A critical skill at the doctoral level is the ability to conduct scholarly research guided by clearly articulated
questions that address a specific issue or problem. For this literature review, your research will be
guided by the following three Research
Questions:
1. How do individual and group decision processes aid or impede business decision making?
2. What are the newest directions in the process of strategy development and execution?
3. How can my academic discipline, as a function within the organization, impact the process of
business strategy development and execution?
Instructions:
https://learn.liberty.edu/bbcswebdav/pid-32695906-dt-content-rid-
398705202_1/courses/BUSI770_B04_201940/BUSI770_Literature%20Review_30Apr2018.pdf
me
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PraiseforGoodStrategy/BadStrategy
“Rumelt’s new book clearly elevates the discussion of strategy. Using
compelling examples and penetrating insights, Good Strategy/Bad Strategy
providesnewandpowerfulwaysforleaderstotackletheobstaclestheyface.
Theconceptsof‘thekernel’and‘theproximateobjective’areblockbusters.
Thisis thenew must-havebookfor everyonewho leadsan organizationin
business,government,orinbetween.”
—RobertA.Eckert,chairmanandCEOofMattel
“Rumelt’snon–fastfoodapproachtostrategyisterrific.Apleasuretoread,
thisbookexplainswhatis,andwhatisnot,goodstrategyandgoodstrategic
thinking.Theexamples,stories,andanecdoteskeptmeengagedthroughout
thiswell-writtenbook.”
—BrianFarrell,chairman,president,andCEOofTHQInc.
“In his provocative new book, Richard Rumelt lays bare an uncomfortable
truth: Most companies have strategies that are quixotic, muddled, and
undifferentiated.Thisishardlysurprising,sinceinrecentyearstheveryidea
of ‘strategy’ has been dumbed down by a deluge of naïve advice and
simplisticframeworks.Rumeltcutsthroughtheclutterandremindsmanagers
that the essence of strategy is a clear and differentiated point of view that
supports forceful and coherent action. Drawing on a wealth of examples,
Rumeltidentifiesthecriticalfeaturesthatdistinguishpowerfulstrategiesfrom
wimpyones—andoffersacacheofadviceonhowtobuildastrategythatis
actuallyworthyofthename.Ifyou’recertainyourcompanyisalreadypoised
tooutperformitsrivalsandoutrunthefuture,don’tbuythisbook.If,onthe
otherhand,youhaveasliverofdoubt,pickituppronto!”
—GaryHamel,coauthorofCompetingfortheFuture
“RichardRumeltreally‘getsit’!Toomanystrategybooksdelveintoesoteric
subjects and forget that a strategy is really about action. Rumelt reinforces
thatastrategyisthesetofactionsanorganizationorteamshouldimplement
and,justasimportant,theactionsanorganizationshouldavoidastheydrive
forwardintheirmarket.AsGeneralGeorgeS.Pattonisoftquoted,‘Agood
planviolentlyexecutednowisbetterthanaperfectplanexecutednextweek.’
GoodStrategy/BadStrategyfocusesthereaderondevelopingasetofactions
aroundidentifiedtriggerpointsandpassionatelyimplementingthoseactions.
The book contains many case examples that illustrate Rumelt’s points.
RichardRumeltreinforcesthatastrategyisnotagoalorobjectives.Itisthe
battle plan for action that is designed upon a unique set of attributes or
conditions (kernels) that sets an organization apart from its competitors
(leverages)andresultsinexceptionalandsustainableprofits.”
—ChuckHarrington,CEOofParsonsCorporation
“ThisisthefirstbookonstrategyIhavereadthatIhavefounddifficulttoput
down.ForRumelt,strategyisnomore—orless—thanstructured,intelligent
thinkingaboutbusiness.Thisbookteachesyouhowtodoit.”
—JohnKay,LondonBusinessSchool
“Booksoncorporatestrategyarerare.Rarerstillareonesthatexplaingood
versusbadstrategythroughclearillustrationswhereorganizationsgotitright
orwrong. Thisis amust-read forCEOsorplannerswhosejobdependson
gettingitright!”
—KentKresa,formerchairmanofGeneralMotorsandformerCEOof
NorthropGrumman
“Anyexecutivereadingthisbookwillbemotivatedtoexaminethestrategyof
his or her firm, come to a judgment about it, and then work to develop or
improve it. The many fascinating examples of good strategy provide great
insight,butevenmorevaluablearethoseofthe‘bad’variety.Rumeltwrites
withgreatverveandpullsnopunchesashepinpointssuchstrategy‘sins’as
fluff,blue-skyobjectives,andnotfacingtheproblem.”
—JamesRoche,formersecretaryoftheairforceandpresidentof
ElectronicSensors&Systems,NorthropGrumman
“Thereare preciousfew booksthatenableyoutonotonlyrethinkthe way
you think but also improve your performance. Richard Rumelt’s brilliant
Good Strategy/Bad Strategy is one, a milestone in both the theory and
practiceofstrategy.Cuttingtothecoreofwhatmakesthedifferencebetween
success and being an also-ran, Rumelt uses vivid examples from the
contemporary business world and global history that clearly show how to
recognizethegood,rejectthebad,andmakegoodstrategyalivingforcein
yourorganization.”
—JohnStopford,chairmanofTLPInternationalandProfessorEmeritus,
LondonBusinessSchool
“GoodStrategy/BadStrategypinpointsthepolardifference:thediagnosisand
actionsthatconstitutegoodstrategy,thefluffandfailuresthatcausethebad.
Richly illustrated and persuasively argued by a researcher, teacher, and
consultant, Richard Rumelt has authored the playbook for anybody in a
leadershippositionwhomustthinkandactstrategically.”
—MichaelUseem,professorofmanagement,TheWhartonSchool,
UniversityofPennsylvania,andauthorofTheLeadershipMoment
GOODSTRATEGY/BADSTRATEGY
THEDIFFERENCEANDWHYIT
MATTERS
RICHARDP.RUMELT
FirstpublishedinGreatBritainin2011by
PROFILEBOOKSLTD
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PineStreet
LondonEC1R0JH
www.profilebooks.com
FirstpublishedintheUnitedStatesofAmericain2011by
CrownBusiness,animprintoftheCrownPublishingGroup,
adivisionofRandomHouse,Inc.,NewYork
Copyright©RichardRumelt,2011
13579108642
PrintedandboundinGreatBritainby
Clays,Bungay,Suffolk
Themoralrightoftheauthorhasbeenasserted.
Allrightsreserved.Withoutlimitingtherightsundercopyrightreserved
above,nopartofthispublicationmaybereproduced,storedorintroduced
intoaretrievalsystem,ortransmitted,inanyformorbyanymeans
(electronic,mechanical,photocopying,recordingorotherwise),withoutthe
priorwrittenpermissionofboththecopyrightownerandthepublisherofthis
book.
ACIPcataloguerecordforthisbookisavailablefromtheBritishLibrary.
ISBN9781846684807
eISBN9781847657466
Thepaperthisbookisprintedoniscertifiedbythe©1996Forest
StewardshipCouncilA.C.(FSC).Itisancient-forestfriendly.Theprinter
holdsFSCchainofcustodySGS-COC-2061
ForRuthjane
CONTENTS
INTRODUCTIONOVERWHELMINGOBSTACLES
PARTIGOODANDBADSTRATEGY
CHAPTER1GOODSTRATEGYISUNEXPECTED
HowSteveJobssavedApple
Business101issurprising
GeneralSchwarzkopf’sstrategyinDesertStorm
Why“PlanA”remainsasurprise
CHAPTER2DISCOVERINGPOWER
DavidandGoliathisabasicstrategystory
DiscoveringWal-Mart’ssecret
MarshallandRoche’sstrategyforcompetingwiththeSovietUnion
CHAPTER3BADSTRATEGY
IsU.S.nationalsecuritystrategyjustslogans?
Howtorecognizefluff
Whynotfacingtheproblemcreatesbadstrategy
ChadLogan’s20/20planmistakesgoalsforstrategy
What’swrongwithadog’sdinnerofobjectives?
Howblue-skyobjectivesmissthemark
CHAPTER4WHYSOMUCHBADSTRATEGY?
Strategyinvolveschoice,andDEC’smanagerscan’tchoose
Thepathfromcharismatotransformationalleadershiptofill-in-the-
blankstemplate-stylestrategy
NewThoughtfromEmersontotodayandhowitmakesstrategyseem
superfluous
CHAPTER5THEKERNELOFGOODSTRATEGY
Themixtureofargumentandactionlyingbehindanygoodstrategy
DiagnosingStarbucks,K–12schools,theSovietchallenge,andIBM
GuidingpoliciesatWellsFargo,IBM,andStephanie’smarket
ThepresidentoftheEuropeanBusinessGrouphesitatestoact
IncoherentactionatFord
Centralization,decentralization,andRoosevelt’sstrategyinWWII
PARTIISOURCESOFPOWER
CHAPTER6USINGLEVERAGE
AnticipationbyToyotaandinsurgentsinIraq
HowPierreWackanticipatedtheoilcrisisandoilprices
Pivotpointsat7-ElevenandtheBrandenburgGate
Harold Williams uses concentration to make the Getty a world
presenceinart
CHAPTER7PROXIMATEOBJECTIVES
Why Kennedy’s goal of landing on the moon was a proximate and
strategicobjective
Phyllis Buwalda resolves the ambiguity about the surface of the
moon
Aregionalbusinessschoolgeneratesproximateobjectives
Ahelicopterpilotexplainshierarchiesofskills
Whywhatisproximateforoneorganizationisdistantforanother
CHAPTER8CHAIN-LINKSYSTEMS
Challenger’sO-ringandchain-linksystems
StucksystemsatGMandunderdevelopedcountries
MarcoTinelliexplainshowtogetachain-linksystemunstuck
IKEAshowshowexcellenceistheflipsideofbeingstuck
CHAPTER9USINGDESIGN
HannibaldefeatstheRomanarmyin216B.C.usinganticipationand
acoordinateddesignofactionintimeandspace
Howadesign-typestrategyislikeaBMW
DesigningtheVoyagerspacecraftatJPL
Thetrade-offbetweenresourcesandtightconfiguration
Howsuccessleadstopotentresourcesthat,inturn,inducelaxityand
decline
Design shows itself as order imposed on chaos—the example of
Paccar’sheavy-truckbusiness
CHAPTER10FOCUS
AclassstrugglestoidentifyCrownCork&Seal’sstrategy
Workingbackfrompoliciestostrategy
Theparticularpatternofpolicyandsegmentationcalled“focus”
Whythestrategyworked
CHAPTER11GROWTH
Theall-outpursuitofsizealmostsinksCrown
AnoxiousadviseratTelecomItalia
Healthygrowth
CHAPTER12USINGADVANTAGE
AdvantageinAfghanistanandinbusiness
StewartandLyndaResnick’sserialentrepreneurship
Whatmakesabusiness“interesting”
Thepuzzleofthesilvermachine
Why you cannot get richer by simply owning a competitive
advantage
Whatbricklayingteachesusaboutdeepeningadvantage
BroadeningtheDisneybrand
Theredtideofpomegranatejuice
Oilfields,isolatingmechanisms,andbeingamovingtarget
CHAPTER13USINGDYNAMICS
Capturingthehighgroundbyridingawaveofchange
Jean-BernardLévyopensmyeyestotectonicshifts
Themicroprocessorchangeseverything
WhysoftwareiskingandtheriseofCiscoSystems
HowCiscorodethreeinterlinkedwavesofchange
Guidepoststostrategyintransitions
AttractorstatesandthefutureoftheNewYorkTimes
CHAPTER14INERTIAANDENTROPY
ThesmotheringeffectofobsoleteroutineatContinentalAirlines
InertiaatAT&Tandtheprocessofrenewal
InertiabyproxyatPSFSandtheDSLbusiness
ApplyinghumpchartstorevealentropyatDenton’s
EntropyatGM
CHAPTER15PUTTINGITTOGETHER
Nvidiajumpsfromnowheretodominancebyridingawaveofchange
usingadesign-typestrategy
How a game called Quake derailed the expected march of 3-D
graphics
Nvidia’sfirstproductfails,anditdevisesanewstrategy
Howafasterreleasecyclemadeadifference
WhyapowerfulbuyerlikeDellcansometimesbeanadvantage
Intelfailstwicein3-DgraphicsandSGIgoesbankrupt
PARTIIITHINKINGLIKEASTRATEGIST
CHAPTER16THESCIENCEOFSTRATEGY
Hughesengineersstarttoguessatstrategies
Deduction is enough only if you already know everything worth
knowing
GalileoheresytrialtriggerstheEnlightenment
Hypotheses,anomalies,andItalianespressobars
WhyAmericansdrankweakcoffee
HowardSchultzasascientist
Learningandverticalintegration
CHAPTER17USINGYOURHEAD
Abafflingcommentisresolvedfifteenyearslater
FrederickTaylortellsAndrewCarnegietomakealist
Being “strategic” largely means being less myopic than your
undeliberativeself
TiVoandquickclosure
Thinkingaboutthinking
Using mind tools: the kernel, problem-solution, create-destroy, and
thepanelofexperts
CHAPTER18KEEPINGYOURHEAD
Can one be independent without being eccentric, doubting without
beingacurmudgeon?
GlobalCrossingbuildsatransatlanticcable
Builditfor$1.5andsellitfor$8
Theworstindustrystructureimaginable
KurtGödelandstockprices
Whythe2008financialcrisiswasalmostcertaintooccur
The parallels among 2008, the Johnstown Flood, the Hindenburg,
theHurricaneKatrinaaftermath,andthegulfoilspill
Howtheinsideviewandsocialherdingblindedpeopletothecoming
financialstorm
The common cause of the panics and depressions of 1819, 1837,
1873,1893,and2008
NOTES
ACKNOWLEDGMENTS
INDEX
INTRODUCTION
OVERWHELMINGOBSTACLES
In1805,Englandhadaproblem.Napoléonhadconqueredbigchunksof
Europe and planned the invasion of England. But to cross the Channel, he
neededtowrestcontroloftheseaawayfromtheEnglish.Offthesouthwest
coastof Spain, theFrench and Spanishcombined fleet ofthirty-three ships
met the smaller British fleet of twenty-seven ships. The well-developed
tacticsofthedaywereforthetwoopposingfleetstoeachstayinline,firing
broadsides at each other. But British admiral Lord Nelson had a strategic
insight. He broke the British fleet into two columns and drove them at the
Franco-Spanishfleet,hittingtheirlineperpendicularly.TheleadBritishships
took a great risk, but Nelson judged that the less-trained Franco-Spanish
gunnerswouldnotbeabletocompensatefortheheavyswellthatday.Atthe
endoftheBattleofTrafalgar,theFrenchandSpanishlosttwenty-twoships,
two-thirdsoftheirfleet.TheBritishlostnone.Nelsonwasmortallywounded,
becoming,indeath,Britain’sgreatestnavalhero.Britain’snavaldominance
wasensuredandremainedunsurpassedforacenturyandahalf.
Nelson’schallengewasthathewasoutnumbered.Hisstrategywastorisk
his lead ships in order to break the coherence of his enemy’s fleet. With
coherencelost,hejudged,themoreexperiencedEnglishcaptainswouldcome
out on top in the ensuing melee. Good strategy almost always looks this
simpleand obviousanddoes nottake athickdeck ofPowerPoint slides to
explain. It does not pop out of some “strategic management” tool, matrix,
chart, triangle, or fill-in-the-blanks scheme. Instead, a talented leader
identifiestheoneortwocriticalissuesinthesituation—thepivotpointsthat
can multiply the effectiveness of effort—and then focuses and concentrates
actionandresourcesonthem.
Despite the roar of voices wanting to equate strategy with ambition,
leadership,“vision,”planning,ortheeconomiclogicofcompetition,strategy
isnoneofthese.Thecoreofstrategyworkisalwaysthesame:discovering
the critical factors in a situation and designing a way of coordinating and
focusingactionstodealwiththosefactors.
A leader’s most important responsibility is identifying the biggest
challenges to forward progress and devising a coherent approach to
overcoming them. In contexts ranging from corporate direction to national
security,strategymatters.Yetwehavebecomesoaccustomedtostrategyas
exhortation that we hardly blink an eye when a leader spouts slogans and
announces high-sounding goals, calling the mixture a “strategy.” Here are
fourexamplesofthissyndrome.
• The event was a “strategy retreat.” The CEO had modeled it on a
similareventatBritishAirwayshehadattendedseveralyearsbefore.
About two hundred upper-level managers from around the world
gatheredinahotelballroomwheretopmanagementpresentedavision
for the future: to be the most respected and successful company in
their field. There was a specially produced motion picture featuring
thefirm’sproductsandservicesbeingusedincolorfulsettingsaround
the world. There was an address by the CEO accompanied by
dramatic music to highlight the company’s “strategic” goals: global
leadership,growth,andhighshareholderreturn.Therewerebreakouts
into smaller groups to allow discussion and buy-in. There was a
colorfulreleaseofballoons.Therewaseverythingbutstrategy.Asan
invitedguest,Iwasdisappointedbutnotsurprised.
•Aspecialistinbonds,LehmanBrothershadbeenapioneerinthenew
wave of mortgage-backed securities that buoyed Wall Street in the
2002–6 period. By 2006, signs of strain were appearing: U.S. home
sales had peaked in mid-2005, and home price appreciation had
stopped. A small increase in the Fed’s interest rate had triggered an
increase in foreclosures. Lehman CEO Richard Fuld’s response,
formalized in 2006, was a “strategy” of continuing to gain market
sharebygrowingfasterthantherestoftheindustry.Inthelanguageof
WallStreet, Lehmanwould dothisby increasingits “riskappetite.”
That is, it would take on the deals its competitors were rejecting.
Operatingwithonly3percentequity,andmuchofitsdebtsuppliedon
averyshort-termbasis,thispolicyshouldhavebeenaccompaniedby
clever ways of mitigating the increased risk. A good strategy
recognizes the nature of the challenge and offers a way of
surmounting it. Simply being ambitious is not a strategy. In 2008,
Lehman Brothers ended its 158 years as an investment bank with a
crash that sent the global financial system into a tailspin. Here, the
consequencesofbadstrategyweredisastrousforLehman,theUnited
States,andtheworld.
• In 2003, President George W. Bush authorized the U.S. military to
invadeandconquerIraq.Theinvasionwentquickly.Oncethearmy-
to-army fighting stopped, administration leaders had expected to
overseearapidtransitiontoademocraticcivilsocietyinIraq.Instead,
as a violent insurgency gathered momentum, individual units of the
U.S.militaryfellbackonrunning“searchanddestroy”missionsout
of secure bases—the same approach that had failed so badly in
Vietnam. There were numerous high-sounding goals—freedom,
democracy, reconstruction, security—but no coherent strategy for
dealingwiththeinsurgency.
Thechangecamein2007.HavingjustwrittentheArmy/MarineCorps
Counterinsurgency Field Manual, General David Petraeus was sent to
Iraq, along with five additional brigades of troops. But more than the
extrasoldiers,Petraeuswasarmedwithanactualstrategy.Hisideawas
thatonecouldcombataninsurgencyaslongasthelargepreponderance
ofcivilianssupportedalegitimategovernment.Thetrickwastoshiftthe
military’s focus from making patrols to protecting the populace. A
populacethatwasnotinfearofinsurgentretaliationwouldprovidethe
informationnecessarytoisolateandcombattheinsurgentminority.This
change,replacingamorphousgoalswithatrueproblem-solvingstrategy,
madeanenormousdifferenceintheresultsachieved.
• In November 2006, I attended a short conference about Web 2.0
businesses. The term “Web 2.0” purportedly referred to a new
approachtoWebservices,butnoneofthetechnologiesinvolvedwere
reallynew.ThetermwasactuallyacodewordforGoogle,MySpace,
YouTube,Facebook,andvariousothernewWeb-basedbusinessesthat
hadsuddenlybecomeveryvaluable.Atlunch,Ifoundmyselfseated
withsevenotherattendeesataroundtable.SomeoneaskedmewhatI
do.IbrieflyexplainedthatIwasafacultymemberatUCLAwhereI
taughtanddidresearchonstrategy—andthatIwasaconsultantonthe
subjecttoavarietyoforganizations.
TheCEOofaWeb-servicescompanywassittingdirectlyacrossfrom
me.Heputdownhisforkandsaid,“Strategyisneverquittinguntilyou
win.”Icouldnothavedisagreedmore,butIwasnottheretoargueor
lecture. “Winning is better than losing,” I said, and the conversation
turnedtoothermatters.
Thekeyinsight drivingthisbook isthehard-won lessonofa lifetimeof
experienceatstrategywork—asaconsultanttoorganizations,asapersonal
adviser,asateacher,andasaresearcher.Agoodstrategydoesmorethanurge
usforwardtowardagoalorvision.Agoodstrategyhonestlyacknowledges
the challenges being faced and provides an approach to overcoming them.
And the greater the challenge, the more a good strategy focuses and
coordinates efforts to achieve a powerful competitive punch or problem-
solvingeffect.
Unfortunately,goodstrategyistheexception,nottherule.Andtheproblem
isgrowing. Moreand moreorganizationalleaderssay theyhave astrategy,
buttheydonot.Instead,theyespousewhatIcallbadstrategy.Badstrategy
tends to skip over pesky details such as problems. It ignores the power of
choice and focus, trying instead to accommodate a multitude of conflicting
demandsandinterests.Likeaquarterbackwhoseonlyadvicetoteammatesis
“Let’s win,” bad strategy covers up its failure to guide by embracing the
languageofbroadgoals,ambition,vision,andvalues.Eachoftheseelements
is,ofcourse,animportantpartofhumanlife.But,bythemselves,theyarenot
substitutesforthehardworkofstrategy.
The gap between good strategy and the jumble of things people label
“strategy” has grown over the years. In 1966, when I first began to study
businessstrategy,therewereonlythreebooksonthesubjectandnoarticles.
Today, my personal library shelves are fat with books about strategy.
Consultingfirmsspecializeinstrategy,PhDsaregrantedinstrategy,andthere
are countless articles on the subject. But this plentitude has not brought
clarity.Rather,theconcepthasbeenstretchedtoagauzythinnessaspundits
attachittoeverythingfromutopianvisionstorulesformatchingyourtiewith
yourshirt.Tomake mattersworse,formanypeopleinbusiness, education,
and government, the word “strategy” has become a verbal tic. Business
speechtransformedmarketinginto“marketingstrategy,”dataprocessinginto
“IT strategy,” and making acquisitions into a “growth strategy.” Cut some
pricesandanobserverwillsaythatyouhavea“low-pricestrategy.”
Further confusion is created by equating strategy with success or with
ambition. This was my problem with the Web-services CEO who claimed
“Strategy is never quitting until you win.” This sort of mishmash of pop
culture, motivational slogans, and business buzz speak is, unfortunately,
increasingly common. It short-circuits real inventiveness and fails to
distinguish among different senior-level management tasks and virtues.
Strategycannotbeausefulconceptifitisasynonymforsuccess.Norcanit
beausefultoolifitisconfusedwith ambition,determination,inspirational
leadership,andinnovation.Ambitionisdriveandzealtoexcel.Determination
iscommitmentandgrit.Innovationisthediscoveryandengineeringofnew
waysto dothings.Inspirational leadershipmotivatespeople tosacrificefor
theirownandthecommongood.1Andstrategy,responsivetoinnovationand
ambition, selects the path, identifying how, why, and where leadership and
determinationaretobeapplied.
A word that can mean anything has lost its bite. To give content to a
conceptonehastodrawlines,markingoffwhatitdenotesandwhatitdoes
not. To begin the journey toward clarity, it is helpful to recognize that the
words “strategy” and “strategic” are often sloppily used to mark decisions
madebythehighest-levelofficials.Forexample,in business,mostmergers
and acquisitions, investments in expensive new facilities, negotiations with
important suppliers and customers, and overall organizational design are
normally considered to be “strategic.” However, when you speak of
“strategy,”youshouldnotbesimplymarkingthepaygradeofthedecision
maker. Rather, the term “strategy” should mean a cohesive response to an
importantchallenge.Unlikeastand-alonedecisionoragoal,astrategyisa
coherent set of analyses, concepts, policies, arguments, and actions that
respondtoahigh-stakeschallenge.
Many people assume that a strategy is a big-picture overall direction,
divorced from any specific action. But defining strategy as broad concepts,
thereby leaving out action, creates a wide chasm between “strategy” and
“implementation.” If you accept this chasm, most strategy work becomes
wheelspinning.Indeed,thisisthemostcommoncomplaintabout“strategy.”
Echoingmany others, onetop executive toldme, “Wehavea sophisticated
strategyprocess,butthereisahugeproblemofexecution.Wealmostalways
fallshortofthegoalswesetforourselves.”Ifyouhavefollowedmylineof
argument,youcanseethereasonforthiscomplaint.Agoodstrategyincludes
asetofcoherentactions.Theyarenot“implementation”details;theyarethe
punchinthestrategy.Astrategythatfailstodefineavarietyofplausibleand
feasibleimmediateactionsismissingacriticalcomponent.
Executives who complain about “execution” problems have usually
confusedstrategywithgoalsetting.Whenthe“strategy”processisbasicallya
game of setting performance goals—so much market share and so much
profit, so many students graduating high school, so many visitors to the
museum—then there remains a yawning gap between these ambitions and
action. Strategy is about how an organization will move forward. Doing
strategyisfiguringouthowtoadvancetheorganization’sinterests.Ofcourse,
aleadercansetgoalsanddelegatetoothersthejoboffiguringoutwhattodo.
Butthatisnotstrategy.Ifthatishowtheorganizationruns,let’sskipthespin
andbehonest—callitgoalsetting.
The purpose of this book is to wake you up to the dramatic differences
between good strategy and bad strategy and to give you a leg up toward
craftinggoodstrategies.
AgoodstrategyhasanessentiallogicalstructurethatIcallthekernel.The
kernelofastrategycontainsthreeelements:adiagnosis,aguidingpolicy,and
coherentaction.Theguidingpolicyspecifiestheapproachtodealingwiththe
obstacles called out in the diagnosis. It is like a signpost, marking the
directionforwardbutnotdefiningthedetailsofthetrip.Coherentactionsare
feasiblecoordinatedpolicies,resourcecommitments,andactionsdesignedto
carryouttheguidingpolicy.
Once you gain a facility with the structure and fundamentals of a good
strategy, you will develop the parallel ability to detect the presence of bad
strategy.Justasyoudonotneedtobeadirectortodetectabadmovie,youdo
not need economics, finance, or any other abstruse special knowledge to
distinguishbetweengoodandbadstrategy.Forexample,lookingattheU.S.
government’s“strategy” for dealingwith the2008 financialcrisis, you will
see that essential elements are missing. In particular, there was no official
diagnosis of the underlying malady. So, there can be no focus of resources
andactionsonacure.Therehasonlybeenashiftofresourcesfromthepublic
to the banks. You do not need a PhD in macroeconomics to make this
judgment—itfollowsfromunderstandingthenatureofgoodstrategyitself.
Badstrategyismorethanjusttheabsenceofgoodstrategy.Badstrategy
hasalifeandlogicofitsown,afalseedificebuiltonmistakenfoundations.
Badstrategymayactivelyavoidanalyzingobstaclesbecausealeaderbelieves
that negative thoughts get in the way. Leaders may create bad strategy by
mistakenly treating strategy work as an exercise in goal setting rather than
problemsolving.Ortheymayavoidhardchoicesbecausetheydonotwishto
offend anyone—generating a bad strategy that tries to cover all the bases
ratherthanfocusresourcesandactions.
Thecreeping spreadof bad strategyaffectsusall.Heavy withgoals and
slogans, the national government has become less and less able to solve
problems.Corporateboardssignoffonstrategicplansthatarelittlemorethan
wishfulthinking.Oureducationsystemisrichwithtargetsandstandards,but
poorincomprehendingandcounteringthesourcesofunderperformance.The
only remedy is for us to demand more from those who lead. More than
charismaandvision,wemustdemandgoodstrategy.
PARTI
GOODANDBADSTRATEGY
The most basic idea of strategy is the application of strength against
weakness. Or, if you prefer, strength applied to the most promising
opportunity. The standard modern treatment of strategy has expanded this
ideaintoarichdiscussionofpotentialstrengths,todaycalled“advantages.”
Thereareadvantagesduetobeingafirstmover:scale,scope,networkeffects,
reputation, patents, brands, and hundreds more. None of these are logically
wrong,andeachcanbeimportant.Yetthiswholemidlevelframeworkmisses
twohuge,incrediblyimportantnaturalsourcesofstrength:
1. Having a coherent strategy—one that coordinates policies and
actions. A good strategy doesn’t just draw on existing strength; it
creates strength through the coherence of its design. Most
organizations ofany sizedon’tdo this.Rather,they pursuemultiple
objectives that are unconnected with one another or, worse, that
conflictwithoneanother.
2.The creation of new strengths through subtle shifts in viewpoint.An
insightfulreframingofacompetitivesituationcancreatewholenew
patterns of advantage and weakness. The most powerful strategies
arisefromsuchgame-changinginsights.
These two essential aspects of good strategy are explored in chapter 1,
“GoodStrategyIsUnexpected,”andchapter2,“DiscoveringPower.”
Theleaderofanorganizationlackingagoodstrategymaysimplybelieve
thatstrategyisunnecessary.Butmoreoftenthelackisduetothepresenceof
bad strategy. Like weeds crowding out the grass, bad strategy crowds out
good strategy. Leaders using bad strategies have not just chosen the wrong
goalsormadeimplementationerrors.Rather,theyhavemistakenviewsabout
what strategy is and how it works. Chapter 3, “Bad Strategy,” presents
evidencefortheexistenceofbadstrategyandexplainsitshallmarks.
Havingmarkedthenatureofgoodandbadstrategy,chapter4answersthe
obviousquestion:“WhySoMuchBadStrategy?”Chapter5,“TheKernelof
Good Strategy,” provides an analysis of the logical structure of a good
strategy—a structure that acts as a guide on reasoning and a check against
generatingbadstrategy.
CHAPTERONE
GOODSTRATEGYISUNEXPECTED
The first natural advantage of good strategy arises because other
organizations often don’t have one. And because they don’t expect you to
have one, either. A good strategy has coherence, coordinating actions,
policies, and resources so as to accomplish an important end. Many
organizations,mostofthetime,don’thavethis.Instead,theyhavemultiple
goals and initiatives that symbolize progress, but no coherent approach to
accomplishingthatprogressotherthan“spendmoreandtryharder.”
APPLE
After the 1995 release of Microsoft’s Windows 95 multimedia operating
system, Apple Inc. fell into a death spiral. On February 5, 1996,
BusinessWeekputApple’sfamoustrademarkonitscovertoillustrateitslead
story:“TheFallofanAmericanIcon.”
CEO Gil Amelio struggled to keep Apple alive in a world being rapidly
dominated by Windows-Intel-based PCs. He cut staff. He reorganized the
company’s many products into four groups: Macintosh, information
appliances, printers and peripherals, and “alternative platforms.” A new
InternetServicesGroupwasaddedtotheOperatingSystemsGroupandthe
AdvancedTechnologyGroup.
Wired magazine carried an article titled “101 Ways to Save Apple.” It
included suggestions such as “Sell yourself to IBM or Motorola,” “Invest
heavily in Newton technology,” and “Exploit your advantage in the K–12
educationmarket.”WallStreetanalystshopedforandurgedadealwithSony
orHewlett-Packard.
BySeptember1997,Applewastwomonthsfrombankruptcy.SteveJobs,
who had cofounded the company in 1976, agreed to return to serve on a
reconstructedboardofdirectorsandtobeinterimCEO.Die-hardfansofthe
originalMacintosh wereoverjoyed,but thegeneral businessworld wasnot
expectingmuch.
Withinayear,thingschangedradicallyatApple.Althoughmanyobservers
had expected Jobs to rev up the development of advanced products, or
engineeradealwithSun,hedidneither.Whathedidwasbothobviousand,
atthesametime,unexpected.HeshrunkAppletoascaleandscopesuitable
totherealityofitsbeinganicheproducerinthehighlycompetitivepersonal
computerbusiness.HecutApplebacktoacorethatcouldsurvive.
Steve Jobs talked Microsoft into investing $150 million in Apple,
exploiting Bill Gates’s concerns about what a failed Apple would mean to
Microsoft’s struggle with the Department of Justice. Jobs cut all of the
desktop models—there were fifteen—back to one. He cut all portable and
handheldmodels backto onelaptop.He completelycut outall theprinters
and other peripherals. He cut development engineers. He cut software
development. He cut distributors and cut out five of the company’s six
nationalretailers.Hecutoutvirtuallyallmanufacturing,movingitoffshoreto
Taiwan.WithasimplerproductlinemanufacturedinAsia,hecutinventory
bymorethan80percent.AnewWebstoresoldApple’sproductsdirectlyto
consumers,cuttingoutdistributorsanddealers.
What is remarkable about Jobs’s turnaround strategy for Apple is how
muchitwas“BusinBusiness101issurprisingess101”andyethowmuchofit
wasunanticipated.Ofcourseyouhavetocutbackandsimplifytoyourcore
toclimboutofafinancialnosedive.Ofcourseheneededup-to-dateversions
of Microsoft’s Office software to work on Apple’s computers. Of course
Dell’s model of Asian supply-chain manufacturing, short cycle times, and
negativeworkingcapitalwasthestateoftheartintheindustryanddeserved
emulation.Ofcoursehestoppedthedevelopmentofnewoperatingsystems—
hehadjustbroughttheindustry’sbestoperatingsystemwithhimfromNeXT.
ThepowerofJobs’sstrategycamefromdirectlytacklingthefundamental
problemwithafocusedandcoordinatedsetofactions.Hedidnotannounce
ambitiousrevenueorprofitgoals;hedidnotindulgeinmessianicvisionsof
the future. And he did not just cut in a blind ax-wielding frenzy—he
redesigned the whole business logic around a simplified product line sold
throughalimitedsetofoutlets.
InMay1998,whiletryingtohelpstrikeadealbetweenAppleandTelecom
Italia,Ihadthechance totalktoJobsabout hisapproachtoturningApple
around.Heexplainedboththesubstanceandcoherenceofhisinsightwitha
fewsentences:
The product lineup was too complicated and the company was
bleedingcash.AfriendofthefamilyaskedmewhichApplecomputer
sheshouldbuy.Shecouldn’tfigureoutthedifferencesamongthemandI
couldn’tgiveherclearguidance,either.Iwasappalledthattherewasno
Appleconsumercomputerpricedunder$2,000.Wearereplacingallof
thosedesktopcomputerswithone,thePowerMacG3.Wearedropping
fiveofsixnationalretailers—meetingtheirdemandhasmeanttoomany
modelsattoomanypricepointsandtoomuchmarkup.
This kind of focused action is far from the norm in industry. Eighteen
months earlier, I had been involved in a large-scale study, sponsored by
Andersen Consulting, of strategies in the worldwide electronics industry.
Working in Europe, I carried out interviews with twenty-six executives, all
divisionmanagersorCEOsintheelectronicsandtelecommunicationssector.
Myinterviewplanwassimple:Iaskedeachexecutivetoidentifytheleading
competitorintheirbusiness.Iaskedhowthatcompanyhadbecometheleader
—evoking their private theories about what works. And then I asked them
whattheirowncompany’scurrentstrategywas.
Theseexecutives, byand large, hadno troubledescribing thestrategy of
the leader in their sectors. The standard story was that some change in
demandortechnologyhadappeared—a“windowofopportunity”hadopened
—andthecurrentleaderhadbeenthefirstonetoleapthroughthatwindow
andtakeadvantageofit.Notnecessarilythefirstmover,butthefirsttogetit
right.
ButwhenIaskedabouttheirowncompanies’strategies,therewasavery
different kind of response. Instead of pointing to the next window of
opportunity, or even mentioning its possibility, I heard a lot of look-busy
doorknobpolishing.Theyweremakingalliances,theyweredoing360-degree
feedback, they were looking for foreign markets, they were setting
challenging strategic goals, they were moving software into firmware, they
wereenablingInternetupdatesoffirmware,andsoon.Theyhadeachtoldme
the formula for success in the 1990s electronics industry—take a good
position quickly when a new window of opportunity opens—but none said
thatwastheirfocusorevenmentioneditaspartoftheirstrategy.
Giventhatbackground,IwasinterestedinwhatSteveJobsmightsayabout
thefutureofApple.HissurvivalstrategyforApple,forallitsskillanddrama,
wasnotgoingtopropelAppleintothefuture.Atthatmomentintime,Apple
had less than 4 percent of the personal computer market. The de facto
standardwasWindows-IntelandthereseemedtobenowayforAppletodo
morethanjusthangontoatinyniche.
Inthesummerof1998,IgotanopportunitytotalkwithJobsagain.Isaid,
“Steve, this turnaround at Apple has been impressive. But everything we
know about the PC business says that Apple cannot really push beyond a
small niche position. The network effects are just too strong to upset the
Wintelstandard.Sowhatareyoutryingtodointhelongerterm?Whatisthe
strategy?”
He did not attack my argument. He didn’t agree with it, either. He just
smiledandsaid,“Iamgoingtowaitforthenextbigthing.”
Jobsdidnotenunciatesomesimple-mindedgrowthormarketsharegoal.
Hedidnotpretendthatpushingonvariousleverswouldsomehowmagically
restore Apple to market leadership in personal computers. Instead, he was
actuallyfocusedonthesources ofand barrierstosuccess inhis industry—
recognizingthenextwindowofopportunity,thenextsetofforceshecould
harness to his advantage, and then having the quickness and cleverness to
pounceonitquicklylikeaperfectpredator.Therewasnopretensethatsuch
windowsopenedeveryyearorthatonecouldforcethemopenwithincentives
ormanagementtricks.Heknewhowitworked.Hehaddoneitbeforewith
theAppleIIandtheMacintoshandthenwithPixar.Hehadtriedtoforceit
with NeXT, and that had not gone well. It would be two years before he
wouldmakethatleapagainwiththeiPodandthenonlinemusic.And,after
that,withtheiPhone.
Steve Jobs’s answer that day—“to wait for the next big thing”—is not a
generalformulaforsuccess.ButitwasawiseapproachtoApple’ssituationat
thatmoment,inthatindustry,withsomanynewtechnologiesseeminglyjust
aroundthecorner.
DESERTSTORM
Anotherexampleofsurpriseattheexistenceofastrategyoccurredattheend
of the first Gulf War in 1991. People were surprised to discover that U.S.
commandersactuallyhadafocusedstrategyfordefeatingtheentrenchedIraqi
invaders.
On August 2, 1990, Iraq invaded Kuwait. Led by elite troops making
airborne and amphibious landings, and four divisions of the Republican
Guard,150,000IraqisoldiersrolledintoandoccupiedKuwait.Itisprobable
that Saddam Hussein’s primary motive for the invasion was financial. The
eight-year war he had started by invading Iran in 1980 had left his regime
with massive debts to Kuwait and other Gulf states. By taking Kuwait and
declaringitthenineteenthprovinceofIraq,Saddamwouldcancelhisdebtsto
thatcountryandbeabletouseitsmassiveoilincometorepayhisdebtsto
othernations.
Five months later, a thirty-three-nation coalition organized by U.S.
presidentGeorgeH.W.BushwascarryingoutairstrikesagainstIraqiforces
andrapidlybuildingitsgroundforces.Iraq,inturn,hadincreaseditsforcein
Kuwaittomorethanfivehundredthousand.Itwashopedthatairpoweralone
mightproducearesolutionoftheconflict,butifitdidnot,agroundoffensive
wouldbenecessarytoreverseIraq’sinvasionandoccupationofKuwait.
Therewasnorealdoubtthatthecoalitionhadtheabilitytothrowbackthe
Iraqis.Buthowcostlywoulditbe?InOctober1990,theFrenchnewspaper
L’ExpresshadestimatedthatretakingKuwaitwouldtakeaboutaweekand
cost twenty thousand U.S. casualties. As Iraqi forces swelled and built
defensivepositions,public discussioninthepress,ontelevision,and inthe
hallsofCongressbegantoevokeimagesofWorldWarItrenchcombat.In
Congress,SenatorBobGraham(D-Florida)notedthat“Iraqalreadyhashad
fivemonthsto diginandtofortify andtheyhavedonesoinamajor way.
