THE STORY
Once there was a young boy who loved chocolate. He was very happy, because at this moment he had a fist full of chocolates. He was joyfully walking down the street until he walked past a chocolate shop. There, something caught his eye and caused him to stop.
In the display window of the shop was a gigantic glass jar of chocolates—more than enough to satisfy him and all his friends. Next to the jar was a sign which read: “Free Samples. Help Yourself.” That sign certainly got the boy’s attention.
There was a problem, however. The boy would need both of his hands to lift the lid off of the chocolate jar. Because one of his fists was full of chocolates, he could not lift the lid off the jar. The boy thought about setting down his chocolates so that he could lift the lid, but he was afraid to, for fear of losing the chocolates he already had. As a result, he just kept walking down the street, happy for still having those original chocolates in his hand.
Unfortunately, it was very hot that day. Soon, the boy’s chocolate began to melt. It oozed out from between his fingers and dripped to the ground. When he opened his hands, all he had left was a little bit of chocolate smeared on his fingers. This made the boy unhappy.
But then he remembered the gigantic jar at the chocolate shop. “I’ll just go back to the chocolate shop and get some from the jar,” he thought to himself. However, by the time he got back to the chocolate shop, all of the chocolate was already taken. There was nothing left. This made the boy exceedingly unhappy, because now he didn’t get any chocolate to eat that day.
THE ANALOGY
The business world is full of change. Change causes old products/business models to become obsolete and new products/business models to take their place. The trick of strategy is in knowing when it is time to abandon the old and when to embrace the new.
In the story, the boy did not make those decisions very well. He held onto his old chocolates far longer than he should have (until they melted away and he received no benefit). He also waited too long before embracing the new, larger prize of the giant jar of chocolates (he waited until everyone else got there first and took the prize). His dilemma was that he couldn’t figure out how he could have both at the same time. Therefore, he kept the smaller prize (which he already had) instead of letting go so that he could reach for the greater prize.
As odd as that decision sounds, it is the same conclusion that many businesses take. They hold on to the older, smaller business model (which they know & are comfortable with) and miss out on getting the bigger prize of taking claim of the next business model. Then, when the current business model melts away into obsolescence, they are left with nothing, because the competition has already staked a dominant position in the new space, leaving nothing but an empty jar.
THE PRINCIPLE
The principle we are talking about is fear of cannibalization. It is the fear that if I go after a new business opportunity, it will require letting go of a current business model that is quite profitable, because the new opportunity grows at the expense of the old opportunity. Not wanting to destroy the business model that is currently providing huge profits, the companies decide not to invest in the new model.
There have been numerous examples of this phenomenon throughout time:
1) Back in 1973, Ford Motor Company invented the Minivan, but they did not introduce it to the marketplace for fear that it would cannibalize the profitable sales of their station wagons. When some of the people who worked on the project moved to Chrysler, they introduced the minivan there. As a result, station wagons became obsolete and Ford has never become a major force in minivans.
2) In the late 1980s, supercenters were starting to evolve in the United States. K Mart wanted to be part of the movement, but it did not want to cannibalize its K Mart store sales. Therefore, when it built its American Fare supercenters, it did not put in the types of merchandise found in a K Mart. Instead it combined convenience driven food with high end apparel and durable hardlines like major appliances. The experiment failed and K Mart was never able to recover from it and compete in supercenters.
3) In the late 1990s, Kodak was slow and reluctant to make a big push into digital imaging because of fear of cannibalizing its powerful position in traditional photography. Kodak’s efforts did not save the core photography business and by dragging its feet, it never got a strong position in digital imaging. Now the company is struggling to find a reason for existing in today’s marketplace.
4) In the 2000s, the traditional record labels were reluctant to pursue digital music for fear of cannibalizing the traditional CD market. It took an outsider like Apple to take the market by storm. Until very recently, EMI continued to ignore the inevitability of the fact that digital music was making CDs and the traditional label business model obsolete. Now many bands are ignoring the labels completely and gaining success on their own through downloads made popular on sites like YouTube and MySpace.
5) The latest example I heard of was the recent complaint that the US mobile phone companies, such as T-Mobile, Verizon and AT&T, are resisting the movement into mobile voice over IP (MVoIP) for fear of cannibalizing their current voice business. My guess is that eventually people will flock to MVoIP and the winners will not be the traditional players in the space today.
In every case, the companies above clung on tightly to the chocolates they had and refused to reach boldly with two hands for the next prize. As a result, the chocolates they thought they had eventually oozed away into nearly nothing, while others got the next prize from the big jar before these companies were willing to go after it.
In the end, these companies did not prevent cannibalization of their products. All they did was help determine who would have the honor of doing the cannibalizing. And they decided to let someone else do it. As long as the business is being replaced anyway, one should at least try to benefit from the situation by cannibalizing one’s self. But alas, many companies do not do so.
Why does this fear of cannibalization cause poor decision-making? It is because a one has to significantly increase short-term risk in order to make the leap. Most business hierarchies have so many layers to go through in order to get approval, that conservatism wins out and the known, less risky cash flow (at least in the near-term) nearly always wins. Consider the obstacles facing someone promoting the leap to the new model:
1) The capital is already invested in the old model. It is a sunk cost. To transfer to the new business model, new capital is required. That’s riskier and in the short-run reduces return on investment.
2) The old model has a known cash flow. The new model is harder to predict, making it riskier and harder to defend.
3) Executives often think “I can reap the rewards of the old model today and get big bonuses. If I invest in the new model, it can lower today’s profits near-term (hurting my bonus) and not show profits until later (after I’ve moved on, so the successor to my position gets the bonus).”
4) The new business model may require new skills and processes which the current group has not mastered. That could result in lack of success in transferring to the new skills, and may put the current team out of work, to be replaced by people with different skills. Why risk a career over that?
As you can see, both personal goals and near-term corporate goals lead one to conclude that making the leap early is very risky and may not benefit my personal situation. Hence, the fear wins out and the company ends up losing out.
SUMMARY
Change is inevitable. Ignoring change and clinging to the past does not make change go away. The cash flows from the old business models cannot be saved by ignoring the future. In the end, new businesses cannibalize old businesses. Rather than resist, it is better to take advantage of the change and get in early, so that you can get the most out of what happens next.
This has been the pattern at Wal-Mart. In the beginning, Sam Walton was in the variety store business. When he saw that discount stores had the potential to make variety stores obsolete, he quickly jumped into the discount store business and created Wal-Mart stores. Then, when he noticed that supercenters had the potential to make discount stores obsolete, he quickly jumped in with Wal-Mart Supercenters. The others, who stayed in the variety store business, are all gone. Most of those who stayed in the discount store business are gone. Wal-Mart is still here and as big and as profitable as ever, because they did not fear cannibalization.
FINAL THOUGHTS
Often times, the winners with the new business model are outsiders who were not a part of the former business model (such as Apple was to the record labels). These outsiders do not fear cannibalization, because they had nothing to be cannibalized. Sometimes, the only way to remain an insider is to think like an outsider.
Wednesday, February 14, 2007
Tuesday, February 13, 2007
Everyone is an Elvis Impersonator
The Story
Making predictions into the future can be a tricky business. To help reduce error and make predictions more accurate, businesses have relied on the science of mathematics. Using complex mathematical formulas, even the smallest of historical trends can be projected into a “mathematically plausible” future.
