Strategic Planning Analogy #482: Owning Vs. Driving

 

THE STORY
In automobile racing, the drivers get all the glory.  They are the heroes; the ones who get in all the photos and are adored by the race car fans.

Yet are the drivers really all that special?  Most are mere employees of large race car companies.  They don’t own the car they drive in the races.  Heck, they don’t even own the clothes they wear while driving.  Both the clothing and the cars are covered with decals and logos of the company sponsors who invest in these large racing enterprises.

Winning in car races requires more than just drivers.  There are the car designers, the pit crew, and a whole host of others.  Yet the glory goes to the one driving the car.

In an episode of The Simpsons, there was a child’s race of coasting “soapbox derby” cars down a hill.  While all the boys were clamoring to be the drivers, one of the coaster car designers lamented, “It’s all in the design.  The drivers are basically ballast in these cars.”  Yet the drivers get the glory.

 

THE ANALOGY
The drivers don’t own anything but they get all the glory.  That’s because, to most fans, it’s not who owns the car that is important, but who drives it. 

A similar idea applies to all businesses.  Many business leaders seem possessed with the idea that their company has to own a lot of things.  They are constantly involved in a wide variety of acquisitions and other M&A activity.  They focus on building a portfolio of owned businesses.

Yet is ownership really all that important?  In auto racing, the glory goes to the one who drives the car, not the one who owns it.  Similarly, as long as your company is driving the way an industry works, does it really need to own that many pieces of the industry?

The key is not ownership, but control.  And as long as you are in control (behind the steering wheel), you can have as many people putting their logos and decals on the venture as they want.  Because it is the driver who gets the biggest prize.

 

THE PRINCIPLE
The principle here has to do with control.  Those who control how an industry or business ecosystem works control how the money flows.  So a business with more control can make more of the money flow to themselves.  

Increasing ownership does not necessarily lead to increasing control and increasing profitability.  In fact, as we will see later, increased ownership can actually reduce control and profitability.

There are many alternatives to ownership, including alliances, joint ventures, partnering, outsourcing, buying on the open market, and a host of contractual arrangements.  These can often lead to greater control and greater profitability than ownership.  If you do these types of arrangements properly, you can be in the driver’s seat for the industry—and get the glory (and the biggest prize).

Problems With Transfer Pricing

Ownership can destroy control and profitability in many ways.  First, there is the problem of transfer pricing.  As an item moves through the pipeline—from raw material to the hands of the ultimate consumer—there are numerous places to transfer ownership, from the extractor to the part supplier to the assembler/manufacturer to the distributor to the retailer to the consumer. 

At each point along this chain a transfer price is negotiated.  Those with power control who benefits the most from how the transfer price is negotiated.  For example, Walmart is a very powerful part of many pipelines. When manufacturers sell to Walmart, I’m sure the Walmart does much better on the transfer price than do the manufacturers or other retailers negotiating with those same manufacturers.

A problem can frequently occur, however, if a company owns too many parts of that pipeline.  If they forward and backward integrate significantly through acquisition, they can end up owning most of the transfer points.  In essence, the company ends up negotiating with itself.  Therefore, the fully integrated company cannot use control, power and leverage to extract above average returns through transfer pricing.  After all, if you own both sides of the negotiating table, if one side wins and the other loses, you are no further ahead in total, because you own the winner and  the loser in the negotiation.  In other words, the extra ownership reduces your control over how the money flows in transfer pricing.

Problems With Alienation

The mere fact that you own an additional piece of the supply chain can destroy the value of what you have purchased due to the reaction of others.  For example, let’s assume you buy one of your suppliers—someone who was a supplier to you as well as some of your competitors.  Those competitors, who were happy to purchase from that supplier before you owned it, may no longer want to use the supplier after you own it, because they don’t want to give business to their competition.

For example, when Walmart purchased McLane Distribution, it thought it would gain knowledge of fast moving consumer good distribution in groceries.  What they failed to consider was how many convenience store customers would drop McLane as their supplier because they didn’t want to help Walmart.  Walmart had to sell McLane in order for McLane to keep its customers.  So, by owning McLane, Walmart destroyed McLane’s power to control its other customers.

