Strategy Planning Analogy #561: I’m Going to be Rich and Famous

THE STORY

One time, I was talking to an expert on the subject of marketing to teenagers. She said research shows that most teenagers believe that in a relatively short time, they will become rich and famous.

The rationale for why most teenagers thought they would become rich and famous went something like this:

a)     They looked at all the rich and famous people in teenage pop culture.

b)     They decided that most of those famous ones are only marginally talented or skilled.

c)     They saw that most of these rich and famous people were also messed up jerks in real life.

d)     They looked at themselves and concluded that they were at least as talented (if not much more talented) than the rich and famous ones AND they had it a lot more together in their personal lives than the rich and famous ones, too.

e)     Therefore, the teens concluded that if those “losers” could become rich and famous, then a more talented and more “together” person such as themselves would have an even better chance of becoming rich and famous. Hence, the teens felt that they were going to become rich and famous.

That’s teenage optimism for you.

THE ANALOGY

If you look at the total number of teenagers alive today (about 25 million in the US alone) and compare that to how many of them actually become rich and famous in teen pop culture (probably much less than 100), the odds of any US teen becoming rich in famous this way is less than 1 in 250,000. In other words, the likelihood of one of these teens becoming rich in famous is less than 0.0004%.

Yet, despite these terrible odds, most teenagers believe they will be one of those rich and famous ones. That seems like foolish optimism, right? Only teenagers would be silly enough to think this way, right?

Well, consider the fact that most business people think they are going to be successful. Most companies adopt strategies that they think will succeed. If you read the press releases or public filings of companies, they almost always seem to talk positively about future success. Even companies with a horrible track record and huge piles of losses talk about how their new strategy will turn things around.

It looks like that silly teenage optimism is contagious. Many businesspeople have caught that same crazy notion that THEY too will beat the odds and be one of the successful ones. After all, why would entrepreneurs put in all the effort to start businesses if they didn’t think they would succeed? Why would companies work hard to implement strategic plans if they thought they would fail?

The logic in the business world tends to be as flawed as in the teenage world. Many think that:

a)     My ___________ (company, strategy, idea, product, people, myself, etc.) is as good or better than a lot of those successful companies out there.

b)     Therefore, if they can be a success, then I should become a success, too.

Yet, we know that most new businesses fail and that a large number of older businesses go into decline, retraction, bankruptcy or some other path that cannot be defined as a major success. Companies fall off the Fortune 500 list all the time. So, is this optimism justified?

THE PRINCIPLE

The principle here is that most truly successful businesses get that way by exploiting the benefits of being a leader. And as we all know, each category can have only one leader. The rest are followers who typically struggle to just stay alive. Therefore, most companies will not be truly successful.

Since the odds are stacked against success, one shouldn’t be like teens who blindly believe that success will naturally come to them. One needs to have their eyes wide open and realize how tough their prospects actually are. Just having a written strategy is not enough. Just doing things well is not enough to ensure success, either.

You have to plan carefully and not only work exceptionally well, but exceptionally differently. This is explained below.

1. Unseating an Established Leader is Exceptionally Difficult

As Al Ries and Jack Trout have pointed out in their many books (most particularly “Positioning,” “Marketing Warfare,” and “The 22 Immutable Laws of Marketing”), established leaders are hard to topple. They have lots of inherent advantages, including:

a)     They own the category in the minds of the consumers.

b)     They have economies of scale.

c)     They have preference in the supply chain.

d)     Habitual patterns are on their side.

e)     Image is on their side (Why would anyone buy from a loser? Doesn’t that make you a loser? Winners buy from winners.)

As a result, Ries and Trout said that just being a little better than the leader is not enough to take that position away from them. In fact, they concluded that one needs to be about three times better than the leader in order to take away their position as leader. Given the unlikelihood that you can imitate the leader and do it three times better, this is a suicide mission. Blind teenage optimism cannot overtake these odds.

Most of the Ries and Trout work was written before the economy was taken over by social media, apps, and digital networking. The laws of networking make unseating a leader in this economy even harder. A network, like Facebook and LinkedIn, gains its power exponentially as their network grows. The value of the business is directly related to the number of connections.

Therefore, to unseat one of these new economy leaders, you have get huge numbers of people to simultaneously abandon the current leader and sign up with you. After all, it’s no fun to join a new network if everyone you want to network with is still with the leader. Even if everything about the way your network works is better than the leader’s, it is worthless if nobody is connected to you. Customer switching costs are so high to leave the leader (where the connections are), that your odds of unseating the leader are as bad as a teenager becoming rich and famous.

Therefore, if you blindly try to unseat the leader at its own game, you will most likely fail, no matter how hard you try, how much better you are or how optimistic you are.

2. Being Different is Better Than Trying To Outdo the Leader

The solution, according to Ries and Trout, is to find a new place to win. Rather than try to outdo the leader at their game, play a different game where the advantages are more in your favor. For example, rather than trying to beat the top burger chain by doing what they do better, do something different, like:

a)     Change the product (Chicken instead of Beef, like Chick Fil A)

b)     Change the image (go further upscale, like Umami Burger or Larkburger, or go further downscale, like Rally’s and Checkers)

c)     Change the customer (go after the health conscious, like Lyfe Kitchen  or go after those who want the best tasting basic burger, like Five Guys or Smashburger)

d)     Change the business proposition (Burger King in Asia does home delivery)

3. Make the Differences a Key Part of Your Plan

Just claiming a new position doesn’t mean you will win. New positions typically require a new business model. Southwest Airlines did not win at the low price differentiation by merely imitating the major airlines and charging a lower price. No, it created a different business model which made lower pricing more profitable, including:

a)     Flying point to point rather than hub and spoke.

b)     Not transferring luggage.

c)     Flying out of secondary airports.

Therefore, your strategy needs to do more than just identify a point of differentiation. It must design a different business model which exploits that point of differentiation and makes the differentiation profitable.

Being different requires acting different. Both differences need to be in the strategy to make it work.

4. Follow Through

A great strategy poorly executed is really a lousy strategy. Don’t be like the teens who think fame will come naturally. Do the hard work to make it happen.

5. Don’t Rest on Past Success

Even if your strategy succeeds today, that does not ensure success tomorrow. Times change, tastes change, technology changes, customers change, regulations change. These changes can make your current strategy and business model obsolete. Being the best carbon paper provider in the age of digital documents is of no benefit, because carbon paper is obsolete. (For those of you too young to remember, carbon paper was used to make multiple copies on a typewriter.)

Just as teen idols come and go, so do successful strategies. Don’t rest on past success.