Unfortunately, mathematics can only go so far in creating a plausible future. Back in the 1970s, a mathematician made an observation regarding the rapid growth in Elvis Pressley impersonators. After Elvis had died, a large number of singers started dressing up like Elvis and performing the old Elvis tunes before audiences. This form of entertainment quickly became very popular. Elvis impersonating became a large, successful business. As a result, there was an extremely rapid rise in the number of people becoming Elvis impersonators.
Using sophisticated mathematical formulas, this mathematician took the historically rapid rise in Elvis impersonators that occurred shortly after Elvis’ death in the 1970s and made a projection: If this growth in Elvis impersonators were to continue at the same rate into the future as had occurred in the past, every human being on the planet would eventually become an Elvis impersonator sometime around the year 2025.
Well, here we are, about thirty years later, and the last time I checked, none of the people I know are Elvis impersonators (or at least none of them admit it). The mathematical formulas may have been correct, but the prediction was wrong.
The Analogy
The goal of strategic planning is to proactively create a more desirable future state for your business. To build a winning position in the future, it is useful to understand the type of future environment you are designing a winning position for. Therefore, good strategic planning begins by trying to understand the future.
Many different tools and techniques are used to try to understand what the future environment might look like. Although these techniques may use different mathematical formulas, most of the techniques rely on taking historical trends and projecting some sort of continuation of these trends into the future. This was the technique used by the mathematician mentioned above to predict the future of Elvis impersonization.
Unfortunately, historical trendlines of the past are rarely continued at the same exact pace forever into the future. That is why we are not all Elvis impersonators today. The rate of growth in Elvis impersonators quickly slowed down considerably and eventually started to decline.
The point at which a trendline or curve changes its rate of growth is called an inflection point (see figure below). If you misunderstand the timing and magnitude of inflection points, your predictions of the future will be as inaccurate as the projection that we would all become Elvis impersonators.
The Principle
I have seen many executives make terrible strategic mistakes because they failed to take into account inflection points in their analysis of the future. When times are good, they assume that times will always be good. They project the growth of today into growth forever. Huge investments are made in adding manufacturing capacity for anticipated growth. About the time the new factories start producing products, the growth in demand for the product has already slowed. Huge inventories are built up that cannot be sold. It turns out the product was only a short-term fad and the company goes bankrupt.
There are several forces that cause inflections to occur:
1. Competitive Reactions
2. Natural Limits
3. Cycles and Pendulums
4. Discontinuities
5. Influence
These are briefly discussed below.
1. Competitive Reactions
If you are being successful in the marketplace, assume that competition will respond to blunt your success. Remember, if you are gaining market share, that means that someone else is losing market share. Those who are losing share will do whatever they can to stop the loss. This typically slows down your growth.
Even if your success is based on creating an entirely new market, expect a reaction. After all, there are so few truly new growth businesses out there. When companies see them, they all want to get a piece of the action. So even if the new market continues to grow rapidly, your participation in that growth may slow down due to increased competition in that space. For more information on competitive reactions, see the blog entitled Bombs Start Wars.
2. Natural Limits
Growth cannot go on forever, because there are natural limits to growth. For example, to be a successful Elvis impersonator, you need to have a large enough audience willing to pay to see you perform. If everyone was an Elvis impersonator, there would be nobody in the audience. Hence, Elvis impersonation is limited by the size of the audience willing to pay to hear a performance. So one needs to understand how limited the preference is for your product or service.
There are other natural limits as well, like finances. Customers have only so much money to spend, and you cannot get over 100% of the available money. There are also limits on the availability of natural resources. For example, I heard someone do the math on what would happen if everyone in China started drinking one extra can of beer per day or one extra hamburger per day. There is not enough grain in the world to meet that kind of demand.
Therefore, one of the initial steps in any strategic plan should be an analysis of the potential limits to the size of your market. If you significantly over- or under-estimate the market size, you may end up making the wrong strategic choices.
3. Cycles and Pendulums
Life tends to operate in cycles. For a while, something may be in fashion. Then it goes out of fashion. Later, it comes back into fashion. This applies to more than just high fashion apparel. Take automobiles, for example. Sometimes, economy cars are more in fashion, sometimes luxury cars are more in fashion. Sometimes trucks, minivans or sport utility vehicles are more in fashion. This is why many companies have a strategy that includes a portfolio of products and services. That way, they can more easily shift with the changing cycles and fashions.
Other times, patterns look more like a pendulum. For example, opinions may grow increasingly more liberal until people see the flaws in liberal extremism, so they start swinging the pendulum back towards conservatism. Then, when they see the flaws in conservative extremism, the pendulum moves towards liberalism, and so on.
Some cycles can be very long and their patterns cannot be detected if you only look at trends from the last couple of years. For example, in economics, there are some who believe in the Kondratiev long wave economic cycle, which takes approximately 50 years to complete. In human behavior, there has been some research around a pattern that repeats itself every four generations. This cycle has been traced back to the late 1500s, with the same pattern of four successive generational types happening over and over again (For more on this subject, see the writings of William Strauss and Neil Howe, including their books “The Fourth Turning” and “Generations” or visit the webpage www.timepage.org/time.html). If you understand these cycles, you can do a better job of predicting what might happen next, even if it is not a direct continuation of the trends of the recent past.
Making predictions into the future can be a tricky business. To help reduce error and make predictions more accurate, businesses have relied on the science of mathematics. Using complex mathematical formulas, even the smallest of historical trends can be projected into a “mathematically plausible” future.
Unfortunately, mathematics can only go so far in creating a plausible future. Back in the 1970s, a mathematician made an observation regarding the rapid growth in Elvis Pressley impersonators. After Elvis had died, a large number of singers started dressing up like Elvis and performing the old Elvis tunes before audiences. This form of entertainment quickly became very popular. Elvis impersonating became a large, successful business. As a result, there was an extremely rapid rise in the number of people becoming Elvis impersonators.
Using sophisticated mathematical formulas, this mathematician took the historically rapid rise in Elvis impersonators that occurred shortly after Elvis’ death in the 1970s and made a projection: If this growth in Elvis impersonators were to continue at the same rate into the future as had occurred in the past, every human being on the planet would eventually become an Elvis impersonator sometime around the year 2025.
Well, here we are, about thirty years later, and the last time I checked, none of the people I know are Elvis impersonators (or at least none of them admit it). The mathematical formulas may have been correct, but the prediction was wrong.
The Analogy
The goal of strategic planning is to proactively create a more desirable future state for your business. To build a winning position in the future, it is useful to understand the type of future environment you are designing a winning position for. Therefore, good strategic planning begins by trying to understand the future.
Many different tools and techniques are used to try to understand what the future environment might look like. Although these techniques may use different mathematical formulas, most of the techniques rely on taking historical trends and projecting some sort of continuation of these trends into the future. This was the technique used by the mathematician mentioned above to predict the future of Elvis impersonization.
Unfortunately, historical trendlines of the past are rarely continued at the same exact pace forever into the future. That is why we are not all Elvis impersonators today. The rate of growth in Elvis impersonators quickly slowed down considerably and eventually started to decline.
The point at which a trendline or curve changes its rate of growth is called an inflection point (see figure below). If you misunderstand the timing and magnitude of inflection points, your predictions of the future will be as inaccurate as the projection that we would all become Elvis impersonators.