KuwaithasfortificationsreminiscentofWorldWarI.”Inthesamevein,the
NewYorkTimesdescribedabattalionoftheSixteenthInfantry as“themen
whoexpecttohavethejobofsloggingitoutinthetrenchesofKuwaitwith
theirM-16riflesandM-60machinegunsblazing.”Timemagazinedescribed
theIraqidefensesthisway:
In an area about the size of West Virginia the Iraqis have poured
540,000oftheirmillion-manarmyand4,000oftheir6,000tanks,along
with thousands of other armored vehicles and artillery pieces.… Iraqi
unitsareentrenchedintheirnowtraditionaltriangularforts,formedof
packed sand, with an infantry company equipped with heavy machine
guns holding each corner. Soldiers are protected by portable concrete
sheltersordugoutsofsheetmetalandsand.Tanksarehulldeepinthe
groundandbolsteredwithsandbags.Artillerypiecesaredeployedatthe
apex of each triangle, pre-aimed at “killing zones” created by flaming
trenchesandminefields.1
On the eve of the ground assault, the Los Angeles Times reminded its
readersthat“Iraqitroopsalongthefrontlinesarewelldugin,andassaulting
such fortified positions is always a risky business. The debacles at Cold
Harbor,theSommeandGallipoliaregrimremindersofthepriceoffailure.
Even success, as at Tarawa, Okinawa or Hamburger Hill, can come at a
terribleprice.”2
What these commentators did not predict was that General Norman
Schwarzkopf,commanderinchiefofU.S.CentralCommand,hadastrategy
forthegroundwar,astrategyhehaddevelopedbackinearlyOctober.
Theoriginalplangeneratedby hisstaff,adirect attackintoKuwait, was
estimatedtocost2,000deadand8,000wounded.Schwarzkopfrejectedthis
approachinfavorofatwo-prongedplan.Airattackswouldbeusedtoreduce
theIraqi capabilitiesby 50percent.Thenheplanned amassive secret“left
hook.”Whiletheworld’sattentionwasfocusedonCNN’s24/7coverageof
troops just south of Kuwait, the coalition would secretly shift a force of
250,000 soldiers well west of Kuwait and then have them move north into
positionsintheemptydesertofsouthernIraq.Whenthegroundwarbegan,
thisforcewouldcontinuenorthandthenturneast,completingthe“lefthook,”
and slamming into the flank of the Iraqi Republican Guard. Attacks aimed
northward into Kuwait itself were to be minor. The U.S. Marines ground
forceswereorderedtomoveslowlynorthwardintoKuwait,aploytoentice
the entrenched Iraqis southward and out of their fortifications, where they
wouldbehitfromthesideby partofthemassive lefthook.Thesea-based
marineswouldnotland,theirfloatingpresencebeingadiversion.
Schwarzkopf’scombined-armsleft-hookstrategywassosuccessfulthatthe
intense ground war lasted only one hundred hours. A month of air
bombardment had conditioned Iraqi troops to disperse and hide their tanks
andartillery,stayoutoftheirvehicles,andkeepmotorsoff.Theswiftnessand
violence of the coalition ground assault, combining tanks, infantry, attack
helicopters, and bombers, was decisive. Republican Guard units fought
bravely but were unable to maneuver or call in reserves fast enough to
respond to the speed and ferocity of the attack. Finally, and perhaps most
important, Saddam Hussein had ordered his commanders not to use their
chemicalweapons.Theseartilleryshells,usedtohaltIranianattacksduring
the Iran-Iraq War, would have caused thousands of coalition casualties.
Marinecommandershadestimatedtheywouldlose20to30percentoftheir
forceifchemicalweaponswereusedagainstthem.3ButSaddamwasdeterred
—postwar intelligence gleaned from the Russians revealed that he feared a
U.S.nuclearretaliationtosuchuse.
Iraq fled Kuwait, much of its invading army destroyed.4 Coalition
casualtieswerelight—onthefirstdaytherewereeightdeadandtwenty-seven
wounded.Thecoalition’ssuccesswiththecombined-armsleft-hookstrategy
wassostarkthatpunditswhowereworriedabouttrenchwarfareinFebruary
were,byMarch,opiningthatthecoalitionhadamassedmoreforcesthanit
neededandthattheoutcomehadbeenaforegoneconclusion.
Schwarzkopf revealed the ground-war strategy to the public in a widely
viewedpressbriefing.Mostpeoplewhosawthisbriefingandthemapofthe
left hook were surprised and impressed. News commentators described the
plan as “brilliant” and “secret.” Few had anticipated this envelopment
maneuver.Butwhyhadn’tthey?TheDepartmentoftheArmypublishesfield
manuals fully describing its basic doctrines and methods. FM 100-5,
publishedin1986,wastitledOperationsandwasdescribedas“theArmy’s
keystone warfighting manual.” Part 2 of FM 100-5 was dedicated to
“OffensiveOperations,”andonpage101itdescribed“envelopment”asthe
mostimportantformofoffensivemaneuver—theU.S.Army’s“PlanA.”The
manualsaid:
Envelopment avoids the enemy’s front, where its forces are most
protectedandhisfiresmosteasilyconcentrated.Instead,whilefixingthe
defender’s attention forward by supporting or diversionary attacks, the
attackermaneuvershismaineffortaroundorovertheenemy’sdefenses
tostrikeathisflanksandrear.
To illustrate this maneuver, FM 100-5 Operations offered a diagram
reproducedonthefacingpage.
Giventhisvividpictureofafeintupthemiddlecombinedwithapowerful
“left hook,” one must ask: “How could Schwarzkopf’s use of the primary
offensivedoctrineoftheU.S.Armyhavebeenasurprisetoanyone?”
Somepartoftheanswerliesinsuccessfuldeception.Schwarzkopfintended
tomakeitappearthatthemainattackwouldbelaunchedintoKuwaitfrom
theseaandthenoverlanddirectlyintoIraqidefenses.Thiswassupportedby
an early visible amphibious raid on the Kuwaiti coast and by actions to
destroy Iraq’s navy. The press unwittingly helped in this misdirection by
reportingonthephotogenicamphibioustraining,thebuild-upoftroopsjust
southof Kuwait,and thenby anguishingover theprospectofWorldWar I
trenchwarfare.
ButanessentialelementoftheU.S.Army’s“PlanA”—envelopment—is
the illusion of a direct attack coupled with a much more massive end run.
And,since“PlanA”wasavailabletoanyonewithtwenty-fivedollarstosend
totheU.S.GovernmentPrintingOffice,5itremainspuzzlingastowhy“Plan
A” was a surprise—a surprise not only to Iraq but also to talking-head
militarycommentatorsontelevisionandtomostoftheU.S.Congress.
Thebestanswertothispuzzleisthattherealsurprisewasthatsuchapure
andfocusedstrategywasactuallyimplemented.Mostcomplexorganizations
spreadratherthanconcentrateresources,actingtoplacateandpayoffinternal
andexternalinterests.Thus,wearesurprisedwhenacomplexorganization,
suchasAppleortheU.S.Army,actuallyfocusesitsactions.Notbecauseof
secrecy,butbecausegoodstrategyitselfisunexpected.
InthecaseofDesertStorm,thefocuswasmuchmorethananintellectual
step.Schwarzkopfhadtosuppresstheambitionsanddesiresoftheairforce,
marines, various army units, each coalition partner, and the political
leadershipinWashington.Forexample,theU.S.Army’sbestlightinfantry—
the Eighty-Second Airborne—was tasked with providing support to French
armor and infantry, an assignment its leadership protested. Eight thousand
U.S.MarineswaitedonshipstolandonthebeachesofKuwaitCity,butdid
not. It was a diversion. Air force commanders wanted to demonstrate the
valueofstrategicbombing—theybelievedthatthewarcouldbewonbyair
attacksonBaghdad—andhadtobeforcedagainststrenuousprotesttodivert
theirresourcestofullysupportthelandoffensive.SecretaryofDefenseDick
Cheneywantedthemissionaccomplishedwithasmallerforceanddetailedan
alternativeplanofattack.PrinceKhalid,commandingtheSaudiforcesinthe
coalition, insisted that King Fahd be involved in the planning, but
SchwarzkopfconvincedPresidentBushtoensurethatU.S.CentralCommand
retainedcontroloverstrategyandplanning.
ENVELOPMENT
Having conflicting goals, dedicating resources to unconnected targets, and
accommodating incompatible interests are the luxuries of the rich and
powerful,buttheymakeforbadstrategy.Despitethis,mostorganizationswill
not create focused strategies. Instead, they will generate laundry lists of
desirable outcomes and, at the same time, ignore the need for genuine
competence in coordinating and focusing their resources. Good strategy
requires leaders who are willing and able to say no to a wide variety of
actionsandinterests.Strategyisatleastasmuchaboutwhatanorganization
doesnotdoasitisaboutwhatitdoes.
CHAPTERTWO
DISCOVERINGPOWER
Thesecondnaturaladvantageofmanygoodstrategiescomesfrominsight
intonewsourcesofstrengthandweakness.Lookingatthingsfromadifferent
orfreshperspectivecanrevealnewrealmsofadvantageandopportunityas
wellasweaknessandthreat.
ASLUNGSTONE
In about 1030 B.C., David the shepherd boy defeated the warrior Goliath.
When Goliath stepped from the ranks of the Philistines and shouted a
challenge,thearmyofKingSaulcringedinterror.Goliathwasoverninefeet
tall,hisspearlikeaweaver’sbeam.Hisbronzehelmetandbodyarmorshone
in the sunlight. David was not old enough to soldier like his brothers, yet
nonetheless wanted to face the giant. Saul advised David that he was too
youngandthegiantaskilledveteran,butrelentedandgavehimarmor.The
armor was heavy and David discarded it, rushing to combat in shepherd’s
garb.MovingtowardGoliath,hetookastoneandlauncheditwithhissling.
Struckintheforehead,Goliathfelldeadonthespot.Davidmovedforward
andtookthefallenchampion’shead.ThePhilistinesfled.
It is said that strategy brings relative strength to bear against relative
weakness. Let’s follow the advice of countless articles and textbooks and
makealistofDavid’sandGoliath’sapparentstrengthsandweaknesses:
This mismatch must have been Saul’s concern as he tried to hold David
back,thenrelentedandgavehimarmor.Inthestory,itisonlyafterthestone
is slung that the listener’s viewpoint shifts and one realizes that the boy’s
experiencewithashepherd’sslingisastrength,asishisyouthfulquickness.
Then the listener realizes that David discarded the armor because it would
onlyslowhimdown;hadhecomecloseenoughtoreceiveablowfromthe
giant,bronzearmorwouldnothavesavedhim.Finally,whenthestonestrikes
Goliath’s forehead, the listener suddenly discovers a critical weakness—
Goliath’sarmordidn’tcoverthisvitalarea.David’sweapondeliveredforce
with precision over a distance, neutering Goliath’s supposed advantages of
sizeandstrength.Thestoryteachesusthatourpreconceivedideasofstrength
andweaknessmaybeunsound.
Itisthevictoryofapparentweaknessoverapparentstrengththatgivesthis
taleitsbite.Morethanthedeftwieldingofpower,thelistenerexperiencesthe
actual discovery of power in a situation—the creation or revelation of a
decisive asymmetry. How someone can see what others have not, or what
they have ignored, and thereby discover a pivotal objective and create an
advantage, lies at the very edge of our understanding, something glimpsed
onlyoutofthecornerofourminds.Noteverygoodstrategydrawsonthis
kind of insight, but those that do generate the extra kick that separates
“ordinaryexcellence”fromtheextraordinary.
WAL-MART
MuchofmyworkwithMBAstudentsandcompaniesinvolveshelpingthem
uncoverthehiddenpowerinsituations.AspartofthisprocessIoftenteacha
caseaboutWal-Mart’sfoundingandrise,endingin1986withSamWaltonas
therichestpersonintheUnitedStates.1InasubsequentsessionIwillfollow
upbydiscussingthemodernWal-Mart,pushingintourbanareas,stretching
outtoEurope,andbecomingthelargestcorporationontheplanetintermsof
revenue.Buttheoldercaseportraysasimpler,leanerWal-Mart—ayouthful
challenger rather than the behemoth it has become. Hard as it is to believe
today,Wal-MartwasonceDavid,notGoliath.
Before beginning the discussion, I copy a phrase from the case onto the
whiteboardanddrawaboxaroundit:
CONVENTIONALWISDOM:
Afull-linediscountstoreneedsapopulationbaseofatleast100,000.
The question for the group is simple: Why has Wal-Mart been so
successful?Tostart,IcallonBill,whohadsomeexperienceinsalesduring
theearlierpartofhiscareer.Hebeginswiththeritualinvocationoffounder
Sam Walton’s leadership. Neither agreeing nor disagreeing, I write “Sam
Walton”ontheboardandpresshimfurther.“WhatdidWaltondothatmadea
difference?”
Bill looks at my labeled box on the board and says, “Walton broke the
conventional wisdom. He put big stores in small towns. Wal-Mart had
everydaylowprices.Wal-Martranacomputerizedwarehousingandtrucking
systemtomanagethemovementofstockintostores.Itwasnonunion.Ithad
lowadministrativeexpenses.”
Ittakesaboutthirtyminutesforsixotherparticipantstofleshoutthislist.
Theyarewillingtothrowanythingintothebin,andIdon’tstopthem.Iprod
fordetailandcontext,asking,“Howbigwerethestores?”“Howsmallwere
thetowns?”“Howdidthecomputerizedlogisticssystemwork?”And“What
didWal-Martdotokeepitsadministrativeexpensessolow?”
Astheresponsesfloodin,threediagramstakeshapeonthewhiteboard.A
circleappears,representingasmalltownoftenthousandpersons.Alargebox
drawn in the circle represents a forty-five-thousand-square-foot Wal-Mart
store. A second diagram of the logistical system emerges. A square box
representsaregionaldistributioncenter.Fromthebox,alinemarksthepath
of a truck, swooping out to pass by some of the 150 stores served by the
distribution center. On the return path, the line passes vendors, picking up
palletsofgoods.Thelineplungesbacktothesquare,wherean“X”denotes
cross-dockingtoanoutgoingtruck.Linesofadifferentcolordepictthedata
flows,fromthestoretoacentralcomputer,andthenouttovendorsandthe
distributioncenter.Finally,aswediscussthemanagementsystem,Idrawthe
pathsoftheregionalmanagersastheyfollowaweeklycircuit:Flyoutfrom
Bentonville, Arkansas, on Monday, visit stores, pick up and distribute
information, and return to Bentonville on Thursday for group meetings on
FridayandSaturday.Thelasttwodiagramsareeerilysimilar—bothrevealing
thehubstructureofefficientdistribution.
Thediscussionslows.Wehavegottenmostofthefactsout.Ilookaround
theroom,tryingtoincludethemall,andsay,“Ifthepoliciesyouhavelisted
arethereasonsforWal-Mart’ssuccess,andifthiscasewaspublished—let’s
see—in1986,thenwhywasthecompanyabletorunrampantoverKmartfor
thenextdecade?Wasn’ttheformulaobvious?Wherewasthecompetition?”
Silence. This question breaks the pleasant give-and-take of reciting case
facts. The case actually says almost nothing about competition, referring
broadlytothediscountingindustry.ButsurelyexecutivesandMBAstudents
wouldhavethoughtaboutthisinpreparingforthisdiscussion.Yetitistotally
predictablethattheywillnot.Becausethecasedoesnotfocusoncompetition,
neitherdothey.Iknowitwillturnoutthisway—italwaysdoes.Halfofwhat
alert participants learn in a strategy exercise is to consider the competition
evenwhennoonetellsyoutodoitinadvance.
Looking just at the actions of a winning firm, you see only part of the
picture.Wheneveranorganizationsucceedsgreatly,thereisalso,atthesame
time,eitherblockedorfailedcompetition.Sometimescompetitionisblocked
becauseaninnovatorholdsapatentorsomeotherlegalclaimtoatemporary
monopoly.Buttheremayalsobeanaturalreasonimitationisdifficultorvery
costly. Wal-Mart’s advantage must stem from something that competitors
cannoteasilycopy,ordonotcopybecauseofinertiaandincompetence.Inthe
case of Wal-Mart, the principal competitive failure was Kmart. Originally
namedtheS.S.KresgeCorporation,Kmartwasoncetheleaderinlow-cost
variety retailing. It spent much of the 1970s and 1980s expanding
internationally and ignoring Wal-Mart’s innovations in logistics and its
growing dominance of small-town discounting. It filed for bankruptcy in
2002.
AftersomemomentsIaskamorepointedquestion:“BothWal-Martand
Kmartbegantoinstallbar-codescannersatcashregistersintheearly1980s.
WhydidWal-MartseemtobenefitfromthismorethanKmart?”
First used in grocery supermarkets, bar-code scanners at retail checkout
stations are now ubiquitous. Mass merchandisers began to use them in the
early1980s.Mostretailerssawthebar-codescannerasawayofeliminating
the cost of constantly changing the price stickers on items. But Wal-Mart
wentfurther,developingitsownsatellite-basedinformationsystems.Thenit
used this data to manage its inbound logistics system and traded it with
suppliersinreturnfordiscounts.
Susan,ahumanresourcesexecutive,suddenlyperksup.Isolatingonesmall
policy has triggered a thought. I gave a talk the day before on
“complementary”policiesandsheseestheconnection.“Byitself,”shesays,
“itdoesn’thelpthatmuch.Kmartwouldhavetomovethedatatodistribution
centersandsuppliers.Itwouldhavetooperateanintegratedinboundlogistics
system.”
“Good,” I say, and point out to everyone that Wal-Mart’s policies fit
together—the bar codes, the integrated logistics, the frequent just-in-time
deliveries,thelargestoreswithlowinventory—theyarecomplementstoone
another,forminganintegrateddesign.Thiswholedesign—structure,policies,
andactions—iscoherent.Eachpartofthedesignisshapedandspecializedto
theothers.Thepiecesarenotinterchangeableparts.Manycompetitorsdonot
havemuchofadesign,shapingeachoftheirelementsaroundsomeimagined
“bestpractice”form. Otherswillhavemorecoherencebutwill haveaimed
theirdesignsatdifferentpurposes.Ineithercase,suchcompetitorswillhave
difficulty in dealing with Wal-Mart. Copying elements of its strategy
piecemeal,therewillbelittlebenefit.Acompetitorwouldhavetoadoptthe
wholedesign,notjustapartofit.
Thereismuchmoretobediscussed:first-moveradvantages,quantifyingits
costadvantage,theissueofcompetenceandlearningdevelopedovertime,the
function of leadership, and whether this design can work in cities. We
proceed.
Withfifteenminutestogo,Iletthediscussionwinddown.Theyhavedone
agoodjobanalyzingWal-Mart’sbusiness,andIsayso.But,Itellthem,there
isonemorething.SomethingIbarelyunderstandbutthatseemsimportant.It
hastodowiththe“conventionalwisdom”—thephrasefromthecaseIputon
thewhiteboardatthebeginningoftheclass:“Afull-linediscountstoreneeds
apopulationbaseofatleast100,000.”
IturntoBillandsay:“YoustartedusoutbyarguingthatWaltonbrokethe
conventional wisdom. But the conventional wisdom was based on the
straightforwardlogicoffixedandvariablecost.Ittakesalotofcustomersto
spreadtheoverheadandkeepcostsandpriceslow.ExactlyhowdidWalton
breaktheironlogicofcost?”
Ipushahead,puttingBillintoarole:“Iwantyoutoimaginethatyouarea
Wal-Mart store manager. It’s 1985 and you are unhappy with the whole
company. You feel that they don’t understand your town. You complain to
yourdad,andhesays,‘Whydon’twejustbuythemout?Wecanrunthestore
ourselves.’ Assuming Dad has the resources, what do you think of his
proposal?”
Billblinks,surprisedatbeingputonthespotforasecondtime.Hethinksa
bit,thensays,“No,it’snotagoodidea.Wecouldn’tmakeagoofitalone.
TheWal-Martstoreneedstobepartofthenetwork.”
Iturnbackthewhiteboardandstandrightnexttotheboxedprinciple:“A
full-linediscountstoreneedsapopulationbaseofatleast100,000.”Irepeat
his phrase, “The Wal-Mart store needs to be part of the network,” while
drawingacirclearoundtheword“store.”ThenIwait.
With luck, someone will get it. As one student tries to articulate the
discovery,othersgetit,andIsenseasmallavalancheof“ahas,”likeapotof
corn kernels suddenly popping. It isn’t the store; it is the network of 150
stores.Andthedataflowsandthemanagementflowsandadistributionhub.
The network replaced the store. A regional network of 150 stores serves a
population of millions! Walton didn’t break the conventional wisdom; he
broketheolddefinitionofastore.Ifnoonegetsitrightaway,Idrophints
untiltheydo.
When you understand that Walton redefined the notion of “store,” your
view of how Wal-Mart’s policies fit together undergoes a subtle shift. You
begintoseetheinterdependenciesamonglocationdecisions.Storelocations
expresstheeconomicsofthenetwork,notjustthepullofdemand.Youalso
see the balance of power at Wal-Mart. The individual store has little
negotiatingpower—its optionsare limited.Most crucially,the network,not
thestore,becameWal-Mart’sbasicunitofmanagement.
In making an integrated network into the operating unit of the company,
instead of the individual store, Walton broke with an even deeper
conventional wisdom of his era: the doctrine of decentralization, that each
kettleshouldsitonitsownbottom.Kmarthadlongadheredtothisdoctrine,
giving each store manager authority to choose product lines, pick vendors,
andsetprices.Afterall,wearetoldthatdecentralizationisagoodthing.But
the oft-forgotten cost of decentralization is lost coordination across units.
Stores that do not choose the same vendors or negotiate the same terms
cannotbenefitfromanintegratednetworkofdataandtransport.Storesthatdo
not share detailed information about what works and what does not cannot
benefitfromoneanother’slearning.
If your competitors also operate this kind of decentralized system, little
may be lost. But once Walton’s insights made the decentralized structure a
disadvantage,Kmarthadasevereproblem.Alargeorganizationmaybalkat
adoptinganewtechnique,butsuchchangeismanageable.Butbreakingwith
doctrine—with one’s basic philosophy—is rare absent a near-death
experience.
ThehiddenpowerofWal-Mart’sstrategycamefromashiftinperspective.
Lacking that perspective, Kmart saw Wal-Mart like Goliath saw David—
smallerandlessexperiencedinthe bigleagues.ButWal-Mart’sadvantages
werenotinherentinitshistoryorsize.Theygrewoutofasubtleshiftinhow
tothinkaboutdiscountretailing.Traditionsawdiscountingastiedtourban
densities,whereasSamWaltonsawawaytobuildefficiencybyembedding
eachstoreinanetworkofcomputingandlogistics.Todaywecallthissupply-
chainmanagement,butin1984 itwasasanunexpected shiftinviewpoint.
AndithadtheimpactofDavid’sslungstone.
ANDYMARSHALL
IfirstmetAndyMarshallinmid-1990.Heisthedirectorofnetassessment
fortheDefenseDepartment,andhisnormalhabitatisasmallsuiteofoffices
inthePentagon,justdownthehallfromthesecretaryofdefense.Sincethe
Office of Net Assessment was created in 1973, there has been only one
director:AndrewMarshall.Hischallengingjobistothinkbroadlyaboutthe
securitysituationoftheUnitedStates.
AndyMarshallandIwerebothinterestedinhowtheprocessofplanning
shapesstrategicoutcomes.HeexplainedtomehowduringtheColdWarthe
traditional budget cycle of the military and the Congress had created a
reactivemindset.
“Our defense planning,” he said, “had become driven by the annual
budgetingprocess.” Eachyear, heexplained, theJointChiefs developedan
assessment of the Soviet threat, which was essentially an estimate of their
present and planned weapons inventory. The Pentagon then developed a
response to the threat that amounted to a shopping list. Congress would
appropriatesomefractionofwhatwasrequested,andthecyclewouldbegin
again.
“ThisprocessofjustifyingexpendituresascounterstoSovietexpenditures
conditioned U.S. actions on Soviet strengths, expressed as threats, not on
Soviet weaknesses and constraints. We had a war strategy—a catastrophic
spasm—but no plan about how to compete with the Soviet Union over the
longterm.”
Soft-spoken, Marshall watched my eyes, checking that I understood the
implicationsofhisstatements.Hetookoutadocument,athinsheafofpaper,
and began to explain its meaning: “This document reflects thoughts about
how to actually use U.S. strengths to exploit Soviet weaknesses, a very
differentapproach.”
Titled“StrategyforCompetingwiththeSovietsintheMilitarySectorof
theContinuingPolitical-MilitaryCompetition,”2ithadbeenwrittenin1976,
near the end of the Ford administration, and bore marginal notations by
President Carter’s secretary of defense, Harold Brown. It had evidently
receivedattention. (Itsauthors were AndyMarshall andJames Roche,who
was,atthattime,hisassistantdirector.)*
Thisfascinatinganalysisofthesituationworkedto redefine“defense”in
new terms—a subtle shift in point of view. It argued that “in dealing
effectivelywiththeotherside,anationseeksopportunitiestouseoneormore
distinctivecompetencesinsuchawayastodevelopcompetitiveadvantage—
bothinspecificareasandoverall.”Itthenwentontoexplainthatthecrucial
area of competition was technology because the United States had more
resourcesandbettercapabilitiesinthatarea.And,mostimportant,itargued
thathavingatruecompetitivestrategymeantengaginginactionsthatimposed
exorbitantcostsontheotherside.Inparticular,itrecommendedinvestingin
technologiesthatwereexpensivetocounterandwherethecountersdidnot
addtoSovietoffensivecapabilities.Forinstance,increasingtheaccuracyof
missiles or the quietness of submarines forced the Soviet Union to spend
scarce resources on counters without increasing the threat to the United
States.InvestmentsinsystemsthatmadeSovietsystemsobsoletewouldalso
force them to spend, as would selectively advertising dramatic new
technologies.
MarshallandRoche’sideawasabreakwiththebudget-drivenbalance-of-
forces logic of 1976. It was simple. The United States should actually
compete with the Soviet Union, using its strengths to good effect and
exploitingtheSoviets’weaknesses.Therewerenocomplexchartsorgraphs,
noabstruseformulas,noacronym-jammedbuzzspeak:justanideaandsome
pointerstohowitmightbeused—theterriblesimplicityofthediscoveryof
hiddenpowerinasituation.
As Andy Marshall and I spoke about this fourteen-year-old document in
1990, the Soviet Union was faltering. A year earlier the Berlin Wall had
fallen.ItwouldbeanothersixteenmonthsbeforetheUSSRdissolved.Butin
1990,when we discussedpolicy processes,before revisionistsofall stripes
started to rewrite history, it was clear that the Soviet Union was faltering
because it was overextended. It was going broke economically, politically,
and militarily. The United States’ more accurate missiles, the rise of
integrated circuits and the yawning technology gap, forward missile
placements in Europe, Ronald Reagan’s Strategic Defense Initiative, and
investmentsinunderwatersurveillancehadallputanunbearablepressureon
theUSSRtoinvest.Butatthesametime,itsresourceswerelimited:Saudi
ArabiaandtheUnitedKingdom(withitsnewNorthSeaproduction)worked
tokeepoilpricesdown,denyingtheSovietUnionextraforeignexchangeand
making Europeans less anxious to buy Russian gas. The USSR’s closed
systemandstatuspreventedeasyaccesstoWesterntechnology.TheSoviets’
warinAfghanistanhadsappedmoneyandinternalpoliticalsupport.Behind
almost all of these forces and events lay the indirect competitive logic that
Marshall and Roche expressed in 1976: use your relative advantages to
imposeout-of-proportioncostsontheoppositionandcomplicatehisproblem
ofcompetingwithyou.
Allmylife,theSovietUnionhaddominateddiscussionsofpolitics,war,
andpeace.Ihadgrownupdivingbeneathmythird-gradedeskuntiltheall-
clearsounded,andworryingaboutSputnik.Duringmyundergraduateyears
attheUniversityofCalifornia,Berkeley,professorshadmereadKarlMarx,
Lenin,JohnReed’svividaccountoftheRussianRevolution(TenDaysThat
ShooktheWorld),andarticlesonworker-peasantself-managementduringthe
revolution.Today,weknowthatduringthefiveyearsIheardlecturesonthe
wondersofrevolutionatBerkeley(1960–65),about1.5millionpeoplewere
killed in the Soviet gulag. During the whole post-WWII period, the Soviet
Union murdered upward of 20 million people, its own citizens and others
under its control, a grisly improvement over the 40 million executed,
purposefully starved, and worked to death in the 1917–48 period. As that
strangeanddeadlyempirecollapsed,howmuchoftheimplosionwasdueto
internal contradictions, and how much to the costs imposed on it by U.S.
policy?As inanycomplex event,thereweremanycauses. IfMarshalland
Roche’sstrategywasoneofthem,andIbelieveitwas,thenitcompelsour
attention. Their insight was framed in the language of business strategy:
identify your strengths and weaknesses, assess the opportunities and risks
(youropponent’sstrengthsandweaknesses),andbuildonyourstrengths.But
thepowerofthatstrategyderivedfromtheirdiscoveryofadifferentwayof
viewing competitive advantage—a shift from thinking about pure military
capability to one of looking for ways to impose asymmetric costs on an
opponent.
MarshallandRoche’sanalysisincludedalistofU.S.andSovietstrengthsand
weaknesses. Such lists were not new, and the traditional response to them
would have been to invest more to tip the “balance” in one’s favor. But
MarshallandRoche,likeSamWalton,hadaninsightthat,whenactedupon,
provided a much more effective way to compete—the discovery of hidden
powerinthesituation.
CHAPTER3
BADSTRATEGY
Badstrategyisnotsimplytheabsenceofgoodstrategy.Itgrowsoutof
specific misconceptions and leadership dysfunctions. Once you develop the
ability to detect bad strategy, you will dramatically improve your
effectiveness at judging, influencing, and creating strategy. To detect a bad
strategy,lookforoneormoreofitsfourmajorhallmarks:
•Fluff.Fluffisaformofgibberishmasqueradingasstrategicconceptsor
arguments. It uses “Sunday” words (words that are inflated and
unnecessarilyabstruse)andapparentlyesotericconceptstocreatethe
illusionofhigh-levelthinking.
•Failuretofacethechallenge.Badstrategyfailstorecognizeordefine
the challenge. When you cannot define the challenge, you cannot
evaluateastrategyorimproveit.
•Mistakinggoalsforstrategy.Manybadstrategiesarejuststatementsof
desireratherthanplansforovercomingobstacles.
•Bad strategic objectives.A strategic objective is set by a leader as a
means to an end. Strategic objectives are “bad” when they fail to
addresscriticalissuesorwhentheyareimpracticable.
THEORIGINOFTHE“BADSTRATEGY”CONCEPT
Icoinedtheterm“badstrategy”in2007atashortWashington,D.C.,seminar
on national security strategy. To understand the concept, it is helpful to
understandthenatureofthedisorderitdescribes.
OrganizedbytheCenterforStrategicandBudgetaryAssessments(CSBA),
the2007seminarhadnineparticipants,includingmajorfiguressuchasJames
R.Schlesinger,formersecretaryofdefense,secretaryofenergy,anddirector
oftheCIA;andFredC.Iklé,memberoftheCouncilonForeignRelations,
formerundersecretaryofdefenseforpolicy,directoroftheU.S.ArmsControl
and Disarmament Agency, and chairman of the bipartisan Commission on
IntegratedLong-Term Strategy.1 We did not come together to examine any
particularstrategybut, rather, tounderstandthereasonsforwhatallagreed
wasadeclineinthequalityofstrategyworkatthenationallevel.
Therewasnodisagreementaboutthefacts.DuringandafterWorldWarII,
especiallywiththeadventofnuclearweapons,U.S.nationalleadershiptook
national security strategy very seriously. But after 1989, as the threat of a
major offensive attack by another large power faded, the need for a new
integratedstrategicreviewofU.S.nationalsecuritystrategybecameapparent.
Anewpost–ColdWarstrategywasneeded,onethatwoulddealwithissues
such as nuclear proliferation, infrastructure protection, the use of space,
energyuseandsupply,globalfinancialmarkets,theinformationrevolution,
advancesinbiotechnology,thefutureofNATO,ethnicconflictsand failing
states,anddifficultieswithRussiaandChina.
This need for a dramatic redesign of the United States’ security-oriented
institutionalstructuresandprocessesbecameevenmoreimportantfollowing
the September 11, 2001, attacks. One analysis, the Princeton Project on
National Security, succinctly described the situation: “While the Bush
administration’s2002NationalSecurityStrategydidarticulateasetofU.S.
nationalgoalsandobjectives,itwasnottheproductofaseriousattemptat
strategic planning.… The articulation of a national vision that describes
America’spurposeinthepost–September11thworldisuseful—indeed,itis
vital—but describing a destination is no substitute for developing a
comprehensiveroadmapforhowthecountrywillachieveitsstatedgoals.”2
Despitetheobviousneed,verylittlehadbeendone.Thecentralquestion
on the table was “Why not?” Was it a problem of leadership, institutional
structure, or shortened time horizons? The seminar was guided by a
fascinatingpaperarguingthattherehadbeenageneraldeclineincompetence
at understanding and formulating strategy.3 It contended, “All too much of
what is put forward as strategy is not. The basic problem is confusion
betweenstrategyandstrategicgoals.”Withregardtotherecenteditionsofthe
nationalsecuritystrategy,itsaid“whenyoulookcloselyateitherthe2002or
2006documents,allyoufindarelistsofgoalsandsub-goals,notstrategies.”
Reading the documents referenced, I had to agree.4 They presented a
plethora of broad goals and affirmations of values such as democracy and
economicwell-being.Buttherewaslittleguidanceastohowtoactuallydeal
withthenationalsecuritysituation.
AtthecenterofthesedocumentslayPresidentGeorgeW.Bush’sdramatic
newdoctrineofrespondingtothethreatofweaponsofmassdestructionwith
preventivewar,ifnecessary.Yettherewerenoindicationsthatthisdoctrine
hadbeenturnedintoacoherentstrategy.Thatis,theconditionsofitsactual
usetodissuade,deter,andintervenewerenotexplored.Further,theproblems
createdbythispolicy,andthe competitivereactions toit,werenot thought
through.Forinstance,toavoiddebaclesashappenedinthe2003Iraqhuntfor
weapons of mass destruction, a policy of preemption should be backed up
withmuchstrongerintelligence.
Toinitiateapreemptivewar,itisreasonabletoexpectthatonewouldmove
far beyond secondhand intelligence and demand actual hands-on hard
evidenceobtainedbyU.S.forces.Preparingthecapabilityforsuchamajor
evidence-producingprestrikeoperationwouldhavetobeacriticalobjective,
yetitwasnot.Norwasthereanyevidencethatthepolicymakershadthought
throughtheproblem,evidentinboththeBosnianandIraqiinterventions,of
theUnited Statesbeingfed falseor exaggeratedintelligence informationin
order to induce military action to the benefit of an external constituency.
Finally,apolicyofpreemptionencouragesadversariestouseextremesecrecy,
coverparties,andcutouts,andtouse,ratherthanhold,weapons.Policiesthat
anticipatedthesepredictablepatternsinothers’behaviorwerelacking.
Lookingatanothersectionofthenationalsecuritystrategy,Ifoundthatthe
UnitedStateswill“workwithotherstodefuseregionalconflicts.”Thisisan
amazingly superficial political slogan. After all, are there really any other
alternatives for dealing with regional conflicts? It seems unlikely that the
UnitedStatescouldactaloneallovertheworldtodefuseregionalconflicts,
and it seems equally unlikely that we would completely ignore regional
conflicts. Stating this slogan provided no useful guidance to anyone. Even
worse, it relegated to the status of an annoying detail the fact that this
approachwaslessandlesseffective.NATOhadfailedtodelivermostofits
promised military and development support in Afghanistan, and the United
Nations appeared incapable of solving the problems in the Sudan, Uganda,
andNepal,anditappearedtoactuallyfosterIsraeli-Palestinianconflict.
Onesupposesthatthesloganmighthavebeencodefor“Wegiveuponthe
United Nations and will work with whoever can help defuse regional
conflicts.”Butageneralwillingnesstoworkwithinterestedotherscanhardly
beelevatedtothestatusofa“strategy.”Astrategywouldhavetoexplainwhy
regional conflicts, which have been a constant in human activity for
millennia, are suddenly a major security problem. And it would have to
explain which instruments of U.S. power and influence might be used to
convince others to work with the United States on such crusades. It would
also have to address the criteria for working with nations that violated the
national security strategy’s other goals of “human dignity,” “free trade,”
“democracy,”and“freedom.”
As another example of slogans substituted for strategy, consider this
keystonegoalofthenationalsecuritystrategy:“topreventourenemiesfrom
threateningus,ourallies,andourfriends,withweaponsofmassdestruction.”
Importantly,the2006documentexplainedtheobjectivethisway:“Weaimto
convinceouradversariesthattheycannotachievetheirgoalswithWMD,and
thus deter and dissuade them from attempting to use or even acquire these
weaponsinthefirstplace.”
It is difficult to understand what the author of this passage had in mind.
Whatwould “convince” enemiesof theUnitedStates thatthreats based on
WMDswouldnotadvancetheirgoals?America’sownColdWarstrategyhad
beenbasedonthreatstouseWMD,whichshouldbeconvincingevidencethat
suchthreatsworkquitewell.Itisclear,forinstance,thathadSaddamHussein
possessed nuclear weapons and the will to use them against allied military
forcesencampedinSaudiArabiain1991,orinKuwaitin2003,hiscountry
wouldnothavebeeninvaded.Histhreattokilloursoldierswouldhavebeen
credible, whereas a reciprocal threat to mass murder Iraqi civilians would
have been less credible. Russian intelligence officers reported that he
understoodthislogicverywellin1991andwasfrustratedthathisthen-secret
nuclear project was not further along. Since the 2006 National Security
Strategydoesnotexplainhowthedeadlyeffectivenessofnuclearthreatisto
bemitigated,thisparticular“goal”appearstobewishfulthinking.
Alogicalreactiontothesedocuments’weaknessesmightbethattheywere
public—that the real strategies were concealed. I had to reject this
explanation. Other analysts with access to privileged information had also
called out the lack of substance and coherence in U.S. national strategy.
Furthermore,theparticipantsatthe CSBAconferencewere insiders,people
whohadshapednationalpolicyatthehighestlevels,andamongthemthere
was no disagreement with the assessment that recent attempts at national
security strategy had produced a plentitude of vague aspirations and new
funding for existing institutions, but no policies or programs that could
reasonablybeexpectedtomakeadifference.
My role at the seminar was to provide a business and corporate strategy
perspective on these issues. My impression was that the participants
anticipated that I would say that business and corporate strategy was done
seriouslyandwithgrowingcompetence.
Using words and slides, I told the group that many businesses did have
powerful,effectivestrategies.Butinmypersonalexperienceswithcorporate
practice, both as a consultant and as a field researcher, I saw a growing
profusionofwhatItermed“badstrategy.”
Badstrategy,Iexplained,isnotthesamethingasnostrategyorstrategy
thatfailsratherthansucceeds.Rather,itisanidentifiablewayofthinkingand
writing about strategy that has, unfortunately, been gaining ground. Bad
strategyislongongoalsandshortonpolicyoraction.Itassumesthatgoals
areallyouneed.Itputsforwardstrategicobjectivesthatareincoherentand,
sometimes,totallyimpracticable.Ituseshigh-soundingwordsandphrasesto
hidethesefailings.
In the several years since that seminar, I have had the opportunity to
discussthebadstrategyconcept withanumberofseniorexecutives.Inthe
process,Ihavecondensedmylistofitskeyhallmarkstothefourlistedinthe
beginning of this chapter: fluff, the failure to face the challenge, mistaking
goalsforstrategy,andbadstrategicobjectives.
