THE STORY
My finance teacher in college was a brand new professor. He had just finished his PhD and made the transition from being the student directly to being the teacher. He had no meaningful real-life experience in finance (nor any meaningful real-life experience at teaching for that matter, either).
This professor was not much older than I was at the time, which was relatively young. Yet when he taught, he spoke as if he had generations of experience and seemed to enjoy telling his students how most everyone in the business world was misguided.
He hated it when a company would introduce a new product, or diversify into new lines of business (to mitigate risk), or change a strategy to adapt to a changing world. In his mind, every business should be required to sell only one product, and sell it in only one way…forever.
What was his reasoning behind this? He believed that the investing shareholders should have ultimate power. If investors like the one product and the one way it is sold, then they can support it by buying shares in the company. If they don’t like the product or the way it is sold, then they can sell their shares in the company (or never invest in it in the first place). The good would get rewarded and the bad would get punished—by the investors.
Whenever a company changed its portfolio or its strategy, he felt it was interfering with his ability to control the company with his ownership. After all, what if the company came up with two products—one he liked and one he didn’t? Now he could no longer support one with his shares and deny the other by not buying shares. This made him very angry.
And if a company had the wrong strategy, he didn’t want it to change, because then the company would be doing something he couldn’t control. Instead, he would prefer that the company kept the bad strategy, so he could sell his shares in that firm and re-invest them into a company that already had the better strategy.
He did not care if a company lived or died. He would just continue to move his money and invest it in the best location at that particular moment
By contrast, Warren Buffet seems to have taken an opposite approach to investment and done quite well with it. I suspect that Mr. Buffet has done much better in investing than my college professor did.
THE ANALOGY
Although most investors are not as blunt as this professor, many act as if they believe what he is saying is true. They have no sense of loyalty or desire to help a business thrive over the long haul. They just want to move their money around to wherever the success is at the moment. What motivates their personal success often is at odds with what is in the best interests of an individual company’s long term success. For them to win, the company often has to fail.
When devising strategies, it is important to consider the desires of your owner. After all, these are the people who pay your salaries and can get you fired. But sometimes you have to take a stand and not do exactly as they desire. Giving them exactly what they desire may end up not giving them what they really need…an economic engine that produces cash flow for a long time.
Warren Buffet understands the big picture and realizes that the best returns usually come from long-term investing in companies that know how to adapt and survive. When the investor’s success depends on the company having long-term success, then usually both sides win. But if the investor’s best interests are not the same as the company’s, then one or both sides tends to lose.
THE PRINCIPLE
Over the past couple of blogs we have been talking about the concept of “who is my customer”. We have seen that you can use different strategic approaches to choose which type of customer you want to serve. You can serve the people who pay the money, the people who use the service, the people who influence the people who use the service, and even the people that may eventually buy your company.
There is another type of customer we haven’t talked about much. That would be the current owner, be it a corporate headquarters (if you work in a division), a board of directors, an active shareholder, or a venture capitalist (if you are a start up), or something similar.
In general, it is a good idea to make this “customer” happy. They are the boss. At the very least, you cannot ignore them. However, sometimes the best path to making them happy is to do something other than they want. It can be a tricky business to disobey a boss, so we must be careful when doing so. The following are a few principles to help determine when to do so.
1) Move in the Direction of the Greater Good
Sometimes a division of a corporation is asked to embark on a strategy which sub-optimizes the individual division, but optimizes the good of the greater corporation. In this case, the path would not be to disobey and try to maximize your individual business, but to act for the greater good of the entire corporation. To ensure that this happens, the division should be rewarded based on its impact on the greater good.
2) Don’t Move in the Direction of Illegal or Immoral Activity
The phrase, “But my boss made me do it,” does not stand up well in court. You always have the option of quitting.
3) The Owner is the Tie-breaker in differences of Opinion
Sometimes people just come to different conclusions. It’s okay to express your differences to the boss, but in the end, their opinion is the one that matters.
4) When the Owner’s goal is clearly not in the best interest of the company, consider firing the owner as your customer.
If a shareholder is making unreasonable demands that will line their pockets with money but bankrupt the company, perhaps you need to look for ways to “fire” your owner. In other words, try to change the profile of the type of investors that invest in you. Try to cultivate more Warren Buffet type of owners, rather than owners like my old college professor. If you stand your ground and fight for the long-term health of your company, you should naturally attract the investors who are looking for that type of business and discourage the investment by other types of investors.
As a general rule, if you manage for the long-run, you tend to build a strong track record of growing cash flow, which leads to a successful stock price. However, if you just focus on short-term tricks to inflate today’s stock price, you may end up being a poor investment over time. So to make owners happy with growing stock prices, you sometimes have to ignore the stock price and focus on the business. Hence the irony that in order to make an owner happy, you sometimes have to focus on something other than trying to make the owner happy. Their happiness is a byproduct of good strategy, rather than making their happiness become the strategy.
SUMMARY
Although it is important to make the owners happy, sometimes the best way to do so is to focus on something else—namely making the business strong. If the owners do not see the wisdom in this, either try to get a different type of owner or go work somewhere else.
FINAL THOUGHTS
The world is a lot more complicated than what I can describe in a short blog. I don’t want to come off sounding as naïve as my old professor. But at the same time, I think leaders need to do some genuine leading every once in awhile and not just be a puppet of the owners.
Tuesday, February 20, 2007
Monday, February 19, 2007
We Can All Act Like Sports Franchise Owners
THE STORY
Back in 2001, Howard Schultz and 57 partners bought the Seattle Sonics professional basketball franchise for $200 million. During the time that Howard Schultz owned the Seattle Sonics, the team suffered annual losses. It is claimed that while Schultz owned the team, the combined operating losses were $60 million.
Yet, in spite of being a business that showed no signs of making a profit, Schultz and his partners sold the Seattle Sonic team in 2006 for $350 million. That is $150 million more than what they paid for the team and $90 more than they paid if you subtract the annual losses. In fact, they supposedly turned down an offer of $425 million (more than twice what they paid for the team) from Larry Ellison, CEO of Oracle, because he wanted to move the team away from Seattle.
This is not a fluke price. In 2004, the New Jersey Nets basketball franchise sold for $300 million and the Cleveland Cavaliers basketball team (and its arena) were sold in 2005 for $375 million.
Willamette Management Associates is an expert in the area of sports franchise valuation. One of their representatives says that it is very difficult to use income flows as a means of evaluating sports franchises. To quote a 2002 paper they wrote on the topic,
“The discounted cash flow method is often used in the valuation of sports franchise intangible assets. However, it may be difficult to use this method in the valuation of the sports business enterprise. This is because many sports franchises either earn negative income or do not generate sufficient income to support the prices paid in actual team sales.”
So it appears that even though the business itself can be a perpetual money loser, in the world of sports franchises that does not mean it is a bad investment. According to the Seattle Times, the annual rate of return on the investment of Howard Schultz and his partners, when you consider the selling price and other factors, was probably around 10.6%. That’s a pretty good return for investing in something that loses money.
THE ANALOGY
At the end of the day, the basic goal of capitalism is to find good returns on investment. As the story above illustrates, it is possible to get very good returns on investment on businesses that provide little to no profitability on an annual basis. The return on investment for the Seattle Sonics did not come from the operating earnings, but rather from the selling price.