Problems With Focus

The more diversified your ownership, the less focused one tends to be.  It takes considerable effort to be state-of-the-art at everything all the time.  There are more opportunities to slip up.  However, if you keep your sphere of ownership smaller, you can specialize at being the very best in a narrow focus.

There are reasons why people outsource things like payroll and IT and other back-office functions to specialists.  That way, they know that there is someone whose whole livelihood is based on being the very best in that area doing the work for them.  Specialization makes those outsourcing firms more powerful and it allows their customers to focus on the areas more critical to their success.  It is a win win.

Nike and Apple

Nike and Apple are two firms which avoid a preoccupation with ownership and instead preoccupy themselves with control.  In both cases, Nike and Apple focus on only two areas—design (business model and product design) and consumer image.  Pretty much everything else is outsourced (including the making of the products).  Nike and Apple own the key drivers for their whole ecosystems.  It puts them in a powerful position to drive how the rest of the entire ecosystem operates, even though they don’t own it.  And both are doing well.

Apple is able to focus in on what matters and leave the rest to the other experts.  And because it is the driver, it negotiates tough deals.  Just ask anyone in media who has had to deal with Apple.  By contrast, Sony tried to own everything—from design to manufacturing to even trying to own the media.  The added ownership worked against Sony.  They lost focus and could not win the battle on transfer pricing.  Worse yet, even though it owned most of the parts, Sony did not build as integrated a business model as Apple.  So Apple—owning fewer of the parts—created a superior integrated model.  Apple was like the race car driver—they didn’t own the car, but they made it go in the right direction because it was their hands on the wheel.  And now, Apple is very profitable and Sony is struggling.

Implications

The key implication of all this is that ownership should not be the automatic default option when looking at how to gain an element for one’s strategy.  In fact, there are so many reasons why other alternatives may be superior that acquisition may need to be the option of last resort.  Ownership may need to become the exception, not the rule.

Before jumping to the conclusion of ownership, check to see if there are ways to gain control without the need to own.  Find a way to drive someone else’s car and steal the glory.

And finally, instead of focusing on how to do M&A deals, focus on how to do non-ownership deals in such a way they you get to be the driver.

 

SUMMARY
When developing strategies, one often finds a need to add certain elements in order to succeed.  But just because you need them does not mean that you have to own them.  It only means that you have to control them.  And in many cases, you gain more control and more profitability if you do not own them.  Therefore, do not automatically default to acquisition as the way to get what you need.

 

FINAL THOUGHTS
A read a study recently which looked at businesses and their level of successes with acquisition, partnerships and building from scratch.  Their conclusion was that acquisition tended to produce the least amount of success when compared to building or partnering.  Their conclusion was to only acquire when building or partnering didn’t make sense.  That sounds logical to me.

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 #333: Ownership

THE STORY
Back when I was getting my MBA, one of the things I was taught was how to do the classic “Rent versus Buy” analysis. The idea is to track the costs over the lifetime of an asset to see if it is cheaper to rent the asset or buy it.

I was so excited about learning this new tool that I immediately wanted to apply this knowledge to the company I was working for part-time while getting my MBA. I did a quick analysis of whether this company should rent or buy its trucks. I was eager to share my results with company management.

Unfortunately, company management was not as excited about by the analysis as I was. Apparently, they had already been doing an analysis of their own, called “Reinvest versus Liquidate.” They had come to the conclusion that they were going to wind down the business instead of reinvesting in it. Thus, an analysis about renting versus buying future trucks was worthless, since they were not going to be needing any additional trucks in a wind down.

This taught me an important lesson: If you don’t have a great long-term strategy, a lot of the day to day decisions lose their importance. Maybe that’s why I’ve spent most of my career trying to help firms find that long-term strategy instead of helping them with “Rent versus Buy” decisions.