FLUFF
Fluff is superficial restatement of the obvious combined with a generous
sprinkling of buzzwords. Fluff masquerades as expertise, thought, and
analysis.Asasimpleexampleoffluffinstrategywork,hereisaquotefroma
majorretailbank’sinternalstrategymemoranda:“Ourfundamentalstrategyis
oneofcustomer-centricintermediation.”TheSundayword“intermediation”
meansthatthe company acceptsdeposits and thenlends them toothers.In
otherwords,itisabank.Thebuzzphrase“customer-centric”couldmeanthat
thebank competesby offering depositorsand lendersbetter termsor better
service.Butanexaminationofitspoliciesandproductsdoesnotrevealany
distinction in this regard. The phrase “customer-centric intermediation” is
purefluff.Pulloffthefluffycoveringandyouhavethesuperficialstatement
“Ourbank’sfundamentalstrategyisbeingabank.”
Fluff has its origins in the academic world and, more recently, in the
information technology industry. There, for example, a recent EU report
defines“cloudcomputing”as“anelasticexecutionenvironmentofresources
involvingmultiplestakeholdersandprovidingameteredserviceatmultiple
granularities for a specified level of quality-of-service.”5 A less fluffy
explanationisthatwhenyoudoaGooglesearch,orsenddatatoanInternet
backup service, you do not know or care which physical computer, data
server,orsoftwaresystemisbeingused—thereisa“cloud”ofmachinesand
networks,anditisuptotheexternalserviceprovidertoworkouthowthejob
isperformedandhowyouwillbecharged.
Isawanexampleofprimefluffinasummer2000presentationbythenow-
defunctArthurAndersen.AtthatmomentEnronwasadarlingofWallStreet,
andArthurAndersen,itsauditor,wasbusytryingtoattractnewclientsbased
onitsknowledgeofEnron’sbusinessstrategy.(Thiswasapresentationbya
unitoftheArthurAndersenaccountingfirm,notbythefirm’strueconsulting
arm,AndersenConsulting.)Thesessionwastitled“StrategiesoftheMovers
andShakers.”6
Thepresenter madeit clearthatthekey“mover andshaker” wasEnron,
andtheexcitementwasaboutitsrecentannouncementthatitwouldcreatea
marketfortradingbandwidth.Inthewordsofthespeaker,“Ninemonthsago,
whenEnronfirstannounceditsbandwidthtradingstrategy,itsmarketvalue
jumped by $9 billion. Today, the market is valuing the bandwidth trading
businessatabout$30billion.”
Deregulation in gas and electricity had created price volatility in these
markets. Public utilities, however, preferred stable prices for their inputs.
Enron’sstrategyinthegasandelectricitybusinesseshadbeentoownsome
physicalassetsandengagein“basistrading.”Thatis,itwouldsellautilitya
contractforfuturedeliveryofgasorelectricityatafixedpriceandthentryto
cover that commitment with a mixture of its own supplies and futures
contracts.Itusedabarrageofcontractswithspeculatorsandothertradersto
hedgeweather,price,andotherrisks.Bybeingthedominantplayerinboth
gasandelectricitytrading,itwasabletocaptureinformationaboutsupplies,
demand,andcongestionthatgaveitanedgeinitstradingactivities.
Thequestionthatshouldhavebeenoneveryone’smindwaswhetherEnron
could actually replicate this way of doing business in bandwidth trading.
Therewasnospotpriceinbandwidthtouseforbasistrading.Therewasno
standardofqualitytohelpdefinethedeliverable.Therewasnowaytoship
bandwidtharoundtobalancesupplyanddemandacrossgeographies.Enron
wanted every trader to deal directly with it—the company would not be a
middleman—yetitsownnetworknodeinNewYorkCitywassomedistance
fromthenodeusedbyalmosteveryoneelse.And,unlikegasandelectricity,
theincrementalcostofaunitofbandwidthwaszero.Thatmeantaslongas
capacityexceededdemand,thespotpriceinsuchamarketwouldbecloseto
zero. Furthermore, by the summer of 2000, it was becoming clear that
installed fiber-optic capacity greatly exceeded demand. Finally, in gas and
electricity, Enron traded the deliverable, not capacity. But bandwidth was
capacity, not the content being delivered. Enron did not have a position in
supplying content—online movies and other bandwidth-intensive content
werehardlycommodities.
The argument given at the presentation was that commodity markets
“evolve”inthesameway,sothesamebusinessstrategiesapplytoall.This
theory was summarized with the following diagram, a page taken from the
PowerPoint handouts at this presentation. This diagram seemed to be
describingsomesortof“evolution”inthesemarketsfromphysicaldelivery
toward a “knowledge space” and “exotics.” There was the implication that
derivative securities (bets on prices) were a means of “sophisticated value
extraction.”
Rather than address the real challenges of establishing a market for
bandwidth,thisdiagramandtheaccompanyingverbalpresentationwerepure
fluff.Therewasthesurfaceappearanceofbeinganalyticalandsummingupa
greatdealofinformation.Butacloserexaminationrevealedthatitwasastew
ofhalf-truths,complexdrawings,andbuzzwords.
INTODAY’SBANDWIDTHMARKETS,CONNECTIVITYISKEY
Marketsdonot necessarily evolvefrom “simple” to“complex”—it often
goes the other way around. Yes, you need a basis to create futures and
options,butabasisdoesnothavetobeacommodityorevenaprice.Traders,
forexample,writefuturescontractsontheChicagoBoardOptionsExchange
Volatility Index (VIX), which is a created measure of price volatility. Yes,
Enron’s gas and electricity trading were developed out of the ownership of
physical assets, but that might be a temporary phenomenon. The oil and
agriculture industries had long supported futures contracts and options
withoutheavyparticipationbyproducers.
Waitingforanswerstomyquestions,Iwasdisappointed.The“meat”inthe
presentationwastheabovefluffydiagramandalistingofthenew“strategies
ofthemarketenablers.”The“strategies”mentionedwerehavinganelectronic
tradingplatform,beinganover-the-counterbroker,andbeinganinformation
provider. These were not strategies—they were just names, like butcher,
baker, and candlestick maker. If you accept that the phrase “information
provider”describesabusinessstrategy,thenyouareaprimecustomerforthis
sortoffluff.
Fourteenmonthslater,itbecameevidentthatEnronwasfailing.Withthe
company’smountainofdebt,fallingprofitmargins,failedmajorprojectsin
the United Kingdom and Brazil, and huge losses in bandwidth trading,
outsidersbegantodoubtitsabilitytofulfillitssideofitscontracts.Noone
wantstowriteafuturescontractwithafirmthatmayfail—whichensuresthat
the firm will fail. As it went bankrupt in December 2001, evidence
accumulated about fraudulent accounting practices. The scandal took its
auditor, Arthur Andersen, down as well. (The accountant’s consulting arm,
Andersen Consulting, was renamed Accenture.) A systematic market for
tradingbandwidthhasyettodevelop.
A hallmark of true expertise and insight is making a complex subject
understandable. A hallmark of mediocrity and bad strategy is unnecessary
complexity—aflurryoffluffmaskinganabsenceofsubstance.
FAILURETOFACETHEPROBLEM
A strategy is a way through a difficulty, an approach to overcoming an
obstacle, a response to a challenge. If the challenge is not defined, it is
difficultorimpossibletoassessthequalityofthestrategy.Andifyoucannot
assessastrategy’squality,youcannotrejectabadstrategyorimproveagood
one.
International Harvester was once the fourth largest corporation in the
United States. Its roots lay in Cyrus McCormick’s reaper, a machine that,
together with the railroad, had developed the American plains. In 1977,
Harvester’sboardbroughtinanewCEO,ArchieMcCardell,whohadbeen
presidentofXerox.Theboardgavehimamandatetoturnaroundthesleepy
company.
McCardell’s administration was the culmination of a decade of
modernization.TheconsultingfirmBoozAllenHamiltonhadredesignedthe
organization;HayAssociateshadputinmodernmanagerialjobdescriptions
and incentives. McCardell brought with him a new cadre of financial and
strategicplanners.InJuly 1979,theyproduceda thicksheafofpaper titled
“CorporateStrategicPlan.”Itwasclassicbadstrategy.
Harvester’s corporate strategic plan was an amalgam of five separate
strategicplans,each createdbyoneoftheoperatingdivisions—agricultural
equipment ($3 billion), truck making ($4 billion), industrial equipment ($1
billion),gasturbines($0.3billion),andcomponents($1billion).Theoverall
“strategy” was to increase the company’s market share in each market, cut
costsineachbusiness,andtherebyrampuprevenueandprofit.Asummary
pagefromthatconfidentialplanisreproducedonthenextpage. Thegraph
showingpastandforecastprofitformsanalmostperfect“hockeystick,”with
animmediaterecoveryfromdeclinefollowedbyasteadyrise.
Thestrategicplandid notlackfortexture anddetail.Lookingwithinthe
agricultural equipment group, for example, there is information and
discussion about each segment. The overall intent was to strengthen the
dealer/distributornetworkandtoreducemanufacturingcosts.Marketsharein
agricultural equipment was projected to increase from 16 percent to 20
percent against competitors John Deere, Ford, Massey Ferguson, and J. I.
Case.
IHCORPORATESALES,ASSETS&PROFITBEFORETAX1977–
1984
Theproblemwithallthiswasthatitignoredtheelephantintheelevator.
Youcan’tdiscerntheelephantbystudyingtheplanbecausetheplandoesn’t
mention it. The elephant was Harvester’s grossly inefficient work
organization, a problem that would not be solved by investing in new
equipment or by pressing managers to grow market share. Work rules at
Harvesterplants,forinstance,allowedthosewithsenioritytotransferjobsat
will,eachtransfersettinginmotionacascadeofothertransfers.Asaresult,
Harvester’s profit margin had been about one-half of its competitors’ for a
longtime.Inaddition,Harvester hadtheworst labor relations in American
industry.Ithad beenthenexusofsomeoftheearliestlabordisputesinthe
United States, especially the 1886 Haymarket riot in Chicago, when an
anarchist’sbombkilledpoliceandworkersatarally.
Ifyoufailtoidentifyandanalyzetheobstacles,youdon’thaveastrategy.
Instead,youhaveeitherastretchgoal,abudget,oralistofthingsyouwish
wouldhappen.
McCardell did improve Harvester’s reported profits for a year or two by
cuttingadministrativeoverhead.Buthethenforcedthecompanytoendurea
six-monthstrikeinanattempttoobtainabetterunioncontract.Hefailedto
gain any significant concessions and, after the strike ended, the company
quicklybegantocollapse.Duringthewhole1979–85period,itlostmorethan
$3 billion, closed thirty-five of its forty-two plants, and shed eighty-five
thousand workers, leaving only fifteen thousand in employment. The
companysoldoffitsvariousbusinesses,theagriculturalequipmentgoingto
Tenneco,tomergewithitsJ.I.Casedivision.Thetruckdivisionwasrenamed
Navistarandhassurvived.Itis,today,aleadingmakerofheavytrucksand
engines.
Today,Harvester’s1979-stylestrategicplanningisoutoffashion.Instead
of long tables of numbers and bubble charts, we have a different type of
ritualizedformalism forproducing“strategic plans.”The currentfill-in-the-
blanks template starts with a statement of “vision,” then a “mission
statement”oralistof“corevalues,”thenalistof“strategicgoals,”thenfor
each goal a list of “strategies,” and then, finally, a list of “initiatives.”
(Template-stylestrategyisexploredfurtherinchapter4,“WhySoMuchBad
Strategy?”)
Despite the fact that they are adorned with modern phrases and slogans,
most of these strategic plans are as bad as International Harvester’s. Like
Harvester’s, they do not identify and come to grips with the fundamental
obstaclesandproblemsthatstandintheorganization’sway.Lookingatmost
ofthisproduct,orlisteningtothemanagerswhohaveproducedit,youwill
find an almost total lack of strategic thinking. Instead, you will find high-
sounding sentiments together with plans to spend more and somehow “get
better.”
The Defense Advanced Research Projects Agency (DARPA) works to
achieve radical technological innovation to support national security. As a
counterpoint to Harvester, DARPA’s strategy is based on a clear-sighted
recognitionofthenatureofthechallenge.HereisDARPA’sownstatementof
afundamentalproblemitsstrategyaddresses:
Abasicchallengeforanymilitaryresearchorganizationismatching
military problems with technological opportunities, including the new
operational concepts those technologies make possible. Parts of this
challenge are extremely difficult because: (1) some military problems
have no easy or obvious technical solutions; and (2) some emerging
technologiesmayhavefar-reachingmilitaryconsequencesthatarestill
unclear.DARPAfocusesitsinvestmentsonthis“DARPA-hard”niche—
asetoftechnicalchallengesthat,ifsolved,willbeofenormousbenefit
toU.S.nationalsecurity,eveniftheriskoftechnicalfailureishigh.7
Toattackthischallenge,DARPAfocusesonprojectsthemilitaryservices
seeastooriskyortooremovedfromtheircurrentmissions.Ittriestoimagine
whatcommanderswillwantinthefutureratherthanwhattheyarecallingfor
today,butitrestrictsitsworktothatconductedbyverytalentedpeoplewith
very good ideas. Some of DARPA’s successes include ballistic missile
defense,stealthtechnology,GPS,speechrecognition,theInternet,unmanned
landandairvehicles,andnanotechnology.
DARPA’s strategy is more than a general direction. It includes specific
policies that guide its everyday actions. For example, it retains program
managersforonlyfourtosixyearstolimitempirebuildingandtobringin
freshtalent.Theexpectationisthatanewprogrammanagerwillbewillingto
challengetheideasandworkofpredecessors.Inaddition,DARPAhasavery
limited investment in overhead and physical facilities in order to prevent
entrenchedinterestsfromthwartingprogressinnewdirections.Thesepolicies
arebasedonarealisticappraisaloftheobstaclestoinnovation.Theyareafar
cry from vague aspirations such as “retain the best talent” and “maintain a
cultureofinnovation.”
DARPA’ssurprisingstrategyhasashapeandstructurecommontoallgood
strategy.Itfollowsfromacarefuldefinitionofthechallenge.Itanticipatesthe
real-worlddifficultiestobeovercome.Iteschewsfluff.Itcreatespoliciesthat
concentrateresourcesandactionsonsurmountingthosedifficulties.
MISTAKINGGOALSFORSTRATEGY
ChadLogan,theCEOofagraphicsartscompany,introducedhimselftome
afterhearingatalkIgaveonself-controlandcommitment.Heaskedmeto
workwithhismanagementteamon“strategicthinking.”
With offices in a downtown commercial building, Logan’s company
providedcustomgraphicsservicestomagazines,bookpublishers,advertisers,
andcorporations.Loganwasacollegesportsheroturnedgraphicsartistwho
had moved into sales. He was also the nephew of the founder; when the
founderdiedtwoyearsbefore,Loganbecamethecompany’sprincipleowner.
The edge-of-town offices and work spaces were utilitarian; the CEO’s
conference room was paneled in teak. Brightly lighted examples of the
company’s work hung on the walls and reflected from the surface of the
polishedconferencetable.
The business was organized into a large design group and three sales
departments: Media sold to magazines and newspapers, Corporate sold to
corporations for catalogs and brochures, and Digital sold mainly to Web-
basedcustomers.
Loganexplainedthathisoverallgoalwassimple—hecalleditthe“20/20”
plan.Revenuesweretogrowat20percentperyearandtheprofitmarginwas
to be 20 percent or higher. “Our overall strategy is set,” he said. “We are
goingtogrow,andgrowprofitably.Myproblemisgettingeveryonealigned
forthispush.WhatIneedissomecoachingformytoppeople.Iwantthemto
be totally up to speed on strategic thinking. I want skills they can use
tomorrowinameetingwithaclient.”
IaskedLoganifhehadworkedoutanyelementsofhisstrategyotherthan
thegrowthandmargingoals.Heslidadocumentacrossthetabletop.Itwas
titled “2005 Strategic Plan.” Mostly, it was a set of projections: revenues,
costs, gross profit, and so on. The projections went out four years. In the
previous four or five years, the company had held its market share and its
after-tax profit margin had been about 12 percent, which is typical for this
industry. The projections were based on a 20 percent profit margin and 20
percentperyearrevenuegrowth.Thefirstpageofthedocumentwaslabeled
“OurKeyStrategies:”
OURKEYSTRATEGIES
•Wewillbethegraphicsartsservicesfirmofchoice.
• We will delight our customers with unique and creative solutions to
theirproblems.
•Wewillgrowrevenuebyatleast20%eachyear.
•Wewillmaintainaprofitmarginofatleast20%.
• We will have a culture of commitment. Corporate goals are
commitmentsweallworktokeep.
•Wewillfosteranhonestandopenworkenvironment.
•Wewillworktosupportthebroadercommunityinwhichweoperate.
“Wespentaboutthreeweeks,goingaroundtoeveryone,todevelopthese
keystrategies,”saidLogan.“Ibelieveinthem.Ibelievethatwecanhavea
companythatweareeachproudtobepartofandthatisworththeeffortit
takestowin.Thereisverygoodbuy-inonthesekeystrategies.”
“This20/20planisaveryaggressivefinancialgoal,”Isaid.“Whathasto
happenforittoberealized?”
Logan tapped the plan with a blunt forefinger. “The thing I learned as a
football player is that winning requires strength and skill, but more than
anythingitrequiresthewilltowin—thedrivetosucceed.Themanagersand
staff in this company have worked hard, and the transition to digital
technologies was handled well. But there is a difference between working
hardandhavingyoureyeontheprizeandthewilltowin.Sure,20/20isa
stretch,butthesecretofsuccessissettingyoursightshigh.Wearegoingto
getmovingandkeeppushinguntilwegetthere.”
WhenIaskedLogan“Whathastohappen?”Iwaslookingforsomepoint
ofleverage,somereasontobelievethisfairlyquietcompanycouldexplode
withgrowth andprofit. A strategyis likea leverthat magnifiesforce.Yes,
you might be able to drag a giant block of rock across the ground with
muscles,ropes,andmotivation.Butitiswisertobuildleversandwheelsand
thenmovetherock.Itriedagain:“Chad,whenacompanymakesthekindof
jumpinperformanceyourplanenvisions,thereisusuallyakeystrengthyou
arebuildingonorachangeintheindustrythatopensupnewopportunities.
Canyouclarifywhatthepointofleveragemightbehere,inyourcompany?”
Loganfrownedandpressedhislipstogether,expressingfrustrationthatI
didn’tunderstandhismeaning.Hepulledasheetofpaperoutofhisbriefcase
andranafingerunderthehighlightedtext.“ThisiswhatJackWelchsays,”he
toldme.Thetextread:“Wehavefoundthatbyreachingforwhatappearsto
betheimpossible,weoftenactuallydotheimpossible.”
“That’swhatwearegoingtodohere,”saidLogan.
Ididn’tthinkthatLogan’sconceptofhis20/20goalwasausefulwayto
proceed. Strategic objectives should address a specific process or
accomplishment,suchashalvingthetimeittakestorespondtoacustomer,or
gettingworkfromseveralFortune500corporations.However,arguingwith
himatthatjuncturewouldn’thavebeenproductive.Aclienthastofirstagree
toengageinadialoguebeforeatoughback-and-forthcanbeproductive.“All
right,”Isaid.“Iseewhereyouarecomingfrom.Givemesometimetolook
overthesenumbers.”
Intruth,Ididn’treallyneedtostudythenumbers.WhatIneededwassome
time to think about my own approach to helping Logan. Although he was
well-intentioned, his plan, to me, was all results and no action. In his own
mind,hebelievedincourage,boldness,motivation,andpush.Hisreference
to“pushinguntilwegetthere”triggered,inmymind,anassociationwiththe
greatpushesof1915–17duringWorldWarI,especiallyatPasschendaele.
Whenwarbrokeoutin1914,jubilantcrowdsjammedthestreetsofcities,and
young men hurled hats in the air as they marched off to prove themselves.
Thephilosophyof the age,most fervently adoptedby the French, wasthat
willpower,spirit,morale,élan,andaggressivenesswerethekeystosuccess.
Forthreeyears,generalsflunghighlymotivatedmenatfortifiedmachine-gun
emplacements, only to see tens of thousands, then hundreds of thousands,
shreddedtomincemeattogainamileofuselessground.
In1917, around thevillage ofPasschendaele inFlanders,Britishgeneral
DouglasHaigplannedanassault.HewantedtobreakthroughtheGermans’
fortifiedlinesandopenupapathtothesea,dividingtheGermanarmy.He
hadbeenadvisedthatshellingtheGermanfortifiedpositionswoulddestroy
the dikes and flood the below-sea-level fields. He shelled the German
fortificationsanyway.Theshellingbrokethedikesandchurnedtherichsoil
to sticky yellow clay, a quagmire that men sank into up to their knees and
bellies.Itdrownedtanks,horses,andthewounded.
Haig, stung by the death of 100,000 British troops at the Somme a year
earlier,hadpromisedtocallofftheadvanceifitdidnotgowell.Itdidn’t,yet
the doctrine of motivation and “one last push” continued for three months,
despiteappalling losses.Ina finalten-day assault,Canadian troopspressed
directlyintothemachine-gunfire,flounderinginthemudandbodypartsof
comrades;theysuffered16,000casualtiestotakeasmallhill.Overthethree
months of battle, five miles of ground were gained and more than 70,000
Alliedsoldiers diedinthe muck.Another 250,000were wounded. Winston
ChurchilldescribedPasschendaeleas“aforlornexpenditureofvalourandlife
withoutequalinfutility.”
AttheSommeandPasschendaele,HaigledanentiregenerationofBritish
andDominionyouthtotheirdeaths—asJosephJoffredidfortheFrenchat
theSomme,andErichvonFalkenhayndidfortheGermansatVerdun.
In Europe, motivational speakers are not the staple on the management
lecture circuit that they are in the United States, where the doctrine of
leadership as motivation is alive and well. Here, for example, is H. Ross
Perot:“Mostpeoplegiveupjustwhenthey’reabouttoachievesuccess.They
quitontheone-yardline.Theygiveupatthelastminuteofthegame,one
footfromawinningtouchdown.”
Hearing this, many Americans nod in agreement. Many Europeans, by
contrast, hear the echo of the “one last push” at Passchendaele. There, the
slaughtered troops did not suffer from a lack of motivation. They suffered
fromalackofcompetentstrategicleadership.Motivationisanessentialpart
oflifeandsuccess,andaleadermayjustlyaskfor“onelastpush,”butthe
leader’s job is more than that. The job of the leader is also to create the
conditionsthatwillmakethatpusheffective,tohaveastrategyworthyofthe
effortcalledupon.
ImetwithChadLoganafewdaysafterourfirstget-together.ItoldhimthatI
wouldexplainmypointofviewandthenlethimdecidewhetherhewantedto
workwithmeonstrategy.Isaid:
Ithinkyouhavealotofambition,butyoudon’thaveastrategy.I
don’tthinkitwouldbeuseful,rightnow,toworkwithyourmanagerson
strategiesformeetingthe20/20goal.
WhatIwouldadviseisthatyoufirstworktodiscovertheverymost
promising opportunities for the business. Those opportunities may be
internal, fixing bottlenecks and constraints in the way people work, or
external.Todothis,youshouldprobablypulltogetherasmallteamof
peopleandtakeamonthtodoareviewofwhoyourbuyersare,whoyou
competewith,andwhatopportunitiesexist.It’snormallyagoodideato
lookverycloselyatwhatischanginginyourbusiness,whereyoumight
getajumponthecompetition.Youshouldopenthingsupsothereareas
manyusefulbitsofinformationonthetableaspossible.Ifyouwant,I
can help you structure some of this process and, maybe, help you ask
some of the right questions. The end result will be a strategy that is
aimedatchannelingenergyintowhatseemtobeoneortwoofthemost
attractiveopportunities,whereitlookslikeyoucanmakemajorinroads
orbreakthroughs.
Ican’ttellyouinadvancehowlargesuchopportunitiesare,orwhere
they may be. I can’t tell you in advance how fast revenues will grow.
Perhapsyouwillwanttoaddnewservices,orcutbackondoingcertain
thingsthatdon’tmakeaprofit.Perhapsyouwillfinditmorepromising
to focus on grabbing the graphics work that currently goes in-house,
ratherthantocompetitors.But,intheend,youshouldhaveaveryshort
listofthemostimportantthingsforthecompanytodo.Thenyouwill
haveabasisformovingforward.ThatiswhatIwoulddowereIinyour
shoes.
If you continue down the road you are on you will be counting on
motivationtomovethecompanyforward.Icannothonestlyrecommend
thatasawayforwardbecausebusinesscompetitionisnotjustabattleof
strength and wills; it is also a competition over insights and
competencies. My judgment is that motivation, by itself, will not give
thiscompanyenoughofanedgetoachieveyourgoals.
ChadLoganthankedmeand,aweeklater,retainedsomeoneelsetohelp
him.ThenewconsultanttookLoganandhisdepartmentmanagersthroughan
exercisehecalled“Visioning.”Thegistofitwasthequestion“Howbigdo
you think this company can be?” In the morning they stretched their
aspirationsfrom“bigger”to“verymuchbigger.”Then,intheafternoon,the
facilitatorchallengedthemtoanevengrandervision:“Thinktwiceasbigas
that,”hepressed.Loganwaspleased.Iwaspleasedtobeelsewhereengaged.
ChadLogan’s“keystrategies”hadlittletodowithstrategy.Theyweresimply
performance goals. This same problem affects many corporate “strategy
plans.”
Businessleadersknowtheirorganizationsshouldhaveastrategy.Yetmany
expressfrustrationwiththewholeprocessofstrategicplanning.Thereason
forthisdissatisfactionisthatmostcorporatestrategicplansaresimplythree-
year or five-year rolling budgets combined with market share projections.
Calling a rolling budget of this type a “strategic plan” gives people false
expectationsthattheexercisewillsomehowresultinacoherentstrategy.
There is nothing wrong with planning. It is an essential part of
management. Take, for example, a rapidly growing retail chain. It needs a
plantoguidepropertyacquisition,construction,training,andsoon.Thisis
what a resource plan does—it makes sure resources arrive when they are
needed and helps management detect surprises. Similarly, a multinational
engineering company needs a plan to guide and fit together its human
resourceactivities,theopeningandexpansion ofofficesinvariousregions,
anditsfinancingpolicies.
You can call these annual exercises “strategic planning” if you like, but
they are not strategy. They cannot deliver what senior managers want: a
pathwaytosubstantiallyhigherperformance.Toobtainhigherperformance,
leaders must identify the critical obstacles to forward progress and then
developacoherentapproachtoovercomingthem.Thismayrequireproduct
innovation,ornewapproachestodistribution,orachangeinorganizational
structure.Or it may exploitinsights into theimplications of changesin the
environment—in technology, consumer tastes, laws, resource prices, or
competitivebehavior.Theleader’sresponsibilityistodecidewhichofthese
pathways will be the most fruitful and design a way to marshal the
organization’s knowledge, resources, and energy to that end. Importantly,
opportunities, challenges, and changes don’t come along in nice annual
packages.Theneedfortruestrategyworkisepisodic,notnecessarilyannual.
BADSTRATEGICOBJECTIVES
Ifyouareamidlevelmanager,yourbosssetsyourgoals.Or,ifyouworkin
an enlightened company, you and your boss negotiate over your goals. In
either setting, it is natural to think of strategies as actions designed to
accomplishspecificgoals.However,takingthiswayof thinkingintoatop-
levelpositionisamistake.
Beingageneralmanager,CEO,president,orothertop-levelleadermeans
havingmorepowerandbeinglessconstrained.Effectiveseniorleadersdon’t
chase arbitrary goals. Rather, they decide which general goals should be
pursued.Andtheydesignthesubgoalsthatvariouspiecesoftheorganization
worktoward.Indeed,thecuttingedgeofanystrategyisthesetofstrategic
objectives(subgoals)it laysout.One ofthechallenges ofbeinga leaderis
mastering this shift from having others define your goals to being the
architectoftheorganization’spurposesandobjectives.
To help clarify this distinction it is helpful to use the word “goal” to
expressoverallvaluesanddesiresandtousetheword“objective”todenote
specific operational targets. Thus, the United States may have “goals” of
freedom, justice, peace, security, and happiness. It is strategy which
transforms these vague overall goals into a coherent set of actionable
objectives—defeat the Taliban and rebuild a decaying infrastructure. A
leader’smostimportantjobiscreatingandconstantlyadjustingthisstrategic
bridgebetweengoalsandobjectives.
Forexample,ChenBrotherswasarapidlygrowingregionaldistributorof
specialtyfoods.Itsoverallgoalsincludedgrowingprofit,beingagoodplace
towork,andbeingseenasthego-todistributorfororganicfoods.Thesewere
all worthy goals. None of them, however, implied a particular strategy or
action,althoughtheycanbeseenasconstraints(thatis,thesesortsofbroad
“goals” work like the rules of football in that they rule out a great many
actionswithoutspecifyingwhattheteamshouldactuallydo).
Chen Brothers’ strategy had been to target local specialty retailers that
wouldpayapricepremiumtocarrydistinctiveproductsnotavailableatthe
largechainstores.Topmanagementhaddivideditscustomersandpotential
customersintothreetiersandsetstrategicobjectivesforeachtier.Themost
importantobjectiveswereshelf-spacedominanceinthetoptier,promotional
parityorbetterinthemiddletier,andgrowingpenetrationinthelowesttier.
TherecentrapidgrowthofWholeFoodswasputtingincreasingpressure
on the local specialty shops that had been Chen Brothers’ target market.
Accordingly,managementwasformulatinganewstrategyoflinkingtogether
smalllocalfoodproducersunderacommonbrandthatcouldbesoldthrough
Whole Foods. This change in strategy had no impact on the company’s
overallgoals,butclearlymeantaradicalrestructuringofitscurrentstrategic
objectives.Insteadofpenetrationobjectivesfordifferentclassesofretailers,
ChenBrothersputtogethera“WholeFoods”teamthatcombinedproduction,
marketing, advertising, distribution, and financial expertise. The team was
entirelyfocusedontheobjectiveofmakingChenBrothers’mostdistinctive
newproductanationalaccountatWholeFoods.Oncethatwasaccomplished,
further objectives concerning other products, shelf space, and market share
wouldbeset.
ChenBrothersdidnotfallintothetrapofbelievingthatstrategyisagrand
visionorasetoffinancialgoals.Instead,managementhadskillfullydesigned
a “way forward” that concentrated corporate attention on one or two
importantobjectives.Onceaccomplished,newopportunitieswouldopenup
andmoreambitiousobjectivescouldbeset.
Dog’sDinnerObjectives
Goodstrategyworksbyfocusingenergyandresourcesonone,oraveryfew,
pivotalobjectiveswhoseaccomplishmentwillleadtoacascadeoffavorable
outcomes. One form of bad strategic objectives occurs when there is a
scrambled mess of things to accomplish—a “dog’s dinner” of strategic
objectives.
A long list of “things to do,” often mislabeled as “strategies” or
“objectives,”isnotastrategy.Itisjustalistofthingstodo.Suchlistsusually
growoutofplanningmeetingsinwhichawidevarietyofstakeholdersmake
suggestionsastothingstheywouldliketoseedone.Ratherthanfocusona
few important items, the group sweeps the whole day’s collection into the
“strategicplan.”Then,inrecognitionthatitisadog’sdinner,thelabel“long-
term”isaddedsothatnoneofthemneedbedonetoday.
Asavividexample,Irecentlyhadthechancetodiscussstrategywiththe
mayor of a small city in the Pacific Northwest. His planning committee’s
strategic plan contained 47 “strategies” and 178 action items. Action item
number 122 was to “create a strategic plan.” As another example, the Los
Angeles Unified School District’s strategic plan for “high-priority schools”
(discussedonthenextpage)contained7“strategies,”26“tactics,”and234
“action steps,” a true dog’s dinner of things to do. This pattern is all too
common in city, school district, and nonprofit strategy work, as well as in
somebusinessfirms.
Blue-SkyObjectives
Thesecondformofbadstrategicobjectivesisonethatis“bluesky.”Agood
strategydefinesacriticalchallenge.Whatismore,itbuildsabridgebetween
that challenge and action, between desire and immediate objectives that lie
withingrasp.Thus,theobjectives agoodstrategysetsshould standagood
chanceofbeingaccomplished,givenexistingresourcesandcompetence.(See
thediscussionofproximateobjectivesinchapter7.)Bycontrast,ablue-sky
objectiveisusuallyasimplerestatementofthedesiredstateofaffairsorof
thechallenge.Itskipsovertheannoyingfactthatnoonehasaclueastohow
togetthere.
A leader may successfully identify the key challenge and propose an
overallapproachtodealingwiththechallenge.Butiftheconsequentstrategic
objectives are blue sky, not much has been achieved. The purpose of good
strategy is to offer a potentially achievable way of surmounting a key
challenge.Iftheleader’sstrategicobjectivesarejustasdifficulttoaccomplish
astheoriginalchallenge,therehasbeenlittlevalueaddedbythestrategy.
In2006,David Brewer,aformeradmiralintheU.S.Navy,tookthe jobof
superintendent of the giant Los Angeles Unified School District (LAUSD).
His daunting assignment was to make a difference in the nation’s largest
schooldistrict.
InCalifornia,schoolsaremeasuredintermsofastatewideaggregatetest
score—the Academic Performance Index, or API. Of Los Angeles’s 991
schools, many did well on these tests. Still, 309 did not meet the U.S.
DepartmentofEducation’sNoChildLeftBehindgoals.Soonafterreviewing
the situation, Brewer defined the challenge as making a significant
improvement in the test performance scores at the district’s 34 weakest
schools:17middleand17 highschoolshetermed “highpriority.”Hisidea
wastoworkonimprovingthese34weakestschoolsfirst,buttothenbuildon
successbyexpandingeffortstotherestofthesystem.
Brewerdeservescreditforcreatingastrategywithafocus—thethirty-four
high-priorityschoolsthathadbeentheconsistentlyworstperformingonthe
APItests.Byfocusingonthelowestperforming34of991schools,therewas
theopportunitytobreakwiththepastandwiththemany-layeredsystemof
regulation, union control, and grossly oversized central administration.
Indeed,itmighthavebeenreasonabletodecidethatthischallenge,byitself,
wasworthbeingthesinglekeystoneofthestrategy.Byzeroinginonthisone
criticalissuesomethingmighthavebeenaccomplished.
Still, it is worth noting that this definition of “performance” was itself
“strategic”inanunpleasantway.UsingAPItestscoressidesteppedLAUSD’s
horrendousdropoutrate,especiallyamongblackandHispanicstudentswho
togetherformtheoverwhelmingmajorityofstudentsinLosAngeles(13and
70percentrespectively).OfblackstudentsenteringLAUSDhighschools,33
percentdroppedout.OfHispanics,28percentdroppedout.Theterribletruth
was that one way to increase a school’s API score was to encourage the
weakeststudentstodropout—theAPImeasuredonlyactivestudents.
Whenaleadercharacterizesthechallengeasunderperformance,itsetsthe
stageforbadstrategy.Underperformanceisaresult.Thetruechallengesare
the reasons for the underperformance. Unless leadership offers a theory of
whythingshaven’tworkedinthepast,orwhythechallengeisdifficult,itis
hardtogenerategoodstrategy.
Forexample,oneofBrewer’ssevenkeystrategieswasto“buildschooland
District leadership teams that share common beliefs, values, and high
expectationsforalladultsandstudentsandthatsupportacycleofcontinuous
improvementtoensurehigh-qualityinstructionintheirschools.”Thiswould
beaccomplishedbybuildingthe“capacityofadministrativeandotherschool
leaders.… Transformational leaders need a strongly focused program to
define,sharpenandapplycriticalskillsetsintheireverydaywork.”
This strategy/objective is “bad” in several respects. First, there is no
diagnosisofthereasonsthatleadershipisweakandexpectationsarelow.A
seriouslookatthisissuewouldrevealthatthehigh-priorityschoolshadbeen
failingfordecades.Asystemspending$25,000perstudentperyear8andthat
cannot guarantee that eighth-graders read, write, and do sums is broken.
While many teachers and principals are dedicated, many are also
incompetent. More important, the top-heavy bureaucratic system has had
decadestoremedythesystemandhasnot.
Second, it is an absurdly blue-sky objective to ask for “transformational
leadership”when (1) thetext of theplan explains thatmany administrators
and leaders have limited ability to meet their daily problems, (2) no one
knowshowtocreate“transformational”leaderseveninthebestofconditions,
and(3)theseschoolsremainembeddedinagiantall-controllingbureaucracy
andunionsystem.Theso-calledtransformationalleaderscannotchangethe
color of the paper they use without permission from higher-ups, and it is
virtually impossible to remove a principal, even if he or she fails to be
transformational.Theproposedsolutions—lotsofcoordinationupanddown
thehierarchy, timeoff,and in-house training—arewoefully inadequate and
illustratethesystem’swastefulself-servingsclerosis.
Aninterestingaspectofthislanguageistheideathatleadershipteamsmust
sharecommonbeliefsandvalues.Thisisnowafrequentdemandineducation
circles.OnewouldhopethattheexperienceofNorthKoreawouldhavecured
people of the idea that forcing everyone to believe in and value the same
things is the road to high performance. Yet, within politically correct edu-
speak, this impossible state of affairs is continually sought as the path to
“transformationalchange.”
Another“strategy”wasto“buildateachschoolacommunityofinformed
and empowered parents, teachers, staff, and community partners who work
collaborativelytosupporthigh-qualityteachingandlearning.”In particular,
theplancalledforthecreationofa“communityliaison”position,mandating
monthly meetings, twice-a-year parent conferences, and a parent volunteer
program.
Ahighrateofcommunityinvolvementmightbeaverydesirablestateof
affairs. But it is hardly a strategy. It is a blue-sky objective. Much of the
underperformance in these thirty-four schools appears at kindergarten and
deepensasstudentsgrowolder.Aprincipalcauseofthisunderperformanceis
thepoverty-strickenchaoticcommunitiestheseschoolsserve.IntheLAUSD,
many students are illegal immigrants or the children of illegal immigrants.
Names and addresses are often fictitious, and parents may be unwilling to
signupforschoolprograms.Manystudentsarethechildrenofteenmothers
whoneverfinishedtheirowneducations,don’tread booksthemselves,and
have little free time or energy, spending hours each day commuting to and
fromlow-payingjobs.Thesearethekindsoftruechallengesagoodstrategy
wouldhavetorecognize.
As we have seen through the examples of U.S. national security strategy,
ArthurAndersen’spresentation,InternationalHarvester,ChadLogan,andthe
LAUSD,badstrategyisvacuousandsuperficial,hasinternalcontradictions,
anddoesn’tdefineoraddresstheproblem.Badstrategygeneratesafeelingof
dull annoyance when you have to listen to it or read it. The next chapter
examineswhysomuchbadstrategyexists.
CHAPTERFOUR
WHYSOMUCHBADSTRATEGY?
Giventhealmostuniversalrecognitionoftheimportanceofstrategy,itis
naturaltoask“Whyisbadstrategysocommon?”Tobegin,badstrategyis
not miscalculation. I am intimately familiar with the myriad mistakes and
errorsthatcanbemadeinassessingthecompetition,one’sownresources,the
lessonsofthepast,andtheopportunitiesandproblemspresentedbychange
andinnovation.
However,afteryearsofworkingwithcompaniesandteachingstrategyto
executives and MBA students, I have found that more training in these
fundamentalareasbarelyputsadentintheproclivitytocreatebadstrategy.
Bad strategy flourishes because it floats above analysis, logic, and choice,
held aloft by the hot hope that one can avoid dealing with these tricky
fundamentalsandthedifficultiesofmasteringthem.
Notmiscalculation,badstrategyistheactiveavoidanceofthehardworkof
craftingagoodstrategy.Onecommonreasonforchoosingavoidanceisthe
pain or difficulty of choice. When leaders are unwilling or unable to make
choicesamongcompetingvaluesandparties,badstrategyistheconsequence.