Now you may be thinking that such opportunities occur only in the world of sports. However, recent trends seem to be indicating that this trend is creeping ever more into the rest of the business world. Just look at some of the prices that hedge funds have been paying recently for businesses that are not very prosperous. Even businesses that lose money are being snapped up at relatively high prices by these hedge funds.
When devising business strategies, there appears to be a strategic option to consider running a business not to necessarily make money through earnings, but rather to gain virtually all of the profits at the point when the property is sold. This is called the “build to flip” strategy.
THE PRINCIPLE
The build to flip strategy takes a different perspective on the question “who is my customer.” Instead of seeing the customer as being the person who pays you for your goods or services, this strategic alternative sees the customer as the person you eventually sell the business to. Taking the adage “please the customer” to heart, the build to flip companies run their business more to make an eventual buyer of the firm happy rather than to make the business operation’s customers happy.
For example, during the dot com bubble of the 1990s, many start-ups had as their strategy the goal of eventually selling the business to Cisco Systems. Cisco had a policy that they would only buy firms located in one of three areas—Silicon Valley, Austin Texas, or the Research Triangle in North Carolina. The reason was that it was too difficult to manage the Cisco empire if all the subsidiaries were scattered all over the place.
Start-up companies knew this policy, so if their goal was to eventually be bought out by Cisco, they knew that they had to locate the business in one of these three areas, even if it was inconvenient to them or to their operating customers. After all, they saw Cisco as their ultimate customer, and if that is what Cisco wanted, then that is what they did.
I personally saw this principle in action when I was in the grocery business. A number of independent grocers, when they got near retirement age, wanted to sell their businesses. These grocers knew how the large supermarket chains thought when considering the purchase of an independent grocer. Large grocery chains believed that it was easier to take a store with high volumes and leverage the volume into higher profitability than it was to take a low volume store and increase its volume. In fact, these chains would prefer to purchase a high volume store that lost money over a low volume store with modest profits, because they believed the high volume store had more upside potential.
Knowing this, the independent grocer thinking of retiring would for a year or two abandon the idea of making a profit and focus all of the strategic effort on doing whatever it took to increase sales volume. They would do this even if the tactic made little economic sense in the long run or even if the tactic was unsustainable in the long run. After all, the eventual buyer of the business wanted to buy sales volume and typically set its purchase price on a multiple of sales. So to give the “customer” what they wanted, the independent grocer would raise the sales volume, regardless of the consequences.
Once the sales volume from these tactics started to peak, the independent grocer would sell the company to the supermarket chain. This strategy would make the independent grocer wealthier than if they had run the business as normal prior to the sale. So as you can see, the idea of getting a good return when losing money is not just a principle for sports franchises.
Even on a smaller level, I have seen this policy used in the real estate business. It is not uncommon for someone to own property on the far outskirts of a city. The owner of the property knows that if they wait a few years, the city will grow out to where his land is. At that time, it will become very profitable to sell the land to a developer. To sell now would bring a lesser return. So what do you do with the property in the mean time, while waiting for the city to grow in this direction?
Well, you don’t want to put a lot of capital into the land, because you are going to only hold it a short time. Since you do not know how the eventual new owner will want to use the property, you don’t want to use the property in such a way that would limit the flexibility of the new owner to do what they want. So what do many of them do?
They put a miniature golf course on the property. The cost to do so is very low, and it leaves a lot of flexibility for the next owner, since a miniature golf course can be easily removed, leaving the land ready for just about any use. The golf course does not have to make a lot of money. Even if it helps cover just a portion of the interest on the real estate, it is beneficial. After all, the goal is to make most of the return on the sale of the land, not the operation of the miniature golf course.
If you are trying to sell a company, there are many decisions that you might make differently if you look at a potential buyer of the firm as the true customer. For example, if you know that potential buyers of the company prefer to operate on particular computer platforms, you may want to run your business on that platform as well, even if it is not your personal preference.
Instead of spending a lot of time making calls on operating business prospects, you may want to divert more energy to speaking at seminars or in getting articles published in places where potential buyers of the company will get exposed to you in a favorable light. The idea is to make it a priority to think about ways to make your company appear more valuable to a potential buyer of the company.
There is something to be learned from running your business as if it were a sports franchise.
SUMMARY
There is more than one way to get a good return on your investment. One way is to focus on getting nearly all of your return at the point in which you sell the company (the build to flip strategy). This tends to be the way that sports franchises have worked for decades and it appears to be an increasingly viable strategy outside the sports world. This is especially true given all of the hedge fund money out there looking for companies to buy. In this strategy, the idea is to look at the eventual buyer of the firm as your true customer and to make decisions based on how it would please this eventual buyer.
FINAL THOUGHTS
If it is true that the majority of the profits of a business strategy could come at the point at which the company is sold, then it must also be true that a lot of the value in the acquiring company could be destroyed if it purchases companies unwisely. Making most of your value by purchasing properly (rather than selling properly) is another way to build a strategy.
Back in 2001, Howard Schultz and 57 partners bought the Seattle Sonics professional basketball franchise for $200 million. During the time that Howard Schultz owned the Seattle Sonics, the team suffered annual losses. It is claimed that while Schultz owned the team, the combined operating losses were $60 million.
Yet, in spite of being a business that showed no signs of making a profit, Schultz and his partners sold the Seattle Sonic team in 2006 for $350 million. That is $150 million more than what they paid for the team and $90 more than they paid if you subtract the annual losses. In fact, they supposedly turned down an offer of $425 million (more than twice what they paid for the team) from Larry Ellison, CEO of Oracle, because he wanted to move the team away from Seattle.
This is not a fluke price. In 2004, the New Jersey Nets basketball franchise sold for $300 million and the Cleveland Cavaliers basketball team (and its arena) were sold in 2005 for $375 million.
Willamette Management Associates is an expert in the area of sports franchise valuation. One of their representatives says that it is very difficult to use income flows as a means of evaluating sports franchises. To quote a 2002 paper they wrote on the topic,
“The discounted cash flow method is often used in the valuation of sports franchise intangible assets. However, it may be difficult to use this method in the valuation of the sports business enterprise. This is because many sports franchises either earn negative income or do not generate sufficient income to support the prices paid in actual team sales.”
So it appears that even though the business itself can be a perpetual money loser, in the world of sports franchises that does not mean it is a bad investment. According to the Seattle Times, the annual rate of return on the investment of Howard Schultz and his partners, when you consider the selling price and other factors, was probably around 10.6%. That’s a pretty good return for investing in something that loses money.
THE ANALOGY
At the end of the day, the basic goal of capitalism is to find good returns on investment. As the story above illustrates, it is possible to get very good returns on investment on businesses that provide little to no profitability on an annual basis. The return on investment for the Seattle Sonics did not come from the operating earnings, but rather from the selling price.
Now you may be thinking that such opportunities occur only in the world of sports. However, recent trends seem to be indicating that this trend is creeping ever more into the rest of the business world. Just look at some of the prices that hedge funds have been paying recently for businesses that are not very prosperous. Even businesses that lose money are being snapped up at relatively high prices by these hedge funds.
When devising business strategies, there appears to be a strategic option to consider running a business not to necessarily make money through earnings, but rather to gain virtually all of the profits at the point when the property is sold. This is called the “build to flip” strategy.
