How important is strategy and why?
Believe it or not, 25 years ago no one even asked these questions. The benefits of an effective strategy, what we might call strategy’s value proposition, seemed overwhelming: The right strategy ensured superior profitability that could be sustained indefinitely. Executives were expected to spend considerable time developing and communicating their strategy. Companies maintained large strategic-planning staffs. Skill as a strategist put the upwardly mobile executive on the fast track.
No longer. Today, no self-respecting fast tracker would seek a job as a strategic planner. Few companies even have them anymore. Although strategic planning remains ubiquitous — every organization needs to coordinate its plans for the future — the planning process
no longer commands top management’s attention. Operational excellence — steadily increasing levels of performance that exceed customers’ expectations — appears to be a more powerful driver of profitability than strategy. Today’s senior executives (and rising stars) focus on building organizations that last, continually improving their performance and adapting to changing market requirements. Beset by impatient investors, demanding customers, and ever-improving competitors, businesspeople juggle too many priorities in too little time. Strategy seems a luxury: Today’s best managers deliver profits. Damn the strategy; full speed ahead!
Of course, students of business have long recognized that both strategy and operational excellence are essential, and that, like a pendulum, emphasis tends to swing from one to the other depending on the economic environment. But because the traditional strategy value proposition (sustained profitability) is no longer credible at most companies, our hypothesis is that the pendulum won’t naturally swing back to a better balance of strategy and operational excellence — unless it gets some help.
Strategy’s value proposition has its roots in the 1980s, when Michael E. Porter’s Competitive Strategy: Techniques for Analyzing Industries and Competitors (Free Press, 1998, originally published in 1980) defined the way we all thought about strategy. Strategy meant taking the long view; strategists focused on selecting attractive industries and on building scale or a strong brand that allowed a company to sustain its profitability despite the demands of customers, competitors, and suppliers. Although the best thinking about the key elements of strategy evolved over time into core competencies, into visions for the future of the industry, or into innovative new business models, the justification for strategy continued to be more profits over a longer time.
Those of us who believe that strategy is important need a new strategy value proposition — not to justify the concept, but to demonstrate to pragmatic businesspeople that more effective strategies are as important as operational excellence. Whatever this new value proposition may be, it will likely require fundamentally new ways to think about strategy.
Three of the best strategy books published this year make growth the new strategy value proposition. Of course, growth in both revenue and profitability has always been important. And although recession and deflation in the world’s major markets may have contributed to the increased focus on growth, we think that something more fundamental has changed. Just as it became clear during the past two decades that operational excellence was a more important driver of profitability than strategy was, managers are now recognizing that operational excellence doesn’t drive growth — not even excellence in product innovation, marketing, or acquisitions. Competition has intensified so much that exceeding customers’ expectations, achieving world-class levels of performance, and continuously improving and adapting to the changing market no longer ensures faster-than-market growth in profits. Instead of accelerated profitable growth, new product development produces shorter product life cycles and fragmented markets; marketing shifts the bargaining power to customers and causes consumers to tune out the bombardment of messages; and acquisitions command ever-higher premiums that benefit acquirees, not acquirers. Great product development, marketing, and acquisition programs are required merely to match competitors. Accelerated profitable growth requires something more: strategy.
These three complementary books together offer more than practical suggestions about how to achieve growth: They outline growth strategy, remarkably different from Porter’s competitive strategy. Although none of the books claims to replace Porter, together their strategy of growth may prove to be strategy as growth — if not in the business school curriculum then at least in the hands of managers searching for a systematic way to accelerate growth.
Clayton M. Christensen and Michael E. Raynor’s The Innovator’s Solution: Creating and Sustaining Successful Growth (Harvard Business School Press, 2003) is the most analytical approach to growth, grounding actionable insights in a sound theory of industry dynamics. It’s also our pick as the best strategy book of the year. The authors’ starting point is the five-step “low-end disruption” industry dynamic that was the subject of Christensen’s The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail (published in 1997 by Harvard Business School Press and named best business book of that year at the Financial Times/Booz Allen Hamilton Global Business Book Awards):
- Successful companies in an industry rapidly improve the value they provide customers through a combination of incremental and breakthrough improvements in both product development and cost reduction.
- Customer needs increase much more slowly than does the value that successful companies offer.
- Initially, because companies provide less than customers need, the pattern is a positive one: As companies meet customer needs more completely, they’re rewarded by increasing margins. However, once these companies offer most customers more than they really need or want, the basis of competition shifts. Existing customers value each improvement less and less, companies compete more on price, and margins are constantly pressured.