THE ANALOGY
Most of the time, we see the “Rent versus Buy” decision as a minor tactic. It is usually not the key to our core business model. Instead, it is just a tool to find the cheapest way accomplish our business model. If the business model is failing, like in my story, “Rent versus Buy” is not seen as powerful enough to stop the failing business model.

However, what if we elevated “Rent versus Buy” to become the core differentiation in our business model? Would it be possible to create a new, more powerful business model based upon assumptions around ownership? Could a creative new approach to ownership create a business model so innovative that a whole new industry is born? Could this help save companies from liquidation?

I think so.

THE PRINCIPLE
This is another blog in my occasional series on innovative business models. In the past, we’ve looked at innovation by adding or taking out intermediaries, in bundling/unbundling, changing access, and in changing how a problem gets solved. In this blog, we will look at innovation by changing ownership.

Everything has to be owned by somebody (or somebodies). For many items, ownership transfers to the buyer at the point of the transaction. For example, if I go to a car dealership and purchase a car, the ownership of that car transfers to me.

For other items, ownership does not transfer at the point of the transaction. Instead, the “purchaser” is only leasing use of the property. For example, an owner of an apartment building maintains ownership of the property and makes money by renting out the apartments.

Other times, a third party takes ownership. For example, a manufacturer may sell an item to a third party finance company who then leases the property to a user.

The point here is that you get a different business model depending on whether ownership is located with the product/service provider, the product/service user, or a third party. If you want to create a new business model innovation, consider shifting from a traditional ownership model to a different one.

1) Shifting From Traditionally Rented to Owned
Let’s look at a few industries that have traditionally used a lease business (provider-owner) model to see what happens when you shift to a user-owner model. For example, apartment buildings were traditionally a provider-owner business. The owner of the building remained the owner. The users of the building rented their space from the owner (never took ownership). But what if the users did take ownership? When this happened, a whole new exciting industry was created, called “condominiums.”

And how about vacations? Traditionally, when you went to a vacation spot, you rented your accommodations from a Hotel, Inn, Bed & Breakfast, or other such facility. But what if you could own that accommodation? Some entrepreneurs tried that and created a new business model, the “timeshare” vacation, where you own a week’s worth of a vacation property, which can be traded for vacation spots all over the world.

This timeshare model has spread to other industries where other business models had previously been dominant, such as commercial jets (NetJets) and boats. Either you went from renting to partial owning, or from full owning to partial owning.

Before the breakup of the telephone utility in the United States, every telephone in the country was owned by the telephone utilities. Customers rented them as part of their monthly utility bill. Now, customers own their own phones. This revolutionized the telephone manufacturing business.

When movie studios first started allowing customers to view video tapes of their movies in people’s homes, a rental model was chosen, spawning firms like Blockbuster. Then the studios lowered the price, so that consumers started buying and owning the movies, benefitting firms like Wal-Mart. Now, in the age of digital streaming of movies, we’re moving back to a rental model.

The point is that you may be able to revolutionize an industry by finding something which is traditionally rented and find a way to transfer ownership to the user.

2) Shifting From Traditionally Owned to Rented
This same principle also works in reverse, where something typically owned by the user is shifted to a rental model. For example, instead of owning your furniture and appliances, you can rent them. Firms like Cort will gladly rent you whatever furniture you need, for home or office. Other firms, like Aarons or Rent-A-Center, use a hybrid rent-to-own model for furniture and appliances.

What about clothing? There are a number of firms specializing in renting out designer clothing and accessories via the internet, including firms such as Wear Today Gone Tomorrow, Rent Me a Handbag, and From Bags to Riches. In New York City, there are designer clothing rental shops, such as Albright and Ilus.

People may have been comfortable renting cars for a short period when away from home, but tended to want long-term ownership or a long-term lease on a car for home-town use. Now, however, there are firms such as ZipCar which will rent you a car for a few hours or a day right in your own home town in a very convenient manner. This is causing many urbanites to abandon car ownership, just renting cars for those occasions when mass transit is inappropriate. Customers claim to save money and help the environment. A new industry is born!

Again, look at industries where users traditionally own the product and consider how you could reinvent the industry by converting to a rental model. You may create the next ZipCar.