THE PRINCIPLE
The build to flip strategy takes a different perspective on the question “who is my customer.” Instead of seeing the customer as being the person who pays you for your goods or services, this strategic alternative sees the customer as the person you eventually sell the business to. Taking the adage “please the customer” to heart, the build to flip companies run their business more to make an eventual buyer of the firm happy rather than to make the business operation’s customers happy.
For example, during the dot com bubble of the 1990s, many start-ups had as their strategy the goal of eventually selling the business to Cisco Systems. Cisco had a policy that they would only buy firms located in one of three areas—Silicon Valley, Austin Texas, or the Research Triangle in North Carolina. The reason was that it was too difficult to manage the Cisco empire if all the subsidiaries were scattered all over the place.
Start-up companies knew this policy, so if their goal was to eventually be bought out by Cisco, they knew that they had to locate the business in one of these three areas, even if it was inconvenient to them or to their operating customers. After all, they saw Cisco as their ultimate customer, and if that is what Cisco wanted, then that is what they did.
I personally saw this principle in action when I was in the grocery business. A number of independent grocers, when they got near retirement age, wanted to sell their businesses. These grocers knew how the large supermarket chains thought when considering the purchase of an independent grocer. Large grocery chains believed that it was easier to take a store with high volumes and leverage the volume into higher profitability than it was to take a low volume store and increase its volume. In fact, these chains would prefer to purchase a high volume store that lost money over a low volume store with modest profits, because they believed the high volume store had more upside potential.
Knowing this, the independent grocer thinking of retiring would for a year or two abandon the idea of making a profit and focus all of the strategic effort on doing whatever it took to increase sales volume. They would do this even if the tactic made little economic sense in the long run or even if the tactic was unsustainable in the long run. After all, the eventual buyer of the business wanted to buy sales volume and typically set its purchase price on a multiple of sales. So to give the “customer” what they wanted, the independent grocer would raise the sales volume, regardless of the consequences.
Once the sales volume from these tactics started to peak, the independent grocer would sell the company to the supermarket chain. This strategy would make the independent grocer wealthier than if they had run the business as normal prior to the sale. So as you can see, the idea of getting a good return when losing money is not just a principle for sports franchises.
Even on a smaller level, I have seen this policy used in the real estate business. It is not uncommon for someone to own property on the far outskirts of a city. The owner of the property knows that if they wait a few years, the city will grow out to where his land is. At that time, it will become very profitable to sell the land to a developer. To sell now would bring a lesser return. So what do you do with the property in the mean time, while waiting for the city to grow in this direction?
Well, you don’t want to put a lot of capital into the land, because you are going to only hold it a short time. Since you do not know how the eventual new owner will want to use the property, you don’t want to use the property in such a way that would limit the flexibility of the new owner to do what they want. So what do many of them do?
They put a miniature golf course on the property. The cost to do so is very low, and it leaves a lot of flexibility for the next owner, since a miniature golf course can be easily removed, leaving the land ready for just about any use. The golf course does not have to make a lot of money. Even if it helps cover just a portion of the interest on the real estate, it is beneficial. After all, the goal is to make most of the return on the sale of the land, not the operation of the miniature golf course.
If you are trying to sell a company, there are many decisions that you might make differently if you look at a potential buyer of the firm as the true customer. For example, if you know that potential buyers of the company prefer to operate on particular computer platforms, you may want to run your business on that platform as well, even if it is not your personal preference.
Instead of spending a lot of time making calls on operating business prospects, you may want to divert more energy to speaking at seminars or in getting articles published in places where potential buyers of the company will get exposed to you in a favorable light. The idea is to make it a priority to think about ways to make your company appear more valuable to a potential buyer of the company.
There is something to be learned from running your business as if it were a sports franchise.
SUMMARY
There is more than one way to get a good return on your investment. One way is to focus on getting nearly all of your return at the point in which you sell the company (the build to flip strategy). This tends to be the way that sports franchises have worked for decades and it appears to be an increasingly viable strategy outside the sports world. This is especially true given all of the hedge fund money out there looking for companies to buy. In this strategy, the idea is to look at the eventual buyer of the firm as your true customer and to make decisions based on how it would please this eventual buyer.
FINAL THOUGHTS
If it is true that the majority of the profits of a business strategy could come at the point at which the company is sold, then it must also be true that a lot of the value in the acquiring company could be destroyed if it purchases companies unwisely. Making most of your value by purchasing properly (rather than selling properly) is another way to build a strategy.
Sunday, February 18, 2007
Who is My Customer
THE STORY
Pity the poor woman who just took a marketing management job at a medical device company. She had never worked in the industry before. She was given the project of working with their latest product—a device that used an entirely new way to cure a disease. After a meeting to demonstrate the device to her, the closing words of her boss to her was “Now go out and market this thing.”
At first, she walked away from the meeting rather confident, since she had been in marketing for some time. But then she started the think, “Go out and market this to whom? Who is my customer?”
Her first thought was that the customer is the patient using the device. Therefore, her marketing should focus on how painless and how quickly the device works.
Then she thought that perhaps the customer is the doctor who prescribes the procedure. If the doctor doesn’t want to prescribe it, then in many ways it really doesn’t matter what the customer wants. If the doctor is the primary customer, then the marketing focus would have to also address issues such as whether insurance companies will readily pay for the procedure and whether it increases the risk of malpractice.
Most of these devices will end up in hospitals, so maybe the focus should be on hospital procurement executives. They will want a marketing presentation that looks at the financial cash flows and revenue streams.
Then she considered whether the insurance company is the primary customer. After all, they are the ones paying the money once the device is used. If they don’t want to pay, the device won’t get used. If they are the primary customer, then the key marketing issue must focus on cost effectiveness relative to other treatment options.
And what about the government? They get to approve the diseases for which this device can be used as treatment. They impact how Medicare will treat this device. There are powerful political lobbies from the companies who sell the products currently used to treat this disease who will use the government to help protect their status quo. Therefore, perhaps the marketing needs to focus on lobbying.
At this point, the marketing executive was very confused and wondering if she could still get her old job back.
THE ANALOGY
There are many different types of decisions that go into getting a product sold. As we saw in the story above, the decision-makers who affected sales of the device included:
· Product Users (Patient)
· Product Prescribers/Advisors (Doctors)
· Product Investors/Determine Access (Hospitals)
· Product Usage Payers (Insurance Companies)
· Product Regulators/Inluencers (Government)
For some products, those decisions are made by a small handful of people who are in charge of multiple roles. Sometimes, as in the story above, there are a great number of constituents who all play separate roles in the decision-making.
This complexity provides opportunities to create strategic advantage via the types of strategic approaches one takes to these various constituents or the type of decisions you want constituents to make.
THE PRINCIPLE
There are two basic ways to gain strategic advantage in the complexities associated with how a product is purchased:
1) Focus on a different aspect of the complexity than the competition; or
2) Redefine the roles of the players in the decision-making process.