The Principle
I have seen many executives make terrible strategic mistakes because they failed to take into account inflection points in their analysis of the future. When times are good, they assume that times will always be good. They project the growth of today into growth forever. Huge investments are made in adding manufacturing capacity for anticipated growth. About the time the new factories start producing products, the growth in demand for the product has already slowed. Huge inventories are built up that cannot be sold. It turns out the product was only a short-term fad and the company goes bankrupt.
There are several forces that cause inflections to occur:
1. Competitive Reactions
2. Natural Limits
3. Cycles and Pendulums
4. Discontinuities
5. Influence
These are briefly discussed below.
1. Competitive Reactions
If you are being successful in the marketplace, assume that competition will respond to blunt your success. Remember, if you are gaining market share, that means that someone else is losing market share. Those who are losing share will do whatever they can to stop the loss. This typically slows down your growth.
Even if your success is based on creating an entirely new market, expect a reaction. After all, there are so few truly new growth businesses out there. When companies see them, they all want to get a piece of the action. So even if the new market continues to grow rapidly, your participation in that growth may slow down due to increased competition in that space. For more information on competitive reactions, see the blog entitled Bombs Start Wars.
2. Natural Limits
Growth cannot go on forever, because there are natural limits to growth. For example, to be a successful Elvis impersonator, you need to have a large enough audience willing to pay to see you perform. If everyone was an Elvis impersonator, there would be nobody in the audience. Hence, Elvis impersonation is limited by the size of the audience willing to pay to hear a performance. So one needs to understand how limited the preference is for your product or service.
There are other natural limits as well, like finances. Customers have only so much money to spend, and you cannot get over 100% of the available money. There are also limits on the availability of natural resources. For example, I heard someone do the math on what would happen if everyone in China started drinking one extra can of beer per day or one extra hamburger per day. There is not enough grain in the world to meet that kind of demand.
Therefore, one of the initial steps in any strategic plan should be an analysis of the potential limits to the size of your market. If you significantly over- or under-estimate the market size, you may end up making the wrong strategic choices.
3. Cycles and Pendulums
Life tends to operate in cycles. For a while, something may be in fashion. Then it goes out of fashion. Later, it comes back into fashion. This applies to more than just high fashion apparel. Take automobiles, for example. Sometimes, economy cars are more in fashion, sometimes luxury cars are more in fashion. Sometimes trucks, minivans or sport utility vehicles are more in fashion. This is why many companies have a strategy that includes a portfolio of products and services. That way, they can more easily shift with the changing cycles and fashions.
Other times, patterns look more like a pendulum. For example, opinions may grow increasingly more liberal until people see the flaws in liberal extremism, so they start swinging the pendulum back towards conservatism. Then, when they see the flaws in conservative extremism, the pendulum moves towards liberalism, and so on.
Some cycles can be very long and their patterns cannot be detected if you only look at trends from the last couple of years. For example, in economics, there are some who believe in the Kondratiev long wave economic cycle, which takes approximately 50 years to complete. In human behavior, there has been some research around a pattern that repeats itself every four generations. This cycle has been traced back to the late 1500s, with the same pattern of four successive generational types happening over and over again (For more on this subject, see the writings of William Strauss and Neil Howe, including their books “The Fourth Turning” and “Generations” or visit the webpage www.timepage.org/time.html). If you understand these cycles, you can do a better job of predicting what might happen next, even if it is not a direct continuation of the trends of the recent past.
4. Discontinuities
Sometimes, dramatic changes just happen which have little to do with the past. Some are discontinuities we can create by ignoring conventional wisdom and trying something radically different. For example, conventional wisdom for almost 100 years said that to sell photographic cameras, you needed to emphasize durability, reliability and quality. Then, all of the sudden, disposable one-use cameras came on the market that never talked about durability, but instead stressed convenience. These disposable cameras are now a significant portion of the photography business. Another discontinuity was getting North Americans, who were used to getting drinking water for virtually free, to start paying for it by the bottle.
Other discontinuities are caused by unusual outside circumstances. For example, an event like the terrorist attack on the United States on September 11, 2001 suddenly changed a number of businesses, such as the airlines industry. Although these types of discontinuities may be difficult to predict, it is sometimes useful in strategy to look at a variety of potential scenarios, so that if one of the scenarios were to suddenly occur, you would be ready to react quickly.
5. Influence
Businesses do not have to just sit back idly and wait for the future to come. Often times, a company has the opportunity to influence how the future will evolve. You may be able to help determine the next fashion cycle. You may be able to influence factors that affect natural limits. You may be able to prepare yourself to optimize in the next phase in a longer cycle and maybe even hasten the advance to the next phase. You can create the next great discontinuity in your business. You can create scenarios to anticipate a variety of potential futures, so that you are prepared in advance for a number of potential outcomes.
As you can see, strategic planning can be very useful in helping you cope with an uncertain future by:
- Helping you to know in which direction to use influence to modify the future to your advantage.
- Helping you to see a larger cycle, so that you can anticipate the next phase and find the path get there ahead of the competition.
- Helping you to envision many potential futures, so that whatever happens in the future, you will have a well thought out strategy for that situation. Strategies thought out patiently in advance tend to be better than hasty reactions when discontinuities first appear.
Summary
One of the main goals of strategic planning is to proactively create a more desirable future state for your business. To do this properly, one must have a reasonable expectation of what that future will look like. Although it is impossible to achieve complete accuracy about what the future will be, it is a safe bet to assume that the future will not be just an identical continuation of the trends of the past. Trends change, due to a number of factors, like:
1. Competitive Reactions
2. Natural Limits
3. Cycles and Pendulums
4. Discontinuities
5. Influence
It is important to include these factors in your predictions of the future. Otherwise, you will end up with predictions as ridiculous as the one that claims we will all become Elvis impersonators.
Final Thoughts
Some people say that because the future is unknown and that recent trends cannot predict what will happen next, planning for the future is a waste of time. Just live for maximizing today and worry about tomorrow when it comes.
I say just the opposite. Because the future is unknown and unpredictable, you have an opportunity to alter the course of how the future unfolds. The beauty of the future is that it is far enough away that you have time to influence in part how it will look. If you take the time to plan properly, you can create a much better position for your business. It is precisely because of the uncertainty that one needs to plan. If the future were entirely knowable, you could not influence the outcome and planning would be meaningless.
Because the future is not obvious, you can obtain a competitive edge if you spend more time trying to understand and influence it than your competition. Uncertainty makes the value of planning increase, not decrease.
Monday, February 12, 2007
What's A Few Seconds Among Friends
THE STORY
Once there were three physicists. They were standing next to a tall skyscraper. Suddenly, a loud voice came from above, shouting, “Watch out! I’m going to jump!” The physicists looked up and saw a man standing on a ledge of the skyscraper looking like he is about to jump.
One physicist turned to the others and remarked, “I wonder how long it would take for the man on the ledge to hit the ground after he jumps.” This started a heated debate. The following comments were made by the physicists:
“Well, speed equals mass times acceleration, so if we can determine the exact mass of the man on the ledge and the exact height of the building, we could get an answer. Maybe if I go to the city records, I can find a blueprint showing the exact building height. While I’m doing that, perhaps one of you could kindly ask the man what his mass is.”