SUMMARY

Just being good is not enough. Almost everyone operating a business is good or they would already be gone. To be truly successful, change your focus from being good to being different (in positioning and the business model which supports the position). Rather than trying to outdo the leader at their own game, find a new place to lead with a new game plan. Otherwise, you will most likely fail, no matter how optimistic you are.

FINAL THOUGHTS

Just as most teens who thought they could be the next “American Idol” failed at this attempt, most businesses fail at achieving major success. Don’t assume success will come naturally. Do the hard work to find your point of differentiation.

Strategic Planning Analogy #541: Necessary for Whom?

THE STORY
I was in a business meeting recently where we somehow got on the topic of Southwest Airlines. I was explaining how Southwest had been so much more profitable than most other airlines for decades because of its unique business model, which in part included the avoidance of the hub and spoke model used by most of its competition.

Someone in the meeting objected to the praise of Southwest. He countered that the traveling world needs a hub and spoke business model. Since the hub and spoke model is necessary, it is not proper to praise a company which avoids this necessity.

In my mind, my reaction was “Necessary for whom?” Is it necessary for some business travelers? Yes. Is it necessary for Southwest? Absolutely not.

THE ANALOGY
Two of the key aspects of strategy are determining WHERE to compete and HOW to compete. Answer these concerns properly and success is more likely. Answer them wrong and success is nearly impossible.

One method businesses use to determine where and how to compete is by looking for necessity of demand. After all, if something is viewed as a necessity and demanded by a large sector of society, it must be a good place to be, right?

Just look at the illegal drug business. The junkies feel that getting their next fix of the drug is the most necessary thing they must do. And the suppliers of those illegal drugs make a lot of money off that perceived necessity.

The problem is that there is not a strong correlation between necessity of demand and profitability. It worked in the illegal drug business. It didn’t work so well for those satisfying the necessity of hub and spoke in the airline business.

Southwest chose its “where to compete” principally in the lower price, non-business portion of the airlines industry. Southwest chose its “how to compete” by doing a number of things differently, including the elimination of the hub and spoke model. These were very profitable choices for Southwest.

In fact, it was a more profitable choice than going after the demands of the business traveler, even though the demand for business travel is higher (and presumably more necessary) than for non-business travel.

Just because something out there in the marketplace is a necessity does not mean that you have an obligation to provide it. Like Southwest, it may be better to avoid it.

THE PRINCIPLE
The Southwest example illustrates a common situation in business. This is the principle that the highest profits are often found by avoiding the highest demand. This may seem counterintuitive at first, but there is logic behind this point of view.

Why High Demand Items Are Often Not Very Profitable to Supply

There are many factors which tend to lower the profitability of serving many high-demand segments. The first is that high demand segments tend to attract a lot of competition. Businesses like to flock to where the big sales potential lies. But when too many companies are fighting for those sales, the profitability of those sales plummet. Price wars suck the desirability out of those sales. You may be able to get a much higher return going after smaller, less competitive markets.

A second problem is that high demand necessities tend to attract a lot of government regulation. Food and health care are high demand necessities. Many governments get involved in significant regulation how those necessities are supplied. This often takes a lot of the profitability out of the system.

Just look at the results when communism gets involved in the necessity of supplying food. They impose all sorts of regulations and price controls. They often insert themselves into owing a lot of the food businesses. The net result is that businesses pull away and consumers are stuck with shortages and long lines.

A third problem is that high demand needs pull in the masses. And the masses do not always have a lot of discretionary income. They cannot afford to pay as much for their demands as other, smaller segments. You cannot charge more than they are able or willing to pay, no matter how much it costs you to serve them. Just look at the automobile industry. Those selling cars to the masses tend not to do as well as those selling cars in luxury or high performance segments. Customers in the luxury and high performance segments are willing and able to pay a lot more for their cars, making them more profitable, even if the segments are smaller than the mass segment. That's the reason why Tesla decided to start by targeting the high performance end of the electric car business.

When you try to appeal to the masses, you often end up with “average” offerings. Unfortunately, there will always be competitors who specialize in targeting the smaller niches. The specialists will offer items that are cheaper, or of higher quality, or of higher prestige, or of higher functionality. These more profitable niches will eat away at your mass market, leaving you with some of the less profitable middle ground. This is what Southwest did when it specialized in the profitable low price, non-business segment (and firms like Virgin Airlines and Net Jets at the high end), leaving the other airlines fighting over the unprofitable middle.

Fourth, high demand areas are often in fairly mature businesses. Mature and aging businesses, by their very nature, tend not to be as profitable as businesses in their younger, faster growing stage. Look at Procter & Gamble. They completely divested out of the food business (an extremely high demand business). Why? Because it did not have high prospects for future growth and profitability. It was too mature.

Instead, P&G has been pouring money into beauty care. You can say that food is a necessity and beauty care is a more discretionary luxury (less necessary). Yet, beauty care is where P&G have better prospects for growth and profitability. P&G is doing a great job of choosing where and how to compete, even if it means walking away from a lot of high demand products. 

Choose Wisely

As a business, you have choices. Strategy is about helping you make better choices. Those choices need to consider more than just the size or necessity of demand. They also need to look at the profitability within that demand. Smaller segments can often be better strategic choices.

In most businesses, there is no law that says that you have to target unprofitable segments. Even if you think that a particular function is necessary to make the world work, that doesn’t mean you have to serve it. It’s okay to walk away from some businesses and leave it to someone else.

Others may have business models better suited to those situations. Keep in mind that when P&G has been divesting all of its non-desired businesses, it has been finding buyers for those businesses. Many of those buyers are companies who do things differently from P&G and are better suited for wringing value out of mature, slow growth businesses.

Is There a Moral Obligation?

There may indeed be some moral issues here. Is it right to only serve the profitable rich and ignore the masses? Can we ignore the poor because they are unprofitable? Businesses work within a society and they have some obligations to that society. But they also have obligations to shareholders, debt holders and employees.

If businesses choose to or are forced to take on bad business models, this is bad for everyone. If they cannot make an adequate return, employees lose their jobs, and equity/debt holders don’t get a return. More importantly, the companies don’t make any profits which can be used for charity or for taxes to governments to help solve these issues.

Strong, healthy businesses are in a better position to provide jobs and provide funding for social issues. Then the question turns from business models to social accountability.

SUMMARY
Strategy is ultimately about making choices, such as where and how to compete. These few strategic choices can have a bigger impact on business success than almost any other thing you do. Choosing what not to do is usually more important than choosing what you do. And some of the things you should not be doing are perhaps serving large “high necessity” demands. It’s okay to walk away from them and go in a direction better suited to who you are.

FINAL THOUGHTS
When you look at large, mass oriented businesses, there are usually only a small handful of winners (often only one or two). The rest struggle to stay alive. If you are not the winner in that mass space, it is usually better to walk away and switch to leading in a smaller segment. And that’s okay.