3) Other Interesting Ownership Changes
Governments have traditionally been responsible for providing its citizens with a number of services, such a prisons and highways. However, even though the government is responsible for providing the service does not mean they have to own the service. Lots of government services, like toll roads and prisons are now owned or operated by non-government third parties. There may be many other government responsibilities that can be done by independent third parties.

Outsourcing can be applied to a lot of areas. This shifts ownership to others, rather than to yourself. Are there new frontiers in outsourcing yet to be developed?

And what about cooperatives? Group ownership of property may be better than owning it all by yourself.

And maybe you can split a single transaction into two. For example, one business model being considered in the electric car industry is one where you would buy the car, but rent the very expensive battery inside the car.

SUMMARY
One component of a business model is who retains ownership. It could be the provider (who rents), the user (who buys), or a third party (who facilitates). One can invent exciting new business innovations by merely changing the traditional ownership pattern in an industry business model. Maybe such an opportunity exists in your business.

FINAL THOUGHTS
My initial excitement about “Rent versus Buy” was quickly deflated in the story. However, if you look at ownership issues as the opportunity to potentially reinvent an industry, there is plenty of reason to get excited again.

Strategic Planning Analogy #286: Who’s Strategy is it?

THE STORY
Let’s imagine for a moment that a friend of yours asked to borrow your conservative-looking car for a few days. Being the nice person you are, you let the friend borrow the car.

After those few days are up, your friend returns the car. To your shock and horror, you notice that your friend had made changes to the automobile. The exterior had been repainted to a color you do not like. Flame-like decals were put on the sides of the car. The interior was redesigned in an awful checkerboard pattern. The carpeting was replaced with some awful shag that looked like something out of a 1960s Hippie “Love Van.”

Naturally, you would be furious with your friend for trashing up the look of your car. You’d probably say something like, “What is the matter with you? I let you drive my car for a few days and you totally destroy its appearance. Have you lost your mind? This was MY car! You had NO RIGHT to change it like that!”

You friend answers as follows: “I knew I’d only be using the car for a short time, but during that time I wanted to be able to make a statement. I wanted to car express my personality.”

At this point, you’re probably ready to scream, “Well now you can express yourself on a check to pay for all the damage you did to my car!”

THE ANALOGY
It’s hard to believe that someone would be that disrespectful of your car. After all, it is your car. It belongs to you.

Yet something similar seems to occur often in the business world. A newly hired CEO, CMO or strategist will come on the scene. As the new person in the company, they want to quickly make their mark on the firm. They want to make a statement and express themselves. As a result, they start to make all sorts of changes to the brand.

The consumer then screams back, “What are you doing to MY brand? You are destroying it! You had no right to make those changes! Make it the way it was before!”

Remember the debacle of “New Coke?” There was a consumer revolt because the consumers felt that “their” brand had been violated. New Coke had to be eliminated and the classic form needed to return.

The Coca-Cola brand was like the car in the story. Consumers felt they owned the brand. The executives, who tend to stick around in their job for a only short time, had “borrowed” the brand and returned it as an ugly “New Coke.”

THE PRINCIPLE
The principle here is that consumers of a brand tend to stick around longer than the managers of that brand. So, in essence, the brand belongs to the consumer and the managers are only borrowing it for a short time. Therefore, our brand strategies should take more of a “borrower” approach.

A typical CEO holds that position for about 3-4 years. A CMO typically holds its position for only about a year. A Chief Strategist probably falls somewhere in-between. This is a very short period compared to the expected life of the brand or company being managed.

The only one sticking around for the long haul tends to be the consumer. In many ways, they are the ones who own the brand. After all, branding success depends on creating the proper image/position in the mind of the customer. The customer owns their mind. They don’t like people playing mind games to mess it up (even more than they hate having people mess up their car).

Look at what Pepsi did in 2009 by redesigning all of its brand logos. Between the cost of the redesigns and the cost of the transferring all of the visuals to the new look, Pepsi probably spent well into the hundreds of millions of dollars world-wide.

