Analogy #183: Bridge Out Ahead

THE STORY
A friend of mine told me the story of a time back when large sections of the interstate highway system were being built. There was a large section of this expressway which appeared to be completed near where my friend lived. Yet, for some reason, the government would not open it up for use.

At first you could assume that perhaps they were waiting for the concrete to dry and cure. Or maybe they were waiting until all the signs were up. However, after a large number of weeks had gone by, you still were not allowed to drive on the new highway. Surely by now the concrete was ready. You could see that all the signs were up.

One man in particular was upset by the delay in opening that expressway. He knew it would make his daily commute both faster and smoother. As each day passed, he became a bit more angry about not being able to use that highway.

Eventually, he could not stand the wait any longer. One night, after dark, he pulled away one of the barricades and drove up the ramp to the new highway. It was wonderful! The road was smooth—no potholes! He could drive as fast as he wanted because there were no other cars on the road.

Just as he was starting to relax, he caught a glimpse of something ahead. The highway was missing a bridge! He immediately slammed on his breaks. Unfortunately, he could not stop in time, and he drove over the edge to his death.

I guess there was a reason for not opening up that highway after all.

THE ANALOGY
Strategic planning is about moving a company from its current location to a superior destination. In that respect, building a strategy is like building a highway—a route one can take to get to that destination.

It may appear that the strategy is in great shape, just like that new highway. Unfortunately, there can be some critical pieces missing, just like that bridge. Unless you make sure that all of your bridges are in place, your strategy can drop off the edge and never return.

THE PRINCIPLE
The principle here is that not everything moves in a smooth incremental succession. Sometimes, there are gaps that can only be crossed by building an additional strategic bridge.

Bridges tend to take a lot longer to build than the highway on either side of the bridge, because the bridge is a more complicated structure. Therefore, if you don’t start building the bridge until the highway reaches the gap, there will be a very long wait before you can use that highway. A lot of precious time will be lost in the race to the future.

A better approach would be to determine in advance where those large gaps are and start building the bridges right away. Then, by the time your strategic highway gets to that point, you will be ready to connect it to the bridge and not skip a beat.

A good example of this has to do with managing the succession from one CEO to the next. Due to egos and cultures and other such issues, that transition can sometimes be quite difficult. It can be like a bridge, which needs to be worked on far in advance of when it is needed.

At Microsoft, Bill Gates had a great deal of difficulty relinquishing power and control to Steve Balmer. Fortunately, they started the transition well in advance of the time when Bill Gates was to leave the company. And they needed all those years to get the egos and the bugs all worked out (too bad the transition to Vista did not go as smoothly).

The time to start thinking about successors is not the day after the CEO announces his or her retirement. That is as irresponsible as building a highway and forgetting to build the bridges.

Perhaps the next step in succession is not a new CEO but to sell the company to a larger one. The time to start work on the deal is not at the time when you want to sell. This is another one of those bridge concepts which takes extra time. It can sometimes take years to woo a company into cooperation. Because Microsoft ignored this long courtship process in going after Yahoo, the deal had difficulty creating any traction.

If you want to sell out, not only do you need to woo the potential suitor, but you may need to transform your company into something more desirable to them. Perhaps you have overlapping businesses you need to sell in order to gain government approval. Or perhaps you need to migrate your business to a more compatible platform. Or perhaps some key investors need to be persuaded. The more of this you do up front, the less desperate you will be later on to get all the pieces to fit. And let me tell you, if you have to get it all done at the last minute, it will cost you dearly.

Sometimes, bridges have to deal with acquiring scarce resources, be it raw materials, technology or people skills. It can take extra time to get these resources in place, so treat them like a bridge. For example, rather than relying on the open “spot market” to try to gain those resources on a just-in-time basis, you may want to work well in advance to develop the kinds of relationships that will allow you to get long-term contracts that guarantee supply at favorable rates.

If you have to acquire to get the technology you need, start the courtship well in advance.

In a prior blog, we talked about how the time before we hit the gap is usually shorter than we think (see “The room is Smaller than you Think”). It is equally true that the time it takes to build a bridge over that gap is usually longer than we think.

As a result of these two trends, we can hit a stall point, where the bridge is not ready in time. Impatient investors, board members and employees will get as upset as the man in the story and want to plow ahead before the bridge is ready. If you resist, they may replace you. If you do not resist, then you will be the one driving that car off the edge of the highway.