“That’s all well and good, but I think the weather will affect your calculation. It is very humid and windy today. This will alter the speed. I need to check with the weather bureau for precise conditions.”
“And don’t forget about that coat he’s wearing. It is a big trench coat. I suspect that when he jumps, the coat will fill up with air and act like a parachute, slowing him down. Perhaps I should run a few models on my computer with various coat-billowing scenarios.”
So all three physicists went off and did serious and extensive research on the problem. When they finally got back together again at the base of the skyscraper, they all had come to different conclusions. One predicted 5.34 seconds, one predicted 6.02 seconds and the third predicted 6.53 seconds. This started another series of arguments as to who was right and why the others’ analyses were flawed.
Finally, one of them said, “The only way that we’ll ever know is through experimentation. Let’s time how long it takes the man on the roof to hit the ground after he jumps.” They all agreed, but when they looked up, the man was no longer on the ledge.
As it turns out, while they were out doing research, the man on the ledge jumped and hit the ground in 5.7 seconds. Police and the ambulance service had already taken care of the problem before the physicists got back. Unaware of what happened, the physicists turned their attention to ponder another problem—why the sidewalk by the skyscraper was so dirty.
THE ANALOGY
Sometimes, in our attempt to precisely understand a problem, we get caught up in the research and the minutia, missing the big picture. The big picture in the story was that a man was contemplating a jump to his death. The physicists had the opportunity to try to stop the tragedy. They could have tried to talk him out of it. Or they could have called some experts to come in to help. Or they could have tried to find a net to cushion his fall. Instead, they wasted time trying to get more precision on the phenomenon.
In the end, it doesn’t really matter if the man hits the ground in 4 seconds, 5 seconds or 6 seconds. In the end, what matters is that a tragedy was about to occur and they did nothing to stop it.
This same thing happens in strategic planning. People can spend months (or maybe years) trying to make the forecasts of the future as accurate as possible. While all of the time is spent on gaining this extra precision, the world keeps moving forward. By the time one reaches the conclusion, it may already be too late to take any action. The phenomenon one is trying to predict may already occur, and you are unprepared with a strategy for dealing with it.
You can see this in rapidly changing environments, like digital entertainment and mobile phones. By the time the market settles down and you can accurately predict the outcome, it will be too late to develop and implement any sort of strategy to become a major player in that area. The rules will already be in place and the consumers will have already made their choices of who is going to win. You may have accuracy on your side, but the competition will have the profits.
THE PRINCIPLE
Precision can make us feel more comfortable. After all, isn’t it risky to act with less than perfect information? Even if you cannot achieve perfect information, isn’t it true that the more precise and accurate your findings, the better off you are? Not exactly. There are many reasons why the pursuit of added accuracy can be detrimental to your strategic health:
1) Nobody knows exactly how the future will unfold. There are too many variables. At some point, further research will not help get you any closer to understanding the future. You just have to make some educated guesses.
2) Speed can often be very critical. Windows of opportunity can shut quickly. Others can get the advantage quickly if your retaliation is slow. Time spent in search of excessive precision can be time not spent in timely action.
3) In your search for details, you can lose sight of the big picture. You might even end up looking for precision in the wrong direction. It’s like the old saying of understanding a tree but losing sight of the whole forest.
4) Precision can give the illusion of knowing more about an uncertain future than you really know. It can give you the false confidence to move forward boldly, without giving any further scrutiny to your situation.
So, if too much precision is potentially dangerous and no knowledge is dangerous, what is a person to do? The answer is to substitute precision with assessment. Assessment involves knowing three things:
1) DIRECTION: Which direction are the trends heading? Higher or lower; bigger or smaller; better or worse; stronger or weaker? This can apply to consumer beliefs/behavior trends, competitive trends, technology trends, economic trends, etc.
2) MAGNITUDE: How far is it going in that direction? Big or Really Big; a Little Better or Much Better; a Little Stronger or Quite a Bit Stronger?
3) SPEED: Is the trend moving in the direction to this magnitude quickly or slowly? How soon will the trend manifest itself?
The key in the whole analysis game is to research until you are reasonably sure that further research would not make a major difference in what you choose to do. Then stop the research and do what you choose to do. In most cases, if you know the direction, magnitude and speed of the trends around you, then you know enough to do the right thing.
In the story, it was irrelevant whether the jump from the skyscraper would take 5, 6, or 7 seconds. No matter how many seconds it took, the key facts were already known:
1) Direction: Is the trend going Up or Down?
2) Magnitude: Is it happening a little or a lot?
3) Speed: Is it happening quickly or slowly?
In most cases, this will let you know enough to get your company moving in the right strategic direction (and save a lot of precious time).
FINAL THOUGHTS
The physicists were so busy gathering data that they didn’t even know that the terrible event actually occurred. The clean up was so quick that all they saw was a dirty sidewalk. If you miss out on acting timely due to busyness, your business will quickly disappear as well, leaving little more than a little smudge in the memory of time.
Once there were three physicists. They were standing next to a tall skyscraper. Suddenly, a loud voice came from above, shouting, “Watch out! I’m going to jump!” The physicists looked up and saw a man standing on a ledge of the skyscraper looking like he is about to jump.
One physicist turned to the others and remarked, “I wonder how long it would take for the man on the ledge to hit the ground after he jumps.” This started a heated debate. The following comments were made by the physicists:
“Well, speed equals mass times acceleration, so if we can determine the exact mass of the man on the ledge and the exact height of the building, we could get an answer. Maybe if I go to the city records, I can find a blueprint showing the exact building height. While I’m doing that, perhaps one of you could kindly ask the man what his mass is.”
“That’s all well and good, but I think the weather will affect your calculation. It is very humid and windy today. This will alter the speed. I need to check with the weather bureau for precise conditions.”
“And don’t forget about that coat he’s wearing. It is a big trench coat. I suspect that when he jumps, the coat will fill up with air and act like a parachute, slowing him down. Perhaps I should run a few models on my computer with various coat-billowing scenarios.”
So all three physicists went off and did serious and extensive research on the problem. When they finally got back together again at the base of the skyscraper, they all had come to different conclusions. One predicted 5.34 seconds, one predicted 6.02 seconds and the third predicted 6.53 seconds. This started another series of arguments as to who was right and why the others’ analyses were flawed.
Finally, one of them said, “The only way that we’ll ever know is through experimentation. Let’s time how long it takes the man on the roof to hit the ground after he jumps.” They all agreed, but when they looked up, the man was no longer on the ledge.
As it turns out, while they were out doing research, the man on the ledge jumped and hit the ground in 5.7 seconds. Police and the ambulance service had already taken care of the problem before the physicists got back. Unaware of what happened, the physicists turned their attention to ponder another problem—why the sidewalk by the skyscraper was so dirty.
THE ANALOGY
Sometimes, in our attempt to precisely understand a problem, we get caught up in the research and the minutia, missing the big picture. The big picture in the story was that a man was contemplating a jump to his death. The physicists had the opportunity to try to stop the tragedy. They could have tried to talk him out of it. Or they could have called some experts to come in to help. Or they could have tried to find a net to cushion his fall. Instead, they wasted time trying to get more precision on the phenomenon.