- Eventually, a new disruptive competitor introduces products and services that are not as good as what’s currently available, but that offer other benefits (simplicity, greater convenience, or lower cost) that appeal to new or less-demanding customers. Secure in their mainstream customers, the established competitors often welcome the disruption, exit the market that seems “fringe” to them, and for a time enjoy higher margins.
- As the new competitor rapidly increases the value it provides, eventually it meets the needs of mainstream customers, too. Then, the disruptive competitor is on a path that will ultimately destroy the established competitors.
The steel industry’s minimills, the airline industry’s discount competitors like Southwest and JetBlue, discount retailers like Kmart and Wal-Mart, and discount stockbrokers like Charles Schwab all illustrate this pattern of low-end disruption. Personal video recorders like TiVo are beginning to show a disrupting effect on established television networks. Christensen’s earlier book developed this five-step dynamic to explain how “many of history’s most successful and best-run companies lost their positions of leadership.” Using 75 examples of industry disruptions, The Innovator’s Solution demonstrates that the dynamic affects more than a few industry leaders: It’s pervasive.
Christensen and Raynor extend the low-end disruption dynamic in three important ways. First, they add a second type of disruption, “new market,” in which the disruptive competitor introduces products that “are so much more affordable to own and simpler to use that they enable a whole new population of people to begin owning and using the product, and to do so in a more convenient setting.” The personal computer, Sony’s first battery-powered transistor radio, and Canon’s desktop copier are examples. New-market disruptions are distinctive because their initial target is new consumers who haven’t been consumers of the previous products and services, because they require new value networks, and because the competitive dynamic is slightly different (because the value offered by the disruptive competitor increases more rapidly than the needs of established customers, customers jump from the established value network to the new network). However, both types of disruption produce the same result: rapid growth in revenue and profit for the disruptive competitor and destruction of the established competitors.
Second, the authors offer a wealth of practical advice for companies that aspire to be disruptive and grow by overturning the established leadership in their industry. For example:
- Look for new-market opportunities for your disruptive technology that are distant from established customers, as when Sony popularized transistors as a replacement for vacuum tubes not in the core desktop radio market but rather in the wholly new application of handheld portables for teenagers.
- Distribute your disruptive technology through channels that see a disruptive opportunity to increase their margins. Honda did this by selling motorcycles through power equipment and sporting goods retailers (rather than motorcycle dealers), Sony did it by distributing its portable radios through discount stores (not appliance stores), and Johnson & Johnson did it by marketing angioplasty to cardiologists (not to the cardiac surgeons who perform bypass operations).
- When you’re deciding which operations to keep in-house, focus on what you will need to master in the future in order to excel at delivering improvements that customers will consider important — don’t worry about the core competencies that have served well in the past. Vertically integrate in the early stages when product functionality and reliability aren’t good enough to address customer needs, and look toward modularity and de-integration to reduce costs once customer needs are fully met.
Finally, Christensen and Raynor speculate about a new value-chain dynamic that creates opportunities for insightful companies, whether or not they intend to be disruptive competitors. They hypothesize that there is a law of conservation of profits, much like the law of conservation of energy in physics: When profits are drained from one part of a value chain because the needs of customers are fully met, opportunities for differentiation and profitability are created elsewhere. For example, they argue, when PCs didn’t fully meet customer needs, Apple Computer was able to earn great profitability with its significantly more user-friendly Macintosh computers, whose usability was made possible through the integration of computer manufacture and operating system. Once PCs exceeded the needs of most users, Apple’s profitability declined, the modular Wintel architecture dominated, and new not-yet-good-enough opportunities blossomed for Intel in microprocessors and Microsoft in the operating system. If this hypothetical law of conservation of profits turns out to be valid, then the popular tactic of mapping an industry’s profit pools and targeting the stages of value added where profits are made today will prove to be an extraordinarily poor strategy. Companies that position themselves at a spot in the value chain where performance is not yet good enough will capture extraordinary profits.
The Innovator’s Solution offers a definitive guide to growth for companies that intend to disrupt their industries, not only startups but also established companies. Christensen and Raynor explain why startups can successfully disrupt an industry more easily than established competitors. They catalog many of the organizational and cultural problems that established companies face, and they offer a few possible solutions. However, the book offers little for companies that don’t aim to be disruptive competitors. Although it warns them what to look out for, it has little advice about how to grow.
Growing the Core Business
Michael Treacy’s Double-Digit Growth: How Great Companies Achieve It — No Matter What (Portfolio, 2003) is a perfect complement. For established companies, Treacy provides a street-smart, entertaining, easy-to-understand handbook, enlivened by a cornucopia of positive and negative examples. Treacy argues that the companies that sustain rapid growth are masters of several (at least three) of five growth disciplines:
- Penetrating existing customers more deeply
- Taking business from competitors
- Targeting rapidly growing segments
- Invading adjacent markets
- Entering new lines of business
Although these five disciplines aren’t surprising, they make up a very useful framework for managing growth that is heavily weighted toward expansion of the core business, which is the best source of profitable growth for most established companies.