Strategic Planning Analogy #533: Planning the Periphery

THE STORY
Last week I got bumped off an airplane in exchange for a ticket voucher discount for a future trip. I thought that was a pretty good deal until I tried to redeem it.

The airlines said I had to redeem it on their online site. Unfortunately, there was a flaw in the website making it impossible for me to redeem the voucher online. As a result, I had to call the airline on the phone.

After a terrible phone experience, I finally got an email notification of my transaction. There were two parts of the email that irritated me. First, they still had not corrected the problem. Second, they charged me a $25 service fee for using the phone to do my booking.

So I had to call the airlines a second time. It struck me that this was a pretty good deal for the airlines. By creating incompetency on their website and on the phone, they were able to create numerous $25 services fees they would not otherwise receive.

They were getting rewarded for incompetence as my travel voucher was becoming less of a deal.

THE ANALOGY
Airlines have an interesting pricing strategy. They sell the seat ticket at unsustainably low prices and then make up the difference by charging all sorts of associated fees, like the $25 I had to pay for calling them on a telephone. They have other extra fees for things like luggage, earlier pre-boarding, seats with slightly more legroom, pillows, blankets, meals and a host of other things.

How did it get to this point? Well, the core business of selling a seat to get you from one airport to another became commoditized. Let’s face it. There is very little difference between the standard seat experience in one airline over another. If you closed your eyes, you’d never be able to determine which airline you were flying.

I remember one time flying from London to Germany. I was about to go up the boarding steps to the airplane door when I noticed that the steps had the wrong airline logo on them. At first I thought that I might be boarding the wrong plane. But then an airline employee came along with a magnetic sign with the right airline logo. He put in on top of the other logo. Voila! Suddenly I was going up the proper airline set of stairs.

But that’s how it is. The standard airline service is so commoditized that you could slap any logo on it and it wouldn’t make a difference.

And we all know what happens when a core service becomes commoditized. The only way to create a preference is by lowing the price. So all the airlines lowered ticket prices to unsustainably low levels.

Since the airlines could no longer make a profit on the seats, they had to get the money somewhere else. That’s why I had to pay $25 to make a phone call to complain about a defective website.

And the point of this blog is that nearly every industry is moving in a direction towards this airline pricing model. Core businesses in numerous sectors are becoming commoditized. If you cannot come up with ways to make money on the periphery of your business (like charging for phone calls), you will have an unsustainable business model.

THE PRINCIPLE
The principle here is that in industry after industry, the core business is becoming commoditized. The commoditization is causing core businesses to be priced as a “loss leader.” To remain viable, one has to get nearly all of the profit from non-core elements on the periphery. So, ironically, one’s strategy may need to be more focused on the periphery than the core if one wants to succeed.  So much for all that literature on “sticking to one’s core.”

Fast Food Example

This is not just an airline problem. Look at the fast food industry. The basic hamburger is commoditized. All the major fast food restaurants sell the core hamburger at a loss.

With the core product priced at a loss, the only way to make money is by focusing on the periphery. So McDonald’s adds fancy coffees and fruit smoothies. They all start putting a slice or two of bacon on everything so that they can charge a premium price. They push the higher margin fries and beverages. They try to get you to upsize to a larger combo meal and to add a dessert.

This is their version of what the airlines do. They come up with all sorts of peripheral things to charge you for, because the core item on the menu (the hamburger) can no longer make it on its own.

Others

Or how about the cable TV industry?  Cable TV in the US is commoditized. They all give you essentially the same channels in the same way. When watching your favorite show on TV, the viewing experience is identical, regardless of the cable company piping it to your screen.

As a result, US cable TV companies can no longer price their core TV business at a profit. The only way to earn a profit is by focusing on the periphery—phone service and internet service. Cable TV service has become a loss leader in order to sell the periphery.

In a similar fashion, phone companies sell talking over the phone at a loss and have to make it up on peripheral services like data transfer.

In social media, it is quite common for companies to give away the core business for free and then try to recoup their losses in sales of peripheral features to peripheral customers (think of LinkedIn). It’s called the “Freemium” model. It is very common in gaming, where the core game is free and you pay for periphery features which help in the game experience.

It’s common for digital companies to use the word “monetization.” It is their way of saying that they have to give away the core for free in order to build out network to a critical mass. So, to make a profit, you have to create a secondary strategy for collecting cash—the “monetization.”

When you try to buy something at the store, they try to get you to pick up impulse items at the checkout, get the extended warranty, add on the optional extras, get a matching belt for the pants, and so on. Why? Because the core products are not profitable. The money is made on the peripheral goods. Even big ticket items like cars are sold this way.

I could go on and on, but you get the idea.

Implications

So what should a strategist do? Well, first one can try to fight the commoditization by creating uniqueness at the core. It can be difficult, but some can succeed. I’ve talked about this in a prior blog. The problem is that if everyone starts adding the same “uniqueness”, then that becomes a commodity as well.

Therefore, one should seriously consider the periphery while developing the core strategy. The periphery strategy may be even more important than the core strategy. After all, if the core truly is commoditized, all you need to do is copy industry best practices and build scale to get credibility at the core.

It is in the periphery where you not only get a chance to make extra margin. It is also the place where you have the best shot at creating differential advantages. The periphery is where you have a shot at creating a sustainable reason to be preferred over the competition.

For example, Comcast has a reputation for absolutely horrible customer service. A cable TV competitor can take the peripheral element of customer service and create a meaningful advantage over Comcast. Southwest Airlines has created an advantage by treating the peripheral business of baggage differently from its competitors.

Apple tries to get around commoditization in smartphones through the unique peripheral features in the closed system it attaches to its phones. All along, it has been the closed systems circling on the periphery (like iTunes) which have made all the Apple innovations truly successful.

So the periphery may not be at the core of the industry, but it is probably at the core of what helps you to win and make a profit. So treat it accordingly when doing your planning.

SUMMARY
There is a tendency for the core business of all industries to become commoditized and/or become a loss leader in price. As a result, if your strategy only focuses on the core, you will most likely never achieve sufficient profitability to make your business a financial success. Real profit tends to come from the periphery, where there are more opportunities to enhance your margins. As an added bonus, the periphery also often is the best place to create meaningful differentiation. With all those potential benefits coming from the periphery, one should not leave the periphery to chance. It needs strategic planning emphasis as much as the core, if not more.

FINAL THOUGHTS
I know a lot of social media companies have a singular focus on building out the core. They say they will get around to figuring out how to monetize it later. That’s like saying I have a great strategy, except that it does not provide me with a differentiating position or a way to make a profit. You’d never settle for a strategy like that. Why would you settle for a business like that?