Allow me to give a simple example of how this works. Let’s say you sell children’s breakfast cereal. The child is the user and an influencer in the purchase, but the parent is the advisor/prescriber and the person who pays for it. Principle #1—focus on a different aspect of the complexity—would work something like this: If all of the competition is focusing their efforts on getting the child to demand the product from the parent, perhaps you can create a strategic advantage by focusing on getting the parent to override the child’s demands and buy the product for reasons that please the parent, such as nutrition. A third approach could be that instead of spending most of the marketing money on the child or the parent, the money is spent on buying better shelf space and pricing promotions with the supermarket company (who influence access and pricing).
The second principle—redefine the roles—could work something like this: You repackage the cereal into individual snack sizes and put them into vending machines where the children hang out. Now, the parent is no longer defined as the purchaser, but the child is, who buys the snacks on his or her own out of the vending machine. The access is no longer defined as the store, but as a machine.
You can also see this taking place in the world of broadcast entertainment. Looking at principle #1, you can focus on either trying to get content pleasing to the audience (the users) or content pleasing to the advertisers (the payers). In many cases, the same strategic move can please both: if you draw a large audience (such as the Superbowl) you can have many willing to pay large sums for the right to advertise.
This, however, is not always the case. Sometimes one can draw a large audience with controversy, and many advertisers do not want to be connected with controversy. Take, for example, Fox television’s attempt in November to broadcast the OJ Simpson story “If I did it, Here’s How it Happened.” No matter how popular, no advertiser wanted to be associated with the story, so the network did not air it.
Other times, advertisers can demand that they not only get advertising via commercials, but product placements into the show’s content. Take, for example, the ever-present coke beverages located by the judges of American Idol. This is all about pleasing the advertising customer rather than the viewing customer. So depending on which customer you want to focus on, one can come up with different strategic approaches for the types of entertainment one broadcasts.
Looking at principle #2, broadcast entertainers can also redefine the roles. For example, many entertainment programs now ask the audience to vote with their cell phone. This is a huge money-making opportunity, which now makes the viewer also a payer. A new trend is to make the audience also the creator of some of the content, such as with YouTube, or some of the commercials on Superbowl XLI. In the case of controversy, if the audience demand is large enough, one can use pay-per-view to get the audience to pay for things that advertisers shy away from.
In the new digital economy, business models are starting to look more like the broadcast entertainment model, where users get content for free and advertisers pay for space on the screen. But again, there may be opportunities for a strategic advantage based on how one focuses on the complexities of the business model. One can take limited resources and focus on getting the absolute best content or one can take limited resources and focus on building the most efficient online advertising model. One can redefine roles and get the users to pay for the content. And I’m sure that there will be many new models to evolve that we haven’t seen yet.
In retailing, some firms are redefining their role from being influencers and access points to becoming the manufacturer of the products they sell. Similarly, manufacturers are starting to go direct to the user with their own stores. In other words, instead of focusing on the store as their customer, the manufacturer is going direct to the user as their customer.
The beauty is that because there is no one single best way to go to market, there are opportunities to gain an advantage by taking a new strategic approach. The problem is that if you do not think more open-mindedly about different ways to define customers and the other stakeholders, you will always be left behind and copying others.
SUMMARY
Answering the question “Who is my customer?” is not as obvious as it first appears. Often, there are many stakeholders involved in completing a purchase, including users, influencers, access points, payers, regulators, etc. In a sense, they are all your customer. Yet given one’s constraints of money and time, one cannot always give high attention to all of them. By thinking outside the conventional box, one can redesign the business model amongst these players, either by:
1) Altering who gets focused on (i.e, who becomes the primary customer)
2) Altering the roles played by the various stakeholders, which might even lead to adding new players or eliminating some of the former players from the decision-making process.
How you manage these decisions can have a major influence on how you design your business model and how you design your marketing program.
FINAL THOUGHTS
Another stakeholder or constituent whom we did not address is the firm that you may eventually intend to sell your company to. That’s the big cash buyer. A little focus on them as your customer could go a long way to getting the deal to happen. But this topic will be covered in more depth in another blog.
Pity the poor woman who just took a marketing management job at a medical device company. She had never worked in the industry before. She was given the project of working with their latest product—a device that used an entirely new way to cure a disease. After a meeting to demonstrate the device to her, the closing words of her boss to her was “Now go out and market this thing.”
At first, she walked away from the meeting rather confident, since she had been in marketing for some time. But then she started the think, “Go out and market this to whom? Who is my customer?”
Her first thought was that the customer is the patient using the device. Therefore, her marketing should focus on how painless and how quickly the device works.
Then she thought that perhaps the customer is the doctor who prescribes the procedure. If the doctor doesn’t want to prescribe it, then in many ways it really doesn’t matter what the customer wants. If the doctor is the primary customer, then the marketing focus would have to also address issues such as whether insurance companies will readily pay for the procedure and whether it increases the risk of malpractice.
Most of these devices will end up in hospitals, so maybe the focus should be on hospital procurement executives. They will want a marketing presentation that looks at the financial cash flows and revenue streams.
Then she considered whether the insurance company is the primary customer. After all, they are the ones paying the money once the device is used. If they don’t want to pay, the device won’t get used. If they are the primary customer, then the key marketing issue must focus on cost effectiveness relative to other treatment options.
And what about the government? They get to approve the diseases for which this device can be used as treatment. They impact how Medicare will treat this device. There are powerful political lobbies from the companies who sell the products currently used to treat this disease who will use the government to help protect their status quo. Therefore, perhaps the marketing needs to focus on lobbying.
At this point, the marketing executive was very confused and wondering if she could still get her old job back.
THE ANALOGY
There are many different types of decisions that go into getting a product sold. As we saw in the story above, the decision-makers who affected sales of the device included:
· Product Users (Patient)
· Product Prescribers/Advisors (Doctors)
· Product Investors/Determine Access (Hospitals)
· Product Usage Payers (Insurance Companies)
· Product Regulators/Inluencers (Government)
For some products, those decisions are made by a small handful of people who are in charge of multiple roles. Sometimes, as in the story above, there are a great number of constituents who all play separate roles in the decision-making.
This complexity provides opportunities to create strategic advantage via the types of strategic approaches one takes to these various constituents or the type of decisions you want constituents to make.
THE PRINCIPLE
There are two basic ways to gain strategic advantage in the complexities associated with how a product is purchased:
1) Focus on a different aspect of the complexity than the competition; or
2) Redefine the roles of the players in the decision-making process.
Allow me to give a simple example of how this works. Let’s say you sell children’s breakfast cereal. The child is the user and an influencer in the purchase, but the parent is the advisor/prescriber and the person who pays for it. Principle #1—focus on a different aspect of the complexity—would work something like this: If all of the competition is focusing their efforts on getting the child to demand the product from the parent, perhaps you can create a strategic advantage by focusing on getting the parent to override the child’s demands and buy the product for reasons that please the parent, such as nutrition. A third approach could be that instead of spending most of the marketing money on the child or the parent, the money is spent on buying better shelf space and pricing promotions with the supermarket company (who influence access and pricing).
The second principle—redefine the roles—could work something like this: You repackage the cereal into individual snack sizes and put them into vending machines where the children hang out. Now, the parent is no longer defined as the purchaser, but the child is, who buys the snacks on his or her own out of the vending machine. The access is no longer defined as the store, but as a machine.