Treacy shares his personal experience about each growth discipline. For example, he begins the discussion of deeper penetration of existing customers by debunking the overhyped concept of customer loyalty. “Customer loyalty is a contradiction in terms — an oxymoron,” Treacy writes. “If there ever were any customers who would never abandon you for a competitor’s product — as we were all told at our father’s knee — they are nowhere to be found today. Sentimental loyalty doesn’t exist. Companies that have committed to complicated schemes for customer loyalty management don’t have much to show for it.” The oft-cited icons of customer loyalty have in fact achieved limited results: The repurchase rate of Lexus owners is lower than that of Ford pickup owners, Cadillac DeVille owners, and Buick LeSabre owners; Staples, the office supplies retailer, dismantled the complex, expensive system that tracked the purchases of all its customers and substituted simple rebates for its largest customers; since frequent-flyer programs add little to base retention, American Airlines Marketing Services focuses on selling frequent-flyer miles to other companies as rewards for their customers. Even Siebel, the foremost proponent of customer relationship management software, shows limited results from customer loyalty. When an independent market research firm contacted the testimonial companies listed on Siebel’s Web site, “61 percent of the customers were convinced that they had yet to achieve a return on investment after two years with the Siebel applications, which cost an average of $6.6 million over a three-year period.”
It’s easy to criticize Double-Digit Growth because of what it’s not. Treacy doesn’t contribute a new theory, can’t claim the credibility of having analyzed a large mass of data, and offers no tools or new concepts. Some people may complain that the principles Treacy recommends in each growth discipline are obvious. For example, “Companies that grow in new lines of business have three characteristics in common. They know how to: Identify, evaluate, and select new lines of business and potential acquisitions; value and structure acquisition deals; and exert financial, managerial, and strategic control over the acquired businesses.” Would anyone disagree? Treacy’s power is not in offering something unique, but in providing pragmatic wisdom and easy-to-communicate frameworks, as in his previous bestseller, The Discipline of Market Leaders: Choose Your Customers, Narrow Your Focus, Dominate Your Market (Perseus Publishing, 1995), written with Fred Wiersema.
Growing by Serving New Needs
The third book, How to Grow When Markets Don’t (Warner Business Books, 2003), by Adrian Slywotzky and Richard Wise with Karl Weber, offers a powerful new concept that can be the basis of any company’s growth strategy: demand innovation. Demand innovation is:
Identifying and serving a series of new customer needs, all focused on the activities that surround the products [your company] sells…. While the product sale may be the culmination of the manufacturer’s efforts, it usually marks the beginning of the customer’s. Think about your own product or service. If your business is typical, your customers spent time, effort, and money figuring out how to use your product, maintain it, finance it, store it, and eventually dispose of it. It may have complex interactions with other products or be used as one input to a complicated process. It may serve more than one user, each with different needs and priorities.
To identify these opportunities for demand innovation, Slywotzky and Wise suggest that you should look for ways to help customers:
- Improve their cost structure by reducing waste, excess operating and capital costs, and process inefficiencies.
- Reduce complexity, make better decisions, and speed their own offerings to market.
- Reduce their risk and volatility.
- Grow their top-line revenue.
Slywotzky and Wise also argue that hidden liabilities prevent firms from identifying and seizing attractive growth opportunities. Everyone who works in a large firm will recognize the list of 12 hidden liabilities: corporate mind-set, culture and history, leadership and commitment, organizational structure, skills and capabilities, measurements and incentive systems, budgeting and resource allocation processes, information systems, brand/authority, customer readiness, investor resistance, and distribution channels/alliances. The authors assert that because two or three liabilities acting together are usually fatal to a growth initiative, the liabilities must be identified, mapped, and even quantified so that middle managers can navigate around them and senior managers can create an organizational system more conducive to growth. Addressing these organizational inhibitors can jump-start growth at most companies.
Despite these strengths, we have two major concerns about How to Grow When Markets Don’t. First, Slywotzky and Wise significantly overstate the importance of demand innovation. For example, in their discussion of Cardinal Health, the leading pharmaceutical distributor in the U.S., the authors ignore the Treacy-like growth in the core business that Cardinal generated from its extraordinary operational excellence. Similarly, the authors cite as successes several demand innovations, such as Deere’s entry into the landscape distribution business, even though it’s far too early to tell if they will in fact accelerate profitable growth. So reader beware. Demand innovation is one attractive growth strategy; it’s certainly not the only effective growth strategy and may not even be the most important.