Strategic Planning Analogy #509: High Occupancy Vehicles

THE STORY

To help alleviate pollution, congestion and speed up traffic, some urban areas have put HOV lanes on their highways. HOV stands for High Occupancy Vehicles and is typically defined as a car having at least two people in it.  The HOV lanes usually only allow high occupancy cars and other efficient vehicles, like buses.

Because about 75 to 85% of workers commute by driving alone in their car, most commuters cannot legally take advantage of the HOV lanes. As a result, the HOV lanes are less congested and move along faster. Seeing the HOV cars moving faster makes some of those driving alone try to find ways to cheat in order to get into the HOV lanes.

One way used to cheat is to put a mannequin or a life-size blow-up doll in the passenger seat. For example, in 2010, a 61 year old woman put a mannequin in the passenger seat so she could ride in the HOV lane in New York. Unfortunately for the woman it was a cloudy day, and the hat and sunglasses on the mannequin looked out of place to a highway officer. The woman ended up having to pay a $135 fine and had two points taken off her license.

THE ANALOGY

We live in a business environment which has been described as faster than any time in history and getting even faster. Businesses feel the pressure to move ever faster or die. To a large extent, speed has become the default universal strategy.

One way businesses try to increase speed is by unburdening themselves of as much as possible. Management is eliminated, rules are eliminated, and strategic planning is eliminated—all in the cause for speed.

The elimination of strategic planning is justified with reasons like “We don’t have time to waste on that” or “Things move too fast to plan anything long-term” or “All we have to do is release the next version of our product before the competition—you don’t need strategic planning for that.”

The problem is that the business world is more like those HOV lanes than these people realize. All this unburdening is making businesses look more like those single person cars—going it alone. And since nearly everyone is taking this same approach, they are all crammed into the slower lanes.

Ironically, the faster HOV lane is the one where cars are “burdened” with extra passengers. And, as we will see in this blog, if companies load up their “car” with extra passengers like strategic planning, they will have access to the faster lane and get to their destination more quickly.

THE PRINCIPLE

The principle here is that the proper use of strategic planning does not slow a company down, but actually puts a company on a faster path. So instead of dropping strategic planning in the name of speed, we should be adding it to our “car”. Described below are three reasons why adding strategic planning gets you into the HOV lane of business.

1) Strategic Planning Improves Speed Via Focus

A focused company can move faster than an unfocused company, and strategy improves focus. Lack of focus leads to anarchy and confusion. You can yell at an unfocused company to “Move Faster!” all you want, and all you get is faster anarchy and faster confusion. Everyone is moving in random directions rather than making forward progress. Faster randomness is not improved progress.

Strategic Planning, when used properly, is a way to provide a business with focus. Not only can it tell a business what are the right things to work on; more importantly, it can tell a company what are the wrong things to work on. Strategic planning simplifies the agenda by taking a lot of options off the table (the things that are off-strategy). All the time-wasting rabbit trails are eliminated before they begin.

With a strong, focused strategy, you don’t have to waste time in endless meetings continually asking yourselves “should we be doing this or something else?” Instead, you can speed things up by focusing on how to improve on the things everyone already knows are important to the strategy.

Look at Apple. Under Jobs, Apple did not go in all directions trying to do everything as quickly as possible. Jobs had a specific strategy in mind as to what Apple would focus on. It had to do with designs that emphasized quality, elegance, coolness, and user-friendliness, made possible by focusing on building closed end-to-end systems. It became obvious what was appropriate for Apple to be doing and what was not.

The “not” list for Apple under Jobs was large. They did not work on low price products, or products not tied to the larger closed system. They did not even work on manufacturing. This allowed Apple to become very focused and quickly build a whole new digital future.

2) Strategic Planning Improves Speed By Overcoming the Leapfrog Trap

When speed alone becomes the substitute for strategy, a company is no longer building unique competitive advantages or competencies (except maybe the competency of speed). All they are doing is racing everyone else to be the first to release the next new improvement to the status quo. This is very common in areas like consumer electronics & digital media, and becoming more common elsewhere.

This process leads to what I call the leapfrog trap. Any small success gained by getting to the next improvement first is lost when a competitor leapfrogs you and gets to the improvement which follows before you. Gains are short and fleeting, since others are racing to leapfrog your most recent advancement as soon as they can.

Here is the crux of the problem. Because everyone is focusing on the same thing (speed), nobody is creating a competitive advantage. All the companies look about the same, with the same types of engineers in the same types of culture working on the same types of issues. You cannot create a lasting advantage in this scenario because you bring no real competitive advantage to the marketplace. Others can copy you almost immediately because they have a similar business approach with similar tools at their disposal.

By contrast, a true strategy builds differential advantages which allow a business to do certain things better than others. Rather than playing the same game of leapfrog with everyone else, you go your own way and build a different game where you have an edge and are not so easily copied. This leads to the third point below.

3) Strategic Planning Improves Speed Through Business Model Superiority

Great strategies understand the importance of making trade-offs. They don’t try to do everything well. They understand that:

a)     There are not enough resources to do everything well; and

b)     Even if there were enough resources, it is still not possible to win on all fronts because of conflicting agendas. For example, it is nearly impossible to win at lowest price AND highest quality AND most innovation at the same time, because what it takes to win in one of these areas makes it harder to win in the others.

Therefore, great strategies choose what to specialize in and make all the proper tradeoffs to win there, even if it means giving up abilities in places outside their specialty. Take, for example, Southwest Airlines in the US. For decades, they have had both consistently lower prices than their competitors as well as consistently higher profits. Why? Southwest Airlines built a business model to specialize in lowering costs. This caused many trade-offs, where Southwest didn’t do things everyone else did if it got in the way of the low cost strategy.

When other airlines tried to copy Southwest’s pricing, they did not achieve Southwest’s higher profits, but made their profits even worse. Why? Because their business models were not laser-focused on making enough tradeoffs to pay for the lower prices.

When all you look at is speed, you take your eyes off building the right trade-offs in your business model to allow real differential advantage. If the business model does not provide an edge, then you cannot quickly build a place where you can win. You are stuck in the leapfrog trap.

SUMMARY

Ironically, the singular drive for speed does not usually end up putting a business on the fastest track to lasting success. Instead, the faster track also needs to include a drive for great strategy. The addition of strategy improves speed by:

a)     Adding Focus (on what to do and what NOT to do);

b)     Adding Differentiation (to avoid leapfrog trap); and

c)     Adding a Trade-off Based Business Model Design (which makes it harder for others to copy you).

These additions allow you to take a superior path that speed-only businesses cannot get on.

FINAL THOUGHTS

There’s a reason why mannequins are referred to as “dummies.” And if you think you can sneak onto the fast lane without real strategy in the passenger seat, then that mannequin may not be the only dummy in your car.

