Strategic Planning Analogy #507: Hammers Are Lousy As Saws

THE STORY

Joe the carpenter wanted to be as efficient as possible, so he decided to only carry around only one tool—a hammer.

Joe had three tasks that day: hammer some nails, screw some screws and cut some boards. Joe decided to do all three tasks with his hammer. Hammering the nails went quite well with the use of the hammer.

Getting the screws into the wood with the hammer, however, was far more difficult. By the time Joe could bang the screw into the wood with the hammer, the screw was all bent, the wood was a bit shattered, and the screw was doing a lousy job of holding the wood together.

Finally, Joe discovered that if you whack at a board long enough with a hammer, you can break it into two pieces. But when compared to cutting a board with a saw, whacking it with a hammer was less accurate in getting the cut in the right place, and the edges where it was “cut” with the hammer were all distorted and ragged. This made the board less useful than if a saw had been used.

But in spite of all the problems with the results, Joe the carpenter was still proud of his work. After all, as Joe put it, “I simplified my work by having to carry only one tool.”

THE ANALOGY

Joe’s approach to his work was rather misguided. What good does it do to simplify the number of tools you carry if the end results are awful? Replacing the screwdriver and saw with a hammer lead to a rather useless outcome. Not only would the results have been better if Joe had used a different tool for each task, it would have taken less time and been easier.

Business leaders wouldn’t be as misguided at Joe, would they? In one way, I think many are. There is this tool that businesses use, called a “budget.” The budget is a good business tool, just as a hammer is a good carpentry tool. But just as a hammer cannot effectively do all the work of carpentry, a budget cannot effectively do all the work of business.

Three of the key tasks of business management are to:

1. Effectively manage the treasury function;
2. Make sure the business operating divisions are doing the right things; and
3. Provide incentives for employees to act in the best interests of the company.

Many companies rely primarily on the budget process to do all three tasks. But as we will see in this blog, that is like using a hammer to tighten screws and cut boards. The budget is an effective tool to help the treasury function, just as the hammer is effective in hammering nails. But for the other two tasks, there are better tools than budgets. By trying to use a single budgeting process to do all three, one ends up with a mess. There are better tools for monitoring the operating functions and providing employee incentives, and they should be used instead of the “hammer” of budgets.

THE PRINCIPLE

The principle here is that companies are not doing themselves any favors by using budgets as a tool where it doesn’t belong. It is great for the treasury function, but inappropriate for many of the additional places where it is used.

1. The Budget “Hammer” Works Well on the Treasury “Nail”

The key function of treasury is to ensure that the cash of the business is properly managed. It looks for efficient (and cost effective) sources of cash when internal cash flows fall short of need and looks for efficient uses of excess cash produced internally. Timing of these actions is very important, so that the proper level of funding is available to match the fluctuating cash flow needs.

The budgeting process is a rather good tool to help in this treasury function. It provides a broad overview of cash flows over time. This helps the treasury function plan in advance so that the right amount of money is in the right place at the right time at the best price. The budget is also a good tool to share with the debt and equity community, so that they will cooperate more favorably with your cash needs. It helps build trust, so that they will provide cash at a favorable rate. Treasury should be the primary goal of the budget.

2. The Budget “Hammer” is a Poor Choice for the Employee Incentive “Screw”

However, when budgets are also used as the primary tool to incentivize employees, it destroys the integrity of the budget. Employees will try to “game the budget system” in order to insure easier and higher bonuses. This creates a budget which no longer reflects best estimate of cash flows, because the numbers are padded to improve the likelihood of a bonus. As a result, it damages not only the ability of the budget to get employees to work harder but it damages the ability of the budget to accurately help the treasury plan accurate cash flow estimates.

In addition, employees understand that there is usually more than one way to hit a budget number—and not all of these ways are equally good for the long term health of the business. For example, this quarter’s budgeted profit number can be hit by doing lots of actions harmful to long term prosperity, like improperly cutting investment in the future, cutting research, cutting maintenance, cutting quality, cutting service, overcharging customers, and so on. Since both good and bad behaviors can be used to hit a budget number, the budget is not very effective as an incentive for ensuring right behavior. It is like trying to secure a screw by banging at it with a hammer.