What were the results? First, the redesign of the Tropicana orange juice carton was received so poorly by the consumers that Pepsi had to return to the former design. The consumer response was “How dare you change MY juice carton. You made it ugly; change it back!”

Changing Gatorade to “G” caused a lot of initial confusion for the customer. Is this the same old Gatorade I’m used to or did you mess it up like Coca-Cola did with New Coke? As for the other Pepsi logos, I doubt one will ever be able to find a positive return on the huge investment. The new management over-stepped and wasted a lot of money.

Remember, we are only borrowing the brand/product/company for a short time. We need to act more like borrowers. As a borrower, we should manage by a few rules.

Rule #1: Do Not Ignore the Legacy You Are Inheriting
Typically, the brand/product/company was around for a long time before you got there. You are not starting with a clean whiteboard. That whiteboard is already filled with years of impressions and experiences between the brand and the customer. Some of those impressions/experiences are etched in pretty deep. You cannot just erase this history as if it never occurred.

Before embarking on any strategic or cosmetic change, first make sure you understand all of that historical heritage. That legacy tends to box you in on your strategic options. Depending on the history, certain strategies will be compatible. Others will not.

Coca-Cola’s legacy was around authenticity. Coke was “the real thing.” Coke was “it.” The historically-based impression was that the Coke formula was the enduring essence of refreshment throughout the generations and that everything else is a poor imitation.

This legacy boxed in the strategic options. Throwing away the old formula and replacing it with a new one was not compatible with this legacy. If old Coke was “real” then new Coke had to be “fake.” If old Coke was “it,” then new Coke was “not it.”

Based on the history one has inherited, you only have permission to go in certain strategic directions. If you stray too far from history, consumers will tell you that you had no permission to do so and will try to force you to return the brand back. We talked more about permission in a recent blog.

In this Web 2.0 world, the customer has more power to fight back than ever before. So do not ignore the history you are inheriting. Pay heed to impressions already in place. Go only where history allows you to go.

Rule #2: Remember Where the Battle is Taking Place (the Consumer’s Mind)
To win with the consumer, you have to win at the point where decisions are being made—in the mind of the consumer. You do not own the mind of the consumer. You can visit it, but trust me, the consumer is very protective of what goes on there.

As I said earlier, if you think someone is going to be mad because you messed up their car, just watch what happens if you try to mess up their mind.

Therefore, treat the consumer’s mind with respect. Respect the historical impressions which already are already embedded in the brain. If you stray too far, your message/strategy will not be believed.

Remember, you are only a visitor, borrowing a bit of their mental attention.

Rule #3: You Are A Caretaker of the Brand For the Next Generation
Just as the brand/product/company was around well before you got there, hopefully it will be thriving well after you leave. You are a caretaker of the brand for only a brief time. If you are a poor caretaker, you will destroy the brand’s long-term viability.

If you only think short-term, you can find many ways to get a quick bump in profits. Some of these tactics, however, can destroy the long-term prospects.

Think of the luxury fashion industry. The heritage is wrapped up (in part) in exclusivity. In the near term, one can get a boost in luxury goods sales/profits by taking the brand to the masses. However, once the masses embrace the brand, the exclusivity heritage can be destroyed. In the long-term, this will lead to defection from the brand by luxury customers. Once the luxury customers no longer embrace/endorse the brand, the masses will no longer see the value, so they will eventually reject it as well. The net result is that the short-term boost lead to long-term brand destruction.

Remember, the key determinant of stock price is anticipated future cash flow. If your actions appear to be destroying long-term prospects, the stock price will be depressed, even if you get a near-term bump. Keep a long-term perspective in your strategy. When you hand off the brand to the next manager, give them a strong brand.

SUMMARY
We are managers for only a brief period in the life of what we are managing. We are inheriting the legacy of those who came before us and we are leaving a legacy to those who come after us. The best strategies understand this larger perspective. They take advantage of the opportunities provided by the old legacy and create enduring strength which transcends our tenure. After all, the brand really belongs to the customer. We are only caretakers.