You can also see this taking place in the world of broadcast entertainment. Looking at principle #1, you can focus on either trying to get content pleasing to the audience (the users) or content pleasing to the advertisers (the payers). In many cases, the same strategic move can please both: if you draw a large audience (such as the Superbowl) you can have many willing to pay large sums for the right to advertise.
This, however, is not always the case. Sometimes one can draw a large audience with controversy, and many advertisers do not want to be connected with controversy. Take, for example, Fox television’s attempt in November to broadcast the OJ Simpson story “If I did it, Here’s How it Happened.” No matter how popular, no advertiser wanted to be associated with the story, so the network did not air it.
Other times, advertisers can demand that they not only get advertising via commercials, but product placements into the show’s content. Take, for example, the ever-present coke beverages located by the judges of American Idol. This is all about pleasing the advertising customer rather than the viewing customer. So depending on which customer you want to focus on, one can come up with different strategic approaches for the types of entertainment one broadcasts.
Looking at principle #2, broadcast entertainers can also redefine the roles. For example, many entertainment programs now ask the audience to vote with their cell phone. This is a huge money-making opportunity, which now makes the viewer also a payer. A new trend is to make the audience also the creator of some of the content, such as with YouTube, or some of the commercials on Superbowl XLI. In the case of controversy, if the audience demand is large enough, one can use pay-per-view to get the audience to pay for things that advertisers shy away from.
In the new digital economy, business models are starting to look more like the broadcast entertainment model, where users get content for free and advertisers pay for space on the screen. But again, there may be opportunities for a strategic advantage based on how one focuses on the complexities of the business model. One can take limited resources and focus on getting the absolute best content or one can take limited resources and focus on building the most efficient online advertising model. One can redefine roles and get the users to pay for the content. And I’m sure that there will be many new models to evolve that we haven’t seen yet.
In retailing, some firms are redefining their role from being influencers and access points to becoming the manufacturer of the products they sell. Similarly, manufacturers are starting to go direct to the user with their own stores. In other words, instead of focusing on the store as their customer, the manufacturer is going direct to the user as their customer.
The beauty is that because there is no one single best way to go to market, there are opportunities to gain an advantage by taking a new strategic approach. The problem is that if you do not think more open-mindedly about different ways to define customers and the other stakeholders, you will always be left behind and copying others.
SUMMARY
Answering the question “Who is my customer?” is not as obvious as it first appears. Often, there are many stakeholders involved in completing a purchase, including users, influencers, access points, payers, regulators, etc. In a sense, they are all your customer. Yet given one’s constraints of money and time, one cannot always give high attention to all of them. By thinking outside the conventional box, one can redesign the business model amongst these players, either by:
1) Altering who gets focused on (i.e, who becomes the primary customer)
2) Altering the roles played by the various stakeholders, which might even lead to adding new players or eliminating some of the former players from the decision-making process.
How you manage these decisions can have a major influence on how you design your business model and how you design your marketing program.
FINAL THOUGHTS
Another stakeholder or constituent whom we did not address is the firm that you may eventually intend to sell your company to. That’s the big cash buyer. A little focus on them as your customer could go a long way to getting the deal to happen. But this topic will be covered in more depth in another blog.
Friday, February 16, 2007
If You Can Open the Door, So Can Others
The Story
There is a situation I have seen repeated over and over again in the business world, especially in the airlines industry. To protect the people who have fallen into this trap over the years, I will tell a generic version of the story.
Bob sees himself as an entrepreneur skilled at finding opportunities in relatively mature businesses, by getting aggressive and shaking up the status quo. Bob looks at the airline industry and says to himself, “Here is an industry I can shake up in my favor.”
Bob leases some airplanes and starts his bold plan. He notices that some routes are more profitable for the established airlines than others—routes where airlines charge abnormally higher than average fees. Bob puts his planes on these routes and charges ticket prices significantly below the established airlines. This plan gives Bob two strategic benefits:
1. Consumer Benefit: He is making a low price statement to the consumers on the routes where he can get the largest price savings impact with the least impact to his bottom line.
2. Competitive Benefit: He is disproportionately taking away the routes with the greatest source of income from the established airlines, making it hardest for them to finance a retaliation.
Sure, Bob will lose large sums of money at first with his plan. In the long run, though, Bob is confident that he will knock some of the weaker airlines out of business and have the market restabilize with his company having a meaningful market share. At that point, Bob will be able to raise prices and start reaping a respectable return on his investment. Bob thinks he’s a strategic genius.
For awhile, Bob’s plan works very well. He disrupts the status quo and gains market share. Bob continues to add routes and gain public favor with his “too good to be true” low prices. Weaker airlines are in retreat. The losses pile up at Bob’s company, but Bob assures himself that a new stability is just around the corner. Soon, he will have achieved his desired market strength, allowing him the power to raise fares to a profitable level.
Just as Bob predicted, that time of new stability arises. Weaker players have left the industry. Bob’s market share is strong. Bob raises his prices. Then he puts his feet up on his desk, relaxes, and says, “My job is done. I have won the game.”
What Bob doesn’t know is that on the other side of town there is an entrepreneur named Jane who also likes to make money by shaking up established industries. At about the same time Bob is putting his feet up on the desk, Jane is looking at the newly stabilized airlines industry and says, “Here is an industry I can shake up in my favor.”
Jane utilizes a strategy similar to Bob’s and upsets the pricing stability with her “too good to be true” low prices. Bob has to respond by putting his prices back to the old unprofitable levels. Eventually Bob goes out of business and Jane survives. Then Jane takes advantage of the new restabilization of the industry by raising her prices.
At about this time, Lee is looking at the airlines industry, saying, “Here is an industry I can shake up in my favor.” And the cycle repeats itself yet again.
The Analogy
Strategies are based on assumptions. If you choose the wrong assumptions, your strategy will likely fail. There is a failed assumption I like to call “The Last One Through the Door” assumption. This assumption rarely leads to long-term strategic success. With “The Last One Through the Door” assumption, businesses assume that they can enter an industry, buy market share by offering prices or features below cost, and then get their profits later when the market restabilizes and they can raise prices.
The problem with this approach is that it only works if nobody comes behind you and destabilizes all over again. In other words, for this strategy to succeed, the path you took to enter the industry must be a door that you can lock behind you, so that nobody else can enter in the same way you did. You have to be “the last one through the door.”
Unfortunately, if you are able to find a way to open the door, others will often find a way to open that door as well. This is what happened to Bob, whose strategy failed because he could not keep Jane from later entering through the same door that Bob used. Jane fell to the same fate when Lee opened the door behind her.
Bob made a terrible error in his strategic planning. His plan’s success was based on his ability to achieve long-term stability in the airlines industry, long enough to recoup his early losses and provide a respectable return on his investments. This was a bad assumption, because it was based on the false assumption that he would be the last one through the door.
Bob may not have even realized that his strategy depended on being able to lock the door behind him. He probably thought that once he restabilized the market, the war was over. Bob believed that he was the final victor and his enemies were vanquished. If indeed the war is over, there is no need to look back at the door behind you.
However, in business, the war is never entirely over. You may win battles, like Bob did, but new battles are always on the horizon. New enemies crop up where you least expect them. The peace of market stability may never be achieved. All because Bob couldn’t lock the door behind himself.