3. The Budget “Hammer” is a Poor Choice for the Operational “Board”

Similarly, the budget is a poor choice as the primary means of determining the specific actions of the operating divisions. The main problem is that budgets are frozen well in advance, before the year begins. As we all know, the marketplace is a dynamic, rapidly changing environment. It is impossible to fully anticipate all of these potential changes. It makes no sense to tie up your operations into budgeting straightjackets, unable to adjust to the changing business environment just because the best guess estimate put into the budget nearly a year earlier has proven to be off.

Does it make sense to not exploit a great opportunity merely because that opportunity was not in the budget? That would be like a miner refusing to take advantage of a huge find of gold in the mountain because they only budgeted to take a meager amount of silver out of the mountain. And the opposite is also true…why continue a particular action merely because it is in the budget if the changing situation makes that action no longer viable?

Budgets are typically broad-based numeric documents. They are not good at understanding strategic nuances, competitive dynamics or the actions behind the numbers.  To expect that out of budgets is like expecting a hammer to effectively cut a board.

Recommendations

To get around these problems, I suggest the following:

a) Get A Screwdriver. Get a tool specifically designed for incenting employees. To insure people are incented to do the right things, specifically outline what right things those are and reward achieving behaviors instead of numbers. For example, if you want an employee to master a skill, make skill mastery the criterion for bonus. Or if you want an employee to successfully roll out a new product or enter the Brazilian market or reduce the time to convert a plant to a new production run, then spell it out IN WORDS (specific enough to be difficult to game).  In the old days, we called that Management by Objectives which then morphed into Balanced Scorecards and now Key Performance Indicators (KPI). I think the migration may be going in the wrong direction towards fewer behavior-based words and more game-able numbers, but at least it is better than bonuses based almost exclusively on budgets. In fact, I might suggest doing the “screwdriver” in the spring and the “hammer” in the fall in order to keep budgets from creeping too deeply into the incentive process.

b) Get A Saw. Get a tool specifically designed for directing operations on what is an acceptable approach to their sphere of influence. This tool would tend to set up measures using a more strategic language. It would explain the strategic role that operational unit has within the organization. It would explain what “winning” would look like for that group. It would explain what the proper trade-offs are on attributes and outcomes. It would point the direction in which the operations are to migrate to in order to reach future strategic goals. Then the company delegates the specifics, to free up the operating unit to bob and weave with the changing environment in order to exploit the moment, provided the actions remain within the strategic boundaries.

c) Improve the Hammer. Budgets can be more dynamic. Draw up some contingency budgets in advance (based on different scenarios) so that you are ready if situations drastically change. Consider rolling budgets that adjust quarterly or semi-annually (depending on your business). Note: this becomes easier to do when the budget is freed by no longer having to also work as a screwdriver and saw. Also, consider doing the screwdriver and saw work PRIOR to finalizing the budget. That way, the budget more accurately reflects what will actually be done, instead of being just a wish list. Remember, the budget shows financial outcomes which are determined by action inputs. So get the inputs figured out before declaring the outcomes.

This is not to say that budgets are totally ignored outside of treasury. The budget provides discipline for the more routine aspects of business. The budget can help to determine if the desired strategy is achievable under current cash constraints. And if the budget has no connection to actions, it ceases to accurately reflect what the future cash situation will really be. So a little bit of the strategy needs to permeate the other areas. But it shouldn’t be the primary driver.

SUMMARY

Budgets are very useful, but they should not be the master tool to drive all of your management concerns. Budgets are most effective when centered primarily on the needs of the treasury function. A second, more action-related tool would be used to incent employees and a third, more strategic tool would be used to manage operational units.

FINAL THOUGHTS

Efficiency is not the same as effectiveness. Having a single tool may appear efficient, but it may be so ineffective that it destroys your ability to properly run your business.

Strategic Planning Analogy #506: Perspective

THE STORY

Let’s assume that a government transportation committee examined whether to add more lanes to an urban highway. 

