Strategic Planning Analogy #448: Tornado Chasers

THE STORY
Tornado chasers are an odd bunch of people. Some would say they are crazy.

First, they spend countless hours in research looking the next possibility of a tornado attack. Most people would say that there is enough trouble coming our way on its own, so don’t look for any extra trouble. But tornado chasers are driven to proactively look for the next opportunity for danger. (Yes, to them tornados are an “opportunity”).

Second, once they find the danger, tornado chasers don’t run away from it. No, they run towards it. They try to get as close to the tornado as they can. They chase after it as fast as they can as soon as they can.

Third, the tornado chasers don’t stop after doing it once. They continue to do it year after year after year, running towards danger.

Yes, that does sound a bit crazy.

THE ANALOGY
Tornados are not the only dangerous and destructive force out there. Just look at the business landscape. Large, formerly great, industry-leading companies disappear all the time. It is as if a tornado wiped them out. Nothing is left but debris. Enron; PanAm; Lehman Brothers; Kodak; Firestone; Worldcom; Montgomery Ward. and the list goes on.

Sometimes the destructive force starts from within the company. Sometimes the destructive force that destroys the company comes from the outside environment. But no matter where the force comes from, the ultimate blame for the destruction needs to fall on management. It’s their fault, because they did not come up with a strategy to deal with the destructive force.

Destruction is not inevitable. Other companies have been faced with similar destructive forces and survived. They reinvented themselves to stay on top. Like Judo, they used the dangerous force coming at them and redirected it to their advantage.

In many ways, these surviving firms are like the tornado chasers. Rather than ignore or avoid danger, they embrace it. They look for it. They run towards it to take it on before it has a chance to destroy them.

At first this approach may seem crazy, but as we will see in this blog, it is a lot safer for businesses to chase after the tornado than to just sit in their headquarters and have the tornado come and blow them away.

THE PRINCIPLE
The principle here is that often times the best way to deal with a destructive force is not by avoiding it or by building a bigger defense. That can be the path to ruin.

As Victor Hugo put it, “There is nothing more powerful than an idea whose time has come.” It is so powerful that no defense can overcome it. When it was time for the digital revolution, there was nothing the analog world could do to prevent it. The force was too powerful. The analog firms who tried to ignore or stop the revolution lost. The firms which embraced the transformation won.

No, the best approach is often to run towards the destructive force and embrace it. We need to become more like tornado chasers.

In particular, there are four things we can learn from tornado chasers which can help our business thrive in world of destructive forces.

1. Look for Danger Before It Exists
Tornado chasers don’t wait until a tornado has touched down before taking action. No, they look for meteorological conditions where tornados MIGHT appear. In other words, they prepare for tornados before the tornado exists by examining conditions which can lead to tornados. That way, they are fully prepared in advance—in the right place at the right time when the tornado comes.

This same principle applies to business. If you wait until a danger is in full force before starting action, it is usually too late. There is not enough time to respond. You will miss your window of opportunity. The rules will already be re-written by others. You will be left out. In addition, by acting early, you still have the strong cash flow of your core to help fund the battle. The more you wait, the more cash flow you will need in the fight, and the less you will be generating (as the force increasing eats away at your core).

Think about Google and its Android platform. Android was conceived at a time when smartphones were little more than a novelty and the thought of doing meaningful activity on them via the internet was little more than a dream. However, like a tornado chaser, Google could see that mobile could create the condition for a major competitor force in the future which could blow away Google’s computer-based search foundation.

Therefore, they went to mobile early and created a way to harness the eventual force to their advantage. Experts predict that by 2013, internet access via mobile will surpass internet access via mobile. It has indeed become a major force which could have destroyed Google’s base. However, because Google attacked the danger before it existed (via Android), they have used the force to their advantage and can move their search strength to the mobile platform.

Contrast this to the history of Microsoft. Historically, Microsoft has waited until the force of threat is already quite strong before making a move. It occurred with internet access, cloud computing and mobile. With mobile already larger than computers, Microsoft is still just trying to penetrate the market. They are very vulnerable to suffering significant damage from this force because they waited too long.