The Principle
The first rule of strategy, according to Harvard Professor Michael Porter, is to make sure you are competing in an industry that has profits. Some industries are inherently less profitable than others. In some industries, none of the companies make an acceptable return on investment. What good is it to build a strategy to win in an industry where even the winners cannot make a good return on their investment?
What makes an entire industry relatively unprofitable? Usually, it is a result of low barriers to entry. In other words, it is easy for new players to enter the industry. If new players can continually enter an industry, then it will be under constant churn and never achieve the kind of stability required for profitability. These are typically industries to avoid.
For example, the trucking industry is a relatively unprofitable industry. This is because it is easy for an independent to lease a few trucks and start upsetting the industry. By comparison, look at how profitable Microsoft is. That is because there are high barriers to creating a new operating system for PCs that could successfully compete against Microsoft. The best strategies are those where you can get into an industry early, like Microsoft, and then be able to lock the door behind you with high barriers to entry.
Therefore, when building your strategy, keep the following principals in mind:
1. Never forget the fact that if it is relatively easy for you to enter an industry, then it is probably relatively easy for others to enter that same industry. This could be an indication that the industry may never stabilize at a level of adequate profitability. It is usually better to find an industry where it is difficult for you to enter and impossible for others to enter, than to find an industry that is easy for you and anyone else to enter.
2. Once you enter an industry, try to find ways to lock the door behind you. Look for ways to redefine the industry so that others can no longer take the path you did. Find ways to increase the barriers to entry.
3. Don’t ever assume that permanent stability can be reached in an industry. There is always enough change in the external environment to eventually make it possible for another company to find a new way to disrupt it, either through new technology, new processes, or by taking advantage of changes in customer needs and desires. Even if you can effectively lock the door that got you in, others may find new doors to get in. There is never a time when you can say “the war is over,” put your feet up on the desk, and stop having to compete.
4. If temporary advantages are what made you initially successful, don’t assume that you will continue to be as successful once those temporary advantages disappear. When customer loyalty is tied to a tactic your company cannot sustain, like unusually low introductory prices that are below cost, don’t expect your customers to automatically remain loyal to you when that tactic is abandoned. If they are only loyal because of your ridiculously low prices, they may leave when you raise them to more normal levels. Make sure you are providing enough consumer benefits so that once the temporary tactics are lifted, you are still providing a superior value in some form.
Summary
The first rule in strategy is to make sure the industries you participate in make money. Otherwise, winning may lead to an unprofitable prize. Industry profits are usually linked to high barriers to entry. If the barriers to entry are too low, there will be constant competitive churning and instability, which typically leads to unprofitable price wars. Therefore, when building a strategy based upon entering a new industry, keep the following principles in mind:
There is a situation I have seen repeated over and over again in the business world, especially in the airlines industry. To protect the people who have fallen into this trap over the years, I will tell a generic version of the story.
Bob sees himself as an entrepreneur skilled at finding opportunities in relatively mature businesses, by getting aggressive and shaking up the status quo. Bob looks at the airline industry and says to himself, “Here is an industry I can shake up in my favor.”
Bob leases some airplanes and starts his bold plan. He notices that some routes are more profitable for the established airlines than others—routes where airlines charge abnormally higher than average fees. Bob puts his planes on these routes and charges ticket prices significantly below the established airlines. This plan gives Bob two strategic benefits:
1. Consumer Benefit: He is making a low price statement to the consumers on the routes where he can get the largest price savings impact with the least impact to his bottom line.
2. Competitive Benefit: He is disproportionately taking away the routes with the greatest source of income from the established airlines, making it hardest for them to finance a retaliation.
Sure, Bob will lose large sums of money at first with his plan. In the long run, though, Bob is confident that he will knock some of the weaker airlines out of business and have the market restabilize with his company having a meaningful market share. At that point, Bob will be able to raise prices and start reaping a respectable return on his investment. Bob thinks he’s a strategic genius.
For awhile, Bob’s plan works very well. He disrupts the status quo and gains market share. Bob continues to add routes and gain public favor with his “too good to be true” low prices. Weaker airlines are in retreat. The losses pile up at Bob’s company, but Bob assures himself that a new stability is just around the corner. Soon, he will have achieved his desired market strength, allowing him the power to raise fares to a profitable level.
Just as Bob predicted, that time of new stability arises. Weaker players have left the industry. Bob’s market share is strong. Bob raises his prices. Then he puts his feet up on his desk, relaxes, and says, “My job is done. I have won the game.”
What Bob doesn’t know is that on the other side of town there is an entrepreneur named Jane who also likes to make money by shaking up established industries. At about the same time Bob is putting his feet up on the desk, Jane is looking at the newly stabilized airlines industry and says, “Here is an industry I can shake up in my favor.”
Jane utilizes a strategy similar to Bob’s and upsets the pricing stability with her “too good to be true” low prices. Bob has to respond by putting his prices back to the old unprofitable levels. Eventually Bob goes out of business and Jane survives. Then Jane takes advantage of the new restabilization of the industry by raising her prices.
At about this time, Lee is looking at the airlines industry, saying, “Here is an industry I can shake up in my favor.” And the cycle repeats itself yet again.
The Analogy
Strategies are based on assumptions. If you choose the wrong assumptions, your strategy will likely fail. There is a failed assumption I like to call “The Last One Through the Door” assumption. This assumption rarely leads to long-term strategic success. With “The Last One Through the Door” assumption, businesses assume that they can enter an industry, buy market share by offering prices or features below cost, and then get their profits later when the market restabilizes and they can raise prices.
The problem with this approach is that it only works if nobody comes behind you and destabilizes all over again. In other words, for this strategy to succeed, the path you took to enter the industry must be a door that you can lock behind you, so that nobody else can enter in the same way you did. You have to be “the last one through the door.”
Unfortunately, if you are able to find a way to open the door, others will often find a way to open that door as well. This is what happened to Bob, whose strategy failed because he could not keep Jane from later entering through the same door that Bob used. Jane fell to the same fate when Lee opened the door behind her.
Bob made a terrible error in his strategic planning. His plan’s success was based on his ability to achieve long-term stability in the airlines industry, long enough to recoup his early losses and provide a respectable return on his investments. This was a bad assumption, because it was based on the false assumption that he would be the last one through the door.
Bob may not have even realized that his strategy depended on being able to lock the door behind him. He probably thought that once he restabilized the market, the war was over. Bob believed that he was the final victor and his enemies were vanquished. If indeed the war is over, there is no need to look back at the door behind you.
However, in business, the war is never entirely over. You may win battles, like Bob did, but new battles are always on the horizon. New enemies crop up where you least expect them. The peace of market stability may never be achieved. All because Bob couldn’t lock the door behind himself.
The Principle
The first rule of strategy, according to Harvard Professor Michael Porter, is to make sure you are competing in an industry that has profits. Some industries are inherently less profitable than others. In some industries, none of the companies make an acceptable return on investment. What good is it to build a strategy to win in an industry where even the winners cannot make a good return on their investment?
What makes an entire industry relatively unprofitable? Usually, it is a result of low barriers to entry. In other words, it is easy for new players to enter the industry. If new players can continually enter an industry, then it will be under constant churn and never achieve the kind of stability required for profitability. These are typically industries to avoid.