The conclusion of their study went something like this:

Yes, we concede that during a brief period of the day (rush hour), the highway becomes highly congested and traffic stops moving. However, outside of rush hour, the highway is operating well below capacity and flows very smoothly. Since the highway is well below capacity for approximately 85% of the day, we see no reason to add any lanes. After all, 85% efficiency for a highway is quite acceptable.

The response from a consumer group advocating extra lanes went something like this:

The reason why the highway flows well outside of rush hour is because that is not the time when the highway is most used and most needed. According to our research, 85% of the cars using the highway use it during the congested rush hour period when cars greatly outnumber the current highway capacity. Since the highway is well above capacity when 85% of the drivers are on it, we see a clear justification for adding more lanes to the highway. After all, 85% inefficiency for a highway is quite unacceptable.

So is the current highway 85% efficient or 85% inefficient?

THE ANALOGY

Strategy creation involves making decisions. Facts are a key input for making those decisions. In fact, I had a boss once who on a daily basis would say that he would not make any decisions unless they were “fact-based.”

But how reliable is the “fact-based” approach? In the story above, two groups used facts to reach a conclusion. The transportation committee used facts to “prove” that the highway was 85% efficient. The consumer group used facts to “prove” that the highway was 85% inefficient. These facts lead each group to come to a different conclusion about adding lanes to the highway.

Was one group’s facts right and the other group’s wrong?  No, both groups had equally true facts:

a)     85% of the TIME OF DAY the highway had excess capacity.

b)     85% of the TIME OF DRIVERS using the highway was during times of inadequate capacity.

So what is the right “fact-based” decision? Obviously, we need more than just these facts to reach an acceptable decision. And when it comes to strategy we need more than just facts as well.

THE PRINCIPLE

The principle here has to do with perspective. Facts alone do not automatically lead to the proper conclusion. It is only when we place those facts within the context of the proper perspective that we see what is the right thing to do. Therefore as much care and effort should be given to developing the proper perspective as is given to acquiring the right facts.

Perspective depends on two items: Where one is looking from and what one is looking at. In strategic analysis there are usually multiple places to look from and multiple items to look at. If you miss out on examining some of these options, you may come to the wrong conclusion.

Perspective #1: Where One Is Looking From

From the eyes of the transportation officials looking at the highway from afar, what they saw was smooth operations nearly all day long. From the eyes of the drivers on the highway, nearly all of them saw congestion nearly every moment they were on the highway. Their different perspectives cause them to see the situation very differently.

A similar situation can occur in developing your strategy. From the eyes of the executives inside your organization, you may see a particular strategic option as ideal for your bottom line. But how does that option look from the perspective of other eyes?

Perhaps your decision places added burdens on your suppliers, causing them to no longer want to supply you or only supply you if they get added compensation for those added burdens. That added compensation might wipe out a lot of the original advantages you saw from the internal executive eyes. A similar situation could also occur with your distributors.

Or perhaps your decision triggers an adverse reaction from your customers when they see it. This problem could not be seen with the internal executive eyes, but was quickly apparent to the customers’ eyes.  The unperceived adverse consumer reaction could make that original strategic option no longer as viable as first seen.

Or perhaps when your competition sees the strategy, they perceive it as a bigger threat than you thought and they react far more aggressively than anticipated. This aggressive reaction wipes out your perceived benefit.

Or maybe when those ideas from headquarters get down to the factory floor, they cannot be operationalized as smoothly as one thought. Something gets lost in the implementation on the factory floor which hurts the strategy’s effectiveness.

Therefore, before making a decision, step away from the pile of facts and look at the situation through other sets of eyes. How will the decision be seen by all the other relevant parties (suppliers, distributors, customers, competition, front line employees, the government, etc.)? How will their perspective affect their behavior, and how will that behavior impact your strategy?

You may find a need to modify your strategy in order to get all of the players see the situation in a manner which moves them all in a favorable direction for your business.

In addition, consider how you communicate your decisions, so that you can help influence how others see it. How the decision is communicatted may be just as important as the decision itself when it comes to implementation.