Now there is not enough time or resources to treat everything like a bridge. Fortunately, not every gully needs to be crossed on a deluxe bridge. Sometimes, you can move along quickly by just paving over those little hills and valleys and live with a few little bumps.

The trick is to isolate those key gaps where serious bridge-building is needed and get to work on them with sufficient lead time.

SUMMARY
If you want smooth, seamless transitions in your business, then you have to realistically evaluate how long it will take to build those transitions. Then, you need to sequence the timing of your projects so that the projects end in time to be ready when needed. And since those gaps tend to come a little sooner than you think, and the building tends to take a little longer than you think, build in some slack time.

FINAL THOUGHTS
Most movies are not filmed sequentially, from beginning to end. That can be a very inefficient way to make a movie, wasting both time and money. Complicated scenes are started earlier, some scenes are filmed simultaneously on different lots, and scenes using the same resources may be filmed together, even though they do not occur in the movie together.

The same can be said about implementing your strategy. It may be more efficient to tackle the projects “out-of-sequence.” Get to the bridges sooner. Although it may look messy on your side, the customer will only see the smooth, continuous movie.

Strategic Planning Analogy #154: Gaps & Plugs Part 2

THE STORY
Many people find themselves in a situation where they need to lose weight. Since a lack of discipline is often the reason why they got into this problem in the first place, usually they are not looking for a disciplined approach to solve the problem.

Instead, many of these people look for a simple one-step solution for losing weight. For example, they may buy an exercise machine and expect that to solve all of their problems. The problem with just doing exercise alone is that:

1) It can make you hungrier, so you end up eating more and not lose weight.
2) It can put undesired muscle bulk on the body, so you don’t lose weight.
3) If you discontinue the exercise, the muscle bulk can turn to fat.

Then there are the various starvation diets. If you do that alone,

1) Your body will adjust and slow down its metabolism, so the reduction in calories becomes less effective.
2) Eventually you have to come off the starvation diet, and because your metabolism has slowed down, you gain weight faster.

Experts agree that the best method to lose weight is a balanced, disciplined approach, combining modest reductions in eating with modest increases in exercise. Not only is this more effective, it is more sustainable over the long haul.

THE ANALOGY
Just as people want to lose weight, companies want to gain sales and profits. As we saw in the prior blog (part 1), undisciplined extreme approaches in a singular direction rarely lead to sustained growth.

Instead, just like weight loss works best with modest modifications to both diet and exercise, planning for growth works best with modest modifications to both current businesses and new ventures.

THE PRINCIPLE
The principle here is that instead of putting all of your growth bets on one big “home run,” it is usually better to string along a lot of base hits, both in shoring up the current business as well as experimenting with new ventures. Here are three rules to keep in mind when taking this type of balanced approach.

Rule #1: If you want different results, you need to do things differently
On the old TV show “Third Rock From the Sun,” Harry Solomon was watching a Road Runner cartoon on TV. Harry turns to Tommy and says that he knows that the latest trick of the Coyote is going to work to capture the Road Runner. Tommy reminds Harry that he has already seen this cartoon and that it did not work when he saw it last time. To this, Harry says something to the effect of, “Yes, but this trick is too ingenious not to work eventually.”

There’s an old saying that the definition of an insane person is one who continues to do the same thing and expects different results. Harry was under this same delusion in thinking that if the Coyote did the same thing over and over, eventually the cartoon would have a different result.

As silly as this sounds, some strategic planning processes aren’t much different. They plan an ambitious goal for a current operating division—something that the division has never come close to achieving in the past. Then they do nothing different and are surprised when the goal is not met.

If you want a different result, then you need to do different activities. Planning is more than just planning goals. It is about planning activities. The key question to ask is “What are you going to do differently in the current division in order to achieve a different (and much better) outcome?”

The strategic plan should not just map out results. It needs to map out the new processes and approaches which will be used to achieve these new results. Premeditated forethought into how to re-engineer the current business is needed to provide the catalyst for improvement. Otherwise, people will tend to return to the comfort of the status quo, which produces status quo outcomes. When the change is articulated into the plan, it is more likely to occur, because it is more likely to be measured.