FINAL THOUGHTS
When I was a Boy Scout, we were taught about treating nature with respect. We were told that we were nature’s caretaker on behalf of future generations. When it came to camping, the rule was to “leave the campgrounds in a better condition than you found it.” I’d say this concept applies equally well to strategic management.

Analogy #233: Ownership Vs. Control

THE STORY
In the recent financial meltdown, people from all sectors of society have seen the value their investments wiped out. Some was due to poor investment decisions by the investment companies. Some was due to being victims of Ponzi scemes from people like Bernie Madoff.

These losses point out the difference between ownership and control. The investors owned their money. The investment houses, however, controlled the money. When the owners tried to pull their money back out of the investments, they found that the money no longer existed. The ones who controlled the investments had either stolen it or lost it through bad financial decisions.

The owners of the money lost much of their wealth. The controllers of the money ended up making really good salaries/bonuses.

So where is the real power—in ownership or control?

THE ANALOGY
Many of the discussions in a strategic planning process seem to center around ownership:

1) What position do we own?
2) What should we own in our portfolio?
3) What core competencies, skill sets, intellectual property, etc., do we need to acquire (for ownership)?
4) What should we no longer own?
5) How can we get the things we own to run more efficiently?

The underlying assumption is that the better the mix of the things one owns, the better the overall strategy. However, as we saw in the story, sometimes a better measure of success is what we CONTROL, rather than what we own.

Just as ownership of financial investments in the story did not guarantee wealth, ownership of all your strategic assets may be a mistake. Being able to control the strategic environment should normally take a higher priority than ownership.

If you control the environment, you are better able to move in positive harmony with the environment as it shifts over time. This is because you can control both where you go and where the environment goes.

By contrast, ownership in an investment tends to lock you into more of a static position. Some flexibility is lost. As the environment shifts, that investment can go out of favor. It’s hard to get out of an investment that is out of favor. Just ask the owners of newspapers how easy it is to sell out of these poor investments. Nobody wants to take them off their hands.

THE PRINCIPLE
The principle here is that strategic discussions should spend more time looking for ways to control one’s destiny, instead of how to own things.

Take a look at Nike. It doesn’t own any factories. It doesn’t own any major professional sports teams in the US. Instead, Nike has spent its time controlling the evolution of sports and the key influencers in the sports field. This has allowed Nike to continually move to wherever sports outfitting has gone and be a leader. It even helps determine the direction of the industry, due to its clout.

Why own factories when you can control them? Nike gets the products produced the way it wants (control) for probably less than if it owned the factories. Nike can sidestep some of the manufacturing ownership and labor controversies. If something goes wrong, Nike can shift to another factory (flexibility). If the product mix shifts, Nike can more easily shift away from manufacturers of the obsolete to manufacturers of the up-and-coming.

The negative factors associated with ownership include the following:

1) Less Flexibility
Once entangled with ownership of assets, it is harder to untangle one’s self when it is time to move onto the next big thing. If all of your assets are tied up obsolete technology, it is harder to free up capital to exploit new technology. In the current credit crunch, it is harder to find others to loan you the money to buy into ownership. That is why the automakers need a government bailout to move from gasoline to new technology engines.

2) More Bureaucracy
At some point, there tend to be diseconomies of scale in management when a company gets too large. Big conglomerates can choke on their internal bureaucracy. If the pieces are kept smaller and more independent, they can keep the entrepreneurial spirit alive in a lean and mean, efficient structure. Some has suggested that “too large” can occur as small as with 200 employees (depending, of course on a number of industry factors). At that point, some suggest that the company be broken up.

Also, an employee in a large impersonal conglomerate may not be as motivated as someone who has more of an ownership stake in a smaller entity. A loose gathering of owner-operators can be far more powerful than a mass of mere employees. This is one of the benefits of the franchising model.

3) Conflicts of Interest
As we talked about in detail in a previous blog, you may have fewer customers for a division if you own it. The idea is that many of our competitors do not want to do anything to put cash into our hands. The more pieces we outright own in the business ecosystem, the more pieces that our competition may boycott so as to avoid us. If we merely align with these pieces, rather than own them outright.