Perspective #2: What One Is Looking At

In the story, everyone was looking at the same issue: what is the proper number of lanes to have on the highway.  It assumes that the only way to address congestion is by looking at lane-count for the highway. Is this a fair assumption?

Perhaps there are other solutions one could look at, like:

a)     Increasing use of public transportation;

b)     Convincing more people to use alternate routes;

c)     Getting businesses to stagger the hours employees work;

d)     Reallocation of traffic direction for the current lanes depending upon time of day (e.g., more inbound lanes in the morning and more outbound lanes in the evening).

e)     Financial incentives for carpooling.

f)      Building a separate road nearby.

How do you know you are making the right decision if you have not fully explored all potential options? All those facts you’ve gathered may only be applicable to examining one particular option. If you look at the problem in a different way, you may find that you need a different set of facts altogether.

Remember, business success usually depends on offering a superior solution to your customers’ problems. There may be many distinctively different ways to solve that problem. Unless you examine many alternatives, you may not offer the right solution.

Perfecting the obsolete is not a path to success. After all, even a mediocre smart phone is far superior to the best Morse code telegraph solution, no matter how much time you spend trying to perfect it.

So don’t frame your strategic discussion too narrowly. Before deciding on the best way to do something, first make sure it is something worth doing. First frame the discussion around finding the best solution rather than just finding ways to improve the status quo.

SUMMARY

Facts are useful, but facts alone are incomplete. Facts are only useful if seen from the proper perspectives. Therefore, before deciding a course of action, improve your perspective by:

a)     Looking at the problem through all the eyes of the various people who have an influence on the successfulness of the strategy (suppliers, distributors, customers, competition, front line employees, the government, etc.).

b)     Looking at multiple ways to solve the problem. Creative, superior solutions may look nothing like the status quo.

FINAL THOUGHTS

Great strategic solutions may take you into uncharted territory—doing things in a way they have never been done before. There won’t be a big pile of facts to help you in uncharted territory. And if you wait to act until you can get a big pile of facts, someone else will have already captured that strategic space. Perspective helps fill in the holes when facts are hard to come by.

Strategic Planning Analogy #505: Secrecy is Silly

THE STORY

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

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

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

THE ANALOGY

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

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

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

THE PRINCIPLE

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

The Problems With Secrecy

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

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

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

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

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

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

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

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

The Faulty Logic Behind Secrecy

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

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

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

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

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

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

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

SUMMARY

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

FINAL THOUGHTS

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

Strategic Planning Analogy #504: Fixing a Plane After it Crashes

THE STORY

After 17 years, the tragic crash of TWA flight 800 is back in the news. A documentary has come out claiming that the official explanation of the crash (static electricity igniting the fuel) is wrong. Instead, the documentary endorses the alternative explanation that the plane had been attacked with a rocket, perhaps sent by terrorists.

I have a couple of thoughts about this. First, I can easily understand why so many prefer the rocket attack explanation. After all, it always feels better to blame some outside force (beyond our control) for our problems than to admit internal incompetence, either in the plane design, maintenance or operation.

My second thought is that for the 230 aboard that flight who died 17 years ago, it largely doesn’t matter anymore which theory is correct. Neither explanation will bring them back to life or restore the plane so that they could reach their original destination. For them, it is too late.

THE ANALOGY

The business world is full of tragedies. Companies crash and burn, negatively affecting hundreds, if not thousands, of people. In terms of financial impact, these corporate tragedies are larger than the tragedy of TWA flight 800.

When these events happen, it is common for the leaders of these destroyed organizations to take an approach similar to the one in the TWA documentary—they try to blame it on outside forces beyond their control. “It wasn’t me or my leadership which caused the disaster,” they say. “No. It was the fault of some evil outside force which nobody could have prevented.”

Outside forces which get the blame can include international economic conditions, the weather, political unrest, too much (or too little) government intervention, illegal market manipulations, unfair competitive environment, and so on. The logic is that despite the Herculean effort of management to counter these evil outside forces, the situation was just too great. Nobody could have saved the company.

In a narrow sense, there may even be some truth to these claims. Dire situations can be devastating to companies. But this explanation only works if your time horizon is narrow.