For example, the trucking industry is a relatively unprofitable industry. This is because it is easy for an independent to lease a few trucks and start upsetting the industry. By comparison, look at how profitable Microsoft is. That is because there are high barriers to creating a new operating system for PCs that could successfully compete against Microsoft. The best strategies are those where you can get into an industry early, like Microsoft, and then be able to lock the door behind you with high barriers to entry.
Therefore, when building your strategy, keep the following principals in mind:
1. Never forget the fact that if it is relatively easy for you to enter an industry, then it is probably relatively easy for others to enter that same industry. This could be an indication that the industry may never stabilize at a level of adequate profitability. It is usually better to find an industry where it is difficult for you to enter and impossible for others to enter, than to find an industry that is easy for you and anyone else to enter.
2. Once you enter an industry, try to find ways to lock the door behind you. Look for ways to redefine the industry so that others can no longer take the path you did. Find ways to increase the barriers to entry.
3. Don’t ever assume that permanent stability can be reached in an industry. There is always enough change in the external environment to eventually make it possible for another company to find a new way to disrupt it, either through new technology, new processes, or by taking advantage of changes in customer needs and desires. Even if you can effectively lock the door that got you in, others may find new doors to get in. There is never a time when you can say “the war is over,” put your feet up on the desk, and stop having to compete.
4. If temporary advantages are what made you initially successful, don’t assume that you will continue to be as successful once those temporary advantages disappear. When customer loyalty is tied to a tactic your company cannot sustain, like unusually low introductory prices that are below cost, don’t expect your customers to automatically remain loyal to you when that tactic is abandoned. If they are only loyal because of your ridiculously low prices, they may leave when you raise them to more normal levels. Make sure you are providing enough consumer benefits so that once the temporary tactics are lifted, you are still providing a superior value in some form.
Summary
The first rule in strategy is to make sure the industries you participate in make money. Otherwise, winning may lead to an unprofitable prize. Industry profits are usually linked to high barriers to entry. If the barriers to entry are too low, there will be constant competitive churning and instability, which typically leads to unprofitable price wars. Therefore, when building a strategy based upon entering a new industry, keep the following principles in mind:
- Never forget the fact that if it is relatively easy for you to enter an industry, then it is probably relatively easy for others to enter that same industry and create instability.
- Once you enter an industry, try to find ways to lock the door behind you.
- Don’t ever assume that permanent stability can be reached in an industry.
- If temporary advantages are what made you initially successful in entering an industry, don’t assume that you will continue to be as successful once those temporary advantages disappear.
Final Thoughts
In your quest for growth, you may find yourself looking for ways to enter new industries. Keep in mind that while you are doing that, other firms looking for growth may be trying to find ways to enter your industry. While you are keeping one eye looking out to find new doors to enter, keep your other eye looking in to make sure your doors are locked.
Thursday, February 15, 2007
Going in Circles
THE STORY
There once was an important executive at an amusement park. He needed to get an urgent message to someone at the other end of the park, so he gave the letter to one of his subordinates and said, “Quick, get on this horse and hand deliver the message to the man at the other end of the amusement park.”
So the man got on the horse that the man pointed to, just as he was ordered to do. Unfortunately, this was a wooden horse on the park’s merry-go-round. The merry-go-round went around in circles a couple of times and dropped of the subordinate at the same location as where he started. This made the important executive furious. He yelled, “What’s the matter with you? I thought I told you to deliver this letter to the other end of the park. Give me back the letter.”
So then the executive gave the letter to another one of his subordinates and gave her the same message—get on a particular horse and hand deliver the message to the man at the other end of the amusement park. So the second subordinate got on the merry-go-round horse, went around in circles a couple of times and she ended up where she started, still holding the letter.
Again, the executive was furious, so he gave the letter to a third associate and gave him the same message. He got on the merry-go-round and had the same result. This lead the executive to give the same orders to a succession of other subordinates—all leading to the same disappointing result.
Finally, a thought occurred to the executive as to why he was having so many problems delivering the letter. “I finally know what’s wrong,” said the executive. “The problem is that nobody knows how to ride horses any more.”
THE ANALOGY
Over time, businesses will hit periods of difficulty. The old ways suddenly seem less effective. The business is no longer appears to be going anywhere, just like the merry-go-round horses don’t seem to be going anywhere. There is lots of activity, but no forward progress. All that activity just seems to make you go in unproductive circles, like the merry-go-round. Just as in the story, your difficulties prevent you from completing your business's mission.
In times of trouble, many executives resort to changing the person in charge of the mission. The thinking is that the reason the mission is failing is because the person in charge of the mission is incapable or unqualified for the task. Therefore, if you put someone new in charge, the problem will get fixed. This was the thought pattern of the man in the story. He kept thinking that if he could just put the right subordinate in charge of the mission, he or she would succeed.
Unfortunately, the problem was not the person in charge, but rather the business model chosen for the mission. No matter who was put in charge, no one was going to get to the other side of the park by using a merry-go-round horse. Rather than changing leaders, the executive should have been changing horses…finding a different kind of horse that is capable of getting to the other side of the park.
The same is true in business. Quite often the only path to success is not in changing leaders, but in changing the business model. That is where strategy comes in—to tell you when to change horses and which type of horse to change to. The sad part of the story was that the executive never caught on to this truth. He kept thinking that if he switched leaders long enough, he would eventually find one that could ride the merry-go-round horse to the other side of the park.
THE PRINCIPLE
The principle here revolves around degrees of control. Typically, the more control you have over your destiny, the more successful your future will be. Studies have shown that in most cases, strategic decisions impact your destiny than more than the person in currently in charge of the strategy. The leaders have less control of their destiny than most people think. They’re freedom to act is constrained by the strategy they inherit.
Years ago, I went to a retailing seminar where the professor said that the ultimate success of companies (and particularly retailers) can only be affected about 20 to 30% by the leader. The other 70 to 80% is determined by major strategic decisions made long ago. You can see this when you replace a bad store manager with a good store manager. Yes, the store will have better performance under the better store manager, but rarely will the results move by more than 20%. Earlier strategic decisions account for the rest of the performance:
If the brand reputation is terrible and your business model is uncompetitive, there is not much that a new leader can do in the near term to make a huge difference. He or she has inherited a wooden horse strategy that won’t make it to the other end of the park. Even a good manager can do only so much when given a mission based on an obsolete business model.
Often times you will see someone leave a successful company and go to lead a less successful company. The person frequently brings others from the more successful company to help him or her. Yet, despite their past success, they do not turn around the less successful company. The reason is because people alone are not enough. There is a reason why that company was less successful in the first place. Frequently, it is because it has an inferior strategy. Until the strategy is changed, there is only so much the new management can do. Making the merry-go-round go faster will not get you any closer to the other end of the park. Similarly, working harder at executing an obsolete or inferior strategy will not lead to great success.
Yes, sometimes current management has done such a poor job of executing a good strategy that new management can make a meaningful difference by just improving the execution. However, if you’ve changed the management two or three times and things are still looking bad, it may be time to concentrate on changing horses rather than changing riders.
February seems to be the time when you see a lot of changes in retail management. Financial results for the year are coming in, and if they are bad, there is often a change in management. Just yesterday I saw seven press releases announcing top level management changes at large retail companies.