Rule #2: If you want to be in the right place at the right time, be in lots of places
Because the current business is more familiar, it is easier to articulate the specifics of change into the plan. However, when moving into new ventures, there are more unknowns. Predetermining all the specifics can be premature (and potentially destructive) because the likelihood of guessing wrong is high.

Therefore, it is usually safer, particularly in the early stages, to make a lot of small bets in new ventures. Many experiments will help educate the company on the best eventual path. As Thomas Edison used to say, the benefit of doing lots of experiments is that you learn what doesn’t work. Then you can concentrate on the things which do work.

In other words, if you want to be in the right place in picking new ventures, first put yourself in a lot of places. This doesn’t mean that you should just randomly pick things to experiment on. Every experiment should be consistent with the over-arching strategy and should try leverage current strengths. But that still leaves lots of opportunity.

One of the strengths of Google is its constant experimenting into related businesses. Most don’t pan out, but by doing so, they find the few nuggets which pay off big. They put themselves in a lot of places in order to eventually be in the right place.

Rule #3: If you want the right experiments to move to the next level, don’t predetermine expectations.
One of the most critical elements in experimentation is knowing when an experiment is not working and needs to be dropped. Quite often, there is a tendency to continue to waste resources long after the project should have been dropped.

As we discussed in the prior blog, there is a hesitancy to drop a project if a company is already psychologically attached to it due to prior expectations of success. The pressure to fulfill those expectations can make us throw good money after bad and keep bad projects alive.

Therefore, in the early stages, do not assign quantifiable expected goals for an experiment. For example, don’t start six experiments and say from the start that you expect all six to each place a million dollars of profit on the bottom line next year. At that point, you have declared them to no longer be experiments. They are now projects that must be completed in order to achieve that predetermined goal. It is almost impossible to pull the plug on them now, even if they are bad, because expectations have been set under the presumption that it must succeed and make $1 million.

A better approach would have been to say that we don’t know which of the six experiments will work, but somewhere in here is a multi-million dollar success story. That way, if one of the experiments does not appear successful, it is easier to drop it early, when losses are small.

SUMMARY
Setting ambitious goals is often a good early step in planning. However, trying to get all of the extra performance from a single source can be quite risky. It is usually better to take a balanced approach, looking for gains from both current business and new ventures. For current businesses, focus on new ways to do things, since the old ways produce the old results. For new ventures, experiment in the early phases on multiple ideas, and then prudently stop investing in the experiments which do not work.

FINAL THOUGHTS
Another quick way to lose weight is through amputation, but I don’t recommend it. The side effects are worse than the benefits. Similarly, a quick way to gain sales in a business is to make a big acquisition. Since most big acquisitions end up destroying value, I would think long and hard before making that choice. Lots of sales growth isn’t worth much if it destroys profits.

Strategic Planning Analogy #153: Gaps & Plugs Part 1

THE STORY
Although Wal-Mart is on the leading edge of technology today, this was not always the case. Back in the early 1960s, when Wal-Mart was first starting out, its systems were very crude.

The accounting system consisted of a bunch of pigeon holes on the wall of the office—one pigeonhole per store. The paperwork for each store would then be stuffed into its appropriate pigeonhole. Once a month, the paper would be taken out of the holes and Sam Walton and Wanda Wiseman would close the books.

Not wanting to waste a lot of time doing paperwork, Sam Walton came up with a way to really speed up closing the books. He called it the ESP method. This is how Sam Walton explained the method in his autobiography:

“It’s a pretty basic method: if you can’t make your books balance, you take however much they’re off by and enter it under the heading ESP, which stands for Error Some Place.”

THE ANALOGY
Sam Walton used a simple plug to make his books balance. The plug was needed because Sam did not know how else to bridge the gap in his books.

A similar situation often occurs in strategic planning. First, one comes up with ambitious goals for the company. Then the core business is examined to see if it can achieve the ambitious goal. Many times, the core business appears to fall short of the goal. This creates a “planning gap.”

The question then is how to plug this strategy gap. One approach is to just make-up a line in the plans and stick the gap there, sort of like what Sam Walton did with his accounting books. Perhaps instead of calling it ESP, we could call it USP—Unknown Source of Profits.