In reality, strong, well run companies can anticipate most of the potential tragedies which could occur. Using strategic planning and scenario analyses, they can anticipate and be prepared for the worst. In fact, the great strategic plans avoid the disasters entirely by steering their company in a new direction before the outside forces come to pass.

Sure, it’s easy to claim that nothing can be done if you wait until your “plane” is on fire and already close to crashing before looking for a solution. But, in most cases, advanced strategic thinking years earlier could have provided a solution so that you avoid the fire altogether.

The best time for analysis is not after the crash occurs. By then, it is too late. The tragic results have already occurred; the damage is already done. No, the best time for analysis is years, if not decades in advance. That way, you have sufficient time to use the knowledge to create a path which puts a company out of harm’s way.

THE PRINCIPLE

The underlying principle here is that the best time for critical strategic analysis is not during (or after) a crisis, but before the crisis, when times are still relatively good. By attacking potential future disasters while times are still good, you have many advantages:

1)     You have more time to prepare and implement a solution;

2)     You have more cash flow to apply to the solution;

3)     You still have a strong reputation, good market share, and a consumer following, making the transition easier for your key stakeholders;

4)     You can analyze the problem more rationally, instead of making rash moves in the heat of the disaster.

5)     If you have to retreat from a business to avoid the future disaster, there is still time to find buyers for it who will pay a good price.

By contrast, if you wait until the disaster is upon you before creating an exit strategy, the situation is working against you:

1)     You have very little time to find and implement a new course;

2)     Your options are limited because your cash flow is already decimated and customers have already started abandoning you.

3)     The crisis is so obvious that nobody wants to bail you out by paying a handsome sum to take over your disaster.

Example #1: Department Stores

Look at the situation JCPenney is in. It’s on fire and looks like it could be headed for a crash. There is a lot of speculation about what or who to blame for the disastrous results of late, such as losing about a third of their business.

Some would say that the problems for the department store industry are so bad that there was really nothing that any leader could have done to save JCPenney, be that Ron Johnson, the recently fired CEO, or Mike Ullman, the replacement executive (as well as having been the top executive prior to Johnson).  The reasoning is that the department store industry was doomed due to outside economic, technological and competitive forces. It is beyond redemption.

But that is only if you start trying to fix the problem now, after the plane is already on fire.

Look at the Dayton Hudson Corporation. They used to be a major player in the department store industry decades ago. The executives there were smart. They knew that the best days for the department store format were behind them. They knew that the format was on a course headed for eventual bad times.

So while times were still good, Dayton Hudson started selling off its department store properties. First, they got rid of their holdings in the fast-growing southwestern part of the US in the 1980s, when competitors were trying to out-bid each other to buy them. They finally sold the remainder of their department stores to the May Company (another department store company) in 2004 (for a good price).

But then the bad times started to hit the industry. Soon thereafter, the May Company was in such bad shape that they had to sell themselves to Federated (now called Macy’s) at a terrible price. And now, almost all the remaining department store companies are struggling to find a winning strategy, like JCPenney, Sears and Bon-Ton.

What did Dayton Hudson do? They took the money from the sale of the department stores to invest in the future, their Target store chain. Dayton Hudson (now called Target Corp.) is doing well and avoided the department store mess.  

The point is that if you wait until the industry is in trouble (like JCPenney) before crafting a solution, you will find it very difficult. But if you start crafting a solution while the times were still good (like Dayton Hudson), you have a greater chance of success.

Other Examples

A similar situation occurred in grocery wholesaling. To an astute observer, it was obvious decades ago that the small independent grocer (the key customer of grocery wholesalers) was entering a troubling future. Walmart supercenters and the big grocery chains were putting pressure on many of the independents. Eventually, it was likely that many of these independent grocers would be out of business. It doesn’t take an expert to figure out that if your key customer is going out of business, it doesn’t bode well for those supplying them.

Therefore, while times were still good, Cardinal Foods decided to act. They used their cash flow to diversify into a field where their distribution expertise had longer life—pharmaceuticals. Now, Cardinal Foods, whose name was changed to Cardinal Health, is a strong #21 on the Fortune 500 while many of the few remaining grocery wholesalers are in challenging times.