Strategic Planning Analogy #505: Secrecy is Silly

THE STORY

One time I was doing some work for a client which I found very frustrating. I kept trying to give them the insight I thought they needed for their decision, but it seemed like my efforts were always a little bit off from what they were looking for.

It wasn’t until much later (after the project was over) that I found out what the problem was. My client had deceived me about what their true intentions were. They wanted to keep their true intent a secret, so they gave me instructions under false pretenses.

No wonder my insights were a bit off the mark. They were designed to meet the false pretense rather than the real objective.

THE ANALOGY

My client was not the only one who likes to keep secrets. Secrets can be found all over the business world. This secretive approach often finds its way into the world of strategy.

There seems to be this idea out there that if a strategy “gets out” and is made public, it ceases to be an effective strategy. Somehow, mere knowledge of the strategy takes away its competitive advantage.

The problem is that the true value of a strategy is in its execution. And if those executing the strategy are kept in the dark, they cannot execute it well. As we saw in the story, I could not effectively do my job when I was kept in the dark.

THE PRINCIPLE

The principle here is that strategies are most effective when they are well communicated, both inside and outside the organization. A secretive approach to strategy diminishes its effectiveness.

The Problems With Secrecy

There are quite a few reasons why keeping a strategy a secret is detrimental to its effectiveness.

1. If your employees do not fully comprehend the strategy, they will not be able to fully execute the strategy. Thousands of decisions are made all over the organization every day. Depending on how those decisions are made, they can move a company either closer to or further away from your desired strategic direction. If the strategic direction is not known all the way down the organization, it will only be random luck if their decisions move the company in the right direction. Remember that your REAL strategy is not what you put on a piece of paper, but what you actually do. So to get what you do to match what you put on the paper, you’d better make sure the doers know what is on that piece of paper.
2. When your employees know what the strategy is, then they can use their insights and initiatives to make the execution even better. By contrast, if just the top executives know the strategy, then the only way to get the strategy executed is by having the top executives order people to do specific actions designed to support the strategy while keeping the strategy behind the actions a secret. This only makes sense if you believe that:

1. All the great ideas are found only at the top of an organization; and
2. A top-down only control of the business like the old communist economies is the best way to go.

The bankruptcy of the old communist system should be proof enough that a top-down only secretive approach has many flaws. The alternative is to let the people at the bottom in on the secret and allow them to make contributions to the effort. Strategies are made much stronger when input comes from the collective intelligence of the entire organization working on a common known goal.

3. Strategies usually include a reason why certain consumers should prefer patronizing your brand over the alternatives. Why should these consumers flock to your brand if you keep your reason for preference a secret? You should be shouting your strategic benefit from the rooftops, so that there is no mistake as to why you should be preferred. And to make the claim believable, it helps to show why your strategic approach makes the claim a true differential advantage.

Take the insurance business, for example. If your strategy is based on low price and you get there by going direct and eliminating the independent insurance agent to save money, let the customer know. Conversely, if your strategy is based on best service, play up your strategic approach of having the best local independents working for you (something the price-oriented insurers eliminated).

Positioning is about owning a spot in the mind of the customer. You won’t own that position if you keep it a secret.

4. The stronger you cement your position and strategy with your customers and your employees, the harder it will be for the competition to take it away from you. In fact, if you make it clear to your competition what your strategy is and how strongly you will defend it, you can cause your competition to no longer want to fight in that space and instead take a differentiating strategy. For example, Walmart has made it clear they will fight to the death to defend their low price position, so most competitors stop trying to win price wars against Walmart and instead go a different route, which strengthens Walmart as the everyday low price leader.

The Faulty Logic Behind Secrecy

Some believe that if you let the competition know what your strategy is, then they can quickly copy it and take it away. That is why they want to keep it a secret. But this thinking is flawed, because there is a big difference between knowing what a strategy is and knowing how to best deliver it.

Great strategies are built upon great business models. And great business models are often very complex and very difficult to imitate.

For example, Southwest Airlines has done very well with its low price strategy. But if a competing airline merely copied Southwest Airline’s low prices, they would not be as successful as Southwest. Southwest’s strategy works because they have a unique and complex approach to their business model, including choice of airplanes, choice of airports, point-to-point routes, corporate culture, and so on. You need the full business model to make the strategy work. This is nearly impossible for an established competitor to convert to.

In another example, Wells Fargo has created success with a superbly executed plan to win via cross-selling.  Now it’s one thing to say “we will win via cross-selling.”  It’s another thing to have a sophisticated business plan designed specifically to optimize cross-selling.  As Wells Fargo CEO John Stumpf put it recently, “We could leave our strategic plan on an airplane and it wouldn’t matter.  It’s all about execution.” In other words, there is no reason to hide the “what” of Wells Fargo’s strategy from competition, because it would take them years and years to figure out the “how” behind the strategy, and by then you’d have made even further advances, so they never could catch up.

Here’s a little secret for you. If a competitor can immediately copy your strategy upon hearing it, then you really don’t have much of a strategy. A good strategy is based upon making a number of deliberate choices about how you operate. Trade-offs are made in certain areas so that you can better excel in other areas. These choices and trade-offs attempt to optimize against your unique strengths and weaknesses. The net result is a complex business model which is not easily copied due to its complexity and its unique suitability to your own situation.

We live in an era of transparency and openness. If secrecy is your only defense, then you are in trouble.

Remember, great strategies try to find a place where YOU can win, not where anyone can win. If anyone can supposedly win there, then nobody will win there, because nobody will have an advantage.

SUMMARY

When it comes to strategy, secrecy is a disadvantage. Strategic secrecy keeps your employees from doing their best, it hurts your ability to own your position with the consumer, and it weakens your ability to scare off a competitor from going head-to-head against you. Great strategies are built upon great business models, which are extremely difficult to imitate. As a result, even if competition knows your strategy, it doesn’t mean they know how to take it away from you. So don’t keep your strategy a secret.

FINAL THOUGHTS

If your strategy is nothing more than a hollow platitude, like “We will be the Best” or “We will be the Most Profitable” then I might consider keeping it a secret, because I would be too embarrassed to let others know how silly my so-called strategy is.

Strategic Planning Analogy #495: The 3 Keys to Success (Part 2)

THE STORY

I was excited the first time I was to visit the Museum of Modern Art in New York.  The museum is full of famous works of art.  I had read about or seen pictures of this art in books, but now I was going to get a close up look at the original paintings. I imagined that it would be a very inspiring visit.