In the end, it doesn’t really matter if the man hits the ground in 4 seconds, 5 seconds or 6 seconds. In the end, what matters is that a tragedy was about to occur and they did nothing to stop it.
This same thing happens in strategic planning. People can spend months (or maybe years) trying to make the forecasts of the future as accurate as possible. While all of the time is spent on gaining this extra precision, the world keeps moving forward. By the time one reaches the conclusion, it may already be too late to take any action. The phenomenon one is trying to predict may already occur, and you are unprepared with a strategy for dealing with it.
You can see this in rapidly changing environments, like digital entertainment and mobile phones. By the time the market settles down and you can accurately predict the outcome, it will be too late to develop and implement any sort of strategy to become a major player in that area. The rules will already be in place and the consumers will have already made their choices of who is going to win. You may have accuracy on your side, but the competition will have the profits.
THE PRINCIPLE
Precision can make us feel more comfortable. After all, isn’t it risky to act with less than perfect information? Even if you cannot achieve perfect information, isn’t it true that the more precise and accurate your findings, the better off you are? Not exactly. There are many reasons why the pursuit of added accuracy can be detrimental to your strategic health:
1) Nobody knows exactly how the future will unfold. There are too many variables. At some point, further research will not help get you any closer to understanding the future. You just have to make some educated guesses.
2) Speed can often be very critical. Windows of opportunity can shut quickly. Others can get the advantage quickly if your retaliation is slow. Time spent in search of excessive precision can be time not spent in timely action.
3) In your search for details, you can lose sight of the big picture. You might even end up looking for precision in the wrong direction. It’s like the old saying of understanding a tree but losing sight of the whole forest.
4) Precision can give the illusion of knowing more about an uncertain future than you really know. It can give you the false confidence to move forward boldly, without giving any further scrutiny to your situation.
So, if too much precision is potentially dangerous and no knowledge is dangerous, what is a person to do? The answer is to substitute precision with assessment. Assessment involves knowing three things:
1) DIRECTION: Which direction are the trends heading? Higher or lower; bigger or smaller; better or worse; stronger or weaker? This can apply to consumer beliefs/behavior trends, competitive trends, technology trends, economic trends, etc.
2) MAGNITUDE: How far is it going in that direction? Big or Really Big; a Little Better or Much Better; a Little Stronger or Quite a Bit Stronger?
3) SPEED: Is the trend moving in the direction to this magnitude quickly or slowly? How soon will the trend manifest itself?
The key in the whole analysis game is to research until you are reasonably sure that further research would not make a major difference in what you choose to do. Then stop the research and do what you choose to do. In most cases, if you know the direction, magnitude and speed of the trends around you, then you know enough to do the right thing.
In the story, it was irrelevant whether the jump from the skyscraper would take 5, 6, or 7 seconds. No matter how many seconds it took, the key facts were already known:
- Direction: A movement towards injury—a bad direction.
- Magnitude: Very High, Very Severe—nearly certain death.
- Speed: The likelihood is that it will happen very soon, and when it happens, the event will occur very quickly.
That was enough knowledge to take action to prevent the man from jumping. One didn’t need to research the building height, weather conditions, or the air resistance of a coat. One needed to act immediately.
This is also true in business. If you can quickly assess the direction, magnitude and speed of what is going on around you, then you can move forward. In fact, if you continued on and built a big fat binder full of numbers to three decimal points, it is unlikely that your conclusion would meaningfully be any different than if you had stopped when you knew the direction, magnitude and speed.
SUMMARY
When in need of a strategic decision, before diving into a lengthy research project with lots of precision, ask yourself three questions:
1) Direction: Is the trend going Up or Down?
2) Magnitude: Is it happening a little or a lot?
3) Speed: Is it happening quickly or slowly?
In most cases, this will let you know enough to get your company moving in the right strategic direction (and save a lot of precious time).
FINAL THOUGHTS
The physicists were so busy gathering data that they didn’t even know that the terrible event actually occurred. The clean up was so quick that all they saw was a dirty sidewalk. If you miss out on acting timely due to busyness, your business will quickly disappear as well, leaving little more than a little smudge in the memory of time.
Saturday, February 10, 2007
Home Field Dis-Advantage
The Story
Businesses often use sports analogies to describe business strategy. One aspect of sports is the concept of “home field advantage.” Home field advantage refers to the fact that sports teams are more likely to win games played at their own field or court than they do playing at the opponent’s field. Let us see how this principle applies to the business world in the following story.
I knew a retailer that had a very successful retail concept, which had been expanded to a large section of the United States. Virtually everywhere the retailer built these stores, it quickly gained significant market share and became very profitable. There was one significant exception to this pattern. When the retailer expanded into one particular city in the United States, it ran across a competitor that it could not beat. In fact, the stores the retailer built in this city did so poorly that they were quickly closed.
This rival competitor was a much smaller company with far fewer resources. Yet this smaller competitor was starting to expand into the area held by my retail friend. Given the overlapping expansion plans for both companies, it was becoming obvious that these two competitors were destined to compete again in the future.
This left my retail friend with a choice:
The first choice would be like playing a sports game at home, while the second option would be like playing an away game.
My retail friend used to be a professional sports athlete. Relying on his sports background, he chose the option of playing the game at home and let the competitor come into his stronghold. His figuring was that, like in sports, he was more likely to win on his home territory, so this was the better place to have the contest.
What my retail friend failed to realize was that the competitor had increased prices in its own retail stronghold in order to fund the battle against my friend. This competitor started attacking some of my friend’s most profitable markets with a small handful of stores. Although I’m sure those new stores were not very profitable for the competitor, they wiped out a larger amount of profitability for my friend, since he had more stores in the market and these were some of his most profitable stores.
With some of his most profitable markets in shambles, my friend’s overall chain results were noticeably down. Not wanting to disappoint his shareholders with bad results, he started raising the prices in his remaining markets to cover the losses in the contested markets. All that served to do was make those uncontested markets less competitive and even more vulnerable for attack. Since the competitor was still making good profits in his stronghold markets, he was able to fund an increase in attacks. All the while, he was getting stronger, while my friend was getting weaker.
To make a long story short, in the years since this competitive battle began, my friend has had to retreat to the point where virtually the only place where the business makes money anymore is in the original home city. By contrast, the competitor is much larger, much stronger, and competes over a much larger territory. It looks like the home field advantage was not much of an advantage after all.
The Analogy
Although there are many parallels between sports and business, the battles are not identical. The analogy between sports and business breaks down because business is not played one game at a time. In team sports:
By contrast, in the business world:
As a result, many of the reasons why home field advantage works in the sports world do not work in the business world. In fact, the opposite is often true—there is often a home field dis-advantage.
As we saw in the story above, my friend tried to move the business battle to where he thought he would have home field advantage. As a result of that decision, he ended up losing the overall battle against this competitor. The disadvantages of “playing the game at home” where one already has a strong position are as follows:
Businesses often use sports analogies to describe business strategy. One aspect of sports is the concept of “home field advantage.” Home field advantage refers to the fact that sports teams are more likely to win games played at their own field or court than they do playing at the opponent’s field. Let us see how this principle applies to the business world in the following story.
I knew a retailer that had a very successful retail concept, which had been expanded to a large section of the United States. Virtually everywhere the retailer built these stores, it quickly gained significant market share and became very profitable. There was one significant exception to this pattern. When the retailer expanded into one particular city in the United States, it ran across a competitor that it could not beat. In fact, the stores the retailer built in this city did so poorly that they were quickly closed.