Unfortunately, just as Sam had no idea what caused his accounting error, this method will give you no idea for how to fill your strategy gap. Your strategic goal in this case has no real connection to your planning activities. Therefore, it should be no surprise that when plugging your goal in this manner, you usually fall short of hitting the goal. The unknown source of profits becomes an unfound source of profits.

THE PRINCIPLE
In general, there are two places to look when trying to fill this gap—current operations and new ventures. The main principle here is that “putting all of your eggs into one basket,” be it current operations or a new venture, is typically sub-optimal. Instead, a more balanced approach between the two is normally more successful.

In this blog, we will examine some of the pitfalls associated with the extremes—either looking to get it all from current operations or all from new ventures. In the next blog, we will look at how a more balanced approach can often be better.

1) Too much Dependence on the Core can Start a Death Spiral
Ambitious goals are not bad, per se. In the book Built to Last, the authors say that successful companies tend to have “Big Hairy Audacious Goals,” called BHAGs.

If a goal is big, hairy and audacious, then it must by definition expect more than what one would naturally receive from current operations run similar to how they are run today. Therefore, by definition, BHAGs create a planning gap with current operations.

One way to fill the planning gap is to place nearly all of the expectations for filling the gap on current operations, even though by definition BHAGs stretch beyond the capacity of current operations. In other words, once the current patterns of expectations are trended out, they are adjusted to become exceedingly aggressive—far more than just stretch goals. For example:

a) Sales growth goals could be raised significantly above historical trends;
b) Cost cutting goals could place expense expectations well below anything ever done before;
c) Performance is expected to improve even though capital spending is curtailed.

Under this scenario, the implications to the company tend to follow one or more of these patterns:

a) Internal Decline: Employees figure out that the goals are unrealistic/unattainable and that they will now have a miserable time being yelled at and no longer get any bonuses. The good people will start to leave the company and the rest will be demoralized. The balance of employees’ time could move from trying to make improvements to trying to “cover one’s ass” and deflect the blame to someone else. Instead of performance getting better, performance will get worse.

b) External Decline: In order to hit the extraordinary near-term goals, the long-term viability will be threatened. For example, to hit unrealistic sales goals, promises may be made that cannot be fulfilled. To hit unrealistic expense goals, customer service could suffer. Lack of proper investment could eventually make your internal processes obsolete. For a short period of time, these tactics could work, but in the long run, they will ruin your future potential. Customers will eventually realize you do not live up to your promises, have lousy service and are obsolete. They will take their business elsewhere.

These two types of decline can put a company into a “Death Spiral.” It works as follows: over time, demoralized employees and defecting customers hurt performance. As a result, the planning gap between ambitious goals and shrinking results gets even larger. With a bigger gap, the pressure increases on the core business, causing even more internal and external decline. Every year it gets worse until the whole thing blows up.

2) Too much Dependence on New Ventures can Start a Money Pit
Although putting all the burden for filling the gap on the current business can lead to a death spiral, it is also potentially dangerous to put all of the burden on new ventures. One of the big problems with new ventures is that they tend to be at least partly outside our range of expertise. Without that expertise, we do not know what a realistic expectation should be for new ventures. Not knowing all the potential pitfalls, there is a tendency to set these goals unrealistically too high.

This can lead to one or more of the following issues:

a) Distorting One’s Risk Profile:
There are two ways this can increase the riskiness of your firm. First, if one wants big rewards quickly, there is a tendency to gravitate towards riskier investments (risk=rewards). Second, to find big results quickly, one tends to focus on fewer, larger ventures rather than a lot of smaller ones. By focusing on fewer, larger new ventures, the likelihood of failure increases, since most new ventures fail and you don’t have a large pipeline of options.

Technically speaking, if your risk profile goes up, then your key stakeholders should demand an even higher return on investment, since they want to be compensated for taking the added risk. This places even more pressure on looking for even bigger near-term returns. Even if you do not increase your return hurdle rate due to extra riskiness, it should be done. Otherwise you may approve projects at the lower rate which would not pass the test at the more accurate higher rate.

b) Hesitancy to Pull Back if News is Bad:
With all the pressure to find a success with a few big new ventures, there is pressure to be overly optimistic in expectations on these ventures. Revenues tend to be estimated on the high range and costs tend to be estimated on the low range. When reality starts setting in—and prospects do not look as bright—there is pressure to keep plodding along anyway. Too much has already been invested, people are expecting a success, there is little else in the pipeline to replace it, and your career may be damaged if you admit failure. As a result, bad ventures tend to live on longer than they should.

