and Bidding Wars
In the fight to win the battle to survive consolidation, emotion can sometimes get the better of us. The passion to win can create a buying frenzy, where competing firms bid up the price of acquisition targets. As stated in a previous blog, even great acquisition targets can become lousy acquisitions if the bidding frenzy pushes the price too high (see the blog “It Depends”).

Given these three factors (over estimation of external factors, over estimation of internal factors, and bidding wars), it should not be surprising to find that the company who sells during the consolidation often creates greater value for its shareholders than the one who purchases the company.

For example, let’s look at the traditional department store industry in the United States and how the Target Corporation (formerly called the Dayton Hudson Company) played the consolidation game.

During the growth phase of the industry, the Dayton’s department store company bought up a number of department store properties across the United States. At the same time, they were experimenting with a new concept, called Target discount stores. Eventually, the company figured out that discount stores had a strong path ahead of them and that department stores were starting to reach maturity. As a result, in 1984, when department stores were still going strong, the company sold its department store divisions in non-core markets---John Brown in Oklahoma and Diamond’s in Arizona. Because the industry was still seen to be strong and growing by others at the time, Dayton Hudson received a premium price when they sold the properties.

By the 1990s, consolidation was in full force and Federated Department Stores (now called Macy’s) and the May Company were in a battle to become a surviving consolidator. Dayton Hudson took advantage of the frenzy to get a fairly good price for selling its remaining department store divisions to May Company in 2004.

Unfortunately, by now, traditional department stores were well into the decline phase. They were being successfully attacked from below by Kohl’s and discount stores. They were being successfully attacked from above by high-end department stores like Neiman Marcus and Nordstrom’s. Sales per store for the May Company were in a long-term decline. They had paid too much for their acquisitions. The “bills were coming due” and they could not afford them.

The May Company became desperate and in 2005 sold out to Federated, who changed all the store names to Macy’s. Because May had stayed in the game too long, Federated was able to purchase the May Company relatively inexpensively (and got all of those Dayton Hudson stores for far less than what the May Company had paid for them a year earlier).

And there are many doubts in the industry as to whether the Macy’s Company will be able to ultimately get a favorable return on its department store investment. Yet, Dayton Hudson took its profits from getting out early and put it into Target stores and is appearing to do quite well.

SUMMARY
Often times, the factors involved in consolidation create a situation where the ultimate survivor overpays for the right to be the “last one standing.” Selling out early can often be a better strategic choice.

FINAL THOUGHTS
If your strategy is to ride out a consolidation to the end, here are some suggestions. First, develop a core competency in integrating businesses. This is not an easy task. It takes special skills. Second, be realistic in your expectations for the industry. Don’t overestimate the benefits. Third, be willing to walk away from a deal if the bidding gets too high. You may have a chance to come back later and get it at a lower price.

Strategy Planning Analogy #143: Business Entropy

THE STORY
A long time ago, I learned that if you leave a moist slice of cake exposed to the air, it will dry out. That made sense to me, so I devised a rule that whenever you leave food exposed to the air, it will dry out.

I was shocked, then when at a later time I left dry, crunchy food exposed to the air, like graham crackers and cookies. I expected nothing to happen, since air dries out food, and these items were already dry. However, when I came back, these graham crackers and cookies over time had gotten moist.

Now I was confused. It seemed like the air was just plain mean. It was out to ruin all of my food. If the food was moist, it made it dry. If the food was dry, it made it moist. How, I wondered, did the air know which type of food was out there, so that it would know how to ruin it?

THE ANALOGY
Different types of foods have different points of distinction. Some are very moist, like a slice of cake. Some are very crunchy, like a graham cracker or cookie. It is these points of distinction which give each of them their uniquely desirable taste.

However, if you expose these foods to the environment, they tend to lose that tasty uniqueness. The moist becomes less moist and the crunchy becomes less crunchy. No matter what the original point of distinction, when left out in the air, they become more bland. Rather than having distinctive moistness or crunchiness, they started to all become average, or mediocre, in their moistness.

When I want moistness, I want it really moist. When I want crunchiness, I want it really crunchy. Semi-moist or semi-crunchy won’t do. Yet that’s what happens when food is left out in the elements.

This same principle applies to business strategies. Successful business strategies tend to be based on creating a distinctive point of superiority. Just as a cake is distinctively superior in moistness, a business strategy can be distinctively superior in attributes like quality, price, service, speed, and so on.

However, you cannot just wrap up your strategy in plastic wrap to preserve the distinctiveness, as one would do with a slice of cake to keep it moist. Strategies have to be worked out in the marketplace. You have to expose yourself to customers and the competition.

Just as the environment weakens the distinctiveness of cakes and cookies, the business environment tries to ruin your strategy’s distinctiveness. There tends to be a force at work in the marketplace to weaken distinctiveness and move all companies towards mediocrity.