This rival competitor was a much smaller company with far fewer resources. Yet this smaller competitor was starting to expand into the area held by my retail friend. Given the overlapping expansion plans for both companies, it was becoming obvious that these two competitors were destined to compete again in the future.
This left my retail friend with a choice:
- Does he allow the competitor to come into his geographic stronghold and fight the battle here; or
- Does he aggressively go into the stronghold of the competitor and fight the battle there?
The first choice would be like playing a sports game at home, while the second option would be like playing an away game.
My retail friend used to be a professional sports athlete. Relying on his sports background, he chose the option of playing the game at home and let the competitor come into his stronghold. His figuring was that, like in sports, he was more likely to win on his home territory, so this was the better place to have the contest.
What my retail friend failed to realize was that the competitor had increased prices in its own retail stronghold in order to fund the battle against my friend. This competitor started attacking some of my friend’s most profitable markets with a small handful of stores. Although I’m sure those new stores were not very profitable for the competitor, they wiped out a larger amount of profitability for my friend, since he had more stores in the market and these were some of his most profitable stores.
With some of his most profitable markets in shambles, my friend’s overall chain results were noticeably down. Not wanting to disappoint his shareholders with bad results, he started raising the prices in his remaining markets to cover the losses in the contested markets. All that served to do was make those uncontested markets less competitive and even more vulnerable for attack. Since the competitor was still making good profits in his stronghold markets, he was able to fund an increase in attacks. All the while, he was getting stronger, while my friend was getting weaker.
To make a long story short, in the years since this competitive battle began, my friend has had to retreat to the point where virtually the only place where the business makes money anymore is in the original home city. By contrast, the competitor is much larger, much stronger, and competes over a much larger territory. It looks like the home field advantage was not much of an advantage after all.
The Analogy
Although there are many parallels between sports and business, the battles are not identical. The analogy between sports and business breaks down because business is not played one game at a time. In team sports:
- The entire contest takes place at a single location against a single opponent.
- The entire battle typically falls within the confines of a timed event. When the time runs out, the team with the most points wins.
- After the game is over, the next game is played as if that last game never occurred. The points do not carry over. You both start out the next game tied at 0-0.
By contrast, in the business world:
- The business plays in multiple locations at the same time against multiple opponents. Resources can be moved between battles in the middle of the battle.
- The battle does not end when time runs out. It either ends when one side is so devastated that it gives up, or when both sides find a way to peacefully co-exist.
- After the battle is over, the strengths and weaknesses continue into the next game. If you ended the last battle in weakness, you start the next battle in weakness.
As a result, many of the reasons why home field advantage works in the sports world do not work in the business world. In fact, the opposite is often true—there is often a home field dis-advantage.
As we saw in the story above, my friend tried to move the business battle to where he thought he would have home field advantage. As a result of that decision, he ended up losing the overall battle against this competitor. The disadvantages of “playing the game at home” where one already has a strong position are as follows:
- In business, if you win a game at home, you are no better off than when you began. You have only defended to achieve what you already had. In fact, even if you win, you may be further behind than when you started, because of the resources spent to defend your position. However, if you lose at home, it is a real and major loss of a profitable portion of your business that does not come back once the contest is over. Hence, there is little upside and a big downside to playing at home where you are strong.
- A loss at home in the business world leaves you in a weakened position when the contest is over. The loss permanently reduces one’s available resources to use in the next battle. Unlike sports, the loss carries over in the next game, making it harder to win future games. Even if you win a battle at home, it does not necessarily make you any stronger against the next opponent. You just stay even. Hence, a loss at home creates the potential for a long-term downward spiral across many battles, whereas a win just helps you maintain the status quo.
The opposite occurs when a business “plays an away game” in the heart of where the opponent is strongest. If you win, you gain greatly—you have gained a stronghold in a new area as well as greatly weakened an opponent. You have moved the balance of power more in your favor by adding new profit opportunities for yourself while taking profit opportunities away from your opponent. If you lose, most of what you have lost is just the opportunity to gain more ground.
Most importantly, by moving the battle to the opponent’s stronghold, you keep the battle from attacking your most profitable markets while you attack your opponents most profitable markets. It is easier for you to fund the battle when your core markets are protected, while it is harder for your opponent to fund that same battle when their core is under attack.
The Principle
In the business world, there are many ways in which you can have the option of either playing a home game or an away game. A home game is where you are relatively stronger. An away game is where your competition is relatively stronger. That strength can be in many categories. It could be a geographical strength, where in international business competition, you are stronger in some countries than in others. It could be a product category strength, where you have higher market shares in some categories than in others. It could also be a technology strength, a distribution channel strength, or a consumer demographic strength.
When developing strategy, you often have the choice of determining whether your competitive struggles take place predominantly at your position of strength or at the position of your competitor’s strength. Often, our initial reaction is to always set the battle to take place at our position of greatest strength. We think this will automatically give us “home field advantage.”
However, as we saw in the story above, home field can often be a disadvantage. There may be many times when it makes more sense to make the competitive battle an away game. There are two times when away games make more sense in the business world:
- When I am very large and resourceful while my competitor is much smaller with fewer total resources.
- When I am much smaller with fewer resources and my competitor is very large and resourceful.
In the first instance, the analogy would be like siege warfare. In siege warfare, an army with large resources would surround the castle of its enemy, cutting off its access to any resources beyond the castle. In a process of attrition, the larger force with the greater resources would outlast the weaker force in the castle, who eventually runs out of food and must surrender or starve.
Even though the “home team” in the castle is stronger in that particular area of business than the attacker, the attacker can draw upon resources from other businesses where it is overall much stronger. The strategy for the attacker becomes total resources against total resources, rather than weakness against strength in this particular area of business.
Relating this to the story mentioned at the beginning of this chapter, my friend could have attacked the stronghold “castle” market of the smaller competitor and outlasted him because my friend had far more resources. In a war of attrition, the competitor would have run out of resources first in defending its territory. The added benefit for my friend would have been that if he had held siege to the competitor’s castle, the competitor would have been unable to fund attacks into my friend’s territory. Unfortunately, he did not do this.
In the second example, the analogy would be guerrilla warfare. The strategic goal of guerrilla warfare is to make small, quick attacks on your stronger enemy—in their territory—in such a way that the damage to the opponent is greater than the damage to yourself. Over time, such attacks will gradually make the guerrilla stronger, while gradually making his opponent weaker. In time, the balance of power would change, and the formerly weaker guerrilla becomes the stronger of the two.
The assumption here is that, even if you are relatively weaker, you have some uniqueness in your overall strategic position so that you can win some of the guerrilla skirmishes. For example, even though you are smaller, you may be faster, more personalized, or provide better service. If you are both smaller and have no unique benefits to bring to bear, then it doesn’t matter what you do. You will lose no matter what you do.
Guerrilla warfare was the tactic the competitor effectively used against my friend in the story above. It worked well and my friend lost the overall battle.
Summary
Business strategy is often similar to sports strategy. However, not all sports analogies apply well to business. In particular, the idea of “home field advantage” in sports is often “home field dis-advantage” in the business world. When designing a business strategy, it can frequently make sense to move the location of the competitive battle away from your position of strength into your competitor’s position of strength.