Instead, it turned out to be a very disappointing visit.  As it turned out, not only do you see the greatness of the paintings when you see them up close.  You also see all the imperfections.  In particular, I remember looking at some very famous Picasso paintings.  When you studied them up close, you could see the rough pencil sketch underneath the paint.  They looked a lot sloppier than the little photographic reproductions I had seen of them earlier in art books.  After awhile, I became so fixated on the imperfections that I couldn’t enjoy the paintings.

I kept thinking to myself that I could probably find many artists who would be able to reproduce all of these paintings and have fewer imperfections. But in later reflection, I realized that I was missing the point.  No matter how much more “perfect” these reproductions would be, they would never be more valuable than the original.

THE ANALOGY

Copying is a lot easier than creating something entirely new. Imitators may even be able to make small improvements over the original.  But in the world of art, the value belongs with the original, no matter how flawed it might be. 

A similar situation exists in the business world.  The ones who create, get known for and exploit exciting new business models first usually create more value than the later imitators.

Therefore, you’d think that there would be more business people striving to be the next Picasso—creating something new, exciting and very valuable. Yet, when I look around, it seems that the business world is more often filled with imitators and copiers. The idea seems to be that “People like that original over there, so if I make something just like it, they will like mine just as well.”

But as we all know, a “just like Picasso” is never as valuable as a real Picasso.  Why should we expect the rules to be all that different in business?

THE PRINCIPLE

We are currently on the second blog in a series on the three characteristics which tend to determine whether a business is a great, lasting winner, or a long-term loser. In the first blog, we looked at “Passion” and saw that the winners have a passion for the business and the intricacies of the business model which makes it work in the marketplace.  The losers focus their passion on the money that comes out of the business and are only tangentially concerned about the details in how it is made.

In this blog we will look at “Direction.”  Winners tend to move in new and different directions, like Picasso.  Losers direct themselves to follow what is already working (the imitators).

The Problems With Following

There are many reasons why the followers rarely become the great companies. It doesn’t matter if you are following the standard rules of convention for your industry or following the innovation of the leaders.  You are still following.  And followers rarely reap great rewards.

There are three problems with focusing on following the conventional rules for how your industry works.  First, if everybody is doing the same things in the same way, then you tend to have parity of offerings amongst the competition.  How do you win over the competition if you are all perceived as being the same?  This tends to lead to price wars (“everything is the same, but we cost less”), and we all know that price wars are not the path to creating above average prosperity.

Second, even if you can execute within the conventional rules a little bit better than everyone else, it is usually only a temporary advantage. In an earlier blog, we looked at the battle between Fuji and Kodak in conventional analog photographic film.  Sometimes Fuji would have a slight advantage; then Kodak would get a slight edge—back and forth it went with no clear winner.  The real winners were the innovators who abandoned the conventional rules of photography and brought digital imaging to the masses.

Third, there are limits to how much better one can become by playing by the same rules. The law of diminishing returns tells us that ever increasing improvements tend to lead to ever smaller perceived benefits.  For example, I could make an ever more perfect nail, but at some point, the guy hammering that nail into a board won’t be able to see how those perfections improve his hammering.  In other words, superior executions of the status quo often do not create enough of a differentiating benefit to shift habitual shopping patterns for the customers.

So what about following the innovators?  Well, you’re still a follower.  The last time I checked, followers never win races.  Just as Picasso gets superior credibility for pursuing a new path, business innovators get superior credibility over their followers.  The innovator becomes synonymous with the innovation.  The rest are seen as mere copiers. 

For example, Google means search.  Even though the follower Bing claims a slight superiority in blind tests, Google still wins the war for market share in search.  Why?  We are not brand blind.  The emotional bonds associated with the leader brand overcome the slight differences.  The same thing happened when follower Pepsi claimed superior taste in blind taste tests over Coke.  Coke still won the war.

Finally, the follower usually is one step behind the innovator.  By the time the follower catches up to where the leader was, the leader has moved on to the next innovation. That is why hockey great Wayne Gretzky attributed his success to ignoring where the puck currently is and instead going to where the puck is going to be.  Rather than following the puck, he got in front of it. 

There are only two ways to win by following.  First, you can win by having your competitors make colossal mistakes. Their failure becomes an opening for your gain.  But a strategy that depends on others to make mistakes is not much of a strategy.  In addition, if you are a follower, you will probably follow them into similar mistakes.  For example, the financial collapse which triggered the great recession was caused by colossal mistakes in the banking industry.  But because most of the big banks tended to be following each other and playing by the same flawed rules, most of them fell victim to the flaw and could not gain meaningful advantage.

The second way to win playing by conventional rules is if you are substantially larger than everyone else and can leverage your size to your advantage.  However, this begs the question of how one gets to be so much larger than the others in the first place.  Usually the bigger players got to be so much bigger because they were the innovative leaders which rewrote the old conventional rules into what became today’s conventional rules. It was their leadership which made them big, not any form of followership.

The Value of Being Different

There are two ways to be different.  First, you can create a new business model which is inherently superior to the status quo model at delivering value.  For example, Southwest Airlines has been a consistent success competing against other airlines who struggle to survive.  Why?  Southwest Airlines played by a different business model, focused on point-to-point (among other things).  It’s unique business model allowed it to provide superior value that those playing by conventional rules could not imitate.  Even the best player by conventional rules could not exceed the value offered by Southwest’s different approach to the business.

Another example would be Salesforce.com.  While others were playing by the old rules of installing and supporting software scattered everywhere, Salesforce.com eliminated the software paradigm and was a leader in putting everything up in the cloud.  That change in business model gave Salesforce.com inherent advantages that the conventional operators couldn’t match if they stayed in the old paradigm, no matter how well they executed it.

This helps reinforce the first differentiation we talked about in the prior blog—where winners focus on business models.  You won’t find the success of a Southwest Airlines of Salesforce.com unless you spend time focused on business models. 

The second way to win in difference is by creating a new value proposition which did not exist before.  Apple has been a winner by creating wholly new types of value expectations.  The iPod, iPhone, and iPad changed the whole way people thought about how to live and enjoy their lives.  They created new values in new places.

The “Fast Fashion” operators, like H&M, Zara and Forever 21, helped change the definition of what to value in fashion for a significant segment.  Instead of defining fashion by Exclusive Labels, High Prices, High Quality and Fashion Seasons, they made fashion more disposable, where frequent change/variety combined with low prices (and lower quality) was a new winning formula.

If you look across the spectrum of business, you will find that nearly every great company at some point took one of these different directions.  They either came up with a new business model which had inherent advantages over the old model in the conventional industry, or they invented whole new industries by redefining or creating new value formulas.

SUMMARY

One of the key differences between business winners and losers is the direction the leaders take the company.  The losers tend to move in a following direction—either following the conventional rules or following the innovators.  By contrast, the winners tend to move in a new direction, either by finding new ways to better satisfy old values or by creating new values through new industries.