Do you have an eye out looking for where potential dangers can occur, or do you wait until the danger has built up a force of power before taking action.

2. Move to Where the Action Is
Tornado chasers don’t wait for the storm to come to them. They go to the storm. This is also true for businesses. In a prior blog, I explained why it is usually advantageous to fight your battles at the periphery before it gets to your core. If the new force is going to be the next new thing, then you need to embrace the force before it makes you obsolete.

When Google saw internet time moving to mobile, they went to mobile. When Sam Walton saw that supercenters, with groceries, had the potential to under-price his discount stores, he shifted to Wal-Mart Supercenters. When Amazon saw how digital books could ruin their business model, they agressively brought out the Kindle reader.

Now people could argue that Google had no right to get into creating a mobile platform. Their expertise was search algorithms and advertising. It looked crazy. People said the same thing when Wal-Mart added groceries—it was not a part of their expertise. It looked crazy. Amazon was a digital retailer, yet it reinvented itself as a device manufacturer with the Kindle. It looked crazy.

But here is the point. If the new force is drawing away your customers, you don’t have much of a choice. Either you find a way to become an expert in the new area, or the force will blow you away, like a trailer park in the path of a tornado.

3. Take the Threat Seriously
Most tornado chasers are not idiots. They realize that tornados are powerful, destructive forces. They respect that power and take precautions. They take their threat seriously. That’s how they stay alive. The same should be true for businesses. When a new threat arises, don’t be casual and half-hearted. Treat the threat for what it truly is—a force with the potential to destroy your brand’s very existence. Take it seriously and fight as if your life depended on it.

Google took the mobile threat very seriously. They did not wait for someone to build a platform to put their search engine on. They made sure there was a platform available for them by building it themselves (Android). In addition, they were concerned enough with the possibility that the Apple platform would try to lock them out that they gave away the Android for free. Now that shows how seriously Google respected the threat. As a result, Android now has close to half the market share and Google remains a powerful force in search and advertising.

Facebook could see a potentially forceful threat by Instagram, the photo-sharing site. They took the threat so seriously that they immediately purchased the company for $1 billion, even though the sight had no revenue. Now the potential threat is an ally.

Other companies often will put up a small fight in the new space, but do not treat the battle as seriously as they should. They do not fully respect the power of the new force to destroy them. Kodak did not fight the digital imaging war as seriously as it should have.  As a result, it did not land a new position in the digital space and had the digital competition blow away Kodak’s analog film business. It ended up with nothing.

Whereas Wal-Mart was willing to bet the company on an aggressive push into supercenters, Kmart only dabbled half-heartedly with the concept. As a result, Wal-Mart grew ever-stronger and Kmart grew ever weaker.

All strategies eventually fail. They become overtaken by a new force in the marketplace. Resisting the new force in an attempt to save the core usually leads to failure in both spaces. You end up with nothing. Take the threat seriously for its potential to wipe away your core and envision a way to win even if your core is severely damaged (or completely wiped out).

4. Never Rest
The thing about tornados is that they come back every year. You can never say that you’ve seen the last tornado. There will always be another one.

The same is true in business. Forces of change will continue to come. Today’s status quo will be replaced by the next big thing. And that next big thing will eventually be replaced as well. It doesn’t stop.

As a result, one cannot rest on the past. One has to always keep an eye out for the next storm.

That is what makes the half-hearted moves by Kmart into supercenters so interesting. Back in the 1960s, Kmart (then called Kresge) could see that the force of discounting was going to destroy their Kresge variety stores. Therefore they bet the company on the new trend by abandoning the variety stores and aggressively embracing the Kmart discount store format. As a result, Kmart was a powerful, dominant, and highly profitable force in retail for many, many years.

Yet, when the supercenter force came, they did not follow the pattern of destroying the old (Kresge) for the new (Kmart). They rested on the strength of Kmart and only pursued supercenters as an additional piece—not as a replacement. As a result, Wal-Mart supercenters are replacing Kmart in the marketplace.