Asecondpathwaytobadstrategyisthesirensongoftemplate-stylestrategy
—fillingintheblankswithvision,mission,values,andstrategies.Thispath
offers a one-size-fits-all substitute for the hard work of analysis and
coordinated action. A third pathway to bad strategy is New Thought—the
belief that all you need to succeed is a positive mental attitude. There are
other pathways to bad strategy, but these three are the most common.
Understanding how and why they are taken should help you guide your
footstepselsewhere.
THEUNWILLINGNESSORINABILITYTOCHOOSE
Strategy involves focus and, therefore, choice. And choice means setting
asidesomegoalsinfavorofothers.Whenthishardworkisnotdone,weak
amorphousstrategyistheresult.
Inearly1992,Isatinonastrategydiscussionamongseniorexecutivesat
theDigitalEquipmentCorporation(DEC)thatconcernedthefuturedirection
of the company. A leader of the minicomputer revolution of the 1960s and
’70s and an innovator of user-friendly operating systems, DEC was rapidly
losing ground to the newer 32-bit personal computers. There were serious
doubtsthatthecompanycouldsurvivewithoutdramaticchanges.
Whiletherewereseveralkeypeopleatthismeeting,Iwillsimplifymatters
bysummarizingthe positionsofthoseattendingthroughthevoices ofonly
three executives: “Alec,” “Beverly,” and “Craig,” each of whom argued in
favorofadifferentdirectionforthecompany.
Alec held that DEC was and always had been a computer company,
integratinghardwareandsoftwareintousablesystems.
Beverly derisively named Alec’s preference as the “Boxes” strategy. She
felt that “Boxes” had become a commodity and that the only real resource
DEC had to build on was its customer relationships. Hence, she argued in
favorofastrategythatsolvedcustomerproblems,astrategytheothersnamed
“Solutions.”
CraigdisagreedwithbothAlecandBeverly,holdingthattheheartofthe
computer industry was semiconductor technology, and that the company
shouldfocusitsresourcesondesigningandbuildingbetter“Chips.”DEChad
no distinctive competence, Craig argued, in finding Solutions to customer
problems. “We are having enough trouble solving our own problems,” he
said.AlecandBeverlydisagreedwiththeChipsstrategy,believingthatDEC
wouldnotbeabletocatchuptocompaniessuchasIBMandIntelinthechip
business.
Why not forgo the arguments and do all three? There were two reasons.
First,ifonehasapolicyofresolvingconflictbyadoptingalltheoptionson
thetable,therewillbenoincentiveforanyonetodevelopandsharpentheir
argumentsinthefirstplace.Onlytheprospectofchoiceinspirespeoples’best
arguments about the pluses of their own proposals and the negatives of
others’.Asin thelaw, disciplinedconflictcallsforthstrongerevidenceand
reasoning. Second, both Chips and Solutions represented dramatic
transformationsofthefirm,andeachwouldrequiredevelopingwhollynew
skillsandworkpractices.Onewouldn’tchooseeitherriskyalternativeunless
the status quo Boxes strategy was failing. And one wouldn’t choose to do
bothChipsandSolutionsatthesametimebecausetherewaslittlecommon
ground between them. It is not feasible to do two separate deep
transformationsofacompany’scoreatonce.
Here are Alec, Beverly, and Craig’s rank-order preferences for the three
alternativesfacingDEC:
TheirrankingscreatewhatisknownasCondorcet’sparadox.1Theparadox
arises if the three vote on the strategies in paired comparisons. In a first
contest between Boxes and Chips, Alec and Beverly both prefer Boxes, so
Boxeswins.Now,comparethewinnerofthatvote(Boxes)toSolutions.In
thissecondvote,BeverlyandCraigbothpreferSolutions,soSolutionswins.
Thus, Solutions beat Boxes, which beat Chips. Given these outcomes, one
wouldthinkthatthegroupwouldpreferthetwo-roundwinner(Solutions)to
the first-round loser (Chips). But, alas, in a contest between Solutions and
Chips, Alec and Craig both prefer Chips, so Chips beats Solutions. This
cyclingofresults,withnoendingpoint,isCondorcet’sparadox.
Youmightimagineresolvingthisproblemwithacleverervotingscheme.
Perhaps the three could weight their preferences and one could somehow
combinetheseweights.EconomistKennethArrowreceivedaNobelPrizein
1972 for proving that such attempts are fruitless.2 This sort of group
irrationalityisacentralpropertyofdemocraticvoting,afactnotcoveredin
highschoolcivics.
TheDECgroupdidnotcarryoutaformalvoteinitsmeetings.However,
theeffectoftheCondorcetparadoxwasfeltinthegroup’sinabilitytoforma
stable majority coalition. Staying with the simplification of three people,
whenanytwotriedtoagreeonanoutcome,formingamajority,oneofthem
wasthentemptedtodefectandjoinforceswiththethird,formingadifferent
majoritythat wascloser totheirdesire.Suppose,forexample,thatBeverly
andCraig formed acoalition to supportSolutions. Becausethispolicy was
Craig’ssecond-bestchoice,hewouldbetemptedtodefectandjoinwithAlec
inamajoritysupportingChips.ButthatcoalitionwasalsounstableasAlec
wouldthenbetemptedtodefectandteamupwithBeverlytosupportBoxes,
andsoon.
Withequallypowerfulexecutivesarguingforthreeconflictingstrategies,the
meeting was intense. The opinions expressed were not grounded in self-
centeredmotives,butexpresseddifferingbeliefsaboutwhatwasgoodforthe
company.
DEC’s chief executive, Ken Olsen, had made the mistake of asking the
grouptoreachaconsensus.Thegroupwasunabletodothatbecausethere
was no basis in logic or hierarchy to reject a subgroup’s passionately held
positions.Instead,thegroupcompromisedonastatementlikethis:“DECis
committedtoprovidinghigh-qualityproductsandservicesandbeingaleader
indataprocessing.”
This fluffy, amorphous statement was, of course, not a strategy. It was a
political outcome reached by individuals who, forced to reach a consensus,
couldnotagreeonwhichinterestsandconceptstoforgo.Sotheyavoidedthe
hardworkofchoice,setnothingaside,hurtnointerestgroupsorindividual
egos,butcrippledthewhole.
CEO Ken Olsen was replaced in June 1992 by Robert Palmer, who had
headedsemiconductorengineering.Inshortorder,Palmermadeitclearthat
thestrategywouldbeChips.Hestoppedthelossesforawhilebutcouldnot
stemthetideofevermorepowerfulpersonalcomputersthatwereovertaking
thefirm.DECwasacquiredbyCompaqin1998,which,inturn,wasacquired
byHewlett-Packardthreeyearslater.
Seriousstrategyworkinanalreadysuccessfulorganizationmaynottake
place until the wolf is at the door—or even until the wolf’s claws actually
scratchonthefloor—becausegoodstrategyisveryhardwork.AtDEC,the
wolf was at the door in 1988, but still the hard work of combining the
knowledgeandjudgments of peoplewith differentbackgrounds andtalents
wassidestepped.Whenthewolffinallybrokeintothehouseitself,onepoint
ofviewwonandpressedasidetheothers.Bythen,itwasfiveyearstoolateto
matter.
Therehasbeenalotofinkspilledontheinnerlogicofcompetitivestrategy
and on the mechanics of advantage. But the essential difficulty in creating
strategyisnotlogical;itischoiceitself.Strategydoesnoteliminatescarcity
anditsconsequence—thenecessityofchoice.Strategyisscarcity’schildand
to have a strategy, rather than vague aspirations, is to choose one path and
eschewothers. Thereisdifficultpsychological,political, andorganizational
workinsaying“no”towholeworldsofhopes,dreams,andaspirations.
Whenastrategyworks,wetendtorememberwhatwasaccomplished,not
thepossibilitiesthatwerepainfullysetaside.Forinstance,oneofPresident
Eisenhower’s campaign promises made during the presidential election of
1952 was to roll back the Soviet Union from Eastern Europe. He won the
election in a landslide. But after the election he initiated a study (Project
Solarium)ofnationalpolicywithregardtotheSovietUnion, aprojectthat
remainsthegoldstandardforhowsecuritystrategyshouldbemade.Having
studied the problem and the alternatives he then made the hard choice—he
put aside his campaign promises and chose not to challenge the USSR’s
conquestsinEasternEurope.3WewoulddetertheSovietUnionfrommilitary
attacksonWesternEurope,buttherewouldbenorollback.Therewouldbe
Radio Free Europe and spies, but the countries dominated by the Soviet
UnionattheendoftheWorldWarIIwouldbeleftunderitscontrol.
Anycoherentstrategypushesresourcestowardsomeendsandawayfrom
others.Thesearetheinevitableconsequencesofscarcityandchange.Yetthis
channelingofresourcesawayfromtraditionalusesisfraughtwithpainand
difficulty.IntelCEOAndyGrovevividlyrelatestheintellectual,emotional,
and political difficulties in moving the company from producing dynamic
randomaccessmemory(DRAM)toonefocusedonmicroprocessors.
Intel was known as a memory company and had developed much of the
complextechnologyrequiredtodesignandmanufacturechips.Butby1984it
was clear that Intel could not match the prices of its Japanese rivals in
DRAM. Losing money, Grove recalls, “We persevered because we could
afford to.” Losing more and more money, senior management engaged in
endless debates about what to do. Grove recalls the turning point in 1985
whenhegloomilyaskedIntel’schairman,GordonMoore,“Ifwegotkicked
outandtheboardbroughtinanewCEO,whatdoyouthinkhewoulddo?”
Moore immediately replied, “He would get us out of memories.” Grove
recalls that he went numb and then finally said, “Why shouldn’t you and I
walkoutthedoor,comebackanddoitourselves?”4
Evenafterformingthatconviction,ittookoverayeartomakethechange.
The memory business had been the engine that drove research, production,
careers,andprideatIntel.Salespeopleworriedaboutcustomerresponse,and
researchersresistedthecancellationofmemory-basedprojects.Grovepushed
through the exit from the memory business and refocused the company on
microprocessors.Thesuccessofthenew32-bit386chipspropelledIntelinto
beingtheworld’slargestsemiconductorcompanyby1992.(Thisgeneration
ofchipswas,interestingly,theundoingofDEC,discussedearlier.)
Strategiesfocusresources,energy,andattentiononsomeobjectivesrather
thanothers.Unlesscollectiveruinisimminent,achangeinstrategywillmake
some people worse off. Hence, there will be powerful forces opposed to
almostanychangeinstrategy.Thisisthefateofmanystrategyinitiativesin
largeorganizations.Theremaybetalkaboutfocusingonthisorpushingon
that,butattheendofthedaynoonewantstochangewhattheyaredoing
very much. When organizations are unable to make new strategies—when
peopleevade the workof choosing amongdifferentpaths into thefuture—
then you get vague mom-and-apple-pie goals that everyone can agree on.
Such goals are direct evidence of leadership’s insufficient will or political
power to make or enforce hard choices. Put differently, universal buy-in
usuallysignalstheabsenceofchoice.
Inorganizationsandpolitics,thelongerapatternofactivityismaintained,
the more it becomes entrenched and the more its supporting resource
allocationsaretakentobeentitlements.Compare,forexample,theinertiain
today’s national security apparatus with that experienced by Presidents
Truman and Eisenhower. During Eisenhower’s administration, the Defense
Department,anindependentairforce,theCIA,theNationalSecurityCouncil,
and NATO were all newly created. Because new structures are more
malleable,PresidentEisenhowerhadenoughpowertoreshapetheirmissions
andinducesomecoordinationwiththeDepartmentofState.Buttoday,after
more than half a century, the power required to reshape and compel
coordination among these organizations is many times greater than
Eisenhowereverused.Itwouldtakeenormouspoliticalwillandtheexercise
of great centralized power to overcome the present levels of institutional
resistancetochange.Suchpoweris,ofcourse,possible,butitwouldtakea
crisisofepicproportionstoengenderit.
TEMPLATE-STYLESTRATEGY
Oddly enough, the study of charisma has led to a common type of bad
strategy.Thepathstartswiththerecognitionthattrulyinspirationalleaders—
ranging from Moses to Churchill to Gandhi to Martin Luther King Jr.—
occupy a different space than leaders who draw authority from birth or
organizational rank. The path then passes through the dry baked clay of
academic sociology before cutting through the shifting sand dunes of
managementconsulting.
TheideaofcharismaticleadershipdatesbacktoMaxWeber(1864–1920),
the father of sociology. Describing leaders, he found it necessary to
distinguishbetweenformalleadersandthosewholedbypersonalcharisma.
Thelatter,hewrote,seemed“endowedwithsupernatural,superhuman,orat
least specifically exceptional powers or qualities … not accessible to the
ordinaryperson.”5
Traditionally,charismawasassociatedwithreligiousandpoliticalleaders,
notCEOsorschoolprincipals.Thisbegantochangeinthemid-1980s.The
tippingpointwastheappearanceoftwobooksin1985:WarrenBennisand
BertNanus’sLeaders:TheStrategiesforTakingChargeandBernardBass’s
influential Transformational Leadership: Industrial, Military, and
Educational Impact. These authors broke with tradition and argued that
charismatic(now“transformational”)leadershipcanbelearnedandpracticed
in settings ranging from schools to corporations to art museums. The
transformational leader, they argued, unlocks human energy by creating a
visionofadifferentrealityandconnectingthatvisiontopeople’svaluesand
needs.Theseworkswerefollowedbyaraftofbooksandarticlesinasimilar
vein:TheLeadershipChallenge:HowtoGetExtraordinaryThingsDonein
Organizations (1987), The Transformational Leader: The Key to Global
Competitiveness(1990),andExecutiveCharisma:SixStepstoMasteringthe
ArtofLeadership(2003).
Not everyone was drawn to this formulation. Peter Drucker, one of the
foremost thinkers about management, said, “Effective leadership doesn’t
depend on charisma. Dwight Eisenhower, George Marshall, and Harry
Truman were singularly effective leaders, yet none possessed any more
charisma than a dead mackerel.… Charisma does not by itself guarantee
effectivenessasaleader.”
The key innovation in this growing stream has been the reduction of
charismatic leadership to a formula. The general outline goes like this: the
transformational leader (1) develops or has a vision, (2) inspires people to
sacrifice(change)forthegoodoftheorganization,and(3)empowerspeople
to accomplish the vision. Some experts place more emphasis on the moral
qualitiesoftheleader,othersoncommitment,andothersontheleaderbeing
intellectuallystimulating.
This conceptual scheme has been hugely popular with college-educated
peoplewho havetomanage othercollege-educatedpeople.Itsatisfies their
sense that organizations should somehow be forced to change and improve
whilealsosatisfyingtheircontradictorysensethatitisawkwardtotellother
peoplewhattodo.
Whatever you think about this definition of leadership, a problem arises
whenitisconfusedwithstrategy.Leadershipandstrategymaybejoinedin
the same person, but they are not the same thing. Leadership inspires and
motivates self-sacrifice. Change, for example, requires painful adjustments,
and good leadership helps people feel more positively about making those
adjustments. Strategy is the craft of figuring out which purposes are both
worthpursuingandcapableofbeingaccomplished.
As an example of charismatic leadership without the craft of strategy,
consider the famous Children’s Crusade. It began in 1212 when young
Stephen,aFrenchshepherdboy,hadavisionofabandofchildrentraveling
toJerusalem to throwout theMuslims.In hisvision, theseaparted before
themasithadforMoses.Thosewhoheardhimspeakofthisvisionandhis
purposewereimpressedwithhispassionandeloquence.WordofStephen’s
visiontraveledto Germany,where anotheryoungman,Nicholas,organized
hisowncrusade,hisvisionbeingtheconversionoftheMuslimsratherthan
their conquest. Both youthful charismatic leaders gathered followers and
begantheirarduousjourneys.
Stephen’slargebandwalkedformonths,finallyarrivingatMarseilles,on
theMediterraneancoast.Theretheymanagedtoembarkonsevenships.Two
wrecked,killingallaboard.TheotherfivewerecapturedbyMuslimraiders,
andallaboardweresoldintoslavery.
Nicholas, starting his trek south with twenty thousand German children,
reachedRomewithamuchsmallernumber.There,mostwereconvincedto
return home. Only a few made it back. The parents of the dead children
hangedNicholas’sfather.
Thereisnodenyingthepowerofcharismaticvisiontomovepeople.Itisa
potent way to overcome inertia and motivate both action and self-sacrifice.
Butin1212,asinmanyothertimes,thousandssacrificedtonoend.
To achieve great ends, charisma and visionary leadership must almost
alwaysbejoinedwithacarefulattentiontoobstaclesandaction,asGandhi
was able to do in India. There, his carefully orchestrated demonstrations,
marches, publicity, and times in jail built his base and eroded the British
rulers’self-imageoffairnessandmorality.Hischarismaandvision,coupled
withagoodstrategy,gaveIndiabothindependenceandaproudheritage.
By the early 2000s, the juxtaposition of vision-led leadership and strategy
workhadproducedatemplate-stylesystemof“strategicplanning.”(Google
“visionmissionstrategy”tofindthousandsofexamplesofthistemplatefor
saleandinuse.)Thetemplategenerallylookslikethis:
The Fillinyouruniquevisionofwhattheschool/business/nationwill
Vision: belikeinthefuture.Currentlypopularuniquevisionsaretobe
“thebest”or“theleading”or“thebestknown.”Forexample,
DowChemical’svisionis“Tobethemostprofitableand
respectedscience-drivenchemicalcompanyintheworld.”6
Enron’svisionwas“tobecometheworld’sleadingenergy
company.”
The
Mission:
Fillinahigh-soundingpoliticallycorrectstatementofthepurpose
oftheschool/business/nation.Dow’smissionis“Topassionately
innovatewhatisessentialtohumanprogressbyproviding
sustainablesolutionstoourcustomers.”
The
Values:
Fillinastatementdescribingthecompany’svalues.Makesure
theyarenoncontroversial.Dow’svaluesare“Integrity,Respect
forPeople,andProtectingOurPlanet.”Enron’swere“Respect,
Integrity,CommunicationandExcellence.”
The
Strategies:
Fillinsomeaspirations/goalsbutcallthemstrategies.For
example,Dow’scorporatestrategiesare“Preferentiallyinvestina
portfoliooftechnology-integrated,market-drivenperformance
businessesthatcreatevalueforourshareholdersandgrowthfor
ourcustomers.Manageaportfolioofasset-integratedbuilding
blockbusinessestogeneratevalueforourdownstreamportfolio.”
This template-style planning has been enthusiastically adopted by
corporations,schoolboards,universitypresidents,andgovernmentagencies.
Scan through these documents and you will find pious statements of the
obviouspresentedasiftheyweredecisiveinsights.
Thereisalargeindustryofconsultantsandbookwriterswhoarewillingto
provide instruction on the delicate differences between missions, visions,
strategies, initiatives, and priorities. From small boutiques to the large IT-
based firms trying to break into strategy work, consultants have found that
template-style strategy frees them from the onerous work of analyzing the
true challenges and opportunities faced by the client. Plus, by couching
strategyinterms ofpositives—vision,mission,and values—nofeelingsare
hurt.
Togetaflavorofthisgenre,itisusefultoexamineanumberofspecific
visionsandmissions:
•Themission ofthe Department ofDefense is to“deter conflict—but
shoulddeterrencefail,tofightandwinthenation’swars.”Itwouldbe
hardtofindanyonewhowouldarguewiththis,butitwouldalsobe
equallyhardtofindanyoneinformedbyit.Awasteofprint.
•CornellUniversity’smissionistobea“learningcommunitythatseeks
toservesocietybyeducatingtheleadersoftomorrowandextending
the frontiers of knowledge.” In other words, Cornell University is a
university.Thisishardlysurprisingandiscertainlynotinformative.It
providesabsolutelynoguidancetofurtherplanningorpolicymaking.
Itisembarrassingforanintelligentadulttobeassociatedwiththissort
ofbloviating.
• California State University, Sacramento (CSUS), announces that its
vision is to “be known throughout and increasingly beyond the
SacramentoRegionforitsexcellentandcomprehensiveacademicand
co-curricularstudentprograms.Wewillbeakeypartnerindeveloping
the highly diverse ‘New California.’” 7 As in many other official
visions,thestandardofexcellencesetisthePeoplemagazinemeasure
ofsuccess:“beingknown.”
TheCSUSplangoesontoestablishseveral“strategicpriorities.”The
first is “a strategically focused, campus-wide effort to improve
recruitment,retention,andgraduationrates.”Thefineprintinformsthe
alertreaderthatthisisakeyprioritybecausestatefundingislinkedto
enrollment.Inotherwords,ifstudentsdropoutorflunkout,theschool
losesrevenue.Oneofthe“strategies”forimprovingretentionistohave
a “culture where retention, graduation, and student success in all its
forms are embraced and pursued.” It is difficult to see any actionable
element in this fluffy admonition. By contrast, the more specific
“strategy” to (somehow) push the graduation rate up from 57 to 62
percent is clearly achievable. However, there is no discussion of the
obvious conflict between a vision of educational excellence and an
objectiveofincreasingstatefundingbyloweringthedropoutrate.
The bottom line is that the increased monies gained from a lower
dropoutratewillbeusedtoraisefacultysalariesandbuildanewlibrary.
• The vision of the Central Intelligence Agency is “One Agency. One
Community. An Agency unmatched in its core capabilities,
functioning as one team, fully integrated into the Intelligence
Community.”8 Digging slightly deeper, the CIA’s publically stated
prioritiesallhavetodowithbetterteamworkandmoreinvestmentin
capabilities. Nowhere did it say that finding and killing Osama bin
Laden was a top priority. Of course, one does not expect to see the
strategiesoftheCIAonapublicwebsite.Butifthatisthecase,why
publishthisfluff?
• I recently attended a strategy presentation in Tokyo by a senior
executiveofNECCorporation.NEC’svisionforthenextdecadeisto
“bealeadingglobalcompanyleveragingthepowerofinnovationto
realizeaninformationsocietyfriendlytohumansandtheearth.”Over
thenexthour,Ialsolearnedthatthecompanyaimstohelpdevelopa
“sustainable ubiquitous networking society that uses a knowledge-
based ICT [information and communications technology] mega-
platform.” Now, NEC is a computer and telecom equipment maker
thathasareasonableshareofthelocalJapanesebusinessbuthasnot
succeededabroad.Thisequipmentmarketisincreasinglycompetitive
withlowmarginsformostplayers.NECisearninglessthan2percent
onequity,anditsoperatingprofitisanastoundinglylow1.5percent
ofrevenue.ItcertainlycannotaffordtheR&Dtowhichitaspires.It
needsastrategy,notasetofslogans.
Thisclassofverbiageisamutantoffspringoftheconceptofcharismatic,
thentransformational,leadership.Inreality,thesearetheflat-footedattempts
oforganizationmentoturnthemagicofpersonalcharismaintoabureaucratic
product—charisma-in-a-can.
One might conclude that if the audience for this verbiage is happy, why
care? The enormous problem all this creates is that someone who actually
wishes to conceive and implement an effective strategy is surrounded by
emptyrhetoricandbadexamples.Andthegeneralpubliciseitherledastray
orputs allsuchpronouncementsintothe samemental binas late-nightTV
advertising.
NEWTHOUGHT
Earlier I described how Chad Logan wished to run his graphics art
company by emulating Jack Welch, pointing out that Welch recommended
“reaching for the impossible.” Logan’s desire to emulate Welch was
understandable.Atthatmoment,JackWelchwasviewedasoneofthemost
successfulmanagersinhistory.Hehadwritten,spoken,andbeeninterviewed
extensivelyonleadership,strategy,andmanagement.However,likedipping
intotheBible,youcouldfindwhateveryouwantedinhisbodyofwork.Yes,
Welchthoughtformalstrategicplanningwasawasteoftime,buthealsosaid,
“The first step of making strategy real is figuring out the big ‘aha’ to gain
sustainablecompetitiveadvantage—inotherwords,asignificant,meaningful
insightabouthowtowin.”Yes,Welchbelievedinstretch,buthealsosaid“If
you don’t have a competitive advantage, don’t compete.” Welch didn’t ask
people to “stretch” in home appliances, or coal, or semiconductors. He
dropped those businesses entirely, focusing GE on businesses where he
believeditwaspossibletomakeadifference.Hedidn’taskthosedivisionsto
buyintothevisionoftheirbeingdropped.IfyouwanttomanagelikeJack
Welch,payattentiontowhathedid,nottowhathe,orhisghostwriters,say
hedid.
The Jack Welch quote about “reaching for what appears to be the
impossible” is fairly standard motivational fare, available from literally
hundreds of motivational speakers, books, calendars, memo pads, and
websites.Thisfascinationwithpositivethinking,anditsdeepconnectionsto
inspirationalandspiritualthought,wasinventedabout150yearsagoinNew
EnglandasamutationofProtestantChristianindividualism.
TheProtestantReformationwasfounded ontheprinciplethatpeople did
not need the Catholic Church to stand between them and the deity. In the
1800s,startingwithRalphWaldoEmerson’s“transcendentalism,”American
theology began to develop the idea that each person’s individual
communicationwithGodwaspossiblebecauseeveryonehasasparkofthe
divinewithinthemselves,experiencedascertainstatesofmind.
The next stage in the development of this idea was Mary Baker Eddy’s
ChristianScience, which heldthat a mindholding thecorrectthoughts and
beliefscoulddrawondivinepowertoeliminatedisease.By1890,thisstream
of religious philosophy had morphed into a set of mystical beliefs in the
powerofthoughttoaffectthematerialworldbeyondtheself.CalledtheNew
Thoughtmovement, it combined religious sentiment with recommendations
for worldly success. The theory was that thinking about success leads to
success.Andthatthinkingaboutfailureleadstofailure.
Prentice Mulford was a comic and a gold miner in California before he
turnedtoinspirationalwriting.His bookThoughts Are Things,publishedin
1889,wasafoundingepistleofNewThoughtmovement.Hereishistheme:
When we form a plan for any business, any invention, any
undertaking, we are making something of that unseen element, our
thought,asreal,thoughunseen,asanymachineofironorwood.That
planorthoughtbegins,assoonasmade,todrawtoitself,inmoreunseen
elements,powertocarryitselfout,powertomaterializeitselfinphysical
orvisiblesubstance.Whenwedreadamisfortune,orliveinfearofany
ill, or expect ill luck, we make also a construction of unseen element,
thought,—which,bythesamelawofattraction,drawstoitdestructive,
andtoyoudamaging,forcesorelements.9
Inthefirsttwodecadesofthetwentiethcentury,hundredsofvolumesand
articlesonthemindandsuccesswerepublished.Perhapsthemostinfluential
wasWallaceWattles’sTheScienceofGettingRich(1910).Histhemewasthat
eachpersonhasgodlikepowers,buthestrippedoutanydirectreferencesto
religion,creatingaseriesofquasi-religiousincantations:
Thereisathinkingstufffromwhichallthingsaremade,andwhich,
initsoriginalstate,permeates,penetrates,andfillstheinterspacesofthe
universe.Athought,inthissubstance,producesthethingthatisimaged
bythethought.Mancanformthingsinhisthought,and,byimpressing
histhoughtuponformlesssubstance,cancausethethinghethinksabout
tobecreated.…Tothinkhealthwhensurroundedbytheappearancesof
disease,ortothinkricheswheninthemidstofappearancesofpoverty,
requires power; but he who acquires this power becomes a MASTER
MIND.Hecanconquerfate;hecanhavewhathewants.10
Ernest Holmes was the founder of the Religious Science movement.
InfluencedbyChristianScience,hefeltlimitedbyitsnarrowfocusonhealth.
Hisbook,CreativeMindandSuccess,publishedin1919,tookNewThought
ideastoawidepublicandhelpedestablishachurchthatremainsactivetoday.
Notice that Holmes insists that the successful person must banish any
thoughtsoffailure:
Thought is not only power; it is also the form of all things. The
conditionsthatweattractwillcorrespondexactlytoourmentalpictures.
Itisquitenecessary,then,thatthesuccessfulbusinessmanshouldkeep
hismindonthoughtsofhappiness,whichshouldproducecheerfulness
instead of depression; he should radiate joy, and should be filled with
faith, hope and expectancy.… Put every negative thought out of your
mind once and for all. Declare your freedom. Know no matter what
others may say, think or do, you are a success, now, and nothing can
hinderyoufromaccomplishingyourgoal.11
Asasocialandreligiousmovement,NewThoughtreacheditspeakinthe
early1920s,whenitagainmorphed,leavingbehindthelocalsocieties,faith
healers, and churches. By the 1930s it had transformed into a stream of
motivational and positive-thinking books and speakers. In this vein are the
still popular Think and Grow Rich (Napoleon Hill, 1937), The Power of
PositiveThinking(NormanVincentPeale,1952),SuccessThroughaPositive
Mental Attitude (Clement Stone, 1960), The Dynamic Laws of Prosperity:
ForcesThatBringRichestoYou(CatherinePonder,1962),AwakentheGiant
Within(Anthony Robbins, 1991), and The Seven Spiritual Laws of Success
(Deepak Chopra, 1995). The most recent major writer in this stream is
RhondaByrne,anunabashedadmirerofWattles.Her2007book,TheSecret,
wasasmashbestseller,hasbeenturnedintoafilm,andwastoutedbyOprah.
Byrne’s “secret” is identical with Mulford’s original principle that you get
whatyouthinkabout.Today,theseideasarecalled“NewAge,”despitethe
fact that they are almost verbatim repetitions of books published a century
ago.
Elements of New Thought have recently seeped into strategic thinking
through literature on leadership and vision. Much of the work in this area
providesahealthycounterweighttobureaucraticandrational-actionviewsof
management and organization. But recently it has taken on a flavor
reminiscentof Mulford’s 1889Thoughts Are Things. The analogy fostering
thisdisplacementisbetweenanindividualthoughtandsharedvisionwithin
anorganization.
To see this displacement, consider Peter Senge’s enormously successful
bookTheFifthDiscipline,publishedin1990.OneofSenge’smostinfluential
ideaswasthevitalimportanceof“sharedvision”:“Itisimpossibletoimagine
the accomplishments of building AT&T, Ford, or Apple in the absence of
shared vision.… What is most important is that these individual’s visions
became genuinely shared among people throughout all levels of their
companies—focusing the energies of thousands and creating a common
identityamongenormouslydiversepeople.”12
Thisstatementisveryappealingtomanypeopleand,atthesametime,is
quiteobviouslyuntrue.AscribingthesuccessofFordandAppletoavision,
shared at all levels, rather than pockets of outstanding competence mixed
withluck,isaradicaldistortionofhistory.Appledidnotinventthepersonal
computer—the technology was in the air and hundreds of entrepreneurs
sought to design and build “computers for everyman.” Apple’s success
derived,inlargemeasure,fromSteveWozniak’sabilitytocleverlytrickthe
MotorolamicroprocessoratthecenteroftheAppleIIintodirectlydrivingthe
videoandafloppydisk—usingstraightoutputsfromtheCPU—ratherthan
buildingexpensivecontrollers.And,fromtheadventofVisiCalc,whichgave
peopleotherthanhobbyistsareasontobuyanAppleII.13
Similarly, Ford’s “cars for everyman” vision was hardly unique and not
necessarilysharedbythefive-dollar-a-dayassemblylineworkers.Detroitwas
the “Silicon Valley” of 1907 and there were hundreds, even thousands, of
engineers and tinkerers working on ways to make and sell automobiles.
Ford’sspecialgeniuswasinmaterials,industrialengineering,andpromotion.
Interestingly, Senge urges leaders to “personal mastery,” which is a
spiritualinwardjourney.Inthisregard,hequotesFord’smysticalbeliefthat
“thesmallestindivisiblerealityis,tomymind,intelligentandiswaitingthere
to be used by human spirits if we reach out and call them in.” Ford was
indeedamystic,believedinreincarnation,andattributedmuchofhissuccess
toreadingNewThoughtwriterRalphWaldoTrine’sInTunewiththeInfinite,
abookcontainingthestandardadvicetoavoidnegativethoughtsandforma
clearpictureinyourmindofwhatyouwant.Ofcourse,Senge’srespectfor
Ford’sphilosophicalmusingsdoesnotextendtothepointofurgingreadersto
alsostudyFord’srabidanti-Jewishranting.14
JustasNewThoughtwritersadvisedpeopletoneverletnegativethoughts
entertheirheads,theshared-visionschoolplacesapremiumoncommitment
—the unwavering belief that the vision is right. In Guiding Growth: How
VisionKeepsCompaniesonCourse,MarkLiptonwrites:
Yet another disorienting factor in the process is a requirement that
thoseinvolvedindevelopingthegrowthvisionsuspenddisbelief.After
all,executiveshavespentyearsofeducationandexperiencelearningto
be realistic and pragmatic. But suspending disbelief is necessary to
enable the executive to think, from the start, that what he or she has
envisionedcanandwillbeachieved.Whileitrepresentstheantithesisof
practicality, it is nonetheless a necessary competency of executive
leadership.Notonlymusttherebeabeliefinthedreambutalsoabelief
inone’sabilitytomakethatdreamcometrue.15
In Senge’s newest work, Presence (coauthored with C. Otto Scharmer,
JosephJaworski,andBettySueFlowers),headmiringlyquotesSrikumarS.
Rao,acontributingeditortoForbesandheadofthemarketingdepartmentat
LongIslandUniversity.Raosays:
Ifyouformandholdyourintentlongenough,itbecomestrue.…You
becomeextremelyclearaboutwhatitisyouwanttodo.…Thisprocess
ofrefinement—thinkingaboutyourintentionmany,manytimes—is,ina
sense,abroadcastof intention.When youbroadcastsuchanintention,
there’svery littleelseyou haveto do.Thebroadcast ofintentiongoes
outandmakesithappen.Yourroleistoremainkeenlyaware,patiently
expectant,andopentoallpossibilities.16
TheamazingthingaboutNewThoughtisthatitisalwayspresentedasifit
werenew!Andnomatterhowmanytimesthesameideasarerepeated,they
are received by many listeners with fresh nods of affirmation. These ritual
recitationsobviouslytapintoadeephumancapacitytobelievethatintensely
focuseddesireismagicallyrewarded.
I do not know whether meditation and other inward journeys perfect the
humansoul.ButIdoknowthatbelievingthatrayscomeoutofyourheadand
change the physical world, and that by thinking only of success you can
become a success, are forms of psychosis and cannot be recommended as
approaches to management or strategy. All analysis starts with the
considerationofwhatmayhappen,includingunwelcomeevents.Iwouldnot
caretoflyinanaircraftdesignedbypeoplewhofocusedonlyonanimageof
a flying airplane and never considered modes of failure. Nevertheless, the
doctrinethat onecan imposeone’s visionsand desireson theworldbythe
force of thought alone retains a powerful appeal to many people. Its
acceptancedisplacescriticalthinkingandgoodstrategy.
CHAPTERFIVE
THEKERNELOFGOODSTRATEGY
Goodstrategyiscoherentactionbackedupbyanargument,aneffective
mixture of thought and action with a basic underlying structure I call the
kernel.Agoodstrategymayconsistofmorethanthekernel,butifthekernel
isabsentormisshapen,thenthereisaseriousproblem.Onceyouapprehend
thiskernel,itismucheasiertocreate,describe,andevaluateastrategy.The
kernelisnotbasedonanyoneconceptofadvantage.Itdoesnotrequireone
to sort through legalistic gibberish about the differences between visions,
missions,goals,strategies,objectives,andtactics.Itdoesnotsplitstrategies
intocorporate,business,andproductlevels.Itisverystraightforward.
Thekernelofastrategycontainsthreeelements:
1. A diagnosis that defines or explains the nature of the challenge. A
good diagnosis simplifies the often overwhelming complexity of
realitybyidentifyingcertainaspectsofthesituationascritical.
2. A guiding policy for dealing with the challenge. This is an overall
approachchosentocopewithorovercometheobstaclesidentifiedin
thediagnosis.
3.A set ofcoherentactionsthat are designed to carry out the guiding
policy.Thesearestepsthatarecoordinatedwithoneanothertowork
togetherinaccomplishingtheguidingpolicy.
Herearesomeexamples:
• For a doctor, the challenge appears as a set of signs and symptoms
togetherwithahistory.Thedoctormakesaclinicaldiagnosis,naming
a disease or pathology. The therapeutic approach chosen is the
doctor’s guiding policy. The doctor’s specific prescriptions for diet,
therapy,andmedicationarethesetofcoherentactionstobetaken.
•Inforeignpolicy,challengingsituationsareusuallydiagnosedinterms
of analogies with past situations. The guiding policy adopted is
usuallyanapproachdeemedsuccessfulinsomepastsituation.Thus,if
the diagnosis is that Iran’s president, Mahmoud Ahmadinejad, is
“anotherHitler,”warmightbethelogicalimplication.However,ifhe
is “another Moammar Gadhafi,” then strong pressure coupled with
behind-the-scenesnegotiationmightbethechosenguidingpolicy.In
foreign policy, the set of coherent actions are normally a mix of
economic,diplomatic,andmilitarymaneuvers.
• In business, the challenge is usually dealing with change and
competition.Thefirststeptowardeffectivestrategyisdiagnosingthe
specific structure of the challenge rather than simply naming
performance goals. The second step is choosing an overall guiding
policy for dealing with the situation that builds on or creates some
type of leverage or advantage. The third step is the design of a
configuration of actions and resource allocations that implement the
chosenguidingpolicy.
• In many large organizations, the challenge is often diagnosed as
internal. That is, the organization’s competitive problems may be
muchlighterthantheobstaclesimposedbyitsownoutdatedroutines,
bureaucracy,poolsofentrenchedinterests,lackofcooperationacross
units,andplain-oldbadmanagement.Thus,theguidingpolicyliesin
the realm of reorganization and renewal. And the set of coherent
actionsarechangesinpeople,power,andprocedures.Inothercases
thechallengemaybebuildingordeepeningcompetitiveadvantageby
pushingthefrontiersoforganizationalcapability.
Icallthiscombinationofthreeelementsthekerneltoemphasizethatitis
thebare-bonescenterofastrategy—thehardnutatthecoreoftheconcept.It
leavesoutvisions,hierarchiesofgoalsandobjectives,referencestotimespan
orscope,andideasaboutadaptationandchange.Allofthesearesupporting
players. They represent ways of thinking about strategy, stimulating the
creationofstrategies,energizinggroupsofpeople,denotingspecificsources
ofadvantage,communicating,summarizing,andanalyzingstrategies,andso
on.Thecorecontentofastrategyisadiagnosisofthesituationathand,the
creation or identification of a guiding policy for dealing with the critical
difficulties,andasetofcoherentactions.Iwillexplorethethreeelementsof
thekernelonebyone.
THEDIAGNOSIS
After my colleague John Mamer stepped down as dean of the UCLA
Anderson School of Management, he wanted to take a stab at teaching
strategy. To acquainthimself with thesubject, he satin on tenof my class
sessions. Somewhere around class number seven we were chatting about
pedagogyandInotedthatmany ofthelessons learnedina strategycourse
comeintheformofthequestionsaskedasstudyassignmentsandaskedin
class. These questions distill decades of experience about useful things to
think about in exploring complex situations. John gave me a sidelong look
andsaid,“Itlookstomeasifthereisreallyonlyonequestionyouareasking
ineachcase.Thatquestionis‘What’sgoingonhere?’”
John’scommentwassomethingIhadneverheardsaidexplicitly,butitwas
instantly and obviously correct. A great deal of strategy work is trying to
figure out what is going on. Not just deciding what to do, but the more
fundamentalproblemofcomprehendingthesituation.
Ataminimum,adiagnosisnamesorclassifiesthesituation,linkingfacts
intopatternsandsuggestingthatmoreattentionbepaidto someissuesand
lesstoothers.Anespeciallyinsightfuldiagnosiscantransformone’sviewof
the situation, bringing a radically different perspective to bear. When a
diagnosis classifies the situation as a certain type, it opens access to
knowledge about how analogous situations were handled in the past. An
explicit diagnosis permits one to evaluate the rest of the strategy.