FINAL THOUGHTS

Artists create; craftsmen copy.  Are you an artist or a craftsman?

Strategic Planning Analogy #485: Unconventionality

THE STORY 
Sometimes when my wife and I are on a road trip together, I’ll have fun by telling her that I want to race her to the destination.  Of course, that’s a silly suggestion, because we’re both in the same car.  As a result, we will both get to the destination at the same time.

I think that the very silliness of the suggestion is hilarious.  My wife thinks the very silliness of the suggestion is quite stupid.  So I laugh and she frowns.  But every once in awhile, I still bring up the suggestion when on a road trip.   

THE ANALOGY

If everyone is in the same car, they will arrive at the destination at the same time.  It kind of takes the fun out of being in the race, because there is no way to get a lead over everyone else.  It makes the whole idea of racing kind of silly.

Yet, I see businesses doing this all the time.  The company will set up all kinds of goals to win and to exceed the performance of everyone else in their industry.  The goals are quite impressive.

But when you ask them how they are going to win and achieve those goals, the game plan is to operate by the traditional rules of their industry.  My response is, “How do you plan on beating everyone else if you are doing the same exact conventional activities as everyone else in the industry.”

To me, that makes as much sense as trying to win a road race by piling all the drivers into the same car.  For if everyone in the industry is playing by the same conventional rules of operation, you are in the same car—the car of conventionality.   You are running the race the same way, with the same tools, same business models, the same processes, the same strategies. 

How can you expect to pull away and win a decisive victory under those circumstances?  I don’t care how impressive your goals are.  You haven’t shown me a way to pull ahead and win.

THE PRINCIPLE

The principle here deals with another one of my 23 laws of strategy, the Law of Unconventionality.  This law states that: “You do not achieve unconventional profitability with conventional business models.”  In other words, you do not meaningfully beat your competition if you are doing the same thing they are.  If you want unconventionally high levels of profits, you have to do unconventional things.  You have to get out of the same car of conventionality that everyone else is in and get a car of your own—a car that runs a better race.

Why Conventionality Won’t Win the Race

The problem with conventional methods is that they provide little room for differentiation.  If everyone is going after essentially the same customer in mostly the same way with basically the same offering, all the competitors will look about the same to the consumer base.  There is no natural reason for a customer to prefer one competitor over the other.

Without any meaningful natural differentiation, the only way to get an edge is by “bribing” customers with lower prices or added freebies.  Of course, the other competitors will follow, causing a downward price and profit spiral.

That is why the profitability of industries tend to drop over time and mature industries have returns which are about the same as the industry cost of capital. 

The Need to Differentiate

If there is an outlier in an industry who is beating these odds and making high levels of profits, I’ll bet you it is because they are not following the conventional rules of the industry.  They are doing something very different—playing by different rules.

Southwest Airlines has superior profits over conventional airlines because it doesn’t play by conventional airline rules.  It runs a point to point system with different rules on seating, ticketing (won’t use other ticketing sites online), baggage, fuel purchasing, employee relations and host of different things.  By playing by different rules, it has a lower cost structure and an offering which is superior to a significant sector of the population.

Geico made a splash in the insurance industry by running against the conventional approach of selling insurance personally through a huge network of insurance agents.  Instead, they put the money into advertising and call centers and cut out the agent fee, putting that money into other benefits.

Ashley Furniture gets higher than average returns for furniture retailers by direct sourcing much of its furniture from low cost countries and bypassing the branded furniture manufacturers which the conventional furniture retailers use.

Amancio Ortega became the third richest person in the world by re-writing the rules of the fashion industry.  Instead of running the business around a handful of fashion seasons each year, he built a system based on continuous replenishment.  This system supports his Zara stores in a new way, called “fast fashion,” which is very profitable, because it is a much more productive use of capital and inventory than the conventional fashion operators.

Apple became one of the highest valued companies by avoiding the conventional approach of specializing in either hardware, software or distribution and build an integrated, closed system.  It also changed the rules by focusing on elegance rather than just functionality.

Differentiation Breaks the Bribery Trap

When you do things differently, you give yourself a natural edge.  Either you create cost savings the competition cannot copy so that you can profitably underprice them, or you create superior preference so that customers are willing to pay more for your offering.  Either way, you get to zoom past the conventional operators in the race to profits.

Apple has had long lines of people waiting to full price for their integrated offerings, because many consumers thought their different approach made it worth the effort to get one. 

Because Zara sells through its offerings so quickly and replaces them with something different, people learn that it is useless to wait for items to go on sale.  You have to buy it at full price right away.  And because of their different cost structure, Zara’s full price is still a good deal relative to conventional operators.

The Limitations of Bechmarking

This is why benchmarking is only of limited value.  It helps you to understand how others do things, but it doesn’t tell you how to do things differently from everyone else.

If you are falling behind in the race, benchmarking can help you find a way to get into the car of conventionality.  At least then you are no worse than average and can ride with the rest of the conventional operators.

Or, if you see someone breaking away from the pack, benchmarking can help you figure out how to get inside their car.  For example, others like H&M and Forever 21 have copied much of Zara’s business model, which is starting to make that the “new conventional” model.

But benchmarking won’t tell you how to become the next Southwest, Geico, Apple or Zara.

Sources of Differentiation

There are lots of ways to become unconventional.  It can be done by going after a different customer base, offering a different bundle of benefits, offering a radically different way to solve an old problem, changing how a solution is delivered, changing how an offering is paid for, and so on.  There is not enough room in this blog for all the creative ways to break the mold.  Look for your creative way and you’ll be pleased with the results.

SUMMARY

If you run your business the same way as everyone else in the industry, you will never break away from the pack.  You will be stuck in a world lacking differentiation—and the added profits which come from differentiation.  Only unconventional approaches lead to unconventional returns.

FINAL THOUGHTS

A popular old circus act was to have dozens and dozens of clowns pile out of a tiny car.  If you stick to doing things the conventional way, you are like one of those clowns stuffed into the car of conventionality.  And those clowns get laughed at.  Do you want to be laughed at?  If not, get a car of your own.

Strategic Planning Analogy #481: Law of Extremes

 

THE STORY
Back about 40 years ago, Wal-Mart had not yet fully cemented its image as a low cost leader.  Other retailers were still challenging Wal-Mart on price supremacy.  One of those chains was TG&Y variety stores.

TG&Y decided to get into a price war with Wal-Mart.  The item chosen to go to war over was a pair of jeans.  TG&Y would lower the price on jeans and Wal-Mart would retaliate with an even lower price.  This pattern continued for many rounds.

Eventually, Wal-Mart dropped the price of jeans to 9 cents a pair.  At that point, TG&Y gave up and stopped the price war.  Wal-Mart had won supremacy on price, and not too long thereafter, TG&Y ceased to exist.