4) Less Efficient Use of Capital
If you want to get 100% ownership, you have to invest 100% of the capital. However, there are often ways to have the power and influence which come from 100% ownership by only putting up maybe 40% of the capital. You money can go a lot further if you are willing to settle for a controlling share rather than 100% ownership.

If you try to acquire something to get ownership, you typically have to pay a large acquisition premium over the current value to obtain the property. In essence, that high premium price means that you are handing over much of the future profit potential to the former owner which absorbing all the future risk on your own.

Contrast that with the idea of forming an alliance with the other company, where they may be so interested in the benefits of working together that they give you a discount. In addition, because they are still owners of their part, they are absorbing their part of the risk, not you.

5) Less Speed
Coffee manufacturers have often wanted to get their cold coffee beverages into the vending distribution system. They have found it much easier to form alliances with carbonated beverage manufacturers (who already have a vending distribution system in place) rather than take the time to build a 100% owned vending distribution network. By partnering with people who already have key pieces in place, one does not lose precious time trying to develop an expertise or ownership in this area.

6) Lose Benefit of Specialization
In alliances and outsourcing, one is putting together a group where everyone is an expert in their field. They specialize at excelling in their area and are not distracted by getting into areas outside their expertise. If you try to own 100% of everything, it is likely that all of your parts will not be the best in their field. Even if the piece you bought was an expert before you purchased them, the large corporate infrastructure and internal politics could weaken that expertise. You will have weak links in your system.

With all of these problems, why do people focus on getting ownership? The reason is because they are looking for the benefits of control. The more of an industry ecosystem you can control, the more of your destiny you can control. And that usually leads to greater profits.

So, rather than first looking to ownership as a means of getting control, use your strategic analysis to first look at other ways to more efficiently and effectively gain control. This could be strategic alliances, distribution agreements, licensing, outsourcing, franchising, minority ownership, or some other such arrangement. Try to structure them to get as much control (with as much flexibility and as little money) as possible. In the long run, this can create a far stronger strategy.

SUMMARY
Strategic success is more dependent on control than ownership. Although ownership can be one means to gain control, there are often other alternatives which are a more effective and efficient way to gain that control. Make sure these other options are front and center in your strategic discussions and not an afterthought.

FINAL THOUGHTS
Yes, it’s true that these other forms of business structure bring their own sets of risks. Alliances can fail as often as acquisitions. But when a mess is made, it is often easier to undo the mess under these alternative structures. The point is not to automatically flock to one type of structure for every situation. When building the strategy look at them all (and don’t automatically assume that ownership is always to be preferred).

Fire Your Owner

THE STORY
My finance teacher in college was a brand new professor. He had just finished his PhD and made the transition from being the student directly to being the teacher. He had no meaningful real-life experience in finance (nor any meaningful real-life experience at teaching for that matter, either).

This professor was not much older than I was at the time, which was relatively young. Yet when he taught, he spoke as if he had generations of experience and seemed to enjoy telling his students how most everyone in the business world was misguided.

He hated it when a company would introduce a new product, or diversify into new lines of business (to mitigate risk), or change a strategy to adapt to a changing world. In his mind, every business should be required to sell only one product, and sell it in only one way…forever.

What was his reasoning behind this? He believed that the investing shareholders should have ultimate power. If investors like the one product and the one way it is sold, then they can support it by buying shares in the company. If they don’t like the product or the way it is sold, then they can sell their shares in the company (or never invest in it in the first place). The good would get rewarded and the bad would get punished—by the investors.

Whenever a company changed its portfolio or its strategy, he felt it was interfering with his ability to control the company with his ownership. After all, what if the company came up with two products—one he liked and one he didn’t? Now he could no longer support one with his shares and deny the other by not buying shares. This made him very angry.

And if a company had the wrong strategy, he didn’t want it to change, because then the company would be doing something he couldn’t control. Instead, he would prefer that the company kept the bad strategy, so he could sell his shares in that firm and re-invest them into a company that already had the better strategy.