Additionally,makingthediagnosisanexplicitelementofthestrategyallows
therestofthestrategytoberevisitedandchangedascircumstanceschange.
ConsiderStarbucks,whichgrewfroma singlerestauranttoanAmerican
icon.In2008,Starbuckswasexperiencingflatordecliningsame-storetraffic
growth and lower profit margins, its return on assets having fallen from a
generous14percenttoabout5.5percent.Animmediatequestionarose:How
serious was this situation? Any rapidly growing company must, sooner or
later, saturate its market and have to clamp down on its expansion
momentum.SlowinggrowthisaproblemforWallStreetbutisanaturalstage
in the development of any noncancerous entity. Although the U.S. market
mayhavebeensaturated,weretherestillopportunitiesforexpansionabroad?
Deutsche Bank opined that Starbucks faced a great deal of competition
oversees, noting in particular that its 23 remaining restaurants in Australia
competedwith764McDonald’soutletssellingMcCafe-brandedcoffee,lattes,
cappuccinos,andsmoothies.1Bycontrast,Oppenheimeropined,“Wewould
expect that these markets [Europe] are still under-penetrated enough to
maintaingrowth.”2Wastheforeignmarketsaturated?
Orweretheremoreseriousproblems?Wasoverbuildingoutletsasignof
poor management? Were consumers’ tastes changing once again? As
competitors improved their coffee offerings, was Starbucks’ differentiation
vanishing?Infact,howimportantforStarbuckswasthecoffee-shopsettingit
providedversusthecoffeeitself?WasStarbucksacoffeerestaurant,orwasit
actually an urban oasis? Could its brand be stretched to other types of
productsandevenothertypesofrestaurants?
AtStarbucks,oneexecutivemightdiagnosethischallengingsituationas“a
probleminmanagingexpectations.”Anothermightdiagnoseitas“asearch
for new growth platforms.” A third might diagnose it as “an eroding
competitiveadvantage.”Noneoftheseviewpointsis,byitself,anaction,but
eachsuggestsarangeofthingsthatmightbedoneandsetsasideotherclasses
of action as less relevant to the challenge. Importantly, none of these
diagnosescanbeproventobecorrect—eachisajudgmentaboutwhichissue
ispreeminent.Hence,diagnosisisajudgmentaboutthemeaningsoffacts.
ThechallengefacingStarbuckswasill-structured.BythatImeanthatno
one could be sure how to define the problem, there was no obvious list of
good approaches or actions, and the connections between most actions and
outcomeswereunclear.Becausethechallengewasill-structured,areal-world
strategy could not be logically deduced from the observed facts. Rather, a
diagnosis had to be an educated guess as to what was going on in the
situation,especiallyaboutwhatwascriticallyimportant.
The diagnosis for the situation should replace the overwhelming
complexity of reality with a simpler story, a story that calls attention to its
crucialaspects.Thissimplifiedmodelofrealityallowsonetomakesenseof
thesituationandengageinfurtherproblemsolving.
Furthermore,agoodstrategicdiagnosisdoesmorethanexplainasituation
—it also defines a domain of action. Whereas a social scientist seeks a
diagnosisthatbestpredictsoutcomes,goodstrategytendstobebasedonthe
diagnosis promising leverage over outcomes. For instance, we know from
researchthatK–12studentperformanceisbetterexplainedbysocialclassand
culturethanbyexpendituresperstudentorclasssize,butthatknowledgedoes
not lead to many useful policy prescriptions. A very different strategic
diagnosis has been provided by my UCLA colleague Bill Ouchi. His book
MakingSchoolsWorkdiagnosesthechallengeofschoolperformanceasone
of organization rather than as one of class, culture, funding, or curriculum
design.3Decentralizedschools,heargues,performbetter.Now,whetherthe
organization of a school system explains most of the variations in school
performance is not actually critical. What is critical, and what makes his
diagnosisusefultopolicymakers,isthatorganizationexplainssomepartof
school performance and that, unlike culture or social class, organization is
somethingthatcanbeaddressedwithpolicy.
A diagnosis is generally denoted by metaphor, analogy, or reference to a
diagnosis or framework that has already gained acceptance. For example,
everystudentofU.S.nationalstrategyknowsaboutthediagnosisassociated
with the Cold War guiding policy of containment. This concept originated
withGeorgeKennan’sfamous“longtelegram”of1946.Havingservedasan
American diplomat in the USSR for more than a decade, and having seen
Sovietterror and politicsatclose hand, hecarefully analyzed thenatureof
Soviet ideology and power. Kennan started with the observation that the
Soviet Union was not an ordinary nation-state. Its leaders defined their
mission as opposition to capitalism and as spreading the gospel of
revolutionary communism by whatever means necessary. He stressed that
antagonism between communism and capitalist societies was a central
foundation of Stalin’s political regime, preventing any sincere
accommodationorhonestinternationalagreements.However,healsopointed
out that the Soviet leaders were realists about power. Therefore, he
recommendedaguidingpolicyofvigilantcounterforce:
In the light of the above, it will be clearly seen that the Soviet
pressureagainstthefreeinstitutionsofthewesternworldissomething
thatcanbecontainedbytheadroitandvigilantapplicationofcounter-
forceataseriesofconstantlyshiftinggeographicalandpoliticalpoints,
corresponding to the shifts and maneuvers of Soviet policy, but which
cannotbecharmedortalkedoutofexistence.TheRussianslookforward
toaduelofinfiniteduration,andtheyseethatalreadytheyhavescored
greatsuccesses.4
Kennan’s diagnosis for the situation—a long-term struggle without the
possibility of a negotiated settlement—was widely adopted within policy-
makingcirclesin theUnitedStates.Hisguidingpolicyof containmentwas
especiallyattractiveasitspecifiedabroaddomainofaction—theUSSRwas,
metaphoricallyspeaking,infectedbyavirus.TheUnitedStateswouldhaveto
keep the virus from spreading until it finally died out. Kennan’s policy is
sometimescalledastrategy,butitlackedtheelementofaction.Allpresidents
from Truman through George H. W. Bush struggled with the problem of
turningthisguidingpolicyintoactionableobjectives.Overtime,theguiding
policyofcontainmentledtoNATOandSEATO,theBerlinAirlift,theKorean
War, placing missiles in Europe, the Vietnam War, and other Cold War
actions.
ThepowerofKennan’sdiagnosiscanbeseenbyconsideringhowhistory
might have been different if the situation had been framed another way in
1947. Perhaps the Soviet Union could have been enticed into the world
communitythrough a policyof engagement byincluding itinthe Marshall
Plan.Orperhapsitwasn’tanAmericanproblematall,butanissueforthe
United Nations. Or perhaps the Soviet Union was a tyranny rivaling Nazi
Germany, and the United States should have sought to actively oppose it,
undermineit,andliberateitspopulation.
Inbusiness,mostdeepstrategicchangesarebroughtaboutbyachangein
diagnosis—a change in the definition of the company’s situation. For
example, when Lou Gerstner took over the helm at IBM in 1993, the
companywasinseriousdecline.Itshistoricallysuccessfulstrategyhadbeen
organized around offering complete, integrated, turnkey end-to-end
computingsolutionstocorporationsandgovernmentagencies.However,the
adventofthemicroprocessorchangedallthat.Thecomputerindustrybegan
to fragment, with separate firms offering chips, memory, hard disks,
keyboards, software, monitors, operating systems, and so on. (The vertical
disintegration of the computer industry is analyzed in chapter 13, “Using
Dynamics.”) As computing moved to the desktop, and as IBM’s desktop
offeringbecamecommoditizedbyclonecompetitorsandtheWindows-Intel
standard,whatshouldthecompanydo?Thedominantviewatthecompany
andamong Wall Streetanalystswas thatIBMwastoointegrated. Thenew
industrystructurewasfragmentedand,itwasargued,IBMshouldbebroken
up and fragmented to match. As Gerstner arrived, preparations were under
wayforseparatestockofferingsforvariouspiecesofIBM.
Afterstudyingthesituation,Gerstnerchangedthediagnosis.Hebelieved
thatinanincreasinglyfragmentedindustry,IBMwastheonecompanythat
hadexpertiseinallareas.Itsproblemwasnotthatitwasintegratedbutthatit
wasfailingtousetheintegratedskillsitpossessed.IBM,hedeclared,needed
to become more integrated—but this time around customer solutions rather
than hardware platforms. The primary obstacle was the lack of internal
coordinationandagility.Giventhisnewdiagnosis,theguidingpolicybecame
toexploitthefactthatIBMwasdifferent,infact,unique.IBMwouldoffer
customers tailored solutions to their information-processing problems,
leveraging its brand name and broad expertise, but willing to use outside
hardware and software as required. Put simply, its primary value-added
activity would shift from systems engineering to IT consulting, from
hardwaretosoftware.Neitherthe“integrationisobsolete”northe“knowing
all aspects of IT is our unique ability” viewpoints are, by themselves,
strategies. But these diagnoses take the leader, and all who follow, in very
differentdirections.
THEGUIDINGPOLICY
Theguidingpolicyoutlinesanoverallapproachforovercomingtheobstacles
highlighted by the diagnosis. It is “guiding” because it channels action in
certain directions without defining exactly what shall be done. Kennan’s
containment and Gerstner’s drawing on all of IBM’s resources to solve
customers’problemsareexamplesofguidingpolicies.Liketheguardrailson
a highway, the guiding policy directs and constrains action without fully
definingitscontent.
Goodguidingpoliciesarenotgoalsorvisionsorimagesofdesirableend
states.Rather,theydefineamethodofgrapplingwiththesituationandruling
out a vast array of possible actions. For example, Wells Fargo’s corporate
visionisthis:“Wewanttosatisfyallofourcustomers’financialneeds,help
them succeed financially, be the premier provider of financial services in
every one of our markets, and be known as one of America’s great
companies.”5
This “vision” communicates an ambition, but it is not a strategy or a
guidingpolicybecausethereisnoinformationabouthowthisambitionwill
be accomplished. Wells Fargo chairman emeritus and former CEO Richard
Kovacevich knew this and distinguished between this vision and his
company’sguidingpolicyofusingthenetworkeffectsofcross-selling.That
is,KovacevichbelievedthatthemoredifferentfinancialproductsWellsFargo
could sell to a customer, the more the company would know about that
customerandaboutitswholenetworkofcustomers.Thatinformationwould,
inturn,helpitcreateandsellmorefinancialproducts.Thisguidingpolicy,in
contrast to Wells Fargo’s vision, calls out a way of competing—a way of
tryingtousethecompany’slargescaletoadvantage.
Youmaycorrectlyobservethatmanyotherpeopleusetheterm“strategy”
for what I am calling the “guiding policy.” I have found that defining a
strategyasjustabroadguidingpolicyisamistake.Withoutadiagnosis,one
cannot evaluate alternative guiding policies. Without working through to at
leastthefirstroundofactiononecannotbesurethattheguidingpolicycanbe
implemented.Goodstrategyisnotjust“what”youaretryingtodo.Itisalso
“why”and“how”youaredoingit.
Agoodguidingpolicytacklestheobstaclesidentifiedinthediagnosisby
creating or drawing upon sources of advantage. Indeed, the heart of the
matter in strategy is usually advantage. Just as a lever uses mechanical
advantagetomultiplyforce,strategicadvantagemultipliestheeffectiveness
ofresourcesand/oractions.Importantly,notalladvantageiscompetitive.In
nonprofit and public policy situations, good strategy creates advantage by
magnifyingtheeffectsofresourcesandactions.
Inmost modern treatmentsof competitivestrategy, itis now commonto
launch immediately into detailed descriptions of specific sources of
competitiveadvantage.Havinglowercosts,abetterbrand,afasterproduct-
developmentcycle,moreexperience,moreinformationaboutcustomers,and
soon,canallbesourcesofadvantage.Thisisalltrue,butitisimportantto
takea broader perspective.A good guidingpolicy itselfcan be asource of
advantage.
A guiding policy creates advantage by anticipating the actions and
reactionsofothers,byreducingthecomplexityandambiguityinthesituation,
by exploiting the leverage inherent in concentrating effort on a pivotal or
decisiveaspectofthesituation,andbycreatingpoliciesandactionsthatare
coherent, each building on the other rather than canceling one another out.
(These sources of advantage are discussed in detail in chapter 6, “Using
Leverage.”)
For example, Gerstner’s “provide customer solutions” policy certainly
countedontheadvantagesimplicitinIBM’sworld-classtechnologicaldepth
andexpertiseinalmostallareasofdataprocessing.Butthepolicyitselfalso
createdadvantagebyresolvingtheuncertaintyaboutwhattodo,abouthowto
compete,andabouthowtoorganize.Italsobegantheprocessofcoordinating
andconcentratingIBM’svastresourcesonaspecificsetofchallenges.
Tolookmorecloselyathowaguidingpolicyworks,followthethinkingof
Stephanie,afriendwhoownsacornergrocerystore.Shedoestheaccounts,
manages personnel, sometimes runs the cash register, and makes all the
decisions.Severalyearsago,Stephanietoldmeaboutsomeoftheissuesshe
was facing. She was considering whether she should keep prices down or
offermoreexpensive,freshorganicproduce.Shouldshebegintostockmore
AsianstaplesforthemanyAsianstudentswholivedinthearea?Shouldthe
storebeopenlongerhours?Howimportantwasittohaveahelpful,friendly
staffthatgetstoknowtheregulars?Wouldaddingasecondcheckoutstand
payoff?Whataboutparkingin thealley?Shouldsheadvertiseinthelocal
collegenewspaper?Shouldshepainttheceilinggreenorwhite?Shouldshe
putsomeitemsonsaleeachweek?Whichones?
An economist would tell her that she should take actions that maximize
profit, a technically correct but useless piece of advice. In the economics
textbookitissimple:choosetherateofoutputQthatprovidesthebiggestgap
betweenrevenueandcost.Intherealworld,however,“maximizeprofit”is
notahelpfulprescription,becausethechallengeofmaking,ormaximizing,
profitisanill-structuredproblem.Evenin acornergrocerystore, thereare
hundredsorthousandsofpossibleadjustmentsonecanmake,andmillionsin
abusinessofanysize—thecomplexityofthesituationcanbeoverwhelming.
Thinking about her store, Stephanie diagnosed her challenge to be
competitionwiththelocalsupermarket.Sheneededtodrawcustomersaway
fromastorethatwasopen24/7andhadlowerprices.Seekingawayforward,
shebelievedthatmostofhercustomerswerepeoplewhowalkedbythestore
almosteveryday.Theyworkedorlivednearby.Scanningherlistofquestions
andalternatives,shedeterminedthattherewasachoicebetweenservingthe
more price-conscious students or the more time-sensitive professionals.
Transcending thousands of individual choices and instead framing the
problem in terms of choosing among a few customer groups provided a
dramaticreductionincomplexity.
Of course, if both of these customer segments could be served with the
samepoliciesandactions,thenthedichotomywouldhavebeenuselessand
shouldbe castaside.In Stephanie’scase, thedifferenceseemed significant.
Moreof hercustomers werestudents, butthe professionalswho stoppedin
made much larger purchases. Pushing further along, Stephanie began to
exploretheguidingpolicyof“servethebusyprofessional.”Aftersomemore
tinkering, Stephanie sharpened the guiding policy a bit more, deciding to
target“thebusyprofessionalwhohaslittletimetocook.”
Therewasnowaytoestablishthatthisparticularguidingpolicywasthe
onlygoodone,orthebestone.But,absentagoodguidingpolicy,thereisno
principle of action to follow. Without a guiding policy, Stephanie’s actions
and resource allocations would probably be inconsistent and incoherent,
fighting with one another and canceling one another out. Importantly,
adopting this guiding policy helped reveal and organize the interactions
among the many possible actions. Considering the needs of the busy
professionalwithlittletimetocook,shecouldseethatthesecondcheckout
standwouldhelphandletheburstoftrafficat5p.m.Sowouldmoreparking
in the alley. In addition, she felt she could take space currently used for
sellingmunchiestostudentsandofferpreparedhigh-qualitytake-homefoods
instead.Professionals,unlikestudents,wouldnotcomeshoppingatmidnight,
so there was no need for very late hours. The busy professionals would
appreciateadequatestaffingafterworkand,perhaps,atlunchtime.Havinga
guidingpolicyhelpedcreateactionsthatwerecoordinatedandconcentrated,
focusingherefforts.
COHERENTACTION
Manypeoplecalltheguidingpolicy“thestrategy”andstopthere.Thisisa
mistake. Strategy is about action, about doing something. The kernel of a
strategymustcontainaction.Itdoesnotneedtopointtoalltheactionsthat
willbetakenaseventsunfold,buttheremustbeenoughclarityaboutaction
to bring concepts down to earth. To have punch, actions should coordinate
andbuildupononeanother,focusingorganizationalenergy.
MovingtoAction
INSEAD,a global businessschool located inFrance, was thebrainchild of
Harvardprofessor GeneralGeorges F. Doriot. TheINSEAD libraryholds a
bronze statue of Doriot inscribed with his observation “Without action, the
worldwouldstillbeanidea.”
Inmanysituations,themainimpedimenttoactionistheforlornhopethat
certainpainfulchoicesoractionscanbeavoided—thatthewholelonglistof
hoped-for“priorities” canallbeachieved.Itisthe hardcraft ofstrategy to
decidewhichpriorityshalltakeprecedence.Onlythencanactionbetaken.
And,interestingly,thereisnogreatertoolforsharpeningstrategicideasthan
thenecessitytoact.
ThepresidentoftheEuropeanBusinessGrouphadadiscreteprivateofficein
a classic London town home, just west of St. James’ Park. I was there to
discussprogressonthecompany’s“Pan-European”initiative.
A consumer goods producer, the company had a typically complex
international organization. There were country-based marketing
organizations; globally run manufacturing operations; and four product
developmentcenters,oneinNorthAmerica,oneinJapan,oneinGermany,
and one in the United Kingdom. Product managers were responsible for
coordinating activities but had no direct authority. Products tended to be
tailored to country or regional differences, partly as a result of some local
acquisitionsandpartlyduetoperceptionsoflocaldifferencesintastes.
Senior management believed that the company’s European business was
toofragmented.They wantedmostof the productsofferedin Europe to be
Pan-European,exploitinggreatereconomiesofscaleinbothproductionand
marketing. Management had spent time and effort communicating the
message about a Pan-European product line and had created some
mechanismstobringitabout.Theheadsofthecountry-basedorganizations
were placed on a Pan-Europe Executive Committee, which met once a
quarter. Developers from Germany and the United Kingdom were rotated
betweenthetwolocations.ANewProductsgrouphadbeencreatedtoconsult
withalldepartmentsonopportunitiesforPan-Europeanconceptsandbrands.
Part of each executive’s evaluation for promotion was based on his or her
contributiontothePan-Europeaninitiative.Despitethesemeasures,nothing
muchhad happened. TheGerman andBritish developerseach claimedthat
theirinitiativeswereunsupportedbytheother.TheoneBritish-Germanjoint
initiativehadnotbeenpickedupbytherestoftheorganization.
Aswediscussedthesituation,myclient’sfrustrationwasevident.Istopped
taking notes, and we both got up and walked over to the window, looking
down on the mews houses below. “Suppose,” I said, “that this was really
important,reallytop-prioritycritical.Supposeyouabsolutelyhadtogetsome
Pan-Europeanproductsdevelopedandmarketedinthenexteighteenmonths
oreverythingwouldcollapse.Whatwouldyoudothen?”
“Foronething,”hesaid,throwinghisarmsupinmocksurrender,“Iwould
closeoneofthedevelopmentgroups.Theyspendmoretimebickeringthan
developing.”
Thenhethoughtforamomentandsaid,“Ijustmightclosebothandstart
overintheNetherlands.Thereisamarket-testofficetherewecoulduseasa
seed.WecouldtakesomeofthebestpeoplefromtheUKandGermanyand
start fresh. Still, that doesn’t solve the problem of getting the country
managersonboard.”
“Andthecountrymanagers’lackofenthusiasmisbecause…?”Iasked.
“Well, each country manager has spent years understanding the special
conditions in a country, tailoring products and marketing programs to that
country’s local conditions. They don’t trust the Pan-European idea. The
French don’t want to waste marketing efforts on products they see as ‘too
British’or‘tooGerman.’AndtherereallyhasnotyetbeenacompellingPan-
European product that all could get behind. If it were already a success in
threeorfourcountries,therestwouldgetbehindit.Buteveryonehastheir
currentportfolioofproductstoworryabout.”
“Right,”Isaid.“Theirjobsarerunningthepresentcountry-basedsystem.
And you want new Pan-European initiatives. Now, you can use a shoe to
hammeranail,butitwilltakealongtime.Don’tyouneedadifferenttoolfor
thistask?Ifitwerereallyimportanttogetthisdone,Ithinkyouknowhow
youwoulddoit.”
“Ofcourse,”hesaid.“Wecouldhaveasinglegroupdevelop,rollout,and
marketPan-Europeanproductsandtakefullprofitresponsibility.”
“Atthesametime,”Iadded,“youwouldhavetointerveneinthecountry-
basedsystemwithspecialbudgetoverridesforthisinitiative,promotionsfor
peoplewhohelpitalong,andcareerproblemsforpeoplewhodon’t.”
Wemovedbacktothecenteroftheoffice,andhesatathisdesk,aposition
ofauthority.Helookedatmeandsaid,“Thatwouldbeaverypainfulroad.
Manynoseswouldgetoutofjoint.Itwouldbebettertowinpeopleoverto
thispointofviewratherthanforcethemover.”
“Right,” I said. “You would only take all those painful steps if it were
really important to get action on this concept. Only if it were really
important.”
It took another nine months for him to decide that the Pan-European
initiativewasindeedimportantandmovetoreorganizeEuropeanoperations.
There was no magical solution to his problem of wanting strong country-
basedmarketing,Pan-Europeaninitiatives,andnonosesoutofjoint,allatthe
sametime.Aslongasstrategyremainedatthelevelofintentandconcept,the
conflictsamongvariousvaluesandbetweentheorganizationandtheinitiative
remained tolerable. It was the imperative of action that forced a decision
aboutwhichissuewasactuallythemostimportant.
Thisexecutive’sproblemwasprimarilyorganizationalratherthanrootedin
product-market competition. Yet the kernel of strategy—a diagnosis, a
guidingpolicy,andcoherentaction—appliestoanycomplexsetting.Here,as
in so many situations, the required actions were not mysterious. The
impedimentwasthehopethatthepainofthoseactionscould,somehow,be
avoided.Indeed,wealwayshopethatabrilliantinsightorverycleverdesign
willallowustoaccomplishseveralapparentlyconflictingobjectiveswitha
single stroke, and occasionally we are vouchsafed this kind of deliverance.
Nevertheless,strategyisprimarilyaboutdecidingwhatistrulyimportantand
focusingresourcesandactiononthatobjective.Itisaharddisciplinebecause
focusingononethingslightsanother.
Coherence
The actions within the kernel of strategy should be coherent. That is, the
resourcedeployments,policies,andmaneuversthatareundertakenshouldbe
consistent and coordinated. The coordination of action provides the most
basicsourceofleverageoradvantageavailableinstrategy.
Inafight,thesimpleststrategyisafeinttotheleftandthenpunchfromthe
right,acoordinationofmovementintimeandspace.Thesimplestbusiness
strategy is to use knowledge gleaned by sales and marketing specialists to
affect capacity expansion or product design decisions—coordination across
functionsandknowledgebases.Evenwhenanorganizationhasanapparently
simpleandbasicsourceof advantage,suchasbeing alow-costproducer,a
closeexaminationwillalwaysrevealaraftofinterrelatedmutuallysupporting
policiesthat,inthiscase,keepcostslow.Furthermore,itwillbefoundthat
these costs are lower only for a certain type of products delivered under
certainconditions.Usingsuchacostadvantagetogoodeffectwillrequirethe
alignmentofmanyactionsandpolicies.
Strategic actions that are not coherent are either in conflict with one
another or taken in pursuit of unrelated challenges. Consider Ford Motor
Company. When Jacques Nasser was the CEO of Ford Europe and vice
president of Ford product development, he told me, “Brand is the key to
profitsintheautomobileindustry.”6MovingintothecorporateCEOspotin
1999,NasserquicklyactedtoacquireVolvo,Jaguar,LandRover,andAston
Martin.However,atthesametime,thecompany’soriginalguidingpolicyof
“economies of scale” was fully alive and kicking. A senior Ford executive
told me in 2000: “You cannot be competitive in the automobile industry
unlessyouproduceatleastonemillionunitsperyearonaplatform.”Thus,
theactionsofbuyingVolvoandJaguarwereconjoinedwithactionsdesigned
toputbothbrandsonacommonplatform.PuttingJaguarandVolvoonthe
sameplatformdilutesthebrandequityofbothmarquesandannoysthemost
passionatecustomers,dealers,andserviceshops.Volvobuyersdon’twanta
“safeJaguar”;theywantacarthatisuniquelysafe.AndJaguarbuyerswant
somethingmoredistinctivethana“sportyVolvo.”Thesetwosetsofconcepts
andactionswereinconflictratherthanbeingcoherent.
Whataboutalistofnonconflictingbutuncoordinatedactions?In2003,I
workedwithacompanywhoseinitial“strategy”wasto(1)closeaplantin
AkronandopenanewplantinMexico,(2)spendmoreonadvertising,and
(3)initiatea360-degreefeedbackprogram.Nowtheseactionsmayallhave
been good ideas, but they did not complement one another. They are
“strategic”onlyinthesensethateachprobablyrequirestheapprovaloftop
management.Myviewisthatdoingthesethingsmightbesoundoperational
management,butitdidnotconstituteastrategy.Astrategycoordinatesaction
toaddressaspecificchallenge.Itisnotdefinedbythepaygradeoftheperson
authorizingtheaction.
Theideathatcoordination,byitself,canbeasourceofadvantageisavery
deepprinciple. It isoften underappreciated becausepeople tendtothink of
coordination in terms of continuing mutual adjustments among agents.
Strategic coordination, or coherence, is not ad hoc mutual adjustment. It is
coherence imposed on a system by policy and design. More specifically,
design is the engineering of fit among parts, specifying how actions and
resources will be combined. (This approach to coherence is the subject of
chapter9,“UsingDesign.”)
Another powerful way to coordinate actions is by the specification of a
proximateobjective.By“proximate,”Imeanastateofaffairscloseenoughat
handtobefeasible.Ifanobjectiveisclearandfeasible,itcanhelpcoordinate
both problem solving and direct action. (You will find more about this
importanttoolinchapter7,“ProximateObjectives.”)
Strategyisvisibleascoordinatedactionimposedonasystem.WhenIsay
strategyis“imposed,”Imeanjustthat.Itisanexerciseincentralizedpower,
used to overcome the natural workings of a system. This coordination is
unnaturalinthesensethatitwouldnotoccurwithoutthehandofstrategy.
The idea of centralized direction may set off warning bells in a modern
educatedperson.Whydoesitmakesensetoexercisecentralizedpowerwhen
weknowthatmanydecisionsareefficientlymadeonadecentralizedbasis?
One of the great lessons of the twentieth century—the most dramatic
controlled experiment in human history—was that centrally controlled
economiesaregrosslyinefficient.MorepeoplestarvedtodeathinStalin’sand
MaoTse-tung’scentrallyplannedregimesthanwerekilledinWorldWarII.
People continue to starve to death in North Korea today. In modern
economies, trillions of decentralized choices are made each year, and this
process can do a pretty good job of allocating certain kinds of scarce
resources.Thus, when theprice of gasolinerises, people startbuying more
fuel-efficientcarswithoutanycentralplanning.Afterahurricane,whenthere
ismuchtorebuild,wagesrise,attractingmoreworkerstothestrickenarea.
But decentralized decision making cannot do everything. In particular, it
may fail when either the costs or benefits of actions are not borne by the
decentralized actors. The split between the costs and benefits may occur
across organizational units or between the present and the future. And
decentralizedcoordinationisdifficultwhenbenefitsaccrueonlyifdecisions
areproperlycoordinated.Ofcourse,centrallydesignedpoliciescanalsofailif
the decision makers are foolish, in the pay of special interest groups, or
simplychooseincorrectly.
As a simple example, salespeople love to please customers with rush
orders,andmanufacturingpeoplepreferlonguninterruptedproductionruns.
Butyoucannothavelongproductionrunsandhandleunexpectedrushorders
allatthesametime.Ittakespoliciesdevisedtobenefitthewholetosortout
thisconflict.
On a larger canvas, in World War II, President Franklin D. Roosevelt
coordinatedpolitical,economic,andmilitarypowertodefeatNaziGermany,
usingtheUnitedStates’productivecapacitytosupporttheSovietUnion,thus
allowingittosurviveanddegradetheNaziwarmachinebeforeAmericans
landed in Normandy. Another element of his strategy, one with great
consequences,wastofocusthebulkofAmericanresourcestofirstwinningin
EuropebeforefullytakingonJapan,acomplexcoordinationofforcesover
time. Neither of these crucial policies would have emerged out of
decentralizeddecisionmakingamongtheDepartmentsofStateandWar,the
variouswarproductionboards,andmultiplemilitarycommands.
On the other hand, the potential gains to coordination do not mean that
morecentrallydirectedcoordinationisalwaysagoodthing.Coordinationis
costly, because it fights against the gains to specialization, the most basic
economies in organized activity. To specialize in something is, roughly
speaking,tobeleftalonetodojustthatthingandnotbebotheredwithother
tasks,interruptions,andotheragents’agendas.Asiscleartoanyonewhohas
belonged to a coordinating committee, coordination interrupts and de-
specializespeople.
Thus, we should seek coordinated policies only when the gains are very
large. There will be costs to demanding coordination, because it will ride
roughshod over economies of specialization and more nuanced local
responses. The brilliance of good organization is not in making sure that
everything is connected to everything else. Down that road lies a frozen
maladaptivestasis.Goodstrategyandgoodorganizationlieinspecializingon
therightactivitiesandimposingonlytheessentialamountofcoordination.
PARTII
SOURCESOFPOWER
In very general terms, a good strategy works by harnessing power and
applyingitwhereitwillhavethegreatesteffect.Intheshortterm,thismay
meanattackingaproblemorrivalwithadroitcombinationsofpolicy,actions,
andresources.Inthelongerterm,itmayinvolvecleverlyusingpoliciesand
resourcecommitmentstodevelopcapabilitiesthatwillbeofvalueinfuture
contests.Ineithercase,a“goodstrategy”isanapproachthatmagnifiesthe
effectivenessofactionsbyfindingandusingsourcesofpower.
This section of the book explores a number of fundamental sources of
power used in good strategies: leverage, proximate objectives, chain-link
systems, design, focus, growth, advantage, dynamics, inertia, and entropy.
Obviously, thissetis notexhaustive.Thereismore toknowaboutstrategy
thananyonevolumecanpossiblytreat.Thesourcesofpower(andtrouble)
highlighted here were chosen for both their generality and freshness. Most
extend beyond a business context and apply to government, security, and
nonprofitsituationsaswell.Plus,theyexploreparticularissuesthatIbelieve
are fundamental but that have not been given as much attention as they
deserve.
The last piece in this section, chapter15, “Putting It Together,” uses the
exampleofNvidia’sstrategyinthe3-Dgraphicsmarkettoillustratealmost
everysourceofpowertreatedhere.Somereadersmayprefertostartthereand
thenreturntochapters6–14formoredepthoneachissue.
CHAPTERSIX
USINGLEVERAGE
A good strategy draws power from focusing minds, energy, and action.
That focus, channeled at the right moment onto a pivotal objective, can
produce a cascade of favorable outcomes. I call this source of power
leverage.*
Archimedes,oneofthesmartestpeoplewhoeverlived,said,“Givemea
leverlongenough,afulcrumstrongenough,andI’llmovetheworld.”What
henodoubtknew,butdidnotsay,wasthattomovetheearth,hisleverwould
have to be billions of miles long.1 With this enormous lever, a swing of
Archimedes’armmightmovetheearthbythediameterofoneatom.Given
theamountoftroubleinvolved,hewouldbewisetoapplyhislevertoaspot
where this tiny movement would make a large difference. Finding such
crucialpivotpointsandconcentratingforceonthemisthesecretofstrategic
leverage.
Knocklooseakeystone,anda giantarch willfall. Seizethe moment,as
James Madison did in 1787, turning colleague Edmund Randolph’s ideas
aboutthreebranchesofgovernmentwithabicamerallegislatureintothefirst
draftoftheConstitution,andyoujustmightfoundagreatnation.Whenthe
largestcomputercompanyintheworldcomesknockingatyourdoorin1980,
askingifyoucanprovideanoperatingsystemforanewpersonalcomputer,
say,“Yes,wecan!”Andbesuretoinsist,asBillGatesdidin1980,that,after
theypayyouforthesoftware,thecontractstillpermitsyoutosellittothird
parties.Youjustmightbecometherichestpersonintheworld.
Ingeneral,strategicleveragearisesfromamixtureofanticipation,insight
intowhatismostpivotalorcriticalinasituation,andmakingaconcentrated
applicationofeffort.
ANTICIPATION
The strategist may have insight into predictable aspects of others’ behavior
thatcanbeturnedtoadvantage.Atthesimplestlevel,astrategyofinvesting
inManhattanrealestateisbasedontheanticipationthatotherpeople’sfuture
demandforthisrealestatewillraiseitsvalue.Incompetitivestrategy,thekey
anticipationsareoftenofbuyerdemandandcompetitivereactions.
Asanexampleofanticipation,whiletheSUVcrazewasbooming inthe
United States, Toyota invested more than $1 billion in developing hybrid
gasoline-electric technologies: an electronically controlled continuously-
variable-speed transmission and its own chips and software to control the
system. There were two anticipations guiding this investment. First,
management believed that fuel economy pressures would, over time, make
hybridvehiclesamajorproductcategory.Second,managementbelievedthat,
once presented with the chance to license Toyota’s technology, other
automakers would do so and not invest in developing possibly superior
systems.Thusfar,bothanticipationshaveprovenreasonablyaccurate.
Themostcriticalanticipationsareaboutthebehaviorofothers,especially
rivals.ItisnowclearthatU.S.militaryplansfortheinvasionofIraqinthe
springof2003failedtoanticipatetheriseofavigorousinsurgency.Asthe
army’sownassessmentstates:“ThedifficultyinIraqinAprilandMay2003
for the Army, and the other Services, was that the transition to a new
campaignwas notwell thoughtout,planned for, andpreparedfor beforeit
began.Additionally,theassumptionsaboutthenatureofpost-SaddamIraqon
whichthetransitionwasplannedprovedtobelargelyincorrect.”2
At the same time, the Iraqi insurgency was, at least in part, initiated by
Iraqi ex-military officers who anticipated that media coverage of U.S.
casualtieswouldtiltU.S.publicopinioninfavorofwithdrawal,asithadin
Vietnam and, more recently, in Mogadishu. Indeed, according to Bob
Woodward,“SaddamhadcommissionedanArabictranslationofBlackHawk
Downandissuedcopiestohisseniorofficers.”3So,inadeepersense,U.S.
plannersfailedtoanticipatetheIraqis’anticipations.
Moststrategicanticipationdrawsonthepredictable“downstream”results
of events that have already happened, from trends already at work, from
predictable economic or social dynamics, or from the routines other agents
followthatmakeaspectsoftheirbehaviorpredictable.
Someofthemoststrikinganticipationsmadeinanymodernbusinesswere
created by Pierre Wack and Ted Newland of Group Planning at Shell
International. I got to know Pierre Wack in 1980. He told me that “certain
aspects of future events are predetermined: If there is a storm in the
Himalayas,youcanconfidentlypredictthattomorrow,orthenextday,there
will be flooding in the Ganges plain.” The flood Wack and Newland had
predictedbackin1970wastheriseofOPECandtheensuingenergycrisis.
Thestormcreating thisfloodhad been discernedin the patternofincomes
andpopulationsofkeyoil-producingcountries.Inparticular,Iran,Iraq,and
Venezuelaallhadhighoilreserves,largegrowingpopulations,andambitious
developmentgoals.WackandNewlandpredictedthatsuchcountrieswould
bestronglymotivatedtoseekpriceincreases.Theysawthatpriceincreases
would,inturn,makecountriessuchasSaudiArabiaandKuwaitrealizethat
oilinthegroundmightappreciatefasterthanthedollarsitboughtonceitwas
pumpedandsold.4
In 1981, I was fortunate enough to spend a week with Pierre Wack at a
Shell Group Planning retreat in Runnymede, England. Talking about
scenarios,hetoldme:
Ifyoudostandard“scenario”forecasting,youwindupwithagraph
withthreelineslabeled“high,”“medium,”and“low.”Everyonelooksat
itandbelievesthattheyhavepaidattentiontotheuncertainty.Then,of
course,theyplanon“medium”!Buttheyaremissingtherisk.Theriskis
notthatthepriceofoilmaybehighormaybelow.Theriskisthatitwill
gohigh,suckeringyouintoamajorinvestment,andthenturnanddiveto
low,leavingyouwithuselessassets.
ThesuckerbetPierreWackwasworriedaboutin1981wouldplayoutover
thenextdecadeasthepriceofoilstoppeditsupwardtrendataboutthirty-six
dollars per barrel, then turned and sank to twenty dollars a barrel. As he
foresaw, the sharply higher oil prices of the late 1970s spurred renewed
drillingandexploration.ButwhenthenewfindsintheNorthSeaandAlaska
came on line, the increased supply forced the price of oil down. People
withoutWack’sinsight,suchasAmericanoilmanGeorgeW.Bush,whohad
investedheavilyinoffshoredrilling,sawtheirbusinessescollapse.
Anticipation does not require psychic powers. In many circumstances,
anticipationsimplymeansconsideringthehabits,preferences,andpoliciesof
others,aswellasvariousinertiasandconstraintsonchange.Thus,Idonot
expect California to balance its budget anytime soon, but I do anticipate a
continued exodus of talent from the state. I expect another serious terrorist
attack on the United States, but I do not anticipate that the stultifying iron
curtainbetweentheCIAandtheFBIwillberemovedshortofall-outwar.I
expectthatGooglewillcontinuetodevelopoffice-orientedapplicationsthat
can be used online through a browser, but I do not anticipate effective
responses from Microsoft, who will be loath to cannibalize its PC-based
MicrosoftOfficebusiness.Ianticipatearapidlygrowinguseofsmartphones,
butIalsoanticipatethatthiswillovertaxthecellphoneinfrastructure,leading
tosomeindustryconsolidationandausage-basedfeestructure.
PIVOTPOINTS
To achieveleverage, the strategistmusthave insight intoa pivot pointthat
willmagnifytheeffectsoffocusedenergyandresources.Asanexampleofa
pivotal objective, in 2008 I was in Tokyo, discussing competitive strategy
withNoritoshiMurata,thepresidentandchiefoperatingofficerofSeven&i
Holdings.Thiscompanyownsallofthe7-Elevenconveniencestoresinthe
UnitedStatesandAsia,aswellasgrocerysuperstoresanddepartmentstores
in Japan and other ventures. Focusing on Japan, Murata explained that the
companyhadcometotheconclusionthatJapanesecustomerswereextremely
sensitivetovariationsinlocal tastesandfond ofboth newnessandvariety.
“In Japan,” he told me, “consumers are easily bored. In soft drinks, for
example,therearemorethantwohundredsoft-drinkbrandsandlotsofnew
oneseachweek!A7-Elevendisplaysfiftyvarietieswithaturnoverofseventy
percenteachyear.Thesameholdstrueinmanyfoodcategories.”
To create leverage around this pattern, 7-Eleven Japan has developed a
methodofcollectinginformationfromstoremanagersandemployeesabout
localtastesandformingquick-responsemerchandisingteamstodevelopnew
product offerings. To further leverage this information and team skills, the
companyhasdevelopedrelationshipswithanumberofsecond-andthird-tier
foodmanufacturersandfoundwaystoquicklybringnewofferingstomarket
underitsownprivate-labelbrand,atlowprices,usingthefoodmanufacturers’
excesscapacity.