Google did not wait until its computer-based business model was in trouble before pushing hard into the smartphone space with Android. Google did it while it could still leverage its strength. Amazon did not wait for its strength in the computer-based ecommerce era to end before launching Kindle.  By contrast, Zynga was already in trouble from smartphones taking over gaming from the computer when it decided to take the challenge seriously (and is having serious problems now making the transition because it waited until it was in a position of weakness).

There are many more examples I could mention. I’ve talked about some in previous blogs here, here and here.

SUMMARY

All strategies eventually fail. If you wait until failure comes before starting to change, you will most likely not change successfully.  By contrast, if you start adapting while times are still good, you are more likely to make a successful transition.

FINAL THOUGHTS

Think of strategic planning as a parachute to help escape problems. But a parachute is of no use if you wait until the plane has already crashed before putting it on. It only helps if you escape while the plane is still flying.

Strategic Planning Analogy #503: Unbundled Subsidies

THE STORY

When I used to eat at a fast food restaurant, I’d order a burger and fries. But then I realized that the low price menu would have burgers for about the same price as those french fries. After that, I skipped the fries and ordered a second burger.

My logic went like this: Fries are merely grease sponges—just empty calories filled with fat and covered with too much sodium. By contrast, at least with the cheap burger I was getting some protein. They cost about the same and filled me up about the same and were equally tasty. Therefore, instead of getting a burger and fries, I started getting two burgers.

That was all fine by me. But I don’t think the fast food restaurants enjoyed my new decision. After all, they made a good profit on the fries but were losing money on that low-cost second burger.

THE ANALOGY

No matter what business you are in, your customer has choices. Even in a monopoly situation, the customer has choices. They can choose a substitute from another industry or choose not to purchase at all.

Many of the decisions businesses make affect those choices, such as product assortment and pricing. When the fast food industry added low-price value items to their menu, they changed the way I made choices about how I eat.

Unfortunately, my change was to the detriment of the fast food restaurants. I switched from high-margin fries to a negative margin value burger. And it was THEIR decision which caused my changed behavior to work against them. Their actions made me a less profitable customer.

So don’t limit your discussions about what is strategic only to big issues like positioning and productivity. Even smaller issues, like the pricing of a burger, can have a huge impact on performance for years to come.

Think of it like making a small decision about whether or not to bring a woodpecker on board your boat. It’s just a little bird. But one day the woodpecker pecks a hole in the boat. Even then, one little hole is not a big deal—it can be repaired. Over time, however, the woodpecker pecks a great many holes in the boat and it sinks. It is the accumulation of many small, bad consequences from that one little decision about birds which sank the boat.

This is also true for business. It is usually not the big decisions which bring a company down. After all, executives spend a lot of time making sure they get the big decisions right—that’s why they’re called “Big Decisions.” No, it’s the accumulation of many small daily decisions (decided poorly) which sink a company.

Little decisions start chain reactions in how customers make choices. Any one of them may not hurt you, but in total they can create a disaster. If those daily decisions are not made within a strategic context or are not thought through thoroughly, they can destroy the grand design or your larger strategy. After all, your strategy is not what you say, but what you do. And what you do is determined every day with those small decisions. So strategy needs to “sweat the small stuff.”

THE PRINCIPLE

The underlying principle behind the fast food mess is “unbundled subsidies.” And if you are not careful, unbundled subsidies can ruin business models for a lot more industries than just fast food.

1) The Origin Of Subsidies

Many industries are highly competitive. This creates severe downward pressure on prices (competition won’t let you raise prices). And to top it off, we’ve trained consumers to not have to pay full price for anything. Just ask the customers of JCPenney. When JCPenney eliminated sales, they lost over one quarter of their business. It turns out that people expect deals and won’t willingly pay full price.

Therefore, highly desired items are often sold at little to no margin (or even a negative margin). So how do you make money when your key items are sold at or near a loss? The answer is subsidies. You get customers to buy additional items that have a high enough margin to offset the loss on the core.