c) Throwing Money at the Problem:
When prospects start looking bad and you still want to succeed, a common response is to throw more money at the problem. Since this is a new venture, you may not have a lot of internal expertise to rely on…all you have is money. The hope is that if you throw more good money after bad, something good will turn out. It rarely does, so then you try an additional round of throwing money at the problem.

d) Current Business Envy:
With all of the attention and glamour given to the new venture, those working on the current business could feel left out and jealous. All the good people may shift over to the glamour side of the business, which hurts current business performance. Or, to keep them working on the current business, you may need to throw some additional money in their direction.

As a result of these four possible results, a focus on trying to get too big of a return too quickly on too few new projects can create a money pit—a place where you keep throwing money, but see little in return.

SUMMARY
Setting ambitious goals is often a good early step in planning. However, if you have no idea of how to achieve those goals, you will most likely not achieve them. In general, there are two sources for filling the gap between current trends and an ambitious goal—current operations and new ventures.

As we saw in this blog, too much reliance on only one of these sources will tend to lead to problems, so the goal is still not met. In the next blog, we will see that a more balanced approach tends to be more successful.

FINAL THOUGHTS
Studies have shown that smaller, consistent increases in performance improve stock prices more than large promises which are never realized. Too much blind ambition can be a hindrance.

Bob The Basketball Player

THE STORY
Once upon a time, there was a man named Bob. He loved to play basketball. Unfortunately, he was awful at making layups. Bob would always miss when trying to get the ball in the hoop via a layup.

Every day, Bob would practice his layups for hours, but it did him no good. He would always miss.

One day, Bob’s friend Sam dropped by to watch him practice. After an hour or so of watching Bob miss every shot, Sam commented to his friend, “You know, Bob, you’ve been trying the same thing hour after hour, day after day and it is not working. You are not getting any better. Maybe it’s about time you tried something different.”

A few weeks later, Sam ran into Bob at the mall. Sam asked Bob, “So how’s the layup practicing going?”

“Great!” said Bob. “I took your advice and tried something different. Now I make every shot.”

“That’s wonderful,” replied Sam. “What did you do?”

Bob proudly exclaimed, “I lowered the basket by 3 feet.”

THE ANALOGY
Strategies are about setting and achieving goals. Many times there are goals already set for you by your investors, lenders or shareholders. For example, they may require a minimum return on investment.

If you continue to fall short of reaching those minimums, you may be tempted to solve your problem by lowering your goals, similar to how Bob “solved” his problem by lowering the basketball hoop. Unfortunately, just as there are rules in basketball about how high the basket needs to be, there are rules of thumb in finance about how high the returns on investment need to be.

Generally speaking, people do not invest in you because they like you. They invest because they believe they are going to get a return on their investment higher than their minimum requirement. If you cannot meet their requirement, they will invest their money elsewhere. Similarly, if Bob cannot make baskets at the required height, people will not put him on their team. They will look elsewhere.

You may be able to fool yourself for awhile into thinking you are a great basketball player by lowering your hoop three feet. Eventually, however, you will have to play on someone else’s court. Then you will find that if you are like Bob, you cannot effectively play by the normal rules of basketball.

The same thing can happen in business. You may be able to capture a large bonus or two by lowering the goals and trick yourself into believing that you are doing well. It will not last long, however. It is a highly competitive marketplace out there. If you cannot play to the high standards expected in the marketplace, you will eventually fail.

THE PRINCIPLE
The principle here is about finding ways to fill the strategy gap. Returns on investment are based on anticipated future cash flows. Is the cash coming in at a large enough and fast enough rate to meet the goal? If so, you will do alright. If not, you are in trouble.

It is not uncommon for a company to add up all of its anticipated future cash flows and find that there is not enough there to reach their goal. The gap between what you think you can achieve and what you are required to achieve is called the strategy gap. Strategic planning is then needed to find a way to fill that gap. If you cannot find a way to fill that gap, the value of your company will go down.

There are many ways to fill that gap. Some are better than others. Here is a listing of some of those methods:

1) Redefine the Goal
2) Deceive Yourself About Expectations
3) Work on the Denominator
4) Work on the Numerator
5) Work on the business portfolio

Each of these is discussed below.