He did not care if a company lived or died. He would just continue to move his money and invest it in the best location at that particular moment

By contrast, Warren Buffet seems to have taken an opposite approach to investment and done quite well with it. I suspect that Mr. Buffet has done much better in investing than my college professor did.

THE ANALOGY
Although most investors are not as blunt as this professor, many act as if they believe what he is saying is true. They have no sense of loyalty or desire to help a business thrive over the long haul. They just want to move their money around to wherever the success is at the moment. What motivates their personal success often is at odds with what is in the best interests of an individual company’s long term success. For them to win, the company often has to fail.

When devising strategies, it is important to consider the desires of your owner. After all, these are the people who pay your salaries and can get you fired. But sometimes you have to take a stand and not do exactly as they desire. Giving them exactly what they desire may end up not giving them what they really need…an economic engine that produces cash flow for a long time.

Warren Buffet understands the big picture and realizes that the best returns usually come from long-term investing in companies that know how to adapt and survive. When the investor’s success depends on the company having long-term success, then usually both sides win. But if the investor’s best interests are not the same as the company’s, then one or both sides tends to lose.

THE PRINCIPLE
Over the past couple of blogs we have been talking about the concept of “who is my customer”. We have seen that you can use different strategic approaches to choose which type of customer you want to serve. You can serve the people who pay the money, the people who use the service, the people who influence the people who use the service, and even the people that may eventually buy your company.

There is another type of customer we haven’t talked about much. That would be the current owner, be it a corporate headquarters (if you work in a division), a board of directors, an active shareholder, or a venture capitalist (if you are a start up), or something similar.

In general, it is a good idea to make this “customer” happy. They are the boss. At the very least, you cannot ignore them. However, sometimes the best path to making them happy is to do something other than they want. It can be a tricky business to disobey a boss, so we must be careful when doing so. The following are a few principles to help determine when to do so.

1) Move in the Direction of the Greater Good
Sometimes a division of a corporation is asked to embark on a strategy which sub-optimizes the individual division, but optimizes the good of the greater corporation. In this case, the path would not be to disobey and try to maximize your individual business, but to act for the greater good of the entire corporation. To ensure that this happens, the division should be rewarded based on its impact on the greater good.

2) Don’t Move in the Direction of Illegal or Immoral Activity
The phrase, “But my boss made me do it,” does not stand up well in court. You always have the option of quitting.

3) The Owner is the Tie-breaker in differences of Opinion
Sometimes people just come to different conclusions. It’s okay to express your differences to the boss, but in the end, their opinion is the one that matters.

4) When the Owner’s goal is clearly not in the best interest of the company, consider firing the owner as your customer.
If a shareholder is making unreasonable demands that will line their pockets with money but bankrupt the company, perhaps you need to look for ways to “fire” your owner. In other words, try to change the profile of the type of investors that invest in you. Try to cultivate more Warren Buffet type of owners, rather than owners like my old college professor. If you stand your ground and fight for the long-term health of your company, you should naturally attract the investors who are looking for that type of business and discourage the investment by other types of investors.

As a general rule, if you manage for the long-run, you tend to build a strong track record of growing cash flow, which leads to a successful stock price. However, if you just focus on short-term tricks to inflate today’s stock price, you may end up being a poor investment over time. So to make owners happy with growing stock prices, you sometimes have to ignore the stock price and focus on the business. Hence the irony that in order to make an owner happy, you sometimes have to focus on something other than trying to make the owner happy. Their happiness is a byproduct of good strategy, rather than making their happiness become the strategy.

SUMMARY
Although it is important to make the owners happy, sometimes the best way to do so is to focus on something else—namely making the business strong. If the owners do not see the wisdom in this, either try to get a different type of owner or go work somewhere else.

FINAL THOUGHTS
The world is a lot more complicated than what I can describe in a short blog. I don’t want to come off sounding as naïve as my old professor. But at the same time, I think leaders need to do some genuine leading every once in awhile and not just be a puppet of the owners.