And now we look at the force of e-commerce on the brick and mortar stores. Was Wal-Mart resting on its supercenter success too much and not taking the e-commerce threat seriously enough? Has Best Buy rested on its past too much and missed the next retail transformation? Only time will tell.

Yahoo and AOL may have lead the change on one wave of force. However, they may get wiped away by the current wave. You can never rest on the past.

SUMMARY
Economist Joseph Schumpeter coined the term “creative destruction” to describe how capitalism works. His point was that there are forces in the economy which destroy the status quo, much like a tornado. The status quo is then replaced by something more in tune with the marketplace. As a business person, you need to devise strategies to use creative destruction to your advantage. Otherwise, the natural forces will wipe you away.

FINAL THOUGHTS
Which is more dangerous—going out to attack the tornado or sitting inside a mobile home not knowing that a tornado is about to cross your path and destroy your existence? Get out of hiding and embrace the new force before it blows you away.

Strategic Planning Analogy #368: Managing Losses

THE STORY
Once upon a time, there was a man named Bill who liked to bet on horse races. After years of experimenting on ways to beat the odds at the race track, Bill finally found a way to assure that he would always make the winning bet.

His solution? Place a bet on every horse in every race. That way, no matter which horse won the race, Bill was 100% guaranteed to have placed a bet on it.

There was a slight drawback to this system, however. In addition to a 100% guarantee that he would have a bet on every horse that won, this system had a 100% guarantee that Bill would have a bet on every horse which lost. As it turns out, the losses on the losing bets were greater than the winnings on the winning bets. The system left Bill bankrupt.

Bill loved to boast that his system always picked the winners, but the boasts didn’t impress his friends after they learned this system was also path to bankruptcy.

THE ANALOGY
In horse racing, only a small handful of horses win on any given day (only one per race). The vast majority of the horses end up being losers. Therefore, if you bet on every horse, you will end up losing your money, even though a few of the bets will be for winners.

Although Bill’s system is obviously a foolish way to bet on horses, it is not that different from the way many companies bet on their future. Many companies like to make lots of bets on lots of future growth projects, be that in R&D research, new product offerings, acquisitions, brand extensions, and other such investments.

And just as most horses fail to win their races, most new products, acquisitions, brand extensions, and R&D research fail to make a profitable return on investment. Sure, a few of the bets in these areas will produce winners. However, the losses on all the other bad investments can be so high that they wipe out the profits on the few winners. Worse yet, because so much money was poured into the losing bets, there is not enough money left to fully optimize the potential of the few winners. The potential winners become starved for lack of resources.

Yes, if a company bets on everything, they can boast like Bill that they have created some winners. However, if all the bad bets destroy the company (or destroy the ability to optimize the potential on the winners), then it is a rather hollow boast.

THE PRINCIPLE
The principle here is that since most of a business’ strategic activities deal with failure, the strategic process should have a rigorous way to minimize the negative impact of failure.

Living With Failure
What do I mean when I say “most of a business’ strategic activities deal with failure”? Well, strategies are typically about finding and implementing the changes needed to reach a larger and more prosperous future. Many of the tactics used to create that change are associated with activities like those mentioned earlier:

a) Mergers and Acquisitions
b) Research and Development
c) New Product Introductions
c) Brand Extensions
d) Reaching out to New Customer Bases
e) Innovation Activities

Lots of studies have been done which measure the failure rates for these types of activities. Depending upon the research, the failure rates tend to be somewhere in the 75% to 95% range. In other words, the key tactics used in strategy usually fail.

The strategic path is a path dominated by opportunities to create negative returns on investment. It naturally comes with the territory, since most opportunities fail. The only way to avoid running into failures is by deciding to do nothing. But just as betting on every horse leads to destruction, betting on no horses will not lead to success, either. So we need to get comfortable living in a world where we use tools which usually fail.

Therefore, the strategic process needs to find a way to minimize the impact of inevitable failure while a company tries to find and nurture the few opportunities out there for success.