1) Redefine the Goal
To redefine the goal is to do what Bob the Basketball Player did. He redefined the height of the basket to a low enough level so that he could make his shots. In other words, businesses can fill their strategy gap by effectively eliminating the gap—lowering the goal until it exactly equals what the current business model is already obtaining.

Although this process may theoretically eliminate the gap, it may not produce enough of a return to satisfy your investors/creditors/shareholders. Instead, it may only produce a high enough incentive among these people to get them to replace you with someone else.

2) Deceive Yourself About Expectations
This second option is very similar to the first, except that instead of lowering the goal to meet what you can do, you artificially inflate the expectations of what you can do in order to predict a return that exactly achieves the goal. That would be like Bob the Basketball Player promising that the next time he would make all of his layups with a regular height basket, even though past experience would lead one to believe that he will miss most, if not all of them.

The good news is that this process gives the appearance to your investors/creditors/shareholders that you can achieve their goals. At the same time, it makes your job relatively easy, because you just continue business as usual. However, since the expectations made for the business are unrealistically high, it is only a matter of time before your lies are found out. Eventually, you will run out of excuses for the repetition of disappointing performance and have to face the fact that you are not capable of meeting the expectations with the current business model.

It may not be outright deception which causes one to over-inflate expectations to meet a target. It may just be over-enthusiasm and overconfidence…or maybe you think you’ve fixed the problem, so this time the results will be different. In any event, too much optimism can blind us to the fact that perhaps we do not have as good a business model as we think we do. As a result, even though we claim to have filled the gap, we really have not done so.

3) Work on the Denominator
The concept of return on investment is a ratio. The numerator is your return and the denominator is your investment. One way to increase your return in order to fill the gap is to work on the denominator of that ratio. In other words, find a way to get the same return, but with a lower investment.

There is a healthy and an unhealthy way to reduce the denominator. The healthy method usually involves an emphasis on improving the efficiency and productivity of your resources, so that you need less of an investment in order to achieve your return.

The unhealthy method involves deep cost cuts and taking unnecessary risks by eliminating testing or spreading your resources too thin. They say you get what you pay for, and if you pay too little, sometimes you end up getting less than you bargained for. For example, by eliminating maintenance, you may be able to improve your returns and look good in the near-term. However, long-term, without maintenance things will eventually fall apart and cost more to repair than the cost of the maintenance. Then your returns will plummet.

4) Work on the Numerator
The other side of the ratio is to work on the numerator. In other words, improve your return on investment by increasing your returns.

As with the denominator, there is a healthy and an unhealthy way to increase the numerator. The healthy method usually involves an emphasis on improving the efficiency and productivity of your marketing, so that you are better serving your customer, resulting in improved sales.

The unhealthy method involves either:

A) Promising more than you can deliver, which may increase revenues near-term, but reduce repeat business long-term; or

B) Luring people to purchase with excessively high loss-leader purchase incentives (i.e., bribes) which cannot be cost-effectively sustained over time (for more on this, see “If You Want Loyalty, Get a Dog”).

5) Work on the Business Portfolio
The idea here is that if your current business portfolio cannot achieve your goal, add or subtract business and/or capabilities which will create a more effective portfolio. For Bob the Basketball Player, if he cannot make the layups himself, get him some help on the team. For example, use Bob’s skill as a passer and have him pass the ball to someone who can make the layups. Or, to go back to the height issue, have him sit on top of the shoulders of someone else, so that the two combined are tall enough to reach the basket.

High levels of return usually involve tapping into the synergies which come from combining multiple resources. If you can create the right combination in the right way, you can tap into higher returns.

SUMMARY
In this short space, we were only able to touch on the surface issues concerning the achievement of business goals. The key point is that not all methods succeed over the long-term. By taking shortcuts in the near-term, we can actually make our long-term prospects even worse. The best way to fill in the gap between current performance and desired performance is to work on a combination of productivity enhancements, marketing enhancements, and portfolio enhancements. The strategic planning process can help find the best path for your company amongst these options.

FINAL THOUGHTS
When you see someone making excessively high bonuses, it may be more of an indication of their skill at negotiating their compensation than their skill at achieving high long-term returns for their company. Just wait awhile and see if they get those bonuses three or more years in a row. Then you will know how good they are at building lasting performance.