In fast food, the high margin drinks and fries subsidize the low margin burgers. On big-ticket electronic items, high margin extended warranties traditionally subsidized the low margin device. The base sticker price on a car is kept low, but they get you with high margin upgrades, accessories, financing and repair work. Low margin industrial goods are often subsidized with service contracts. Low margin printers are subsidized with high margin ink.

It has become the way of the world. In order to compete on price versus competitors and satisfy customers who want a deal, core items are becoming like loss leaders, forcing businesses to surround them with subsidies in order to survive.

2) Unbundling of Loss Leaders and Subsidies

Originally, the idea was to try to bundle the loss leaders and subsidies as tightly as possible. That way, every purchase could still remain profitable because the loss leaders and subsidies were sold together. In the fast food world, they were called “Combo Meals”—you had to buy the whole bundle of food to get the deal.

Other industries followed with their own version of the bundle. Cable and telecom companies bundled phone/internet/TV. HP used patents so that you could only use their high margin ink on their printers.

But the hypercompetitive world started causing the bundle to fall apart. Between 2000 and 2002, McDonald’s rolled out the Dollar Menu in the US. Now you could buy the cheap items without also buying the subsidies.

In the telecommunications industry, companies started turning subsidies into additional loss leaders. For example, charges for texting used to be the subsidy for voice calls. Then texting became free and had to be subsidized by data downloads. I was talking to someone in the industry who said it is a constant race to find the next subsidy, because someone in the industry is always trying to turn the current subsidy into a loss to get an edge.

And then the dotcom world came up with the “Freemium” model. In this model, most people pay absolutely nothing for the service (it’s free) while a small minority pay for a premium version. This is how linkedin works. I pay nothing for the basic service because it is subsidized by a totally different customer, usually a recruiter, who buys a premium version. Or Zynga had most people playing Farmville for free while a small minority subsidized the whole system by purchasing virtual farm equipment.

This all starts to become dangerous territory when loss leaders and subsidies are unbundled. In fast food, you get people like me who now load up on the loss leaders and avoid the subsidies. In telecommunications, there is the risk of running out of new sources for subsidies to support the ever expanding list of loss leaders.

The price of loss leader consumer electronics got so low that it became “disposable pricing.” If something went wrong, you could afford to just replace it, erasing the need to buy the extended warranty subsidy.

The freemium model runs the risk of the two audiences getting out of balance, with not enough payers to subsidize the freeloaders. Zynga just announced huge layoffs because they are having trouble with their business model.

And it is hard to go backwards on these trends. The telecommunication folks want to dial back the unlimited data plans but are meeting strong resistance. When the fast food people try to dial back the value menus, the customers revolt. Newspapers have been trying to get people to pay for the online version (which used to be free) with only varying levels of success.

Once you set up a subsidy system, you redefine the expected cost for the loss leader. “Regular” price becomes the loss leader price. Consumers see anything higher as outrageously high pricing. This makes it very difficult to reverse the pricing once the loss leader position has been made.

But now that the subsidies are becoming ever more unbundled from the loss leader, it is more difficult to ensure that enough subsidies are sold to offset the loss leader prices. Profits become more elusive. Risk of failure is increased.

3. Lessons Learned

What can we learn from this? First, small actions today have consequences well into the future. And it may not be initially obvious today what those consequences may be. Therefore, before making some of these small actions, we need to take time to consider their impact on the larger picture. Otherwise, we may unintentionally be dismantling our grand strategy one brick at a time.

Second, if strategists (or strategic thoughts) are only limited to an annual offsite meeting, they will be unable to adequately impact all those little day to day decisions. We need to get strategic context around a larger proportion of our decision making.

SUMMARY

Strategy should be more than just big thoughts around big decisions. It needs to permeate the organization more regularly and further down the organization, where many of the more mundane decisions are made. After all, these more “mundane” decisions can accumulate to the point to where they threaten the entire strategy.

FINAL THOUGHTS

How many decisions are made in your business without asking the question “How can this decision impact the long-term viability of our strategy or company?”