Learning From Research
Fortunately, recent research lends some insight into how to do this. My good friends at the Corporate Executive Board have been studying the characteristics of “elite” companies. These are defined as companies which performed above their industry median in both EBITDA margin and growth rates between 1995 and 2008. In other words, these companies successfully managed both the top line and the bottom line over an extended period of time and different parts of an economic cycle.

Starting with a list of more than 1,500 firms, they determined that there were 143 elite companies (less than 10% of the total). The Corporate Executive Board discovered a lot about these elite firms—more than we can comment on here. There was a good summary of some of their findings recently at Businessweek.com. Right now, we will focus on what they learned about how to succeed while living in a world of failure.

In general, we can learn two things.

1) Time Your Bets
The return on investment is a ratio. The return is the numerator and the denominator is the investment. Elite companies have found a way to optimize the numerator and the denominator by timing their activities relative to the business cycle.

The timing is as follows—buy at the bottom of the cycle (when the denominator is lowest) and sell at the top of the cycle (when the numerator is highest). This process will get you reasonable returns on even weak investment opportunities. And the losers will be less of a loss.

Yes, I know it can sound like a cliché—buy low and sell high—but elite companies actively monitor business cycles and proactively try to make the cliché a reality. Their strategies take into account the context of where they are in the business cycle. They boldly buy when the rest of the world is selling and sell when the rest of the world is buying.

This process has the added benefit of improving cash flow. Buy selling high, the elite firms have more money to invest when prices are low. You can afford the risk of a few more failures when flush with cash and buying when the cost is the lowest.

2) Exit Quickly
Instead of being like Bill in the story who bet all the time on every horse, elite companies are also quick to cash out when failure appears inevitable. Patient money is used for the potential winners, but the funding quickly stops for the losers.

This is done in two ways. First, elite companies set up specific, measurable criteria for success prior to making an investment (early warning signs). If the criteria are not met in these early stages, funding stops.

Second, these companies actively monitor investment performance throughout the entire lifecycle of the investment. This has two benefits. On one hand, it lets the elite firm quickly know when an investment is turning into a failure (so that investment can stop). On the other hand, it lets the company learn what works and what doesn’t work, so that they can make more intelligent investments in the future (ones that are less likely to fail).

SUMMARY
Since most strategic activities fail, managing failure is the key to strategic success. The idea is not to avoid failure completely, but to make sure the impact of failure is minimal. This can be done by building strategies around business lifecycles and by actively monitoring investment performance against predetermined criteria throughout the entire investment lifecycle.

FINAL THOUGHTS
Those who bet on horse races do not have the ability to cancel their bet halfway through the race, when they can obviously see the mistake in their original bet. Businesses, however, can back off from their bets if they see failure in the early running of the investment. When things look bad, cut your losses early.

Analogy #235: It’s Not Fair!

THE STORY
Usually, the first words said by a baby have something to do with their father or mother…words like “Mama” or “Dada.”

Although I can’t prove it, it seems to me that one of the first sentences a child says is “It’s not fair!” Even if it is not the first sentence, it is probably one of the most frequent sentences you will hear from a small child…and usually accompanied with some tears (and perhaps a temper tantrum).

THE ANALOGY
Even very small children seem to have a sense of justice. They feel they have rights, and when they do not get what they think they deserve, they cry out “That’s not fair!” Although you may disagree with these young children over what they truly deserve, there is no denying that these youngsters get very unhappy when they feel that they have not gotten a fair deal.

To show their displeasure, they may cry, throw a temper tantrum, or try to create their own sense of justice by stealing back what they believe was unjustly taken away from them. A good parent will eventually show the child that the world is not always fair and that we are not to create our own vigilante justice, but work within the system. In the meantime, parents will teach the child that temper tantrums are not the proper way to resolve problems.

Unfortunately, I have seen companies do the equivalent of crying “That’s not Fair!” and throw temper tantrums when a competitor has what appears to be an unfair advantage. Well, you know what? Life isn’t always fair in business and normally, throwing a temper tantrum will not solve the problem. Crying about an unfair disadvantage won’t suddenly make your “disadvantaged” strategy a rousing success. It is still a failed strategy, regardless of whatever injustice you feel.