Atthesametime,7-ElevenwasexpandingitsoperationsinChina.There,
Murata explained, their outstanding advantage was cleanliness and service.
TheChineseconsumerswereusedtobeingsupplicantsataretailoutlet,and
7-Eleven Japan’s tradition of spotless interiors and white-gloved service
personnelwhogreetedcustomerswithbowsandsmiles,aswellasitsgood-
tastinglunches,wereproducingtwiceasmanysalespersquarefootthanany
competitorobtained.
Murata’sstrategyfocusedorganizationalenergyondecisiveaspectsofthe
situation. It was not a profit plan or a set of financial goals. It was an
entrepreneurial insight into the situation that had the potential to actually
createandextendadvantage.
Apivotpointmagnifiestheeffectofeffort.Itisanaturalorcreatedimbalance
inasituation,aplacewherearelativelysmalladjustmentcanunleashmuch
largerpent-upforces.Thebusinessstrategistsensessuchimbalancesinpent-
updemandthathasyettobefulfilledorinarobustcompetencedevelopedin
onecontextthatcanbeappliedtogoodeffectinanother.
In direct rivalry, the pivot point may be an imbalance between a rival’s
positionordispositionofforcesandtheirunderlyingcapabilities,orbetween
pretension and reality. On June 12, 1987, President Reagan stood at the
BrandenburgGateinWestBerlinandsaid:“GeneralSecretaryGorbachev,if
you seek peace, if you seek prosperity for the Soviet Union and Eastern
Europe, if you seek liberalization: Come here to this gate! Mr. Gorbachev,
openthisgate!Mr.Gorbachev,teardownthiswall!”
Of course, Reagan did not expect Gorbachev to do any such thing. The
speechwasdirectedtoWesternEuropeans,anditspurposewastohighlight,
and thereby exploit, the imbalance between a system that allowed the free
movementofpeoplewithonethathadtorestrainitscitizenswithbarbedwire
andconcrete. Thatimbalance hadexistedfordecades.HadReagangivena
similarchallengetoYuriAndropovin1983,itwouldhavehadlittleeffect.It
became a pivot point because of the extra imbalance between Mikhail
Gorbachev’sclaimthattheSovietUnionwasliberalizingandthefactsonthe
ground.
CONCENTRATION
Returns to concentration arise when focusing efforts on fewer, or more
limited, objectives generates larger payoffs. These gains flow from
combinations of constraints and threshold effects. If resources were not
limited,therewouldbenoneedtoselectoneobjectiveoveranother.Ifrivals
couldeasilysee ourmovesand quicklymobilizeresponses,wewouldgain
little from concentrating on temporary weaknesses. If senior leadership did
nothavelimitedcognition,theywouldgainnothingfromconcentratingtheir
attentiononafewpriorities.
A“thresholdeffect”existswhenthereisacriticallevelofeffortnecessary
toaffectthesystem.Levelsofeffortbelowthisthresholdhavelittlepayoff.
Whentherearethresholdeffects,itisprudenttolimitobjectivestothosethat
canbeaffectedbytheresourcesatthestrategist’sdisposal.
Forexample,thereseemstobeathresholdeffectinadvertising.Thatis,a
verysmallamountofadvertisingwillproducenoresultatall.Onehastoget
overthishump,orthreshold,tostartgettingaresponsetoadvertisingefforts.5
Thismeansitmaypaycompaniestopulsetheiradvertising,concentratingit
intorelativelyshortperiodsof time,ratherthan spreadingitevenly.It may
alsomakesenseforacompanytorolloutanew productregionbyregion,
concentratingitsadvertisingwheretheproductisnewsoastospuradoption.
Duetosimilar forces,businessstrategistswilloften prefertodominate a
small market segment over having an equal number of customers who
representonlyasliverofalargermarket.Politicianswilloftenpreferaplan
that delivers a clear benefit to a recognizable group over one that provides
largerbenefitsspreadmorethinlyacrossthepopulation.
Withinorganizations,someofthefactorsgivingrisetoconcentrationare
the substantial threshold effects in effecting change and the cognitive and
attentionlimitsoftheseniormanagementgroup.Justasanindividualcannot
solvefiveproblemsatonce,mostorganizationsconcentrateonafewcritical
issuesatanyonetime.
From a psychological perspective, there can be returns to focus or
concentrationwhenpeopleignoresignalsbelowacertainthreshold(calleda
“salience effect” in psychology) or when they believe in momentum—that
success leads to success. In either case, the strategist can increase the
perceivedeffectivenessofactionbyfocusingeffortontargetsthatwillcatch
attentionandswayopinion.Itmay,forexample,havemoreimpactonpublic
opinion to completely turn around two schools than to make a 2 percent
improvementintwohundredschools.Inturn,peoples’perceptionsofefficacy
affecttheirwillingnesstosupportandtakepartinfurtheractions.
An example of concentrating on an effective objective was Harold
William’sstrategyfortheGettyTrust.WhenoilbillionaireJ.PaulGettydied
in1976,heleft$700millionintrustforthemuseumhehadbuiltandrunin
Malibu,California.Williams,whohadbeendeanoftheUCLAmanagement
school,hadgoneontochairtheSecuritiesandExchangeCommission.Then,
in1983,hegottheworld’sbestjob—chairmanoftheGettyTrust.Bythen,
the trust had grown to $1.4 billion and was required by law to spend 4.5
percentofitsprinciple,about$65million,eachyear.
During Williams’s tenure, the Getty Foundation grew from a small elite
collectiontoamajorforceintheartworld.InaconversationIhadwithhim
in2000,threeyearsafterheretired,Williamsexplainedhisstrategy:
TheGettyTrustwasaverylargeamountofmoney,andwehadto
spendaconsiderableamounteachyear.Ourmandatewasart,butIhad
todecidehowtoactuallyspendthefunds.Wecouldhavesimplybuilta
greatcollection—thatwouldhavebeentheobviousthingtodo.Buyart.
ButI wasn’t comfortablewiththat asadirection.Allwe wouldreally
accomplishwouldbetodrive upthepriceofart andmovesomeofit
fromNewYorkandParistoLosAngeles.
Ittooksometime,butIbegantodeveloptheideathatartcouldbe,
indeed, should be, a more serious subject than it was. Art is not just
prettyobjects;itisavitalpartofhumanactivity.Inauniversity,people
spendagreatdealofeffortstudyinglanguagesandhistories.Weknow
allaboutmarriagecontractsinremotetribesandthehistoriesofmany
peoples.Butarthasbeentreatedasasideshow.IdecidedthattheGetty
could change this. Instead of spending our income on buying art, we
couldtransformthesubject.TheGettywouldbegintobuildacomplete
digital catalog of all art, including dance, song, and textiles. It would
developprogramstoeducateartteachersandhostadvancedresearchon
artandsociety.TheGettywouldhostthebestconservationtalentinthe
world and develop new methods of conserving and restoration. In this
way,Idecided,wewouldhaveanimpactfarbeyondsimplyputtingart
ondisplay.
With$65milliontospendeachyear,Williamscouldhavesimplybought
artorgivenmoneytoschoolsanduniversitiesfortheirartsprograms.Butby
aimingtotransformthestudyofart,Williamsdesignedanobjectivethatwas
novel and nicely scaled to the resources at his disposal. Put simply, he
investedwherehisresourceswouldmakealargeandmorevisibledifference.
That is the power of concentration—of choosing an objective that can be
decisivelyaffectedbytheresourcesathand.Thereisnowaytoknowwhether
Williams’s strategy created greater good than a simpler strategy of giving
away money, but it did make a bigger bang and, thereby, attracted more
energyandsupportfromemployeesandoutsideorganizations.
CHAPTERSEVEN
PROXIMATEOBJECTIVES
Follyisthedirectpursuitofhappinessandbeauty.
—GEORGEBERNARDSHAW
Oneofaleader’smostpowerfultoolsisthecreationofagoodproximate
objective—one that is close enough at hand to be feasible. A proximate
objectivenamesatargetthattheorganizationcanreasonablybeexpectedto
hit,evenoverwhelm.
Forexample,PresidentKennedy’scallfortheUnitedStatestoplaceaman
onthemoonbytheendofthe1960sisoftenheldoutasaboldpushintothe
unknown.AlongwithMartinLutherKingJr.’s“IHaveaDream”speech,it
has become almost a required reference in any of today’s “how to be a
charismatic leader” manuals extolling the magical virtues of vision and
audacious goals. Actually, however, landing on the moon was a carefully
chosenproximatestrategicobjective.
Kennedy’s1961speechonthisissueremainsamodelofclarity.Lookitup
on the Web and read it. You will be startled at how political speech has
changedsincethen.Kennedyspokeasadecisionmakertalkingtoadults,not
asapreacheraddressingchildren.
Inhisspeech,Kennedydiagnosedtheproblemasworldopinion.Hesaid,
“Thedramaticachievementsinspacewhichoccurredinrecentweeksshould
have made clear to us all, as did the Sputnik in 1957, the impact of this
adventure on the minds of men everywhere.” He argued that the Soviet
Union’sstrategyoffocusingitsmuchpoorertechnologicalresourcesonspace
wasleveraging,toitsadvantage,theworld’snaturalinterestintheseout-of-
this-worldaccomplishments.Hearguedthatbeingfirsttolandpeopleonthe
moonwould be adramatic affirmation ofAmericanleadership.TheUnited
Stateshad,ultimately,muchgreaterresourcestodrawupon;itwasamatterof
allocatingandcoordinatingthem.
Importantly, the moon mission had been judged feasible. Kennedy did
muchmorethansimplypointattheobjectives;helaidoutthestepsalongthe
way—unmannedexploration,largerboosterrockets,paralleldevelopmentof
liquidandsolidfuelrockets,andtheconstructionofalandingvehicle.
This objective was feasible because engineers knew how to design and
build rockets and spacecraft. Much of the technology had already been
developed as part of the ballistic missile program. And this objective was
intenselystrategic.ItgrewdirectlyoutofKennedy’squestion“Howcanwe
beat the Russians in space?” In response to this question, rocket scientist
WernervonBraunwroteaninsightfulmemorandumtoVicePresidentLyndon
Johnson.VonBraunnotedthattheSovietUnionhadabigleadinheavy-lift
rockets. That meant they could win in a race to put up a manned orbiting
laboratory or to put an unmanned vehicle on the moon. But, von Braun
argued:
We have a sporting chance of sending a 3-man crew around the
moon ahead of the Soviets (1965–66) … [and] we have an excellent
chanceofbeatingtheSovietstothefirstlandingofacrewonthemoon
(includingreturncapability,ofcourse).Thereasonisthataperformance
jump by a factor of 10 over their present rockets is necessary to
accomplishthisfeat.1
WhereastheSovietUnion’slargelaunchvehiclesputtheUnitedStatesata
disadvantage in achieving a number of near-term space spectaculars, the
moonlandingwouldrequiremuchlargerrocketsthaneithernationpossessed,
givingtheUnitedStatesanadvantagebecauseofitslargerbaseofresources.
Thus, von Braun recommended a preemptive announcement of the more
ambitiousobjectivebecausetheUnitedStateshadagoodchanceofbeating
the Russians to its accomplishment. Kennedy’s speech was delivered one
monthaftervonBraun’smemorandumarrived.
TheobjectiveKennedyset,seeminglyaudacioustothelayman,wasquite
proximate. It was a matter of marshaling the resources and political will.
Today, for instance, placing an American on Mars by 2020 is a tough but
proximate objective—there would be problems to be solved, but no reason
nottoexpecttheirresolution.Unfortunately,sinceKennedy’stime,therehas
beenanincreasedpenchantfordefininggoalsthatnoonereallyknowshow
toachieveandpretendingthattheyarefeasible.Take,forexample,theWar
onDrugs.Nomatterhowdesirableitmightbetostoptheuseofillegaldrugs,
it is not a proximate objective because it is not feasible within the present
legalandlaw-enforcementframework.Indeed,theenormouseffortsdirected
atthisobjectivemayonlydriveoutthesmall-timesmuggler,raisethestreet
price, and make it even more profitable for the sophisticated drug cartels.
Anotherexampleisthecontinuingcallforenergyindependence,anobjective
thatremainsinfeasibleabsentthepoliticalcouragetoraisegasolinepricesand
committothedevelopmentofnuclearpower.
RESOLVINGAMBIGUITY
TwoyearsafterKennedycommittedtheUnitedStatestolandingapersonon
themoon,IwasworkingasanengineeratNASA’sJetPropulsionLaboratory
(JPL). There I learned that a good proximate objective’s feasibility does
wondersfororganizationalenergyandfocus.
OneofthemainprojectsatJPLwasSurveyor,anunmannedmachinethat
would soft-land on the moon, take measurements and photographs, and, in
latermissions,deployasmallrovingvehicle.Themostvexingproblemfor
theSurveyordesignteamhadbeenthatnooneknewwhatthemoon’ssurface
waslike.2Scientistshadworkedupthreeorfourtheoriesabouthowthemoon
wasformed.Thelunarsurfacemightbesoft,thepowderyresidueofeonsof
meteoricbombardment.Itmightbeanestofneedle-sharpcrystals.Itmight
bea jumbleoflargeboulders,likeaglacialmoraine.Would avehicle sink
into powder? Would it be speared on needlelike crystals? Would it wedge
between giant boulders? Given this ambiguity about the lunar surface,
engineershadadifficulttimecreatingdesignsforSurveyor.Itwasn’tthatyou
couldn’t design a vehicle; it was that you couldn’t defend any one design
againstsomeoneelse’sstoryaboutthepossiblehorrorsofthelunarsurface.
Atthattime,IworkedforPhyllisBuwalda,whodirectedFutureMission
StudiesatJPL.HomeschooledonaranchinColorado,Phyllishadatough,
practicalintellectthatcouldseetotherootofaproblem.Shewasbestknown
forherworkonamodelofthelunarsurface.3Withthisspecificationinplace,
JPLengineersandsubcontractorswereabletostopguessingandgettowork.
ThelunarsurfacePhyllisdescribedwashardandgrainy,withslopesofno
morethanaboutfifteendegrees,scatteredsmallstones,andbouldersnolarger
thanabouttwofeetacrossspacedhereandthere.Lookingatthisspecification
forthefirst time,Iwas amazed. “Phyllis,”I said, “thislooksa lot likethe
Southwesterndesert.”
“Yes,doesn’tit?”shesaidwithasmile.
“But,”Icomplained,“youreallydon’tknowwhatthemoonislike.Why
writeaspecsayingitislikethelocaldesert?”
“Thisiswhatthesmootherpartsoftheeartharelike,soitisprobablya
prettygoodguessastowhatwe’llfindonthemoonifwestayawayfromthe
mountains.”
“But,youreallyhavenoideawhatthesurfaceofthemoonislike!Itcould
bepowder,orjaggedneedles.…”
“Look,” she said, “the engineers can’t work without a specification. If it
turnsouttobealotmoredifficultthanthis,wearen’tgoingtobespending
muchtimeonthemoonanyway.”
Herlunarspecificationwasn’tthetruth—thetruthwasthatwedidn’tknow.
It was a strategically chosen proximate objective—one the engineers knew
howtotackle,soithelpedspeedtheprojectalong.Anditwassensibleand
cleveratthesametime.YoucouldwriteaPhDthesisontheoptionsanalysis
implicit in her insight that if the lunar surface wouldn’t support a
straightforwardlander,wehadmorethanadesignproblem—thewholeU.S.
programoflandingamantherewouldbeindeeptrouble.Writingthehistory
ofSurveyor,OranW.Nickssaid,“Theengineeringmodelofthelunarsurface
actuallyusedforSurveyordesignwasdevelopedafterstudyofallthetheories
andinformationavailable.Fortunately,thismodelwaspreparedbyengineers
who were not emotionally involved in the generation of scientific theories,
andtheresultinglandingsystemrequirementswereremarkablyaccurate.”4
This lunar surface specification absorbed much of the ambiguity in the
situation,passingontothedesignersasimplerproblem.Notaproblemeasily
solved, or to which a solution already existed, but a problem that was
solvable.It wouldtake timeand effort,but weknewthat wecould builda
machinetolandonPhyllis’smoon.
Surveyors were built by Hughes Aircraft Company, and five made
successfullandingsonthemoonin1966and1967.Surveyor3landedinthe
Ocean of Storms in 1967. Just a bit more than two years later, Apollo 12
landedtwohundredyardsaway,andCommanderPeteConradwalkedoverto
themachineandtookitspicture.
Phyllis’s insight that “the engineers can’t work without a specification”
applies to most organized human effort. Like the Surveyor design teams,
everyorganizationfacesasituationwherethefullcomplexityandambiguity
ofthe situationisdaunting. Animportantduty ofany leaderistoabsorba
largepartofthatcomplexityandambiguity,passingontotheorganizationa
simpler problem—one that is solvable. Many leaders fail badly at this
responsibility,announcingambitiousgoalswithoutresolvingagoodchunkof
ambiguityaboutthespecificobstaclestobeovercome.Totakeresponsibility
is more than a willingness to accept the blame. It is setting proximate
objectivesandhandingtheorganizationaproblemitcanactuallysolve.
TAKINGASTRONGPOSITIONANDCREATINGOPTIONS
Manywritersonstrategyseemtosuggestthatthemoredynamicthesituation,
thefartheraheadaleadermustlook.Thisisillogical.Themoredynamicthe
situation,thepooreryourforesightwillbe.Therefore,themoreuncertainand
dynamicthesituation,themoreproximateastrategicobjectivemustbe.The
proximate objective is guided by forecasts of the future, but the more
uncertain the future, the more its essential logic is that of “taking a strong
positionandcreatingoptions,”notoflookingfarahead.HerbertGoldhamer’s
descriptionofplaybetweentwochessmastersvividlydescribesthisdynamic
oftakingpositions,creatingoptions,andbuildingadvantage:
Twomasterstryingtodefeateachotherinachessgameare,duringa
large part of the game, likely to be making moves that have no
immediateendotherthanto“improvemyposition.”Onedoesnotwina
chessgamebyalwaysselectingmovesthataredirectlyaimedattrying
tomatetheopponentorevenattryingtowinaparticularpiece.Forthe
mostpart,theaimofamoveistofindpositionsforone’spiecesthat(a)
increase their mobility, that is, increase the options open to them and
decrease the freedom of operation of the opponent’s pieces; and (b)
impose certain relatively stable patterns on the board that induce
enduringstrengthforoneselfandenduringweaknessfortheopponent.If
andwhensufficientpositionaladvantageshavebeenaccumulated,they
generally can be cashed in with greater or less ease by tactical
maneuvers (combinations) against specific targets that are no longer
defensibleoronlyatterriblecost.5
In2005,Iwasinvitedtohelpasmallerbusinessschoolwithitsstrategicplan.
Businessschoolsteachstrategybutrarelyapplytheconcepttothemselves.At
thisschool,theoverallambitionofthedeanandfacultywastobreakoutfrom
being a local school to one ranked with the best in the region. The draft
strategicplanwastypicalfortheindustry:itwasalistofareasinwhichthe
school would announce initiatives and try harder. It called for increased
research visibility, more alumni giving, the creation of a global business
studiesprogram,theenhancementofitsentrepreneurialstudiesprogram,and
asustainabilityinitiative.Lookingmorecloselyatthesituation,onecouldsee
thatthelargestsegmentofstudentstookjobsinaccountingfirmsandsmall-
to-medium-sizedlocalservicebusinesses.
Strategic planning was the responsibility of the dean and the faculty
executivecouncil.Imetwiththisgroupandexplainedtheconceptsofpivotal
issuesandthe proximate objective.Then I askedthe group to imaginethat
they were allowed to have only one objective.And the objective had to be
feasible.Whatonesinglefeasibleobjective,whenaccomplished,wouldmake
thebiggestdifference?
Afteramorning’sdeliberationtheyhadtwo.Theyweren’tquiteasfeasible
as I would have liked, but they were a big step forward from their vague
ambitiontobeatop schoolintheregion.About one-halfofthegrouphad
come up with an obvious, yet potentially pivotal, objective: “getting the
students into better jobs.” If students got better jobs, it was argued, they
wouldbehappier,facultywouldbehappierteachinghappierstudents,alumni
wouldgivemoremoneytotheschool,betterstudentswouldbeattractedto
theschool,andmoreresourceswouldflowintotheschooltofundresearch
and hiring. The other half of the group was in favor of a public-relations
objective.Theybelievedthatfocusingongettingmorecoverageoftheschool
in business magazines and newspapers would raise its profile, yielding a
numberoffavorableresults.
Importantly,bothobjectivesrepresentedstrongpositionswithinafieldof
actionandwereeachpregnantwithoptionsforfuturestrategizingandaction.
Ipraisedbothobjectivesandaskedthegrouptomakeeitherorbotheven
moreproximate—moreliketasksandlesslikegoals.Bytheendoftheday,
the group had combined the two ideas. They decided that the primary
objective of the school would be to get the students into better jobs. They
would select ten target firms that should be hiring their graduates but
presentlywerenot.Facultycommitteeswouldbecreatedtostudythesefirms’
recruiting practices and create programs to meet their needs and standards.
Secondly, insteadof globalstudies andsustainability,the schoolcommitted
itself to a new course of studies on media management. The idea was that
suchaprogramwouldattractmediapeopletovisittheschool,andifstudents
gotjobsinthemedia,itwouldnaturallyhelpraisetheschool’sprofile.Two
ofthetentargetfirmswouldbemediacompanies.
HIERARCHIESOFOBJECTIVES
Inorganizationsofanysize, high-levelproximateobjectivescreategoals
forlower-levelunits, which,in turn,create theirownproximate objectives,
andsoon,inacascadeofproblemsolvingatfinerandfinerlevelsofdetail.6
Proximateobjectivesnotonlycascadedownhierarchies;theycascadeintime.
For instance, when Nestlé purchased British chocolate company Rowntree,
topmanagementmadeajudgmentthatNestlé’stransnationalfood-marketing
skills would be able to take Rowntree’s Britain-centered brands and move
them into many other countries. The first steps in that direction were very
successful,andthecombinedmanagementsthendevelopedmoresubtleand
nuanced objectives. Anytime a company enters a new business or market,
there is necessarily this cascade of adjusting and elaborating proximate
objectives.
What is proximate for one nation, one organization, or even one person
maybefaroutofreachtoanother.Theobviousreasonisdifferencesinskills
andaccumulatedresources.Myunderstandingofthiswassharpenedduring
anafternoondiscussionabouthelicopters.
AmanIknowonlyasPJlivesontheEastCapeofBajaCalifornia,about
thirtymilesnorthofSanJosedelCabo,ontheSeaofCortez.Heisnowa
surferandfisherman,butPJwasonceahelicopterpilot,firstinVietnam,and
then in rescue work. The land in Baja California is unspoiled by shopping
malls,industry,pavedhighways,orfences.Sittingonahilltopinthewarm
winter we could see the gray whales jump and hear their tails slap on the
water.Makingconversation,Iofferedthat“helicoptersshouldbesaferthan
airplanes.Iftheenginefails,youcanautorotatetotheground.It’slikehaving
aparachute.”
PJsnorted.“Ifyourenginefailsyouhavetopullthecollectivealltheway
down,getofftheleftpedalandhittherightpedalhardtogetsometorque.
Youhaveaboutonesecondtodothisbeforeyouaredroppingtoofast.”He
pausedandthenadded,“Youcandoit,butyoubetternothavetothinkabout
it.”
“So,everythinghastobeautomatic?”Iasked.
“Notall,” hereplied. “Whenan enginefailsyouhavea lotto workout.
Youhavetoconcentrateonwhereyouaregoingtolandandonmaintaininga
smoothslidingpathdowntotheflare.Thatstufftakesalotofconcentration.
Butthebasicactofcontrollingthehelicopter,yes,thathastobeautomatic.
Youcan’tconcentrateonthecrisisifflyingisn’tautomatic.”
PJ opened another Corona and then expanded on his point. “To fly a
helicopteryou’vegottoconstantlycoordinatethecontrols:thecollective,the
cyclic,andthepedals,nottomentionthethrottle.Itisnoteasytolearn,but
you’vegottogetontopofit.You’vegottomakeitautomaticifyou’regoing
todomorethanjusttakeoffandland.Afteryoucanfly,thenyoucanlearnto
flyatnight—butnotbefore!Afteryoucanflyatnightwithease,maybethen
you’rereadytolearntoflyinformation,andthenincombat.”
Ashespoke,PJspreadhisfingers,overlappedhisthumbs,thenswooped
thisminiatureformationaroundtoillustratehispoint.
“Master all that—make it automatic—and you can begin to think about
landing on a mountain in high wind in the late evening, or landing on a
rolling,pitchingdeckofashipatsea.”
As PJ spoke, I could visualize him landing on a ship at sea, timing the
swellsandpitchesofthedeck.Havinglongagomasteredthecoordinationof
cyclic, pedals, and collective, he could concentrate on the coordination
betweenhisaircraftandtheship.
Toconcentrateonanobjective—tomakeitapriority—necessarilyassumes
that many other important things will be taken care of. PJ was able to
concentrateonthecoordinationbetweenhishelicopterandtherescuevessel
becausehealreadypossessedlayeruponlayerofcompetencesatflyingthat
hadbecomeroutine.
Afterthisdiscussion, Icameto seeskillsat coordinationasiftheywere
rungsonaladder,withhigherrungsinreachonlywhenthelowerrungshad
beenattained.Indeed,PJ’sconceptofalayeringofskillsexplainswhysome
organizationscanconcentrateonissuesthatotherscannot.Thisunderstanding
hashelpedshapetheadviceIofferclients.Forexample,whenIworkwitha
small start-up company, their problems often revolve around coordinating
engineering,marketing,anddistribution.AskingtheCEOofsuchafirmto
concentrate on opening offices in Europe may be pointless, because the
companyhasnotyetmasteredthebasicsof“flying”thebusiness.Oncethe
firmstandsfirmlyonthatrung,itcanmoveabroadanddevelopinternational
operations. But, in turn, asking that newly international firm to move
knowledge and skills around the world, as does a global veteran such as
Procter&Gamble,mayalsobepointless.Itmustfirstmasterthecomplexity
ofoperatinginvariouslanguagesandculturesbeforeitcanbegintoskillfully
arbitrageglobalinformation.
CHAPTEREIGHT
CHAIN-LINKSYSTEMS
A system has a chain-link logic when its performance is limited by its
weakestsubunit,or“link.”When thereisaweaklink, achainisnotmade
strongerbystrengtheningtheotherlinks.
Forthespace shuttleChallenger,the weakest link was a solid rubber O-
ring.OnJanuary28,1986,theO-ringinChallenger’sboosterenginefailed.
Hotgasknifedthroughthestructure;therocketexploded.Challengerandits
crew,the“prideofournation”PresidentReagancalledthem,tumbledoutof
theclearblueskyandshatteredontheoceansixty-fivethousandfeetbelow.
Ifachainmustnotfail,thereisnopointinstrengtheningonlysomeofthe
links.Similarly,forChallenger,therecouldbenogaintomakingthebooster
enginesstrongeriftheO-ringwasweak.Therewaslittlepointinimproving
guidance,orcommunications,orincreasingthequalityofcrewtraining,ifthe
O-ringwasweak.Thelogicofthechainisatworkinsituationsrangingfrom
mountainclimbing to thespaceshuttle to aestheticjudgment—situations in
whichthequalityofcomponentsorsubpartsmatters.
Quality matters when quantity is an inadequate substitute. If a building
contractor finds that her two-ton truck is on another job, she may easily
substitutetwoone-tontruckstocarrylandfill.Ontheotherhand,ifathree-
starchefisill,no numberofshort-ordercooks isanadequatereplacement.
One hundred mediocre singers are not the equal of one top-notch singer.
Keepingchildrenadditionalhoursorweeksinbrokenschools—schoolsthat
can neither educate nor control behavior—does not help and probably
increasesresentmentanddistrust.
Talkingwithrealestateexpertsandcontractorsabouthomeremodeling,I
learned that in assessing a property’s potential, one should identify the
limitingfactors.Ifahouseisnearanoisyhighway,thatisalimitingfactor.
Nomatterhowmuchmarbleisputinthebathroomsorhowfinethecabinetry
isinthekitchen,thenoisewilllimitthehouse’svalue.Similarly,ifaroom
haswonderfulhardwoodfloorsandclassicarchitecture,aless-than-excellent
paint job will limit its attractiveness. As an investor, one wants to find
limitingfactorsthatcanbefixed,suchaspaint,ratherthanfactorsthatcannot
be fixed, such as highway noise. If you have a special skill or insight at
removinglimitingfactors,thenyoucanbeverysuccessful.
GETTINGSTUCK
Thereare portionsof organizations, andeven ofeconomies, thatare chain-
linked.Wheneachlinkismanagedsomewhatseparately,thesystemcanget
stuck in a low-effectiveness state. The problem arises because of quality
matching.1Thatis,ifyouareinchargeofonelinkofthechain,thereisno
pointininvestingresourcesinmakingyourlinkbetterifotherlinkmanagers
arenot.
Tomakemattersevenmoredifficult,strivingforhigherqualityinjustone
ofthelinkedunitsmaymakemattersworse!Higherqualityinaunitrequires
investmentsinbetterresourcesandmoreexpensiveinputs,includingpeople.
Sincetheseeffortstoimprovejustonelinkedunitwillnotimprovetheoverall
performanceof thechain-linked system,the system’s overallprofit actually
declines.Thus,theincentivetoimproveeachunitisdulled.
Forinstance,thevariousproblemsatGeneralMotorsfrom1980to 2008
had strong chain-link features. Increasing the quality of an automobile
transmission does little good if the knobs fall off the dashboard and door
panelscontinuetorattle.Improvingfitandfinish,alongwiththedrivetrain,
may offer little overall improvement as long as the designers continue to
producepedestriandesigns.Improvingthelookoftheautomobilesmayonly
increasecostsunlessthecomplextechnologyofdesignformanufacturability
ismastered.Andsoon.
As another example, many of the thorny problems of economic
developmentarisefromchain-linkedissues:
•Itisoflittleusetosupplyadvancedmachinerytounskilledworkers,
butitisalsouselesstoeducatepeopleforjobsthatdonotexist.
•Governmentbureaucracycanbeaterribleburden,butimprovementin
itseffectivenesscanbewononlyifthereisanefficientprivatesector.
•Withoutcorruption,itwouldbeimpossibletoget aroundthe stifling
bureaucracy,butbureaucracyisanecessarycountertonepotismanda
cultureofcorruption.
• Improving the roads puts a strain on poor port facilities, and better
ports without good roads are of little value. Improve both the roads
andports,andcorruptofficialsandunionswilldemandpaymentsfor
lettingshipmentsthrough.
Policyproblemswithchain-linklogicarenotrestrictedtothedeveloping
world.IntheUnitedStates,dysfunctionalinnercities,decayedschools,and
prison systems that institutionalize race-based gangs, violence, and sexual
assault can each be subjected to a chain-link analysis. The Department of
Homeland Security has beefed up passport inspections at airports, a high-
profile practice that can have little total payoff as long as more than four
thousandmilesofborderandasmuchcoastlineremainvirtuallyuncontrolled.
Stoppingtwooutofthreeradiologicalattackswon’tbegoodenough.
GETTINGUNSTUCK
Expertiseisnotevenlydistributedintheworld.Ifyouseekthemostefficient
automobilemakers,youmusttraveltotheKantoplaininJapan,wherethey
cluster. Chemical expertise clusters in Europe where Germany, France, and
Switzerlandcometogether.TraveltotheSantaClaravalleytofindexpertise
in microprocessors and to the English Midlands for Formula 1 racing
machines. And on the Italian Lombard plain, where Italy and Switzerland
cometogether,youwillfindworld-classexpertiseinmechanicalsystems—
fromfastcarstospecializedindustrialequipment.
Marco Tinelli is the general manager of a Lombardy machine company,
operating on the outskirts of Milan. One day in 1997 I toured Marco’s
companyandlunchedwithhimatSavini,theclassicalrestaurantinGalleria
Vittorio Emanuele II, next to the duomo in Milan. Over a perfect risotto,
Marcoexplainedtheturnaroundathisfamily’scompany:
When my uncle passed away, the responsibility for the company
passedto me.Thingswerenotgood. Thequality ofthe machineshad
declined,especiallycomparedwithourbestcompetitors.Costsweretoo
highandthesalespersonnelwerenottechnicallysophisticated.Tosella
sophisticatedmachinewithmicroprocessorcontrolstakesasophisticated
salesperson.Ifwe didn’t change,wewould slowlygoout ofbusiness.
Butitseemedasifeverythinghadtochange.Wheretostart?
As he spoke, I realized that Marco Tinelli’s diagnosis was that his
machinerycompany had chain-linklogic and thatit wasstuck.Any payoff
from better-quality machines was diluted because the sales force could not
accuratelyrepresenttheirqualitiesandperformance.Abettersalesforce,by
itself, would have added little value without better machines. And
improvementsinqualityandsaleswouldnotsavethefirmunlesscostswere
reduced.
“Where did you start?” I asked, echoing his own question. Marco
explained:
Iconductedthreecampaigns,oneafteranother.Inthefirstcampaign
we spent twelve months just on quality. I told the employees that
everythingwedidforthenextyearwouldbetomakeourmachinesthe
bestintheindustry,themostreliableandthefastest.
Oncewe hadgood qualitymachines, Ifocused entirelyon thesales
function. The salespeople had been involved in the quality campaign,
andnowtheengineers andmanufacturingpeopleworkedwithsalesto
buildskills,sellingtools,andcommunicationslinksbacktothefactory.
Marketresultswereslowincoming,butIknewwehadtomakethese
investmentsfirsttoreapbenefitslater.
If one has not internalized the concept of quality matching and the
problems of change in chain-link systems, then Marco’s explanation of his
actions may seem banal—he identified the three problems and worked on
theminturn.Butifonehastheseconcepts,thenMarco’sstatementisdense
withmeaning.
The first logical problem in chain-link situations is to identify the
bottlenecks, and Marco did that—quality, sales’ technical competence, and
cost.Thesecond,andgreatest,problemisthatincrementalchangemaynot
pay off and may even make things worse. That is why systems get stuck.
Marco’ssolutiontothisproblemwastotakepersonalresponsibilityfor the
final result and direct others’ attention to the three bottlenecks, one after
another.Therewerenoimmediatereturnstothefirstcampaign,buthedidnot
stop nor did he operate a system that heaped blame on his department
managers.Instead,hecongratulatedthemforachievingtheproximategoalof
thefirstcampaignandmovedontothesecond.Therearelittleornopayoffs
toincrementalimprovementsinchain-link systems,butMarcoavoidedthis
problem by shutting down the normal system of local measurement and
reward,refocusingonchangeitselfastheobjective.
Oneofthetasksoftheintervieweristolistenforwhatisnotsaid.Marco
didnotsay,“Weturneditaroundbyincreasingthepressureforprofit.”He
did not say, “We developed new measures of quality and demanded
improvements.”Hedidnotsay,“Ibroughtinnew,moreskilled,managers.”
Instead, Marco described a turnaround in which he provided the overall
definitionofwhathadtobedoneandinwhichheanticipatedandabsorbed
thecosts ofchange.In anyorganizationthereisalways amanaged tension
between the need for decentralized autonomous action and the need for
centralizeddirection andcoordination. To producea turnaroundofa chain-
linksystem,Marco Tinellitippedthe balance, atleast for awhile,strongly
towardcentraldirectionandcoordination.
Marco’s explanation of his third campaign was also intriguing. In
particular,Marcosawlogicalandtemporalconnectionsthatdictatedthatthe
cost-reductioncampaigncomelast:
Finally, we spent nine months working just on cost. There was no
other goal during this third campaign. I left cost cutting to the last
because I wanted the cost-reduction campaign to work with, but not
define, the type of machines we build. To reduce costs, we reviewed
each component and each step in the manufacturing process. The big
improvements came from cutting two products out of the line and
bringingin-housesome toolsanddies wehadbeen buyingfromother
companies. By making our own dies we increased the speed of the
machines,andthusincreasedtheirvaluetoourcustomers.Thepriceof
the machine did not fall, but the cost to the user did. It took a
sophisticated sales-engineering team to get this point across to our
customers, which was another reason for making this type of cost
reductionthelaststep.
Marco’seffortspaidoff,andthefamilycompanyisagrowingprofitable
firm with an excellent reputation in its industry. Chain-link systems can be
changedandmadeexcellent.Ittakesinsightintothekeybottlenecks.Plus,it
takesleadershipandthewillingnesstoabsorbshort-termlossesinthequest
for future gains. At Marco Tinelli’s company, he personally took the
responsibility for the costs of change and plowed ahead, guided by the
eventualendstatetobeachievedratherthanmonthlyorquarterlyprofit.
EXCELLENCE
AswelearnfromMarcoTinelli,turningaroundachain-linksystemrequires
directleadershipanddesign.Conversely,theexcellenceachievedbyawell-
managedchain-linksystemisdifficulttoreplicate.
ConsiderIKEA.FormedinSwedenin1943,thecompanydesignsready-
to-assemblefurnitureitsellsthroughspecialIKEA-ownedstores,advertised
by its own catalogs. Giant retail stores located in the suburbs allow huge
selections and ample parking for customers. In the stores, the catalogs
essentiallysubstituteforasalesforce.Itsflat-packfurnituredesignsnotonly
reduceshippingandstoragecosts;theyalsohelpkeepthestoresinstockand
let the customers pull their own stock out of inventory and take their
purchases home, eliminating long waits for delivery. The company designs
muchofthefurnitureitsells,contractingoutmanufacturing,butmanagingits
ownworldwidelogisticssystem.
IKEA’sstrategyisaneffectivewaytocoordinatepolicies,butitishardly
secret. Won’t other companies see how it works and copy it, perhaps even
improveit?Theexplanationforitscontinuedexcellenceandthelackofany
effectiveme-toocompetitionisthatitsstrategybuildsonchain-linklogic.
IKEA’s adroit coordination of policies is a more integrated design than
anyoneelse’sinthefurniturebusiness.Traditionalfurnitureretailersdonot
carrylargeinventory,traditionalmanufacturersdonothavetheirownstores,
normalretailersdonotspecifytheirowndesignsorusecatalogsratherthan
salespeople,andsoon.BecauseIKEA’smanypoliciesaredifferentfromthe
normandbecausetheyfittogetherinacoherentdesign,IKEA’ssystemhasa
chain-linklogic.Thatmeansthatadoptingonlyoneofthesepoliciesdoesno
good—it adds expense to the competitor’s business without providing any
real competition to IKEA. Minor adjustments just won’t do—to compete
effectively with IKEA, an existing rival would have to virtually start fresh
and, in effect, compete with its own existing business. No one did. Today,
morethanfiftyyearsafterIKEApioneereditsnewstrategyinthefurniture
industry,noonehasreallyreplicatedit.
For IKEA’s set of policies to be a source of sustained competitive
excellence,threeconditionsmusthold:
• IKEA must perform each of its core activities with outstanding
efficiencyandeffectiveness.
• These core activities must be sufficiently chain-linked that a rival
cannotgrabbusinessawayfromIKEAbyadoptingonlyoneofthem
and performing it well. That is, a traditional furniture manufacturer
thataddsaready-to-assemblelineisnorealthreattoIKEA,norisa
traditionalretailerthataddsacatalog.
•Thechain-linkedactivitiesshouldformanunusualgroupingsuchthat
expertiseinonedoesnoteasilycarryovertoexpertiseattheothers.
Thus,atraditionalfurnitureretailerthatdidaddacatalogwouldstill
have to master design and logistics and build vastly larger stores to
begin to compete with IKEA. Plus, looking beyond traditional
furniture companies, there are no potential competitors that possess
thismixofresourcesandcompetencies.
IKEA teaches us that in building sustained strategic advantage, talented
leaders seek to create constellations of activities that are chain-linked. This
adds extra effectiveness to the strategy and makes competitive imitation
difficult.Whatisespeciallyfascinatingisthatbothexcellenceandbeingstuck
arereflectionsofchain-linklogic.