If you are still having trouble seeing the benefit of playing an away game, here is something to consider. Over the last century, there have been numerous large, successful, established companies that eventually lost out to a small upstart firm. In almost every case, there was a point in time when the established company had enough relative power that they could have played an away game against the upstart and weakened it to the point where it would never have gained enough clout to eventually win.
A key part of strategy is determining who the next upstart is who might have the power to eventually beat you, and then playing an away game against them early, which keeps them from ever becoming meaningful in the marketplace. For example, in the early 1970’s, K Mart was one of the strongest and most powerful retailers on the planet. At that time, there was a small upstart retailer called Wal-Mart that was starting to grow out of it rural base. K Mart could have played an away game against Wal-Mart at that time in those rural markets and won. Instead, it chose not to do so. Today, K Mart is in bankruptcy and Wal-Mart is the largest retailer on the planet.
Final Thoughts
The irony of the story above was the fact that the basic idea of the home field dis-advantage was pointed out to my friend before he made his choice. He was told that the ideal strategy was to fight the battle at the opponent’s stronghold. His response was, “Don’t give me a strategy. Just tell me how to make money.”
When you play your business as an away game, you will suffer some financial loss at first. Your opponent, however, should suffer an even greater loss. In the long-run, this strategy will usually create much more wealth, even if there is a little pain at the beginning. To quote a famous sports adage, “No pain, no gain.”
Thursday, February 8, 2007
Raking Up Losses
THE STORY
Once upon a time, there was a wealthy man who owned a large estate out in the country. The back of the estate was filled with large trees. They were beautiful to look at, but a real nuisance in the fall when all of the leaves came down.
The wealthy man did not like having those leaves all over his yard, so he decided he would hire all of the young boys in the neighborhood to rake up his leaves for him. It was important to this man that each boy got paid fairly based on the amount of work the boy did. He didn’t want the lazy boys to get paid as much as the boys who worked hard. Therefore, he designed what he thought was a clever plan.
He divided the huge yard into sections. Each boy was given his own section to rake. The rules were simple. Every time you clear your section of leaves you would get paid a predetermined amount. If you didn’t clear your section, you did not get paid anything at all. The wealthy man put his lazy, spoiled son in charge of inspecting the sections, to see if they were cleared of leaves and to then pay the boys each time their area was clear.
This plan made the wealthy man happy. He was so confident in the plan’s success that he ignored the yard for several weeks. Eventually, he decided to go out back to see how the raking was going on. When he got there, he was shocked to find that all of the leaves were still scattered all over the yard. It was a real mess.
He angrily looked for his son to find out what happened. The wealthy man yelled at his son, saying “After all of these weeks, none of the leaves have been raked up. I certainly hope that you didn’t pay any of those young boys.”
“Actually,” the lazy son said, “I ended up paying them a hundred thousand dollars.”
“A HUNDRED THOUSAND DOLLARS?” the man screamed. “Why did you pay them so much money, when it is obvious that all off the leaves are still on the ground? Are you crazy??”
“I only did just what you said,” replied the son. “Each boy started working with the boy in the section next to theirs. One boy would rake his leaves just over the line onto the section next to him. I would pay him. Then the other boy would rake the leaves back over the line to the first boy. So then I would pay the second boy. All day long, they would rake the pile of leaves back and forth just across the line of their section. Each time one of them pushed the pile of leaves across the line, they would get paid. Eventually the boys got very good at quickly moving the leaf piles back and forth. After awhile, they had made so much money that they all decided to go back home.”
Suddenly, the wealthy man could see the major flaw in what he originally thought was a clever plan. He sighed, “Well, it looks like the only thing that got raked over and cleaned out here was my bank account.”
THE ANALOGY
It’s natural to want to reward the people who work hard and not reward the lazy ones. It seems like the fair thing to do. This was what the wealthy man was trying to do. However, in his attempt to be as fair as possible, he lost sight of the bigger goal. What he really wanted was to rid his yard of leaves. By focusing too much on fairness, he created a reward system that encouraged behavior that did not lead to achieving the desired ultimate goal.
Once we determine a desired strategic goal, we want to set up a compensation system which fairly rewards people who help achieve the strategy. However, if we concentrate too much on “individual fairness” we can end up rewarding people for things that never get us closer to achieving the strategy. Like the man in the story, the only thing we end up doing is raking up losses.
THE PRINCIPLE
As people, we often link “fairness” with “control.” We think that the fair thing to do is to only compensate people for those things that they have direct and/or complete control over. After all, does it seem fair to penalize someone when undesirable results happen over which they do not have direct or complete control? Or, conversely, does it seem fair to reward someone when desirable results happen which they didn’t control?
I couldn’t count the number of times I’ve seen someone look at how they were to be compensated and heard them complain by saying something like, “You can’t bonus me on that. I don’t control the outcome. It’s not fair.”
The problem is that if the individual has complete control over the results, then they have complete control over how to manipulate the results to their personal advantage. Now, to me, that doesn’t sound fair, either.
The boys in the story pretty much had complete control over their situation. Not only could they control how quickly their area got clean, but they could also control how quickly it got dirty. By manipulating that control, they got paid far more than they should have while never accomplishing the greater task of getting the yard clean.
That is why the fairest compensation needs to be one that goes well beyond just compensating people for what they can directly control. It needs to include areas for which they have indirect control and areas which relate directly to moving the company towards achieving the desired strategic outcome.
As it turns out, people have more influence on a business than just areas directly under their control. For example, I know of a clothing retailer where the buyers were compensated for buying the apparel from the manufacturers as cheaply as possible. After all, they are buyers, so they should be compensated for buying well. However, in their attempt to get the lowest price, the buyers would not have the manufacturers put the clothes on hangers or put price tags on the clothes. If they would have asked the manufacturer to do these services, the manufacturers would have charged a higher price, which works against the buyer’s compensation.
Unfortunately, because the buyers did not take care of negotiating for the hanging or tagging, someone in the retailer’s distribution center would have to do that service. It is like in the story where the boys did not clean the yard. All they did was push the leaves into someone else’s grid. All the buyers did was push the hanging and tagging problem into the distribution center’s grid.
In most cases, the manufacturer could perform these services for less than half the cost of the distribution center. So the actions of the buyers had an impact over the costs of the distribution center, an area over which the buyers would say they had no control. In reality, however, they had significant influence. Had the buyers been compensated on the lowest cost to get the goods from the manufacturer to the sales floor, they would have complained about lack of control. However, they also would have negotiated to get the manufacturers to hang and tag the goods, thereby saving the company more money than they did under their current compensation.
Often times, the biggest cost bottlenecks are at the point of transfer between two areas in an organization. As long as compensation stays within the areas of complete control, these transfer points do not get adequately addressed, since the responsibility is shared. By compensating based on areas outside one’s complete control, the transfer points get addressed.
Even in areas where there seems to be very little, if any linkage, there are still ways in which you can control the outcome. There is peer pressure. One can give advice or assistance. One can shift or trade some areas of responsibility that will end up making everyone more productive. And so on.
Finally, it is important to link rewards directly with the strategy. The compensation given the boys was never linked to the goal of getting the entire yard cleared of leaves. As a result, the yard was never cleared. At the end of the day, it is more important that the organization achieves its strategy than for individual areas to temporarily gain while the strategy is ignored. For if the strategy is ignored, eventually everyone loses…and that isn’t very fair.