And although you may want to use this “injustice” as an excuse for poor performance, guess what…your shareholders don’t care. They just want performance. Rather than throwing a temper tantrum, just pick yourself up and find a different strategy where you have the advantage in your favor.

THE PRINCIPLE
The principle here is that the world is not always “fair” and that a good strategist does not use unfairness as an excuse. Instead, a good strategist looks for an alternative strategy which creates “unfairness” in its favor. In other words, instead of sitting around pouting over bad performance and blaming “It’s not fair!,” redesign your strategy so that the tables are turned and the competition is now the one claiming “It’s not fair!”

I was recently talking to an executive about a business division that was performing below expectation. I suggested that the problems were primarily due to a particular competitor that was gobbling up market share at their expense. The response I got sounded a bit like a temper tantrum excuse: “But that competitor is a dotcom startup that is not required to turn a profit. Because we require our division to make money, it cannot offer as strong a consumer value.” I half expected the excuse to end with a cry “It’s not fair!”

My answer was that it didn’t matter that the competitor did not feel compelled to make as big a profit as we did. From the customer’s perspective, they don’t care about all that profit stuff. All they know is that the competitor offered a better deal.

Hiding behind that excuse won’t solve the problem. Customers will continually flock to the place where they get the best deal. Eventually, the board and shareholders will stop listening to these cries of “It’s not fair!” and demand results. To solve the problem, this division needs a new strategy which creates a different type of value that the competitor cannot match.

I was reminded of a similar situation earlier in my life. The company I was working with had a division that was doing poorly against a particular large food retailer. This food retailer was privately held. Being privately held, this competitor made financial decisions as if its cost of equity was virtually free. Our company, which was publically held, had to calculate a large cost of equity into its return on investment. As a result, the competitor could “afford” to do things which our firm thought were poor investments.

The customer didn’t care about “cost of equity” and “return on investment.” All they knew was that these so-called “poor” investments created a preferred shopping environment for our competitor. People within our company were saying the equivalent of “It’s not fair!” They hid behind this excuse rather than change the rules with a new strategy. Guess what? The competitor grew and our division shrank. And no amount of temper tantrums would fix that.

So what do we learn from this?

1) Don’t Hide Behind Excuses of “It’s not fair!”
If the situation truly is not fair and you are at a disadvantage, then you have a broken strategy. Sticking with such a broken strategy is suicide. Crying about it won’t change it. Pick yourself up and change your strategy.

2) Develop a Strategy Where you Have Your Own “Unfair” Advantage
If your strategy is broken, you need to reposition yourself relative to the competition in a manner where you can create your own advantage. For example, if the competitor has a unique cost advantage which you cannot touch, then do not use a price strategy against them. That is suicide. Instead, find a place where they are weak (like service) and build your “unfair” advantage there. Remember, the goal is not to beat the competition at their game. The goal is to find your own game where you can win.

There is almost always multiple ways to approach the marketplace, particularly with a niche strategy. Find the approach where you have the edge over the others.

In the end, you may find that your best approach is a strategy where both companies win. For example, if you let them win on price and you win on service, then both companies can succeed on their own and not resort to killing each other firm in a downward competitive spiral.

Unfair does not mean illegal. It is not illegal that taller people win more basketball games. Their height gives them an advantage in basketball, and they can legally use that advantage there. But being tall is not always an advantage. If you are short and small, perhaps you should be competing as a jockey. Riding a racehorse is a place where a huge, tall basketball center is at a disadvantage.

SUMMARY
A good strategy is one where the competition complains “It’s not fair!” about you rather than you complaining “It’s not fair!” about them. This requires looking for positions where your uniqueness gives you an edge that others find difficult to imitate. This proactive search for your own “unfair” edge is much better than just whining and complaining about the unfair edge that someone else has.

FINAL THOUGHTS
Lately the US government has been listening to a lot of whining and complaining about unfairness. The auto industry, for example, is asking for a handout because of the unfair advantage they claim to have versus the foreign auto companies. Just giving them more money won’t change the “unfairness.” Ultimately, the auto industry needs to change and find a strategy which is not broken.