Inthecaseofexcellence,likeIKEA,aseriesofchain-linkedactivitiesare
allmaintainedatahighlevelofquality,eachbenefitingfromthequalityof
theotherandthewholebeingresistanttoeasyimitation.Ontheotherhand,
when a series of chain-linked activities are of low quality, as in General
Motors circa 2007, the system can be stuck, because there is little gain to
improving only a fraction of the activities. Marco Tinelli’s success
demonstratesthattounstickastuckchain-linkedsystem,astrongleadermust
possesstheinsightandfortitudetomakethenecessaryinvestmentsineach
linkofthechain.
CHAPTERNINE
USINGDESIGN
The word “strategy” comes to us from military affairs. Unfortunately,
humanshaveputmoreeffort,overmoretime,intothinkingaboutwarthan
any other subject. Much of this knowledge has very little to tell us about
strategy in nonmilitary situations. In particular, the primary way business
firmscompeteisbyplacingtheiroffersinfrontofbuyers,eachtryingtooffer
a more attractive deal. This is a process more like a dance contest than a
military battle. Businesses do not bomb one another’s factories or kill one
another’s employees. While business employees can quit on a moment’s
notice,soldiersareindentured.Employeesarenotexpectedtostandandgive
up their lives to protect the company. And the impact of size is radically
different.Otherthingsbeingequal,thelargerarmyhastheadvantagewhereas
thewinningbusinesstendstobetheonewhoseofferingsaremostpreferred
by customers, its size being more the consequence than the cause of its
success.Despiteallthesecautions,Ibelievethatifyouarecarefulaboutthe
levelofabstraction,youcantakecertainfundamentallessonsfrommilitary
historyandbethewiserfordoingso.
THEFATHEROFSTRATEGY
To begin at the beginning, armies, together with the authority structures
supportingthem,firstaroseintheBronzeAgeinparallelwithcomplexurban
societies. Just as humans discovered that organized agriculture paid great
dividends, they also found that organizing and coordinating the actions of
fightersgreatly magnified theireffect.Properlyorganizedand led, ordinary
men could defeat skilled warriors who fought as individuals or as small
bands.
The classic example of design in battle strategy, one that is still studied
today,isHannibal’svictoryovertheRomanarmyatCannaein216B.C.At
thattime,theRomanRepubliccontrolledaseriesofterritoriesandcity-states
in Italy. Carthage was a city-state of Phoenicians located in what is today
Tunisia.Fiftyyearsearlier,CarthagehadlostawarwithRomeovercontrolof
thesouthernMediterranean.SeekingtorestoreCarthage’spowerandhonor,
HannibaltookanarmytoSpain,thenthroughGaul(France),andcrossedthe
Alps into Italy. There, he raided towns up and down the Italian peninsula,
seekingfavorabletermsfromRome.
Aftertiringofapolicyofavoidingpitchedbattles,theRomansenatechose
consulsVarroandPaullus,andgavethemanunprecedentedeightlegionsto
defeatHannibal.1Thelocationofthebattlewasanopenfield,neartheruins
ofafortresscalledCannae,ontheAdriaticSea.Tofindthespotonamodern
map,lookforMontediCanne,locatedatthebackoftheankleofItaly’sboot.
AsthemorningofAugust2dawned,eighty-fivethousandormoreRoman
soldiers faced about fifty-five thousand of Hannibal’s troops. Each army’s
frontwasaboutonemilelong,andthetwoarmieswereaboutone-halfmile
apart. Hannibal had arranged his troops in a broad arc, bulging out in the
centertowardtheRomans.Inthatcentralbulge,Hannibalplacedtroopsfrom
Spainand Gaul,soldierswho hadbeen liberatedfromRoman ruleorhired
duringhismarchfromSpaintoItalyandalongthePoRiver.Ontheflanks,or
sides,ofthiscentralbulgeheplacedhisCarthaginianheavyinfantry.
When the advancing Romans met Hannibal’s army, the outwardarced
centerofHannibal’sfrontlinewasthefirstpointofcontact.There,theGauls
and Spaniards slowly fell back, not holding the line, just as Hannibal had
ordered.Encouraged,theRomanarmymovedforwardwithshoutsofvictory,
rushingtoexploitthisapparentweakness.Simultaneously,Hannibal’shorse
cavalry, placed on the sides of his mile-wide army, began its preplanned
gallopinwidetwo-milearcsaroundthesidesoftheRomanarmy,engaging
anddefeatingthesmallerRomancavalry.
As the Roman legions pushed into the Carthaginian center, the original
outwardarcwasreversed,anditbegantobowinwardunderthepressure.As
thecenterlinebowedinward,Hannibal’sheavyinfantryunits,positionedon
eitherend ofthecentralarc,maintainedtheirpositions butdid notengage.
Then,atHannibal’ssignal,reinforcementsmovedtobolstertheCarthaginian
bowed-incenter.Thetroopsinthecenterstoppedtheirretreatandheld.Their
aspect changed from that of panicky barbarians to that of hard, disciplined
troops.Hannibal’s heavyinfantry flanksthen movedto engagethe sidesof
theRomanarmy,whichwasnowsurroundedonthreesides.ThenHannibal’s
cavalryrodeinfrombehindandclosedtheRoman’srearaswell.
TheruthlessgeniusofHannibal’sstrategywasthenrevealed.Notonlywas
theRomanarmysurrounded,butastheirsuperiornumberspressedintothe
arcofHannibal’sbowed-incenter,theRomanranksweresqueezedtogether.
TheybecamesotightlymassedthatmanyRomansoldierscouldnotmoveto
raisetheirweapons.TheRomanshadlostcoherenceandmobility.Encircled
andcompressedtogether,theirnumericalsuperiorityhadbeennullified.
Themenattheverycenterofthecompressedmasswaitedhelplesslyfor
death,unabletomove.TheRomansdidnotsurrenderor askformercy. At
leastfiftythousandRomansoldierswerekilledthatday,moresoldiersthan
havediedinanysingledayofbattlebeforeorsince—moreonthatoneday
thanatGettysburgortheSomme.One-tenththatnumberofHannibal’stroops
died. The Roman dead included counsel Paullus, several former counsels,
forty-eight tribunes, and eighty senators. In a few hours, one-fourth of the
Republic’selectedleadershipwasslaughteredatCannae.Rome’sdefeatwas
sogreatthatmostsoutherncity-statesinItalydeclaredallegiancetoHannibal.
TheGreekcitiesinSicilywentovertoHannibalasdidMacedonintheeast.
Tograspthemagnitudeofthedefeat,imaginethatthe1944Germanarmy,
commandedbyGeneralErwinRommel,totallydestroyedallAlliedforcesin
Europe,thatone-fourthoftheU.S.Congresshadbeenkilled,andthatRussia,
northernEurope,andeasternEuropehadturnedtobecomeGermanallies.
Rome and Hannibal fought in Italy for ten long years after Cannae, and
Hannibal won further significant victories, never losing an engagement.2
Biographer Theodore Dodge named Hannibal the “father of strategy,”
because,overthislongconflict,Romelearnedand,gradually,cametomaster
strategythroughHannibal’spainfulteachings.3Romansocietywashardened
andmilitarizedbythisprolongedstruggle,andRomewentontoconquerand
dominate the known world for five hundred years. In turn, the rest of the
WesternworldlearnedstrategyfromRome.
Theconceptofstrategyhasmanyfaces,andtherearesomewedonotseein
thestoryofCannae.Thehistoryofthisbattletellsuslittleaboutlonger-range
considerationsandlittleabouthowthestrategywascreated.Thefulldesign
forthebattle,atleastintheavailablehistories,seemstohavebeencreatedby
Hannibal, and its implementation was by his personal command. From
Romanhistorians,welearnthatHannibalwasconsiderednobleandadmired
byallwhomethim,evenRomans.Beyondthat,weknowalmostnothingof
hisinterpersonal abilities ormethods. In particular, onewondersat howhe
persuadedtheGaulsandSpaniardsinhiscentralarctostageamockretreat,
anactionthatthesemenwouldhaveviewedasexpensiveinbothbloodand
honor.Wedonotknow.
However, what we do see in the story of Cannae are three aspects of
strategyin bold relief,presented in theirpurest and mostessential forms—
premeditation,theanticipationofothers’behavior,andthepurposefuldesign
ofcoordinatedactions.
Premeditation
Cannaewas notan improvisation;itwasdesignedandplannedinadvance.
Hannibal executed such choreographed strategies not just once, but many
timesinhisyearsofwarwithRome.Therearefuriousdebatesoverthebest
balance,inastrategy,betweenpriorguidanceandon-the-spotadaptationand
improvisation,butthereisalwayssomeformofpriorguidance.Bydefinition,
wingingitisnotastrategy.
Anticipation
A fundamental ingredient in a strategy is a judgment or anticipation
concerning the thoughts and/or behavior of others. The simplest way of
looking at Cannae is that Hannibal surrounded, or enveloped, the Romans.
Butthatisincomplete,fortheRomanlegionswerethemoremobileinfantry
on that field. Actually, the legions were enticed into becoming enveloped,
enticed into a trap, their own mobility, courage, and even initiative turned
againstthem.TheveryessenceofCannaewasthatthebarsofthetrap—the
compressionofthelegions’ranks—wereforged,inpart,bytheRomans’own
vigorousresponsestoHannibal’senticements.
Ingametheoryonepresumesthattheopponentisasrationalasoneself.It
isclearthatHannibaldidnotmakethatpresumption.Howeverindividually
rational the Romans might have been, he saw the Roman army as an
organization with a history, traditions, doctrine, and standardized training.
Furthermore, that organization’s leaders had identifiable motivations and
biases. Consul Varro, for example, was known to be proud and a bit
impetuous.
HannibalknewthesethingsbecauseCarthagehadfoughtRometenyears
earlier and came to understand its military system. The son of a military
family,HannibalwashighlyeducatedandhadwrittenseveralbooksinGreek
and Punic. Also, part of the Roman behavior at Cannae was predictable
because Hannibal had worked to shape it, raiding Varro’s camp the night
before,angeringandembarrassingtheconsulinfrontofhistroops,pushing
him to seek immediate battle. Finally, elements of Roman behavior were
predictable because the battle developed quickly, giving the Romans little
timeto study thesituation and notime to learnnew lessons andalter their
methods.
DesignofCoordinatedAction
Hannibal’s strategy at Cannae was an astoundingly adroit construction of
coordinated actions orchestrated in time and in space. In 216 B.C., the
fundamental formula for military success was fairly basic: keeping in
formation, keeping discipline, and keeping troops from panicking and
running. Therefore, when a Roman saw the enemy retreat, it looked like
victory. The idea that a commander could convince warlike Gauls and
Spaniards into a mock retreat was almost unthinkable. Furthermore, the
normal pattern in ancient battle was that cavalry, after vanquishing the
opposingcavalry,wouldchasefleeingdisorganizedhorsemenandsoldiers.It
was not expected that they would re-form and attack the main body of
infantry.TheCarthaginianarmy’scompetenceanddisciplineatcarryingouta
complexseriesofmovementsbydifferentunits—unitsthatwerephysically
separatedbutactinginpreplannedcohesionaroundacentraldesign—wasa
surprise. No army before Hannibal’s had executed such choreographed
multiplemovementsintimeandspace.4
Itisoftensaidthatastrategyisachoiceoradecision.Thewords“choice”
and“decision”evokeanimageofsomeoneconsideringalistofalternatives
andthenselectingoneofthem.Thereis,infact,aformaltheoryofdecisions
thatspecifiesexactlyhowtomakeachoicebyidentifyingalternativeactions,
valuingoutcomes,and appraisingprobabilitiesofevents. Theproblemwith
thisview,andthereasonitbarelylightensaleader’sburden,isthatyouare
rarely handed a clear set of alternatives. In the case at hand, Hannibal was
certainly not briefed by a staff presenting four options arranged on a
PowerPoint slide. Rather, he faced a challenge and he designed a novel
response. Today, as then, many effective strategies are more designs than
decisions—aremoreconstructedthanchosen.Inthesecases,doingstrategyis
morelikedesigningahigh-performanceaircraftthandecidingwhichforklift
truck to buy or how large to build a new factory. When someone says
“Managersaredecisionmakers,”theyarenottalkingaboutmasterstrategists,
foramasterstrategistisadesigner.
THEPARTSOFAWHOLE
Businessand corporatestrategydeal withlarge-scaledesign-type problems.
The greater the challenge, or the higher the performance sought, the more
interactionshavetobeconsidered.Think,forinstance,ofwhatittakestogive
a BMW 3 Series car that “driving machine” feel. The chassis, steering,
suspension,engine,andhydraulicandelectricalcontrolsallhavetobetuned
tooneanother.Youcanmakeacaroutofhigh-qualityoff-the-shelfparts,but
itwon’tbe a“drivingmachine.”In acaselikethisthereisa sharpgainto
carefulcoordinationofthepartsintoawhole.5
Form an image in your mind of the BMW’s driver; see her taking the
curvesonthewindingAngelesCrestHighway.Lookatherfaceandimagine
sensingherpleasureordispleasurewiththeautomobile.Now,begintovary
the design. Make the car bigger, quieter, a bit less responsive but more
powerful,heavier.Now,lighter,quicker,moreresponsive.Todoso,youhave
to change the chassis, the engine weight and torque, the suspension, the
steeringassembly,andmore.Itwillswaylessandhugtheroad;thesteering
wheel will provide more tactile feedback. Now adjust the chassis: make it
stiffertodampenlongitudinaltwistandsoftenthefrontsuspensionjustabit
toreduceroadshock.Varyingfortyorfiftyparameters,youwilleventually
findasweetspot,whereeverythingworkstogether.Shewillsmileandlike
hercar.
Butthereismore.Herdrivingpleasuredependsuponthepricepaid,sowe
begintoincludecostinourdesign.Weconcentrateonhersmileperdollar.
Manymoreinteractionsmustbeconsideredtofindthesweetspotthatgives
thelargestsmileperdollar.Youcannotsearchtheentirespaceofpossibilities;
it is too complex. But you can probably, with effort, produce a good
configuration.Togetmoresophisticated,youshouldalsoincludethepleasure
thedrivertakesinbuyingapremiumbrand,backedupbyimageadvertising
andswankdealers.Youshouldalsoconsiderherbuyingexperienceandthe
car’s expected reliability and resale value. More design elements to adjust,
moreinteractionstoconsider.Andthen,ofcourse,youshouldconsiderother
driverswithothertastesandincomes,ahugestepupwardincomplexityand
interaction.
Thatdifficultexercisewasdesign.Butinseekingthebestsmileperdollar,
we took a monopoly view. Yes, we went beyond product to include
manufacturing and distribution in the design, but our strategy was tuned to
pleasethecustomer,nottodealwithcompetition.Todealwithcompetition,
expandyour visionagainto includeotherautomobilecompanies.Now you
arelookingforacompetitivesweetspot.Youhavetoadjustthedesign—the
strategy—toputmoresmileperdollaronadriver’sfacethanshecangetfrom
competing products.6 That driver might not be the young woman we first
envisioned on the Angeles Crest Highway. Another firm may more easily
meet her demands, so a critical issue becomes the identification of the
particular set of buyers—our target market—where we have a differential
advantage. Competitive strategy is still design, but there are now more
parameters—moreinteractions—toworryabout.Thenewinteractionsarethe
offeringsandstrategiesofrivals.Veryquickly,youaregoingtofocusonwhat
you,oryourcompany,candomoreeffectivelythanothers.Itwillnormally
turnoutthatcompetitionmakesyoufocus onamuchsmallersubsetofcar
models,manufacturingsetups,andcustomers.
Iamdescribingastrategyasadesignratherthanasaplanorasachoice
because I want to emphasize the issue of mutual adjustment. In design
problems, where various elements must be arranged, adjusted, and
coordinated,therecanbesharplypeakedgainstogettingcombinationsright
andsharpcoststogettingthemwrong.Agoodstrategycoordinatespolicies
acrossactivitiestofocusthecompetitivepunch.
I first discovered the discipline of design in my first job out of college,
working as a systems engineer at the Jet Propulsion Laboratories. It was a
dream job, doing conceptual designs of a mission to Jupiter, a project that
wouldlaterbenamedVoyager.
JPL was organized around the subsystems of a spacecraft—
communications, power, structures, attitude control, computing and
sequencing, and so on.* I was in the systems division, where the job of a
systemsengineerwastheoverallarchitectureofthespacecraftandworking
outthecoordinationamongthespecificationsofallthedifferentsubsystems.
Our basic constraint was weight. We expected that the Titan IIIC rocket
wouldlaunchabout1,200poundsintoatrajectorytowardJupiter.Ifwecould
use the larger Saturn 1B, then we could plan on a 3,000-pound spacecraft.
Overayear,Isketchedouttwodesigns.Eachwasadifferentconfiguration
basedonadifferentweightbudget.
With3,000poundstoworkwith,thedesignworkwasrelativelyeasy.We
could essentially bolt together fairly well-understood subsystems.
Consequently,thedivisionswouldnothavetocoordinateverymuchbecause
thedesignchallengewasrelativelylow.Butifwehadonly1,200poundsto
workwith,thingsweremoredifficult.Interactionsbegantoplayabigrole.
Most of the work in systems design is figuring out the interactions, or
trade-offs, as they were called. The moment you tried to optimize any one
part, that choice immediately posed problems for other parts. The weight
constraintmadethewholethingawebofcompetingneeds,anditallhadto
beconsideredtogether.Cuttingtheweightoftheradioactivethermalpower
unit meant less power for the radio, limiting it to about 35 watts. To
compensateforthelow-poweredradio,wecouldtryforamorefocuseddish
antennaandseekgreateraccuracyinpointingthedishatEarth.Thatmeant
bettersensors,morecomplexcontrollogic,andmorefuelforattitudecontrol
were required. Try to cut the shielding on the spacecraft by putting the
radioactivepowersourceonalongerboomandyouwouldfindthattheboom
sways,makingguidancemoredifficult.
Eachpartofthesystemhadtobereconsideredandshapedtotheneedsof
therestofthesystem.Agreatdealofworkwentintotryingtocreateclever
configurations that avoided wasteful duplication. For example, if a single
device could perform multiple duties, acting as a shield from both sunlight
andmicrometeorites,andserveasacontainerforpropellant,weightcouldbe
saved.Similarly,wesoughtwaystomitigatecompetitionamongsubsystems
forelectricalpowerthroughtheclevertimingofoperations.
NothingIhadlearnedinengineeringschoolatUCBerkeleypreparedme
forthinkingaboutthiskindofdesignproblem.There,Ihadlearnedhowto
mathematicallymodelsystemsandthenminimizesomething,suchascostor
least-squarederror.ButthisworkatJPLwasdifferent.Ihadtolearnenough
aboutallthesubsystemsandtheirpossibleinteractions,andholditallinmy
mind,inorderto imagineaconfiguration thatmight be effective. This was
difficult,tosaytheleast.Ididn’tknowitatthetime,butIwasbeginningto
learnstrategy.
Voyager1waslaunchedfourteenyearsafterthoseinitialstudies.Itweighed
1,588pounds—morethan1,200 becauseofimprovementsinthe TitanIIIC
launchvehicle.IttookphotographsandmeasurementsofJupiterandSaturn.
Themissionplancleverlyusedoneofthescientifictelevisioncamerastoaid
navigation by sending back pictures of the positions of Jupiter’s moons
against the background of stars. It is still operational and is presently 7.8
billionmiles fromthe sun,beyond theedge ofthe solarsystem.Voyager 2
tookaslowerpathbutvisitedJupiter,Saturn,Uranus,andNeptune.
TheTrade-Off
ThelessonItookfromsystemsengineeringatJPLwasthatperformanceis
thejointoutcomeofcapabilityandcleverdesign.Inparticular,givenexisting
capabilities,such asrocket throwweightorpowersupplyefficiency,to get
more performance out of a system you have integrate its components and
subsystemsmorecleverlyandmoretightly.Ontheotherhand,ifcapabilities
(technologies) could be improved, the demand for tight, clever integration
waslessened.Thatis,morepowerfulboosterrocketsorlightercomponents
wouldletusmeettheweightconstraintwithlessworkontightintegration.
Thistrade-offwayofthinkingaboutdesignhas,forme,becomecentraltomy
viewofstrategy:
A design-type strategy is an adroit configuration of resources and
actionsthatyieldsanadvantageinachallengingsituation.Givenaset
bundleofresources,thegreaterthecompetitivechallenge,thegreaterthe
needfortheclever,tightintegrationofresourcesandactions.Givenaset
levelofchallenge,higher-qualityresourceslessentheneedforthetight
integrationofresourcesandactions.
These principles mean that resources and tight coordination are partial
substitutesforeachother.Iftheorganizationhasfewresources,thechallenge
can be met only by clever, tight integration. On the other hand, if more
resources are available, then less tight integration may be needed.7 Put
differently,thegreaterthechallenge,thegreatertheneedforagood,coherent,
design-typestrategy.
Implicit in these principles is the notion that tight integration comes at
some cost. That is, one does not always seek the very highest level of
integrationinadesignforamachineorabusiness.Amoretightlyintegrated
design is harder to create, narrower in focus, more fragile in use, and less
flexibleinrespondingtochange. A Formula1 racingcar,forexample,isa
tightlyintegrateddesignandisfasteraroundthetrackthanaSubaruForester,
but the less tightly integrated Forester is useful for a much wider range of
purposes.Nevertheless,whenthecompetitivechallengeisveryhigh,itmay
be necessary to accept these costs and design a tightly integrated response.
Withlesschallenge,itisnormallybettertohaveabitlessspecializationand
integrationsothatabroadermarketcanbeaddressed.
THEARCOFENTERPRISE
Companies buy pickup trucks, office equipment, vertical milling machines,
andchemicalprocessingequipment,andtheyhiretheservicesofwarehouses,
massesofhighschoolandcollegegraduates,lawyers,andaccountants.None
of these inputs are normally strategic resources. These kinds of assets and
services cannot, in general, confer a competitive advantage, because
competitorshaveaccesstovirtuallyidenticalassetsandservicesonthesame
terms.Astrategicresourceisakindofpropertythatisfairlylonglastingthat
has been constructed, developed over time, designed, or discovered by a
company and that competitors cannot duplicate without suffering a net
economicloss.
A high-quality strategic resource yielding a powerful competitive
advantagemakes forgreat strategicsimplicity.Consider Xerox’spatents on
plainpapercopying.Bythemid-1950sthesepatentswererocksolid,andit
becameclearthatbuyerswould bewillingtopaythree thousanddollarsor
moreforaXeroxmachine—adevicethatcostaboutsevenhundreddollarsto
manufacture.Giventhislargeandprotectedcompetitiveadvantage,Xeroxdid
theobvious—itmadeandsoldXeroxmachines.
Xeroxbuiltfactories,producedXeroxplain-paperphotocopiers,andbuilt
sales and service networks. It experienced no meaningful competition from
any of the old-line wet-process copier companies. It produced documents
called “strategic plans,” but they were merely financial projections. Its
challengewaslow.Itdidnotneedmuchinthewayofadesign-typestrategy
becauseitsresourceposition—itspatent—insulateditfromcompetitionand
becausetheproduct’svalue tobuyerswassomuchgreaterthanthecost of
makingone.
Resourcesaretocoordinatedactivityascapitalistolabor.Ittakesagreat
dealoflabortobuildadam,butthedam’sservicesmaythenbeavailable,for
a time, without further labor. In the same way, Xerox’s powerful resource
position—itsknowledgeandpatentsregardingplain-papercopying—wasthe
accumulatedresultofyearsofclever,focused,coordinated,inventiveactivity.
And,likeadam,oncethatwell-protectedresourcepositionwasachieved,it
persistedformanyyears.AsoneseniorXeroxmanagertoldmein1977,“The
factory sold its machines to the sales division at a transfer price that was
doubleitsfullcostofproduction.Then,thesalesdivisiondoubledortripled
thattransferpricetosetapriceforthecustomer.”
Thus, a strong resource position can obviate the need for sophisticated
design-typestrategy.If,instead,thereisonlyamoderateresourceposition—
perhaps a new product idea or a customer relationship—the challenge is to
build a sensible and coherent strategy around that resource. Finally, the
cleverest strategies, the ones we study down through the years, begin with
very few strategic resources, obtaining their results through the adroit
coordinationofactionsintimeandacrossfunctions.
Theperilofapotentresourcepositionisthatsuccessthenarriveswithout
careful ongoing strategy work. Own the original patent on the plain-paper
photocopier, or own the Hershey’s brand name, or the Windows operating
systemfranchise,orthepatentonLipitor,andtherewillbemanyyearsduring
whichprofitswillrollinalmostregardlessofhowyouarrangeyourbusiness
logic. Yes, there was inventive genius in the creation of these strategic
resources, but profits from those resources can be sustained, for a time,
withoutgenius.
Existingresourcescanbetheleverforthecreationofnewresources,but
theycanalsobeanimpedimenttoinnovation.Well-ledfirmsmust,fromtime
totime,castaside oldresources,justas theyretireobsoletemachinery.Yet
strategic resources are embedded deeply within the human fabric of the
enterprise,andmostfirmsfindthisadifficultmaneuver.Xerox,forexample,
builtaworld-classfast-responserepairandmaintenanceservicetotakecare
ofitsinstalledbaseofcopyingmachines.Thus,itsinitialresource—thepatent
onplain-papercopying—wasusedtocreateanewstrategicresource.Butthe
service system’s value lay in keeping the base of failure-prone leased
machinesrunning.Anditscomplementwasaprofitablebusinessin“special”
Xerox-brandplainpaper,whichjammedthecopierslessfrequently.Thenext
stepshouldhavebeentobuildaworld-classpaper-handlingcapability.That
wouldhaveopenedthedoortoanearlypositioninpersonalcopiers,printers,
faxmachines,andsoon.Butitwouldalsohavereducedtheimmediatevalue
oftheXeroxservice-systemresource.Restingonitslaurels,XeroxletCanon,
Kodak,andIBMdevelopsuperiorpaperhandlingtechnology,whileitstruck
off in the futile search for a way to enter the computer business with a
resource base specialized around maintaining failure-prone mechanical
devices.
Averypowerfulresourcepositionproducesprofitwithoutgreateffort,and
itishumannaturethattheeasylifebreedslaxity.Itisalsohumannatureto
associatecurrentprofitwithrecentactions,eventhoughitshouldbeevident
that current plenty is the harvest of planting seasons long past. When the
profitsrollin,leaderswillpointtotheireveryactionwithpride.Bookswill
bewrittenrecommendingthatothersimmediatelyadoptthesuccessfulfirm’s
dresscode,itsvacationpolicy,itssuggestion-boxpolicies,anditsmethodof
allocating parking spaces. Of course, these connections are specious. Were
there such simple, direct connections between current actions and current
results,strategywouldbealoteasier.Itwouldalsobealotlessinteresting,
foritisthedisconnectbetweencurrentresultsandcurrentactionthatmakes
theanalysisofthesourcesofsuccesssohardand,ultimately,sorewarding.
Success leads to laxity and bloat, and these lead to decline. Few
organizations avoidthistragicarc.Yetitis thisfairlypredictabletrajectory
thatopensthedoortostrategicupstarts.Toseeeffectivedesign-typestrategy,
youmustusuallylookawayfromthelong-successfulincumbenttowardthe
company that effectively invades its market space. There you will find a
tightly crafted and integrated set of actions and policies. Look at Canon,
workingaroundXerox’spatentsandcreatingaradicallynewbusinessmodel
based on reliable desktop copying, rather than centralized high-speed high-
volumecopiers.LookattheyoungMicrosoftbestingIBM;theyoungWal-
MartbestingKmart;theyoungDelltakingbusinessawayfromHP,Compaq,
and IBM; upstart FedEx pushing aside the traditional air-freight carriers;
EnterpriseRent-A-CarcompetingeffectivelywithHertzandAviswithanew
business model; Nvidia coming out of nowhere to steal domination of the
graphics chip market away from Intel; and Google redefining the search
businessandtakingitawayfromMicrosoftandYahoo!Ineachcaseyouwill
findtheupstartwieldingatightlycoordinatedcompetitivestrategy.
Inourlongingforimmortality,weaskthatthesestrategicupstartsextend
their success forever—the aging businessperson’s quixotic search for
sustained competitive advantage. But the incumbent laxity and inertia that
gavetheseupstartstheiropeningsappliestothemaswell.Intime,mostwill
loosentheirtightintegrationandbegintorelymoreonaccumulatedresources
and less on clever business design. Relying on the profits accruing to
accumulated resources, they will lose the discipline of tight integration,
allowingindependentfiefdomstoflourishandaddingsomanyproductsand
projectsthatintegrationbecomesimpossible.Facedwiththenaturalslowing
ofgrowthovertime,theywilltrytocreateanappearanceofyouthfulvigor
withbolt-onacquisitions.Then,whentheirresourcebaseeventuallybecomes
obsolete,they,too,willbecomepreytoanothergenerationofupstarts.Itis
the cycle of life. Its important lesson is that we should learn design-type
strategy from an upstart’s early conquests rather than from the mature
company’sposturing.StudyhowBillGatesoutsmartedthegiantIBMorhow
Nucor became a leader in the declining steel industry and you will learn
design-typestrategy.StudyMicrosofttodayandyouwillseeamaturegiant,
reapingthebenefitsofpastvictoriesbutjustastiedtoitsinstalledbaseanda
richmixofconflictinginitiativesandstandardsaswasIBMin1985.
ORDEROUTOFCHAOS
Oneexampleofgoodstrategyinwhichyoucanseethecoordinatedelements
ofdesignistheU.S.heavy-truckbusiness.DaimlerAGisthemarket-share
leader(38 percent). Itgot that large by buyingFord’s troubled heavy-truck
businessin1977.ThenextlargestproducerisPaccar(25percent),followed
byVolvo(20percent),andthenNavistar(16percent).Plumbinthemiddleof
alow-growth,mature,verycompetitiveindustry,Paccarneverthelessturnsin
a solid performance. Its return on equity over the past twenty years has
averaged16percent,comparedwithanaveragereturnof12percentearned
by its competitors. Even more important, Paccar’s profits have been
remarkablystableinanindustryplaguedbystrongupswingsanddownswings
indemand.Paccarhasnotlostmoneysince1939,anditsprofitrollcontinues
despitetherecessionof2008–9.
ThedrivingelementinPaccar’sstrategyisquality,withitsKenworthand
Peterbilt brands widely recognized as the highest-quality trucks made in
NorthAmerica.PaccarhasreceivedJ.D.Powerawardsforitsheavytrucks
and for its service. The company prices accordingly, maintaining its strong
marketpositiondespitepremiumprices.
Howcanyousellatruckatapremiumprice?Intheoryitissimple—your
truckshavetorunbetterandlastlongersothattheowner’scosttooperatethe
truckislower.Fleetoperatorslookatdifferencesofafractionofacentper
mileinmakingpurchasedecisions,andtheswingincostsismostlyfueland
wages. For example, if you buy a 2008 Kenworth T2000 sleeper for
$110,000,anddriveit125,000milesthatyear,youwillprobablypayanother
$115,000eachyearinoperatingexpensesforfuel,maintenance,repair,and
insurance.Andthatisbeforewagesandbenefits.Becauseofthis,Kenworth
pioneeredlow-dragaerodynamictruckcabsthirtyyearsagoasawaytocut
fuelcosts.
Itisnoteasytoholdthiskindofqualityleadershipforthreebigreasons.
First,noonewillbelieveyouhavethelongest-lastingtrucksuntiltheyhave
alreadylastedalongtimeontheroad.It’sareputationthattakesawhileto
earnandcanbelostquickly.Second,designingaveryhigh-qualitypieceof
machinery is not a textbook problem. Designers learn from other designers
over time, and the company accumulates these nuggets of wisdom by
providing a good, stable place to work for talented engineers. Third, it is
usually quite difficult to convince buyers to pay an up-front premium for
futuresavings,evenifthenumbersareclear.Peopletendtobemoremyopic
thaneconomictheorywouldsuggest.
Paccar’s strategy—its design—is its way of dealing with these three
obstaclestobeingaqualityleader.Thefirstelementofitsstrategyisasubtle
shift away from seeing quality purely in terms of operating cost. Instead,
Paccar views quality through the eyes of the owner-driver. Owner-drivers
increase their wages by pushing themselves harder, driving sixteen hours a
dayormore.Owner-driverscareaboutefficiencybutalsolookbeyondcost
permile,becausethetruckistheirhome,office,lounge,andTVroomonthe
road.Inaddition,driversprizethespecialsenseofclassicAmericanstyle—a
Harley-Davidson-type aura—that attaches to Paccar’s brands, even as the
interiors now have more of a Lexus look and feel. Owner-drivers buy
Kenworth and Peterbilt trucks from experienced dealers who use 3-D
computer displays to select from hundreds of customizing options. Paccar
builds each truck to order, keeping inventories low and using a network of
suppliersforitsmaincomponentsandparts.Thetrucksaredesignedwithas
manypartsincommonaspracticable.
Truckfleetoperatorsdon’tcareaboutauraverymuch;theydocareabout
turnoverandidletimeamongtheirdrivers.Fleetmanagersfindthatbyusing
twodrivers,idletimeiscutinhalformore.Thatmeansoneofthedriversis
sleepingorrestinginthesleepercompartmentagoodpartofthetime,raising
the same concerns about comfort the owner-driver has. Plus, when truck
drivers meet at a stop, the owner-drivers have the highest status and their
opinions have the most weight. The beauty of Paccar’s positioning is that
although fleet buyers pay more attention to cash cost per mile than owner-
driversdo,manyarepushedinsomeofthesamedirectionsbytheirdrivers’
preferences.Whateverthefleetowner’sopinion,manyoftheirdriversprefer
Paccartrucks.
Paccar’sstrategyisbasedondoingsomethingwellandconsistentlyovera
long period of time. That has created difficult-to-replicate resources: its
image, its network of experienced dealers, its loyal customers, and the
knowledgeembeddedinitsstaffofdesignersandengineers.Thispositionand
these kinds of slow-build resources are simply not available to companies,
mesmerizedbythestockmarket,whowantbigresultsintwelvemonths.
AflexibleapproachtomanufacturingmakesPaccar’svariablecostshigher
than competitors’ but provides stability for its designers and engineers. In
addition,itshighermarginscreatealoyal,morededicatednetworkofdealers.
All of this works, in part, because it is not in a high-growth industry that
wouldattractlargenewinvestmentsfromoutside.Toattackitdirectly,arival
wouldhavetocreatenewbrandsandnewdesigns,and,quitepossibly,sign
upnewdealers.Thehigh-endmarketisn’tbigenoughtowarrantthatkindof
investment.
Paccar’s design is expressed in actions that are consistent with its
positioningandthatareconsistentovertime.Itdoesnotmakesmalltrucks,
only large ones. Within the large-truck segment, it does not make cheaper
economy trucks. The product-buyer focus is maintained by its dealers,
designers,andengineers.Becauseitisnotdiversified,thetalkandknowledge
inthe designstudio,inmanufacturing,and inthe executivesuite areabout
truckersandheavytrucks.Theydon’tneedtohireaconsultingfirmtofigure
outtheircorecompetenceortofindoutwhotheirbuyersare.
The various elements of Paccar’s strategy are not general purpose—they
are designed to fit together to make a specialized whole. The design is
clearestifyouimagineatruckmanufacturerassembledoutofgenericbitsof
various truck companies, a sort of Frankenstein’s monster truck company.
With medium-priced truck designs aimed at fleet buyers, dealers aimed at
pickyowner-drivers,anddesignengineerstrainedtocutcoststothebone,it
would not last long. Good strategy is design, and design is about fitting
variouspiecestogethersotheyworkasacoherentwhole.
ThereisnothingmagicalaboutPaccar’sstrategy.Itisclassic“holdthehigh
ground”positioning.Thisdefensivestructurecanprobablybemaintainedas
longastherearenosignificantstructuralchangesintheindustry’seconomics
or buyer behavior. Day-to-day competition in the industry is always
important, and Paccar must introduce new features and models, strive to
improveitsqualityandreduceitscosts,andmaintainitsflexibility.Butgood
strategylookspasttheseissuestowhatisfundamental.Fromthatperspective,
the threats to the company are not specific new products or competitive
moves,butchangesthatunderminethelogicofitsdesign.If,forexample,the
NAFTA treaty encourages more and more shippers to use Mexican trucks
ratherthanU.S.owner-drivers,Paccar’spositionisatrisk.Similarly,thenew
sophisticatedcomputersellingintroducedintodealershipsmaybenecessary,
but there is a concern that it undermines the importance of the dealer’s
knowledgeandexpertise.
CHAPTERTEN
FOCUS
It is a bright April morning and my upcoming session is for executive
MBAs. Some are already there, Web browsing, reading newspapers, or
studying. Today’s case is on Crown Cork & Seal, a maker of metal
containers.1It is one ofthe oldest casesinthe strategy collection.Updated
manytimes,thecasetodaytakesthecompanythrough1989.
Myobjectivesarenottoshowmyclasshowtomanageacancompany,or
evenhowtocreateagoodstrategy.Instead,theyare(1)toteachthemhowto
identify a company’s strategy, (2) to deepen their skills at analyzing
qualitativeinformation,and(3)toexploreaparticularmixtureofpolicyand
positioningcalledfocus.
Crown’sstrategyhadbeencraftedintheearly1960sbyJohnF.Connelly,
whose tight-fisted direction of Crown had become virtually a folktale in
American business. It had been, for example, a favorite of legendary stock
picker Peter Lynch, manager of Fidelity’s Magellan Fund. Over thirty-five
years,thecompanyhadachievedaphenomenalrecord,providinganaverage
return to shareholders of 19 percent per year—an especially impressive
performancegiventheintensecompetitioninitsindustry.
WhatwasCrown’ssecret?Thecaserepeatstheconventionalwisdomthat
Crown specialized in containers for hard-to-hold products such as aerosols
andcarbonatedsoftdrinks.Whiletrue,ofcourse,thisdescriptionisneither
complete nor terribly useful in understanding how Crown competed.
Nevertheless, most analysts stop there, gladly accepting this description of
Crown’s strategy. They will not have noticed that the details of Crown’s
policies point in other directions as well. In general, people will not push
further because the analysis of unstructured information is hard, time-
consuming work that requires both a rich knowledge of facts and well-
developedskillsinlogic,deduction,andinduction.Todaymyopeningisthe
predictablegapbetweentheanalysisdonebytheparticipantsandwhatcanbe
donewithamoredisciplinedeffort.
I start by saying, “Our job today is strategy identification. To begin
identifying a company’s strategy, it is usually most helpful to examine the
competitiveenvironment.Thatis,tolookathowthemajorcompetitorsmake
their livings. Let’s begin with the three major can companies: Continental
Can, National Can, and American Can. The case says that ‘most beverage
companieshadatleasttwosourcesofcansupply.Further,canmanufacturers
oftensetupplantstosupplyaparticularcustomer.’”2
Toillustratethatabeveragecompanymighthavetwodedicatedsuppliers,I
sketchadiagramonthewhiteboard.Ithasaboxinthecenterlabeled“Miller
Brewing”andtwocansuppliers,representedbycirclesoneithersideofthe
box.
Pointing to the diagram, I say, “It doesn’t take a PhD in industrial
economicstoseethatthisisaterribleindustrystructure.Thereisverydirect
competition between close-by can makers, whose products have to be
essentiallyindistinguishable.Plus,thereistheconstantthreatthatthebuyer
maysimplypurchaseacanlineanddothejobitself.Whyintheworldwould
acompanyinvestinsuchadifficultsetting?”
After some discussion, the class concludes that the big can makers have
acceptedbeingcaptiveproducersbecauseofthebenefitsoflongproduction
runs—thereisalargecosttochangingalinefrommakingonetypeofcanto
another.Atthesametime,theynoticethatthemajorcancompanieshavevery
lowprofitrates—4to5percentreturnonassets.
Isay,“Thisisadifficultindustrywithlowreturnsforthemajorplayers.
But Crown Cork & Seal”—I make a show of looking in the case for its
performance numbers—“beats the big three by a substantial margin. On
average, it seems to be fifty to sixty percent more profitable. It’s doing
somethingright—somethingwecallastrategy.