Our other major concern is that one of Slywotzky and Wise’s principal concepts, “hidden assets,” seems to us to be seriously misleading. Their point that some of the competencies that can be leveraged for growth aren’t necessarily “core” may be theoretically correct. But to suggest that a company build on its hidden assets is to give it license to do anything. The correct point, of course, is that profitable growth requires more than the discovery of unmet customer needs: Profits also require superior business economics. As Christensen and Raynor emphasize, the superior economics can be grounded in a disruptive technology. Or, as C.K. Prahalad and Gary Hamel argued more than a decade ago in their Harvard Business Review article “The Core Competence of the Corporation,” established firms can generate superior economics by building on their core competencies — i.e., on their most important assets. While the assets that are leveraged may be “hidden,” the reality is that profitable growth most often results from building on a business’s greatest strengths, which are apparent to all. Cardinal Health illustrates the point. Cardinal’s demand innovations in managing pharmaceuticals in hospitals were extremely profitable precisely because they built on the core of Cardinal’s competitive advantage: its competencies in managing physical distribution. Cardinal’s more recent attempts to build businesses that support pharmaceutical manufacturers (like dosage formulation or clinical support) — attempts that make less use of its core competencies in drug distribution — have, at least to date, been less successful in creating superior returns for investors. When looking for profitable growth, a company is much better advised to look for disruptive technologies or to leverage its core competencies than to focus on its hidden assets. “Hidden assets” may be good marketing for Slywotzky and Wise because the phrase is conceptually distinctive; as advice to companies, however, it’s seriously flawed.
The New Proposition
None of these three books tries to offer a comprehensive strategy of growth in the way that Michael Porter’s seminal work definitively laid out strategy as sustained superior profitability. Yet if we suppose that the measure of an effective strategy — its value proposition — is that it accelerates growth, the three books together offer us many of the elements of the strategy. Christensen and Raynor help us understand the fundamental industry dynamic and exploitation of advantaged disruptive technologies. Slywotzky and Wise provide a powerful way to think about identifying and exploiting unmet customer needs. Treacy helps established companies build on their core. And all offer complementary advice on the organizational changes required to implement the strategy.
Of course, even if strategy’s value proposition is changing, we can still learn from books about optimizing profitability. R. Preston McAfee’s Competitive Solutions: The Strategist’s Toolkit (Princeton University Press, 2002), for example, belongs on every strategist’s bookshelf. McAfee is an economist with a gift for selecting and communicating the best new thinking by economists about business, translating from often abstruse mathematics to clear English and understandable examples. McAfee explains economists’ latest thinking about pricing, auctions, signaling, and incentives — key decisions that have make-or-break potential for a company. His book can help a consumer packaged-goods company decide how many dollars should be spent in promotions, how much a telecommunications company should bid in public auctions of the electromagnetic spectrum, or how a purchasing manager should structure auctions. If you are the person responsible for one of those functions, McAfee’s book helps you do a better job and makes you a hero. But for a senior manager or someone aspiring to be a senior manager, the issue is not so much understanding how to make these decisions; it’s knowing that there are powerful ways to make the right decision and making sure that those approaches are used. Know what’s covered in McAfee’s book so that you know when to take it from your bookshelf and give it to the person responsible for the decision.
And that returns us to the strategy value proposition. The 25-year decline in the time, attention, and resources devoted to strategy reflects the experience of most senior managers that “strategy” is only one of many drivers of profitability — and a far less important driver than functional excellence and effective execution. In that context, McAfee’s insights just raise the bar on what’s required in functional excellence. But for those of us who believe that the pendulum has swung too far and that businesses aren’t sufficiently focused on creating powerful strategies, the question of what will be the new value proposition is critical. Does acceleration of profitable growth require an effective strategy? We think so. The jury is still out on whether or not growth is the definitive value proposition for strategy, but it’s clear that it is at least part of it.
Unless your business is one of the fortunate few confident that it can generate excellent profitability and sustain rapid growth, then The Innovator’s Solution, How to Grow When Markets Don’t, and Double-Digit Growth are essential reading. Since each book excels in a different aspect of the growth story, the books are more powerful when read together than when read separately. Together the three books provide an effective path to growth, supported by examples and practical concepts that serious businesspeople can adapt to accelerate profitable growth. And for the strategists out there, these books are important steps toward an evolving new value proposition for strategy.
Chuck Lucier ([email protected]) is senior vice president emeritus of Booz Allen Hamilton. He is currently writing a book and consulting on strategy and knowledge issues with selected clients. For Mr. Lucier’s latest publications, see www.chucklucier.com.
Jan Dyer ([email protected]) spent 12 years at Booz Allen Hamilton, consulting to a variety of industries and serving as the firm’s first director of intellectual capital. She specializes in strategy and the strategic application of knowledge and learning.