The buzz in retail circles in recent months has been that the strategy of the Gap stores is so obsolete that it didn’t really matter who they chose to run the company. Some even speculated that the Gap would have a hard time finding qualified new executives, because no one would want it. In an article in the Wall Street Journal entitled “Gap Needs a CEO, and Many Qualify; Will Any Apply?” dated January 24th, 2007, it says:
“The job pays well and has plenty of perks. There's just one hitch: You have to be the next chief executive officer of Gap Inc. The successor to former Gap CEO Paul Pressler, who resigned Monday, must contend with unpopular products, falling sales and profits, anxious investors, problematic store leases, fleeing executives, and rivals gobbling market share. There's also an influential founding family that might balk at a restructuring the CEO might favor -- all or any of which might give a contender pause. No simple solutions are at hand.”
That sounds a bit like a wooden merry-go-round horse to me.
SUMMARY
New management can do only so much to change a troubled company if the trouble is due to having an obsolete or inferior strategy. Until the strategy is changed, the impact of having a succession of new management every year or two will do little to improve the circumstances. Management can only impact about 20-30% of performance. The rest comes from strategic decisions. Doesn’t it make sense to concentrate more on areas which impact 75% of performance than on areas that impact only 25% of performance?
FINAL THOUGHTS
There’s an old saying that the definition of an insane person is someone who keeps repeating the same bad behavior over and over again in hopes of getting a different result. Dare I say more?
There once was an important executive at an amusement park. He needed to get an urgent message to someone at the other end of the park, so he gave the letter to one of his subordinates and said, “Quick, get on this horse and hand deliver the message to the man at the other end of the amusement park.”
So the man got on the horse that the man pointed to, just as he was ordered to do. Unfortunately, this was a wooden horse on the park’s merry-go-round. The merry-go-round went around in circles a couple of times and dropped of the subordinate at the same location as where he started. This made the important executive furious. He yelled, “What’s the matter with you? I thought I told you to deliver this letter to the other end of the park. Give me back the letter.”
So then the executive gave the letter to another one of his subordinates and gave her the same message—get on a particular horse and hand deliver the message to the man at the other end of the amusement park. So the second subordinate got on the merry-go-round horse, went around in circles a couple of times and she ended up where she started, still holding the letter.
Again, the executive was furious, so he gave the letter to a third associate and gave him the same message. He got on the merry-go-round and had the same result. This lead the executive to give the same orders to a succession of other subordinates—all leading to the same disappointing result.
Finally, a thought occurred to the executive as to why he was having so many problems delivering the letter. “I finally know what’s wrong,” said the executive. “The problem is that nobody knows how to ride horses any more.”
THE ANALOGY
Over time, businesses will hit periods of difficulty. The old ways suddenly seem less effective. The business is no longer appears to be going anywhere, just like the merry-go-round horses don’t seem to be going anywhere. There is lots of activity, but no forward progress. All that activity just seems to make you go in unproductive circles, like the merry-go-round. Just as in the story, your difficulties prevent you from completing your business's mission.
In times of trouble, many executives resort to changing the person in charge of the mission. The thinking is that the reason the mission is failing is because the person in charge of the mission is incapable or unqualified for the task. Therefore, if you put someone new in charge, the problem will get fixed. This was the thought pattern of the man in the story. He kept thinking that if he could just put the right subordinate in charge of the mission, he or she would succeed.
Unfortunately, the problem was not the person in charge, but rather the business model chosen for the mission. No matter who was put in charge, no one was going to get to the other side of the park by using a merry-go-round horse. Rather than changing leaders, the executive should have been changing horses…finding a different kind of horse that is capable of getting to the other side of the park.
The same is true in business. Quite often the only path to success is not in changing leaders, but in changing the business model. That is where strategy comes in—to tell you when to change horses and which type of horse to change to. The sad part of the story was that the executive never caught on to this truth. He kept thinking that if he switched leaders long enough, he would eventually find one that could ride the merry-go-round horse to the other side of the park.
THE PRINCIPLE
The principle here revolves around degrees of control. Typically, the more control you have over your destiny, the more successful your future will be. Studies have shown that in most cases, strategic decisions impact your destiny than more than the person in currently in charge of the strategy. The leaders have less control of their destiny than most people think. They’re freedom to act is constrained by the strategy they inherit.
Years ago, I went to a retailing seminar where the professor said that the ultimate success of companies (and particularly retailers) can only be affected about 20 to 30% by the leader. The other 70 to 80% is determined by major strategic decisions made long ago. You can see this when you replace a bad store manager with a good store manager. Yes, the store will have better performance under the better store manager, but rarely will the results move by more than 20%. Earlier strategic decisions account for the rest of the performance:
- How you’ve managed the brand image.
- Your particular business model (price, product, service levels, etc.)
- How you’ve positioned yourself versus competition
If the brand reputation is terrible and your business model is uncompetitive, there is not much that a new leader can do in the near term to make a huge difference. He or she has inherited a wooden horse strategy that won’t make it to the other end of the park. Even a good manager can do only so much when given a mission based on an obsolete business model.
Often times you will see someone leave a successful company and go to lead a less successful company. The person frequently brings others from the more successful company to help him or her. Yet, despite their past success, they do not turn around the less successful company. The reason is because people alone are not enough. There is a reason why that company was less successful in the first place. Frequently, it is because it has an inferior strategy. Until the strategy is changed, there is only so much the new management can do. Making the merry-go-round go faster will not get you any closer to the other end of the park. Similarly, working harder at executing an obsolete or inferior strategy will not lead to great success.
Yes, sometimes current management has done such a poor job of executing a good strategy that new management can make a meaningful difference by just improving the execution. However, if you’ve changed the management two or three times and things are still looking bad, it may be time to concentrate on changing horses rather than changing riders.
February seems to be the time when you see a lot of changes in retail management. Financial results for the year are coming in, and if they are bad, there is often a change in management. Just yesterday I saw seven press releases announcing top level management changes at large retail companies.
The buzz in retail circles in recent months has been that the strategy of the Gap stores is so obsolete that it didn’t really matter who they chose to run the company. Some even speculated that the Gap would have a hard time finding qualified new executives, because no one would want it. In an article in the Wall Street Journal entitled “Gap Needs a CEO, and Many Qualify; Will Any Apply?” dated January 24th, 2007, it says:
“The job pays well and has plenty of perks. There's just one hitch: You have to be the next chief executive officer of Gap Inc. The successor to former Gap CEO Paul Pressler, who resigned Monday, must contend with unpopular products, falling sales and profits, anxious investors, problematic store leases, fleeing executives, and rivals gobbling market share. There's also an influential founding family that might balk at a restructuring the CEO might favor -- all or any of which might give a contender pause. No simple solutions are at hand.”
That sounds a bit like a wooden merry-go-round horse to me.
SUMMARY
New management can do only so much to change a troubled company if the trouble is due to having an obsolete or inferior strategy. Until the strategy is changed, the impact of having a succession of new management every year or two will do little to improve the circumstances. Management can only impact about 20-30% of performance. The rest comes from strategic decisions. Doesn’t it make sense to concentrate more on areas which impact 75% of performance than on areas that impact only 25% of performance?
FINAL THOUGHTS
There’s an old saying that the definition of an insane person is someone who keeps repeating the same bad behavior over and over again in hopes of getting a different result. Dare I say more?
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