Unless you are diligent in protecting your differentiating point of distinctiveness, natural forces will work against you. Therefore, you must be vigilant in protecting that point of distinctiveness.

THE PRINCIPLE
The principle here is the scientific concept of “entropy.” Entropy comes from the second law of thermodynamics. Without getting very technical, the principle behind entropy is as follows: If you unprotectedly place items of different energy levels into the same environment, over time the energy will disperse until the entire environment is at the same energy level.

For example, if you put a glass of ice water into a warm room, eventually the ice cubes will melt and the water will become the same temperature as the room. Similarly, if you take a pumped up bicycle tire and puncture it, the air pressure from the tire will disperse until the air pressure in the tire is the same as the air pressure in the room. If you leave a hot frying pan on the stove, eventually the heat of the frying pan will disperse until the frying pan and the kitchen are the same temperature. These are all examples of entropy in action.

This is not that dissimilar to my story about the cake and the cookie. Moisture will disperse until the room, the cake and the cookie reach a moisture equilibrium. This point of equilibrium is less moist than the starting point for the cake and more moist than the starting point for the cookie.

In a sense, there is a similar force at work in business. We will call it “business entropy.” The principle behind business entropy is as follows: Without special protection, when businesses are placed out into the marketplace, the energy behind points of distinctiveness will dissipate until all of the companies become mediocre in performance.

In retailing, a similar concept was made popular back in the 1960s by people like Stanley Hollander and Robert Buzzell. They called it the “Wheel of Retailing.” The concept went something like this:

1) A new retail format would develop by doing something different which would allow them to price items significantly below the older, established formats.

2) Customers would flock from the established retail formats to the new format in order to save money.

3) Because the new format became so successful, others would try to copy the new format.

4) Eventually, there would become overcapacity in the new format, as similar stores were built in the same location by competing firms.

5) In order to stand out in the crowd and beat the others in the same new format, the stores would start to add various features to appear superior. It could be added services, added variety, added convenience or something similar.

6) Over time, a sort of one-upsmanship would take place in which all the competitors would continue to try to get an edge through adding even more features.

7) Eventually, so many features would be added that the format no longer could support its original point of distinction as being the lowest price. All of these features altered the cost structure until it had to raise prices to levels similar to what existed before the new format came along.

8) As a result, another different new format would come about which could gain popularity because it could significantly underprice the prior new format—and the process would start all over again (another turn of the wheel).

This wheel of retailing helps to illustrate business entropy. When the new, low cost retail format is exposed to the marketplace, there are environmental forces at work to disperse the cost advantage and make it more like the status quo. These competitive forces include competitive pressures (and a desire to get an edge on them) as well as consumer demands for more features. If we give into these pressures, business entropy will take place and the price distinctiveness will go away and we will become bland.

Wal-Mart has been able to buck this trend, but only because it has been extremely clear in its low price strategy and been extremely diligent in defending it. It has taken a lot of energy on the part of Wal-Mart executives in order to keep the distinctiveness of low prices in tack. There were a lot of other discount store chains started around the same time as Wal-Mart, but most of them have failed, because they were less clear and less vigilant about fighting against the forces of business entropy. They let costs and features creep in until they lost the key point of distinctiveness—low prices. And now they are no more.

This is not just a retail phenomenon. Business entropy can attack all types of businesses. For example, high end niche businesses can fall victim to environmental forces which want them to grow quickly. To gain more of a mass appeal, they can compromise the very distinctiveness which appealed to the high-end niche. This happens all the time in the fashion world, which is why fashion brands tend to come and go.

Dell computers started out successfully with a lower cost business model. However, because they did not diligently continue to pursue low cost, they lost that advantage. Environmental pressures have caused them to add all types of more fashionable designs and added features which have raised costs. Now they sell some of the more expensive computers and they are struggling a bit. Another victim of business entropy.

In another example, competitive pressures can overcome a high quality or high service business and put it into a price war. As the company ratchets down prices, there are pressures to trim back on some of the quality or services which gave the company its original point of distinction. Eventually, the company loses its point of distinction and becomes mediocre across the board. Yet another victim of business entropy.

SUMMARY
The moral of the story is that points of distinction will not naturally stay that way. The forces of the environment will try to chip away at your successful point of distinction and make you mediocre. The only way to fight this natural law of entropy is to:

1) Be very clear to the organization about what it is that will create your successful point of distinction.

2) Be diligent and expend energy to protect and increase that point of distinction. Be ever mindful of the forces working against it and do what it takes to keep it strong.

FINAL THOUGHTS
One of the biggest environmental forces working against you could be your own shareholders. Their desire for faster growth or bigger near-term profits may create some near-term benefits. However, to hit the near-term goals, one may have to make compromises to your point of distinction which destroys long-term potential. Hence, the forces of entropy could be closer than you think. It is important to help shareholders understand how their pressures can help accelerate the negative forces of entropy.