SUMMARY
It is more important to link compensation to a broader strategy than to what an individual area can completely control. Although this may at first seem unfair, it is actually more fair, because complete control leads to “gaming the system” for personal benefit at the expense of the rest of the organization.
FINAL THOUGHTS
When you focus on smaller goals, you can sometimes perfect a process that does not need to be done at all. For example, if the only thing the wealthy man wanted was to get rid of the leaves, he could have cut down the trees. Then all the costs of raking the leaves every year could be eliminated. Perfecting the unnecessary is a waste of energy. When you focus on the big picture, you often find more creative solutions.
Once upon a time, there was a wealthy man who owned a large estate out in the country. The back of the estate was filled with large trees. They were beautiful to look at, but a real nuisance in the fall when all of the leaves came down.
The wealthy man did not like having those leaves all over his yard, so he decided he would hire all of the young boys in the neighborhood to rake up his leaves for him. It was important to this man that each boy got paid fairly based on the amount of work the boy did. He didn’t want the lazy boys to get paid as much as the boys who worked hard. Therefore, he designed what he thought was a clever plan.
He divided the huge yard into sections. Each boy was given his own section to rake. The rules were simple. Every time you clear your section of leaves you would get paid a predetermined amount. If you didn’t clear your section, you did not get paid anything at all. The wealthy man put his lazy, spoiled son in charge of inspecting the sections, to see if they were cleared of leaves and to then pay the boys each time their area was clear.
This plan made the wealthy man happy. He was so confident in the plan’s success that he ignored the yard for several weeks. Eventually, he decided to go out back to see how the raking was going on. When he got there, he was shocked to find that all of the leaves were still scattered all over the yard. It was a real mess.
He angrily looked for his son to find out what happened. The wealthy man yelled at his son, saying “After all of these weeks, none of the leaves have been raked up. I certainly hope that you didn’t pay any of those young boys.”
“Actually,” the lazy son said, “I ended up paying them a hundred thousand dollars.”
“A HUNDRED THOUSAND DOLLARS?” the man screamed. “Why did you pay them so much money, when it is obvious that all off the leaves are still on the ground? Are you crazy??”
“I only did just what you said,” replied the son. “Each boy started working with the boy in the section next to theirs. One boy would rake his leaves just over the line onto the section next to him. I would pay him. Then the other boy would rake the leaves back over the line to the first boy. So then I would pay the second boy. All day long, they would rake the pile of leaves back and forth just across the line of their section. Each time one of them pushed the pile of leaves across the line, they would get paid. Eventually the boys got very good at quickly moving the leaf piles back and forth. After awhile, they had made so much money that they all decided to go back home.”
Suddenly, the wealthy man could see the major flaw in what he originally thought was a clever plan. He sighed, “Well, it looks like the only thing that got raked over and cleaned out here was my bank account.”
THE ANALOGY
It’s natural to want to reward the people who work hard and not reward the lazy ones. It seems like the fair thing to do. This was what the wealthy man was trying to do. However, in his attempt to be as fair as possible, he lost sight of the bigger goal. What he really wanted was to rid his yard of leaves. By focusing too much on fairness, he created a reward system that encouraged behavior that did not lead to achieving the desired ultimate goal.
Once we determine a desired strategic goal, we want to set up a compensation system which fairly rewards people who help achieve the strategy. However, if we concentrate too much on “individual fairness” we can end up rewarding people for things that never get us closer to achieving the strategy. Like the man in the story, the only thing we end up doing is raking up losses.
THE PRINCIPLE
As people, we often link “fairness” with “control.” We think that the fair thing to do is to only compensate people for those things that they have direct and/or complete control over. After all, does it seem fair to penalize someone when undesirable results happen over which they do not have direct or complete control? Or, conversely, does it seem fair to reward someone when desirable results happen which they didn’t control?
I couldn’t count the number of times I’ve seen someone look at how they were to be compensated and heard them complain by saying something like, “You can’t bonus me on that. I don’t control the outcome. It’s not fair.”
The problem is that if the individual has complete control over the results, then they have complete control over how to manipulate the results to their personal advantage. Now, to me, that doesn’t sound fair, either.
The boys in the story pretty much had complete control over their situation. Not only could they control how quickly their area got clean, but they could also control how quickly it got dirty. By manipulating that control, they got paid far more than they should have while never accomplishing the greater task of getting the yard clean.
That is why the fairest compensation needs to be one that goes well beyond just compensating people for what they can directly control. It needs to include areas for which they have indirect control and areas which relate directly to moving the company towards achieving the desired strategic outcome.
As it turns out, people have more influence on a business than just areas directly under their control. For example, I know of a clothing retailer where the buyers were compensated for buying the apparel from the manufacturers as cheaply as possible. After all, they are buyers, so they should be compensated for buying well. However, in their attempt to get the lowest price, the buyers would not have the manufacturers put the clothes on hangers or put price tags on the clothes. If they would have asked the manufacturer to do these services, the manufacturers would have charged a higher price, which works against the buyer’s compensation.
Unfortunately, because the buyers did not take care of negotiating for the hanging or tagging, someone in the retailer’s distribution center would have to do that service. It is like in the story where the boys did not clean the yard. All they did was push the leaves into someone else’s grid. All the buyers did was push the hanging and tagging problem into the distribution center’s grid.
In most cases, the manufacturer could perform these services for less than half the cost of the distribution center. So the actions of the buyers had an impact over the costs of the distribution center, an area over which the buyers would say they had no control. In reality, however, they had significant influence. Had the buyers been compensated on the lowest cost to get the goods from the manufacturer to the sales floor, they would have complained about lack of control. However, they also would have negotiated to get the manufacturers to hang and tag the goods, thereby saving the company more money than they did under their current compensation.
Often times, the biggest cost bottlenecks are at the point of transfer between two areas in an organization. As long as compensation stays within the areas of complete control, these transfer points do not get adequately addressed, since the responsibility is shared. By compensating based on areas outside one’s complete control, the transfer points get addressed.
Even in areas where there seems to be very little, if any linkage, there are still ways in which you can control the outcome. There is peer pressure. One can give advice or assistance. One can shift or trade some areas of responsibility that will end up making everyone more productive. And so on.
Finally, it is important to link rewards directly with the strategy. The compensation given the boys was never linked to the goal of getting the entire yard cleared of leaves. As a result, the yard was never cleared. At the end of the day, it is more important that the organization achieves its strategy than for individual areas to temporarily gain while the strategy is ignored. For if the strategy is ignored, eventually everyone loses…and that isn’t very fair.
SUMMARY
It is more important to link compensation to a broader strategy than to what an individual area can completely control. Although this may at first seem unfair, it is actually more fair, because complete control leads to “gaming the system” for personal benefit at the expense of the rest of the organization.
FINAL THOUGHTS
When you focus on smaller goals, you can sometimes perfect a process that does not need to be done at all. For example, if the only thing the wealthy man wanted was to get rid of the leaves, he could have cut down the trees. Then all the costs of raking the leaves every year could be eliminated. Perfecting the unnecessary is a waste of energy. When you focus on the big picture, you often find more creative solutions.
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