 

THE ANALOGY
Yes, 40 years ago, you could buy a lot more for 9 cents than you can today.  But even 40 years ago, 9 cents was an unrealistically low price for a pair of blue jeans.  Every jean sold at 9 cents would be a huge loss for Wal-Mart.  But that was the sacrifice Wal-Mart had to make in order to win the image of price against TG&Y.

Times may have changed in the last 40 years, but this type of activity still goes on.  Business leaders understand the value of owning an image and will go to extremes in order to win that image.  This seems especially true on the internet. 

In order to create a large network, internet firms will go to great lengths to get people hooked into their system.  Most end up giving away their product for free.  Other go even further by “paying” people to get on-board, either with badges, coupons or some other form of promotion.  It’s hard to make a living if you have to pay people to use your product.

And it’s not just price where companies go to extremes.  Luxury automobile brands are fighting against each other to own the word “luxury.”  They keep upping the ante by adding ever more exotic features to their automobiles.  At some point, even many luxury auto buyers will balk at paying the premium so that auto makers can get an adequate return on investment for these exotic features.

For most auto dealers, the maintenance area is among its most profitable areas, even more profitable than selling cars.  But, to increase the luxury treatment experience, many luxury dealers are throwing in maintenance for free.  Now, they’ve cut off a key source of profits.

The world is very competitive.  It takes a lot to dramatically own a position in that competitive market.  Every winner has to go to extremes to own their position, be it in price, luxury, service, convenience, technological innovation or whatever.  It’s as if the whole world is becoming the equivalent of 9 cent jeans—a world where the only way you can win is to create a costly, unsustainable extreme.

How do you create a profit if the entry level cost to achieve a winning position is unsustainably high?  That requires a sophisticated strategy.

 

THE PRINCIPLE
The principle here has to do with what I call the Law of Extremes.  It is one of my 23 laws of strategy.  (I know I said in an earlier blog that it was 22 laws, but I’ve since added another law.)  The law of extremes goes like this:  “Creating performance levels needed for ownership requires trade-offs and subsidies.”

Another way of saying this is that when the core business can no longer sustain the extremes, you have to:

1)      Add secondary businesses (called subsidies) to provide cash to cover the extremes; and/or

2)      Subtract secondary activities which take away cash from the building the extreme position (a process called trade-offs).

We will look at each of these separately.

Subsidies

Subsidies are non-core activities or businesses which are principally done only to fund the core.  An example of this practice is the “Freemium” model used by many internet businesses.  The idea is that the core business is free.  Yet in order to afford to give away the business for free, a small subset (often under 3%) pay a price in order to get premium extras.  In other words, around 3% of the users of the internet site subsidize the activity of the other 97% so that the site can make money.  Many internet sites use a freemium model like this, including Linkedin and Pandora.

Another subsidy common on the internet is to use advertising.  If you cannot get the users to pay for your extreme pricing position of free, then you have to get advertisers to pay for the site.  Another subsidy example is when internet sites sell information about you to other business that would pay for that information (watch out when companies put cookies on your device—it can be their door to a subsidy business selling your behavior).   

This subsidy phenomenon also occurs in the retail space.  In consumer electronics, the pricing policies are very extreme, often selling the main items near or below cost.  To subsidize these prices, the retailers need to bundle profitable subsidy purchases to the transaction.  A familiar one is the extended warranty, which is often more profitable to the retailer than selling the item being insured.  Other examples are selling ad space on the screens of the computers being sold, selling extra ink with the printer, selling smartphone accessories, and so on.

This is also seen in fast food restaurants where the core hamburger is sold at a loss and is subsidized by the sales of more profitable french fries and beverages.  (I’ve gotten in the habit of buying a second burger instead of the fries in order to get a better extreme value for myself). 

The irony here is that in a world of extremes, the core business becomes almost like a loss-leader for the subsidy add-on businesses.  At some point, it’s hard to tell what is the real core business anymore.  IF the subsidies are where all the profits come from, does that become the new core?  The extreme image won with the traditional core could now be seen as a loss leader positioning to mask the real positioning, which is to be best at selling the subsidies.

It goes to show that business strategies are getting more complex.  If subsidies are not integral to your business model, the model may no longer work in a 9 cent jeans world.

Trade-Offs

If subsidies are about adding income to the business, then trade-offs are about subtracting costs from the business model.  The principle behind trade-offs is as follows.  If you try to be all things to all people, you will probably never obtain an extreme position on anything.  For example, if you try to be the highest quality, lowest priced and fastest in innovation, you will have to make compromises which will prevent you from being the most extreme in any of these attributes.   There will be specialists focusing on only price or only quality or only innovation which will be the most extreme and win the battle for these positions. 

Therefore, to win in one space, you may need to stop pouring money into other spaces, so that more money can be funneled to the space where you want to win.

An example would be extreme low price “hard discount” grocers, like Aldi, Save-A-Lot, and Lidl. They have prices substantially below conventional grocers—extreme enough to win the low price image.  Yet those low prices are sustainable because these firms make trade-offs.  They stop doing many things the conventional operators do which add costs.  Examples include:

1)      Smaller, Less Costly Assortments (only one brand in one size per category)

2)      Eliminating Lower Margin Branded Goods by Going Direct to the source to create their own brand.

3)      Large reductions in labor by not having service departments, not stacking products individually on shelves, etc.

4)      Lower rent by building smaller stores in less prime real estate.

By trading away variety, ambiance, convenience, selection and other such factors, they can divert cash flow from those activities into sustainable extreme prices.

Southwest Airlines is another example.  They make money when other airlines don’t because they do more trade-offs than traditional airlines.  Activities like only selling point to point tickets, refusing to sell tickets on third party travel websites, focusing on only one-sized plane, and other non-conventional approaches, they have eliminated a lot of costs borne by their competitors.  This allows them to focus on the things important to their image and still make a profit.

The idea with trade-offs is that your successes is defined as much by what you don’t do as by what you do.  Your strategy needs to delineate what activities go onto each list (the do’s and the don’ts).

SUMMARY
In a highly competitive world, it takes extreme levels of performance in order to win a position.  Gaining extreme positions is costly.  In order to afford the cost and still make a profit, firms need strategies about subsidies and trade-offs.  Subsidies are the add-on activities which provide extra cash flow beyond the core.  Trade-offs take away activities which to not reinforce the extreme position in order to provide extra cash flow to invest in the extreme.

 

FINAL THOUGHTS
The things which “delight” the customer tend to “deplete” the cash of the company.  To remedy the situation, the company needs to “destroy” unnecessary costs and “deploy” subsidy businesses. And that is “de-truth.”