“WhatisCrownCork&Seal’sstrategy?”
Todd,arealestatedeveloper,assertsthat“Crownisalow-costproducer.”
Hegoes onto argue,“Youcan’tdifferentiateacan, sothereason itmakes
more money must be that its costs are lower. It keeps its costs down by
runningitsplants24/7andkeepingclosetothecustomer.”
Heisdeadwrong,forCrown’sunitcostpercanisalmostcertainlyhigher,
notlower,thanitscompetitors’costpercan.Isaynothing,writing“low-cost
producer”onthewhiteboard.
Martin, an executive in the entertainment industry, says, “Crown
specializedinhard-to-holdapplications—aerosolsandsoftdrinks.Ithadgreat
customer service. There was lots of technical assistance for customers and
greatresponsiveness,withanemphasisonspeed.Inthecase,Connelly,the
CEO,iswillingtojumponaplanetohelpsortoutonecustomer’sproblem.”
“Excellent,Martin.Thatisindeedwhatthecasesays.Thereisactuallya
section,entitled‘Connelly’sStrategy,’whereitsaysthatthecompanyfocused
oncontainersforhard-to-holdapplications—softdrinksandaerosols.Italso
saysthatitemphasizedcustomerserviceandtechnicalassistance.
“So,Iguesswearedone.”Igotothepodiumandgatherupmynotes,then
pause and look around. “Unless anyone has a problem with the official
explanation.”
Melissa,inthefrontrow,isslowlyshakingherhead.Irarelyhearfromher,
soIdon’tpressforahand,butsimplyask,“Melissa?”
“Well,”shestarts,glancingatMartin,“Idon’treallyseethatputtingsoda
inacanisallthatmuchofabigtechnicalfeat.Crownisn’ttheonlycompany
thatcandothis.Whywouldthatbeahigh-profitbusiness?”
Inodintheaffirmativeandputmypapersbackonthepodium.Withalittle
prodding,Melissahasmadeakeystep.ShehasquestionedMartin’sandthe
conventionalview.Shehasnoticedthatacanforahard-to-holdapplication
isn’tnecessarilyhardtomake.
Isay,“SupposeFortunemagazine,HarvardBusinessSchoolcasewriters,
and stock analysts all say Crown’s strategy is a focus on hard-to-hold
applications—carbonated beverages and aerosols. But also suppose that we
areverystubborn.Wewanttodoourownanalysis.Ifyouareseriousabout
strategy work, you must always do your own analysis. A strategy is not
necessarily what the CEO intended or what some executive says it is.
Sometimes they are hiding the truth, sometimes they are misstating it, and
sometimes they have taken a position as leader without really knowing the
reasonsfortheircompany’ssuccess.
“Ifweare not goingto automatically acceptthe opinions ofothers,how
canweindependentlyidentifyacompany’sstrategy?Wedothisbylookingat
each policy of the company and noticing those that are different from the
norm in the industry. We then try to figure out the common target of such
distinctivepolicies—whattheyarecoordinatedonaccomplishing.”Igotothe
whiteboard and write “policy” over the two policies Martin called out
—technicalassistanceandrapidresponse.ThenIplaceanewcolumntothe
rightlabeled“Target.”
EveryonewillhavenotedthatCrownemphasizedtechnicalassistanceand
rapidresponse,but,likeMartin, willhavethoughtofthesepolicies onlyas
some sort of “good things” that the company does. But they will not have
noticedthatnotallcustomersneedorbenefitfromsuchpolicies.Nowcomes
therealworkoffiguringoutitsfocus.
“Let’s start with technical assistance,” I say. “Melissa pointed out that
putting soda in a can is not atomic science. What kind of customer needs
technicalhelptogettheirproductintoacan?”Myquestiononlyevokesblank
looks.Ihavelecturedonhowtotackleseeminglyformlessquestionslikethis.
The first trick is to replace general nouns with specific examples. I wait a
moment, and then I do it for them, a concrete example of replacing the
abstract with the concrete. “What about Coors, does it need technical
assistancefromcancompanies?”Thetrickworks—handsareup.
Rezaisanaerospaceengineerwhosecontributionsareusuallysound.He
says, “The major beer companies can probably teach the can companies a
thingortwo.ItwasCoorsthatactuallyfiguredouthowtomaketwo-piece
aluminum cans by a double-draw process. It’s smaller companies that need
technical assistance—companies without big technical staffs and without
internalcanningexperienceoftheirown.”
“OK,” I reply, and write “Smaller businesses” across from “Technical
assistance,”underthe“Target”column.“Andwhatabouttherapidresponse
policy,isthatalsofocusedonsmallercompanies?”
“Sure,” says Reza. “Small companies may have less stable demand and
mayplanlesswell.”
Reza’s second response is quick but not careful. When faced with a
questionorproblemtowhichthereisnoobviousanswer,itishumannature
towelcomethefirstseeminglyreasonableanswerthatpopsintomind,asifit
werealifepreserverinachoppysea.Thedisciplineofanalysisistonotstop
there,buttotestthatfirstinsightagainsttheevidence.Reza’sexplanationthat
rapidresponsefavorssmallfirmsagreeswithsomeofthefactsonthetable,
butnotall.Idon’twriteanythingdownonthewhiteboard.
Thereisanuncomfortablepause.Then,astudentsays,“Maybethetargetis
seasonalproducers.”Imoveslightlytowardtheboard.Anothersays,“New
products?”Iamattheboardwithmarkerpoised.Iask,“Ahotterthannormal
summer,anewproduct—thesemean…?”Twoorthreestudentssay“Rush
orders” together. I write “Rush orders” across from “Rapid response” and
under“Target.”
“Allright,”Isay.“Wearemakingprogress.Thetechnicalassistancepolicy
seems to have small companies as a target and the rapid response policy
seemstotargetrushorders.Thesetwotargetsarenotquitethesamething.
Let’s take a look at another policy.” I add “Manufacturing” to the left-side
columnofpolicies.
The information about manufacturing policy is scattered throughout the
case.Ittakesawhiletosurfacethebasics:Crown’splantsaresmallerthan
thoseofitsrivals;noneofCrown’splantsarecaptive—eachhasatleasttwo
customers;Crownhadexcesslinessetupandwaitingfororders.
David,aprivateequityanalyst,hasbeenworkingaspreadsheetandhelps
clarify the implications. “Compared with the majors,” he says, “Crown’s
plantsaresmallerbuthavemorecustomers.SoCrown’sproductionofcans
percustomermustbealotlowerthanthemajors’.Also,sincerevenuesper
plantarehigher,Crown’spricepercanmustbeconsiderablyhigherthanthe
majors’averageprices—maybefortytofiftypercenthigher.”
OnthewhiteboardIwrite“Speed”and“Lessproductionpercustomer”as
thetargetsoftheclusterofmanufacturingpolicies.
Nowitistimetopullthingstogether.Ipointtothelistofpolicytargetson
thewhiteboardandask,“Givenallthis,whatisCrownCork&Seal’sfocus?”
The class has all the pieces, but I want them to tie these pieces to the
fundamentaleconomicsoftheindustry.Itisnoteasytoseethispattern,andI
don’t expect anyone to put it together on the spot. So I continue to speak,
giving some leading hints. “What ties all of these observations together?
Smallercustomers…rushorders…speed…lessproductionpercustomer…
higherprices?”
I wait for perhaps twenty seconds, an eternity of silence in a classroom.
Then I ask, “What is it that drove the majors to accept becoming captive
producers?”Thislastclueisenough.
“Crown does short runs,” exclaims Julia, an entrepreneur. “The majors
acceptlongrunsofstandarditemstoavoidcostlychangeovers.Crowndoes
theoppositeandhasafocusonshorterruns.”
Isay,“Great,”asIdrawabigcirclearoundalloftheelementsonthetarget
list—small customers, rush orders, and less shipments per customer—and
label the circle “Shorter runs,” and sign the label “Julia,” recognizing her
inductiveinsight.
Thephrase“Shorterruns”tiesthecompany’sfocustotheessentialproblem
facedbyproducers in theindustry—the very highcostsof switching acan
linefrommakingoneproducttoanother,orevenprintingonelabelandthen
settinguptoprintanother.“SowearefindingthatwhileCrownspecializedin
softdrinkandaerosolcans,italsohasacomplexfocusaroundshorterruns.
Therunsmaybeshorterbecausethecustomerissmaller,becausetheproduct
is newer, because it is a low-volume high-value product, or because it is a
rushordertocoverseasonalorotherunexpecteddemand,andsoon.”
Aftertestingthisideaagainstothercompanypolicies,Ireturntotheissue
of cost. Everyone can now see that shorter runs mean more changeovers.
That,andCrown’spoliciesofexcesscapacity,lotsoftechnicalassistance,and
rapidresponsealldrivecostsup,notdown.Sowehaveacompanyfocused
onshorterrunswithhighercostspercanbalancedbyhigherprices.
Isay,“Itwouldbeniceiffocusalwaysmeantmoreprofit.Butitjustisn’t
so. It’s time to figure out how all of this allows Crown to earn higher
margins.”
Igotothewhiteboardanddrawacircle,representingCrownCork&Seal,
witharingofsquaresaroundit,eachrepresentingacustomer.Thecontrast
withthenearbypictureof“MillerBrewing”withitstwosuppliersissharp.
“We know that none of Crown’s plants are captive. Who is in the better
position?AmericanCansellingtoMillerBrewingorCrownsellingaspecial
ordertoalocalsoftdrinkbottler?”
Cheryl, a financial analyst for Sony, gets it right away: “Crown. By
focusing on short runs, Crown avoids the captive squeeze. Instead of one
customerwithseveralcompetingsuppliers,Crownisasupplierwithseveral
customersperplant.Goingforlongrunsmadethemajorscaptive.Shortruns
turnthesituationaround.Crownhasn’tgivenupitsbargainingpowerlikethe
captiveshave.”
Usingthediagramsforemphasis,Isummarizewhatwehavediscovered.
Crownandthemajorsareinthesameindustrybutareplayingbydifferent
rules.Byconcentratingonacarefullyselectedpartofthemarket,Crownhas
notonlyspecialized,ithasincreaseditsbargainingpowerwithrespecttoits
buyers.Thus,itcapturesalargerfractionofthevalueitcreates.Themajors,
bycontrast,havelargervolumesofbusinessbutcapturemuchlowerfractions
ofthevaluetheycreate.Thus,Crowncraftedacompetitiveadvantageinits
targetmarket.Itisn’tthebiggestcanmaker,butitmakesthemostmoney.
Thisparticularpattern—attackingasegmentofthemarketwithabusiness
systemsupplyingmorevaluetothatsegmentthantheotherplayerscan—is
calledfocus.Here,theword“focus”hastwomeanings.First,itdenotesthe
coordination of policies that produces extra power through their interacting
andoverlapping effects. Second,it denotesthe applicationof thatpower to
therighttarget.*
As the students discover Crown Cork & Seal’s focus strategy, there is a
senseofsurprise.Theinnerlogicisvisibleafterouranalysis,althoughitwas
notbeforehand. Thelogicof thisstrategywasnotvisible inthecompany’s
own self-description, nor in the pronouncements of Wall Street analysts. It
wasn’t a secret; it was just that it is hard work to fit the pieces together.
Virtually drowning in a twenty-four-hour barrage of superficial news and
commentary, the students are surprised that the real world can sometimes
have an inner logic that is not secret but that nevertheless remains
unremarked.
“Isitalwaysthisway?”astudentasksme.“Ifyoudothework,canyou
findtherealstrategiclogicofeverybusiness?”
“No,”Ireply,“notofeverybusiness.Ifthebusinessisreallysuccessful,
thenthereisusuallyagoodstrategiclogicbehindthatsuccess,beithiddenor
not. But the truth is that many companies, especially large complex
companies,don’treallyhavestrategies.Atthecore,strategyisaboutfocus,
and most complex organizations don’t focus their resources. Instead, they
pursuemultiplegoalsatonce,notconcentratingenoughresourcestoachieve
abreakthroughinanyofthem.”
CHAPTERELEVEN
GROWTH
In 1989, John Connelly, in poor health, stepped down from active
managementatCrownCork&Seal,appointinghislongtimeprotégé,William
Avery,asCEO.Oneyearlater,Connellydiedatageeighty-five.
Upon taking over the leadership of Crown, Avery immediately began a
program of growth through acquisition. Interviewed four years later, he
recalled,“WhenIbecamepresidentin1989,Ihadtolightafireandgetthe
company going again. The company’s growth had slowed down in the
1980s.”1ThefireAverylitwasfueledbypeoplewithexpertiseindealsand
acquisitions. The new team he assembled was led by acquisition specialist
Alan Rutherford, who moved from the Brussels office to become Crown’s
chieffinancialofficer.Inaddition,CraigCallemovedfrominvestmentbank
Salomon Brothers to become Crown’s treasurer, and Torsten Kreider left
investmentbankLehmanBrotherstorunplanningandanalysis.
During1990and1991,AverydoubledCrown’ssizewiththeacquisitionof
ContinentalCan’sdomesticandforeignbusinesses.In1992and1993,Crown
spent$615milliontobuyConstar,aleadingmakerofplasticcontainersfor
thesoftdrinkandbottledwaterindustries,andanother$180milliononVan
Dorn,amakerofplastic,metal,andcompositecontainers.Itpaid$62million
forTri-ValleyGrowers,atraditionalmakerofmetalfoodcans.
In 1995, Crown began an eighteen-month effort to acquire
CarnaudMetalBoxS.A.,thelargestmakerofplasticandmetalcontainersin
Europe. CarnaudMetalBox was the outcome of a difficult merger between
two-hundred-year-old Metal Box of the United Kingdom and Carnaud of
France. It was a leading can maker in both countries, with much of its
productionbeingtraditionalmetalfoodcans.
Commentingonthepurposeofthecombination,Averysaid,“Wewantto
growbiggerandgetabetteruseofourresources.Asthegloballeaderinthe
metal and plastic segments of the packaging industry … we will have a
worldwide foundation for continued international growth.”2Fewexecutives
have been so clear in stating that they want to grow in order to have a
platformforfurthergrowth.
By1997,Avery’steamhadcompletedtwentyacquisitionsandCrownhad
becomethelargestcontainermanufacturerintheworld.Averyhadpredicted
thatitssizewouldallowittogetbetterpricesfromsuppliersandthatCrown’s
traditionalskillatcostcontrolwouldletittrimexcessoverheadandcapacity
fromFrench-runCarnaudMetalBox.Noonementionedtheawkwardfactthat
Crown’straditionalcompetencehadbeenflexibilityandshortruns,notcost
control.
In 1998, troubles appeared. Crown’s foray into plastic containers had
paralleled the rapid growth in this business. The new blow-molded
polyethyleneterephthalate(PET)containersweretakingsignificantbusiness
away from traditional glass and metal containers in soft drinks and certain
foodscategories(forexample,ketchupandsaladdressing).Butthisgrowth
wasnotpoweredbyabasicincreaseinthedemandforcontainers.Rather,it
came from replacing metal and glass with plastic. Growth based upon
substitutionhasaclearceilingand,oncetheconversiontothesubstitutehas
taken place, the growth grinds to a sudden halt. This happened to Crown’s
PET business just as Crown became the world’s largest producer. And not
onlywereconversionsfrommetaltoplasticprettymuchcomplete,butunit
sales of PET containers actually started to shrink as large two-quart plastic
sodabottlesreplacedseveralsingle-drinkcontainers.
Toaddinsulttoinjury, whereasmanagement andanalysts hadhoped for
firmerpricesfromthemoreconsolidatedindustryofmetalcans,pricesbegan
to fall instead of rise, cutting profits dramatically. Several factors were to
blame.NocompetitorseemedwillingtocloseEuropeanplants,eachfacing
laborproblemsifaplantclosedandeachwantingtoincreaseitsmarketshare.
In addition, competition from cheaper PET containers was spilling over to
virtuallyeliminatethealreadyrazor-thinmarginsintraditionalmetalcans.All
ofthis—theslowdownofgrowth,theindustryovercapacity,andthespillover
of price competition from plastic back to metal cans—is basic industry
analysisandcouldhavebeeneasilypredictedbytheuseofthepopularFive
ForcesframeworkdevelopedbyMichaelPorter.3
Between 1998 and 2001, Crown’s stock price dropped catastrophically,
falling from $55 to $5 (see the chart below). In mid-2001, Avery retired,
replaced by John Conway, a longtime Crown employee with training in
economicsandlaw.Theeraofrapidexpansionbyacquisitionwasover,andit
was up to Conway to find some way to make the now gigantic Crown
profitable again. Whereas Avery’s mantra had been grow, Conway stressed
cost,quality,andtechnology.From2001throughtheendof2006,salesand
profitswereessentiallyflat,about$1billionindebtwasrepaid,andthevalue
of a share of common stock climbed gradually from $5 to $20, about $5
higher than it had been seventeen years earlier when the program of
expansionbegan.
Asquotedearlier,whenAverytookoveratCrownhecomplainedthat“the
company’sgrowthhadsloweddown.”Ithad.Duringthetenyears(1980–89)
beforeAverybecomeCEOatCrown,revenuesgrewatonly3.1percentper
year. However, it had nevertheless generated an annual average return to
shareholdersof18.5percent,enormouslymorethanthe8.6percentachieved
by the S&P 500 during the same period. During the seventeen years after
Connelly stepped down, from 1990 to 2006, the company grew rapidly,
becoming the “leading” container maker in the world. But an owner of
Crown’scommonstockreceivedareturnofonly2.4percentperyear,much
lower than the 9 percent provided by the S&P 500 Index. The chart below
shows how Crown’s rapid run-up in sales revenue was accompanied by a
dramatic fall in return on capital—the ratio of profit to investments.4 That
ratiowasarespectable15.3percentwhenAverytookover,butitfellalmost
immediatelytobelow10percent,thentobelow5percentaftertheacquisition
ofCarnaudMetalBox.
Crown’slongrecordofsuperiorperformanceunderConnelly’sleadership
hadresteduponitscarefullydesignedstrategythat,throughacoordinatedset
of policies, focused the company on products and buyers where the
customer’sbargainingpowerwaslessened.WhenAverytookoverleadership
ofCrown,hefoundthatthenewPETbottlesweremakingbiginroadsintothe
market for soft drink containers. Product changeover costs in plastics were
much lower than in metal containers, so the basis of Crown’s traditional
advantagewaseroding.Whattodo?
Averychose togrow thecorporation byacquisition withan emphasison
thePETbusiness,attractedbythegrowthinthatindustry.Theproblemwas
thatheleft thecompany’straditionalcompetitiveadvantage behindwithout
replacing it. Asked about a loss of focus, CFO Calle showed no concern,
interpretingfocusasmerelyarestrictionontheproductline:“It’scurrently
fashionable to focus, but we’ve always been there. We operate in a $300
billionindustryandserveonlythemetalandplasticportion,whichamounts
to$150–200billion.”5Hedidnotchoosetounderstandthedeepermeaningof
focus—aconcentrationandcoordinationofactionandresourcesthatcreates
anadvantage.Instead,heandCEOAveryweremesmerizedbytheprospects
ofexpansion.
TheproblemwithdivingintothegrowingPETindustrywasthatgrowthin
a commodity—such as cement or aluminum or PET containers—is an
industryphenomenon,drivenbyanincreaseinoveralldemand.Thegrowing
demand pulls up profit, which, in turn, induces firms to invest in new
capacity.Butmostof theprofitsofthegrowing competitorsarean illusion
becausetheyareplowedbackintonewplantandequipmentasthebusiness
grows.Ifhighprofitsontheseinvestmentscanbeearnedaftergrowthslows,
thenalliswell.Butinacommodityindustry,assoonasthegrowthindemand
slowsdown,theprofitsvanishforfirmswithoutcompetitiveadvantages.Like
somesortofeconomicblackhole,thegrowingcommodityindustryabsorbs
morecashfromtheordinarycompetitorthaniteverdisgorges.
Thepropositionthatgrowthitselfcreatesvalueissodeeplyentrenchedin
therhetoricofbusinessthatithasbecomeanarticleofalmostunquestioned
faith that growth is a good thing. CEO Avery’s description of his problem
(“Thecompany’sgrowthhadsloweddowninthe1980s”)andhisgoals(“We
wantto growbigger… aworldwide foundationforcontinued international
growth”) are little more than the repetition of the word “growth”—magical
invocationsofthenameoftheobjectofdesire.
Theproblemwithengineeringgrowthbyacquisitionisthatwhenyoubuya
company,especiallyapubliccompany,youusuallypaytoomuch.Youpaya
premium over its ordinary market value—usually about 25 percent—plus
fees.Ifyouhavefriendlyinvestmentbankersandlenders,youcangrowas
fast as you like by acquisition. But unless you can buy companies for less
thantheyareworth,orunlessyouarespeciallypositionedtoaddmorevalue
tothetargetthananyoneelsecan,novalueiscreatedbysuchexpansion.
Corporateleadersseekgrowthformanyreasons.Theymay(erroneously)
believe that administrative costs will fall with size. A poor, but common,
reasonforacquisitionsistomovekeyexecutivestotheperipheryratherthan
let them go. The leaders of larger firms tend to be paid more. And, in a
decentralized company, making acquisitions is a lot more fun than reading
reports on divisional performance. In addition to all these reasons, key
corporate advisers—investment bankers, consultants, mergers and
acquisitionslawfirms,andanyonewhocanclaima“finder’sfee”—canearn
aking’sransombybeing“helpful”inamajordeal.
In 1998, I was retained by Telecom Italia as a special consultant on
strategy. Telecom Italia was then the fifth largest fixed-line
telecommunications operator and Europe’s largest and most innovative
mobileoperator.Ithadbeenprivatizedinaseriesofstepsbeginningin1994
andendinginthesaleofpublicsharesin1997.
At that moment the strategic problems facing traditional fixed-line
European operators were considerable. Many still earned the juicy gross
margins typical of monopoly national carriers, but the future held the
possibility of dramatically increased competition and technological change.
Deregulation was allowing foreign entry into national markets, and the
Internet was blossoming. Companies such as Telecom Italia had large cash
flowsbasedonpastinvestments,andacriticalissuewaswheretoinvestthose
cashflows.Morefixedlinesseemedunwise.Opticalfiberringsaroundcities
looked promising, but three foreign firms already had plans for regional
centers like Milan. Competing against them would simply cannibalize
existingbusinessrevenue.TheInternetwasgrowingrapidly,butincomewas
small—its growth was based on very low prices, much lower than those
chargedforvoiceortraditionaldatatraffic.
ThechairmanandCEO,GianmarioRossignolo,hadbeentalkingaboutan
alliancewithCable&Wireless,acompanybeguninthenineteenthcenturyas
aproviderofunderseatelegraphlinksacrosstheBritishEmpire.Nationalized
in 1947, it had been reprivatized in 1981 by Margaret Thatcher. Cable &
Wireless CEO Richard Brown was an American, brought in to break an
internal political logjam that had kept the company operating like a set of
independentfiefdoms.Brownhadbeenseekingamajoralliance,firstflirting
withBritishTelecom,thenAT&T,thenSprint.The(fluffy)argumentwasthat
telecommunicationswasglobalizingandthattherewouldbevalueinaglobal
brand.
BrownandRossignolohadbeguntheiralliancediscussionswithtalkofa
seriesofcrossholdingsinFrance,theCaribbean,andotherlocations.Bylate
summer,theirinformalproposalhadescalatedintowhatwouldeffectivelybe
amergerofthetwocompanies,withRichardBrownemergingaschairman.
RossignolohadbeenslottedintohispositionasTelecomItalia’schiefby
the influential Agnelli family, which led the small group of “core”
shareholders. By early October 1998, however, some board members,
including Agnelli agents, had become disenchanted with him. They were
particularlyconcernedabouttheproposedmergerwithCable&Wireless.In
this context, I was asked to meet with Joseph Silver (not his real name), a
managing director of Morgan Stanley Dean Witter, which was the lead
investment banker involved in the deal. A board member told me, “Wall
Streethas the globalview ofthe industry.” My assignmentwas tofindout
MorganStanley’srationaleforthemerger.
JosephSilverandImetinaplainconferenceroominMilan.Istartedthe
discussionwithastraightforwardquestion.Inhisview,whatwastherationale
fortheproposeddeal?
“Economiesofscale,”hereplied.
“But these companies operate in totally different regions,” I responded.
“WherearetheeconomiesofscaleincombiningaCaribbeanoperatorwith
oneinItaly,orBrazil?”
“TelecomItalia,”hereplied,“needstomovetrafficfromSouthAmericato
Europe.Cable&Wirelesshascablesthatcanhandlethattraffic.”
This response surprised me. It was a flunking response to a standard
questionin anMBA coursemidterm exam.Youdon’t needto owna cattle
ranchtogetfertilizerforyourrosegardenandyoudon’tneeda$50billion
mergertomovecommunicationstraffic.Acontractwillsuffice.
“Itseemstome,”Isaid,“thatwecouldsimplywriteacontract,rightnow
as we sit here, to move some Telecom Italia traffic on certain Cable &
Wirelesscables.Wedon’tneedamajormergertodoit.”
“Well,professor,”hesaid,“theissueislargerthantraffic.Thefundamental
rationaleforthemergerisreally…economiesofmass.”
“Iamnotfamiliarwiththatterm.”
“What I mean by ‘economies of mass’ is that the two companies will,
together, be larger. The combined company will have much greater cash
flow.”
Again, I was surprised at his argument. Combining any two companies
sums their cash flows—that’s arithmetic. It is not an argument for why a
specificdealisworththeprice.
“Telecom Italia,” I said, “already has substantial cash flow. In fact, the
major reason its stock price is not higher is because analysts and investors
doubtthatthecompanyhasgoodusesforallthatcash.Forexample,Telecom
ItaliajustoverbidforanimportantlicenseinSouthAmerica.Therewasover
$1billionbetweenitsofferandthenexthighestbid.Cable&Wirelessisin
aboutthesameposition,generatingmorecashthanitcanwiselyinvest.Ijust
don’tseeany‘economiesofmass’incombiningthesecashflows.”
Joseph Silver closed his slim briefcase. He was clearly uninterested in
furtherdiscussion.Helookedat measifIwere achild, someonewhojust
didn’tunderstandthebigleagues.Hesaid,“Withmorecashflowyoucando
abiggerdeal.”Thenhelefttheroom.
Pressedtoexplainwhythedealmadesense,Silvercouldonlysuggestthat
it was a gateway to an even bigger deal. Morgan Stanley, of course, stood
readytocollectahealthyfee,skimmedfromthebillionsthatwouldflowin
thisdealandanylargerdealstofollow.Twodaysafterourmeeting,theboard
rejected the proposed merger and, in a stormy session, accepted Gianmario
Rossignolo’sresignation.
Healthygrowthisnotengineered.Itistheoutcomeofgrowingdemandfor
specialcapabilitiesorofexpandedorextendedcapabilities.Itistheoutcome
ofafirmhavingsuperiorproductsandskills.Itistherewardforsuccessful
innovation,cleverness,efficiency,andcreativity.Thiskindofgrowthisnot
justanindustryphenomenon.Itnormallyshowsupasagaininmarketshare
thatissimultaneouswithasuperiorrateofprofit.
CHAPTERTWELVE
USINGADVANTAGE
Two equally skillful chess players sit waiting for the game to begin—
which one has the advantage? Two identical armies meet on a featureless
plain—which one has the advantage? The answers to these questions is
“neither,” because advantage is rooted in differences—in the asymmetries
among rivals. In real rivalry, there are an uncountable number of
asymmetries.Itistheleader’sjobtoidentifywhichasymmetriesarecritical—
whichcanbeturnedintoimportantadvantages.
WRESTLINGTHEGORILLA
In 2000 I was working with a start-up company that had developed a new
microporousmaterialwherethesizeoftheporesadjustedwithtemperature.
Thehopewasthatclothingincorporatingthismaterialwouldshedrain,like
Gore-Tex, but would also be warmer in really cold conditions and cooler
whenitbecamehot.Asastart-up,thishadbeenthecompany’sonlyactivity
and the team was justly proud of their accomplishment. They were excited
about the possibility of taking their patented idea and developing a line of
textilesandoutdoorwear.Theyhadalreadypickedabrandnameandwere
negotiatingwithdesigners.
At the venture-capital firm that had backed the start-up, Susan had been
theirstrongestsupporterandsheknewthemostaboutboththeteamandits
technology. However, when the start-up team met with Susan to work out
third-roundfinancing,orevenaninitialpublicofferingofstock,shewasnot
enthusiastic.“Ithinkitwouldbesmarter,”shesaid,“totakeoursamplesand
work out license arrangements. Or even to sell the company outright to a
majortextilemanufacturer.”
Thestart-upteamfoughtback.TheCEOledthecharge,arguing,“Wehave
shownwhatwecando.Thisisarealopportunitytobuildagreatcompany.”
“You have done a fantastic job,” Susan replied. “You have created a
wonderful new technology. No one can deny your skills at development—
theyareworldclass.Butbuildingatextilecompany,oraclothingcompany,
isacompletelydifferentgame.”
Theairintheroomwastautwithfrustration.Susanmightberight,butthey
wantedtomoveforward.Hadn’ttheyprovedthemselves?
“Look,”Susansaid,“it’slikethis.YouhavewonanOlympicgoldmedalin
the1,500-meterrun.Youhaveagoodchanceatwinningthe10,000-meterrun
and I might back you at that. But you want to switch from running to
wrestlinggorillas.That’snotagoodideaandIcan’tbackyouatit.”
Susan’s powerful image helped sway the team. They wanted to move
ahead,buttheycertainlydidn’twanttowrestlethegorilla.
No one has an advantage at everything. Teams, organizations, and even
nations have advantages in certain kinds of rivalry under particular
conditions.Thesecrettousingadvantageisunderstandingthisparticularity.
Youmustpresswhereyouhaveadvantagesandside-stepsituationsinwhich
youdonot.Youmustexploityourrivals’weaknessesandavoidleadingwith
yourown.
After 9/11 the United States formulated an objective of destroying the
Afghanistan-basedalQaedaleadershipandtheTalibangovernmentthathad
protectedthem.Inmilitaryconflict,theUnitedStateshasenormousresources
andskillsthatenableittoquicklydeliverstupendousamountsofforce.The
UnitedStateshadaclearstrengthandusedittokillalQaedaoperativesand
drivetheTalibanfrompower.Top-levelleadersfailed,however,topressthis
advantageandallowedOsamabinLadentoescapefromhismountainhideout
inToraBoraintonorthwestPakistan.1
Nineyearsafter9/11,OsamabinLadenremainsuncaughtandtheUnited
Statesisinvolvedinacontinuinglow-intensitywarinAfghanistanagainstthe
Taliban.ThepresentstrategyoftheUnitedStatesinAfghanistanisbasedon
turningthepopulaceagainsttheTalibanandtowardthecentralgovernment.
ThisapproachhadtractioninIraqwherethepopulacewasaccustomedtoa
strongcentral government.By contrast,Afghanistan isa medievalwarlord-
basedsocietywhereloyaltyandpowerislocal.AfteryearsofU.S.support,
the Afghan central government remains corrupt and ineffective outside of
Kabul. Thus, the Taliban’s terror tactics against the population are brutally
effective because any protection against the Taliban can only be temporary
andgeographicallylimited.Evenmoreseriously,theTalibanisnotanarmy,it
has no uniform, and everyone in Afghanistan is both armed and probably
relatedtosomeoneintheTaliban.
Alloftheseobstaclescanbeovercomewithtimeandresources.Butboth
ordinarycitizensandtheTalibanknowthattheUnitedStateswillwithdraw.It
will withdraw for political reasons and because staying in Afghanistan is
stupendously expensive. The U.S. military, carefully designed to inflict
crushinghigh-intensityforce,spends$1millionperyeartoputeachsoldierin
Afghanistan.Youdon’twanttohavebeenatooloftheUnitedStateswhen
theseforcesaredrawndownandtheTalibanreturntopower.
InAfghanistan,theUnitedStatesis“wrestlingthegorilla”becauseithas
alloweditselftobedrawnintoaconflictinsupportofanalmostnonexistent
allyandwhereadvantagelieswiththesidewiththemostpatienceandwith
theleastsensitivitytocasualtiesandcollateraldamage.Inthissituation,the
Talibanhastheadvantageandisusingit.
COMPETITIVEADVANTAGEINBUSINESS
Theterm“competitiveadvantage”becameatermofartinbusinessstrategy
with Michael Porter’s 1984 insightful book of that title. Indeed, Warren
Buffett has said that he evaluates a company by looking for “sustainable
competitiveadvantage.”
The basic definition of competitive advantage is straightforward. If your
businesscanproduceatalowercostthancancompetitors,orifitcandeliver
more perceived value than can competitors, or a mix of the two, then you
have a competitive advantage. Subtlety arrives when you realize that costs
vary with product and application and that buyers differ in their locations,
knowledge, tastes, and other characteristics. Thus, most advantages will
extend only so far. For instance, Whole Foods has an advantage over
Albertsons supermarkets only for certain products and only among grocery
shopperswithgoodincomeswhoplaceahighvalueonorganicandnatural
foods.
Defining“sustainability”istrickier.Foranadvantagetobesustained,your
competitorsmustnotbeabletoduplicateit.Or,moreprecisely,theymustnot
be able to duplicate the resources underlying it. For that you must possess
whatIterman“isolatingmechanism,”suchasapatentgivingitsholderthe
legallyenforceablerighttomonopolizetheuseofatechnologyforatime.2
More complex forms of isolating mechanisms include reputations,
commercialandsocialrelationships,networkeffects,*dramaticeconomiesof
scale,andtacitknowledgeandskillgainedthroughexperience.
As an example, Apple’s iPhone business is protected by the Apple and
iPhone brand names, by the company’s reputation, by the complementary
iTunesservice,andbythenetworkeffectsofitscustomergroup,especially
withrespecttoiPhoneapplications.Eachoftheseresourceshasbeencrafted
by Apple executives and put in place as part of a program for building a
sustained competitive advantage. These resources are scarce in that
competitorsfinditdifficult,ifnotimpossible,tocreatecomparableresources
atareasonablecost.
ClaimsinadvertisingorsalespitchesthataparticularITsystemorproduct
or training program will provide a competitive advantage are misusing the
termsincean“advantage”onsaletoallcomersisacontradictioninterms.
“INTERESTING”ADVANTAGES
Stewart Resnick, the chairman of privately held Roll International
Corporation,andhiswife,Lynda,areserialentrepreneurs.Notonlyhavethey
established several very successful companies, they have also used their
wealth to support medical research, education, and the arts. Being able to
createsuccessfulstrategies, notjustonce butoverand overagain,is arare
skill.Anditisclearthattheirskillsarenotrootedinanyoneindustry—they
have been able to succeed in alarm services, flower delivery, collectibles,
agribusiness,andbottledwater.
As I drive to Roll’s headquarters in West Los Angeles, I review what I
knowabout theResnicks.Stewart’s fatherhad owneda barin New Jersey,
andStewart’sfirstbusinesswasajanitorialservicebasedonafriend’sfloor
scrubber.Thebusinessgrew,payinghiswaythroughlawschoolatUCLA.He
solditin1969forabout$2.5millionandinvestedinanalarmservicesfirm.
Lynda’sfirstbusinesswasanadvertisingagency,andwhenStewartsoldthe
alarmservicesfirm,theyworkedtogethertoacquireTeleflorain1979.
ForTeleflora,StewartandLyndacreatedtheconceptofflowersarrangedin
keepsakecontainers,anapproachthatdramaticallyincreasedprofitsforthem
and their florists. In 1985, they bought the Franklin Mint, a producer of
collectors’ coins. Lynda spearheaded the expansion into pop-culture
keepsakes,precisionmodelcars,andahostofotheritems.(TheResnickssold
theFranklinMintin2006.)
During the 1980s, the Resnicks began to invest in agribusiness: citrus
orchards,pistachioandalmondorchards,andpomegranates.Overtime,these
businesseshavebecometheirbiggestprofitmakers.Today,Rollisthelargest
citrusgrowerinCaliforniaandthelargestnutgrowerintheworld.Duringthe
2000s,Rollbeganmarketingpurepomegranatejuiceandjuiceproductsunder
the POM Wonderful brand. It acquired Fiji Water, a company that bottles
waterfromnativeaquifersinSuva,Fiji.AnditacquiredSuterra,anOregon
maker of pheromones that disrupt insect mating behavior, protecting crops
withouttheneedforinsecticides.Today,RollInternationalisoneofthetwo
hundredlargestprivatecompaniesinAmerica.
Roll’sheadquartersisanoasisofartandsculptureinanordinaryWestLos
Angelesofficedistrict.Stewartiscasual,soft-spoken,andself-confident.His
graspofthedetailsofeachofRoll’sbusinessesisunusualforthechairmanof
afirmofRoll’ssizeandcomplexity.
Stewart tells me that Teleflora had been competing on price when he
acquiredthebusiness.“Wechangedtoaservicemodel,”hesays,explaining
thatTelefloraprovidesfloristswiththelargestmembernetwork,anInternet-
basedITsystem, keepsake productsto hold andinclude with flowers,Web
hosting services, credit card processing services, and point-of-sale
technologies. “There is more competition now than ever,” he says, “but
Telefloraisamuchmoresuccessfulbusinessthanitwaswhenweboughtit.
Thenitwasone-tenththesizeofFTD;nowitistwiceaslarge.”
Iaskhimifthereisacommonlessonthatcanbetakenfrombusinessesas
disparateasTelefloraandFijiWater.Stewartopenshishandspalmsupand
tilts his head to the side, a gesture meaning “How can I explain?” After a
pause,hesays,“Byprovidingmorevalueyouavoidbeingacommodity.The
bottled water field is crowded, but Lynda saw something unique in this
product—waterfromadeepaquiferinFijithathasbeennaturallyfilteredfor
severalhundredyears.Waterthatfelltoearthbeforetheindustrialage,before
pollution and chemicals. It is a unique proposition that the original owners
hadnotexploited.”
Iunderstandaboutavoidingbeingacommodity.Yet,Rollhasbecomethe
largest citrus grower in California and the largest almond and pistachio
growerintheworld.Iask,“Aren’ttheseagriculturalproducts,bydefinition,
commodities?”
Stewart says that he began to buy agricultural land in 1978 as a passive
hedgeagainstinflation.Thebreakthroughcamewhenherealizedthatthese
businesseswereactuallyquite“interesting.”
“Interesting?”Iask.Ifhumanearscouldperkup,minewould.
After thinking for a moment, Stewart says, “To me, a business is
‘interesting’whenIcanseewaystoincreaseitsvalue.Thetypicalnutfarmer
can’tcontrolhisowndestiny.Hesimplyacceptswhatthetreesyieldandthe
market’sprices.
“A small nut farmer can’t afford the investments needed to develop the
marketordoresearchonyieldsordoefficientprocessing.Butwehadalarge
holding.Wewerelargeenoughtoearnbackthecostsofresearchonyields
andquality.AndIrealizedthatifwecouldstimulatethedemandforalmonds
andpistachios,thentherewouldbearealbenefit.Ofcourse,allCalifornianut
farmers would benefit from the increased demand, but we were the only
growerwiththesizetomaketheinvestmentworthwhile.Andithasworked.
Consumption keeps growing and exports are up. Our ‘Wonderful’ brand
commandsapricepremium.Almondsandpistachiosarehealthysnacks,and
thereisstillahugepotentialforexpansion.”
I suggest that stimulating the demand for nuts would provide only a
temporary benefit to Roll. Wouldn’t the advantage dissipate once other
growersincreasedtheirproductiontomatchthehigherdemand?
“Things don’t happen with lightning speed in agriculture,” Stewart
explains.“Ittakesseventotenyearsfornewlyplantedtreestomature.That
gaveustimetoinvestinplanting,branding,processing,andmerchandising.
Then, as demand grew, we aggressively built nut-processing capacity. The
scaleeconomiesinprocessingmakeithardforsmallerfarmerstobuildtheir
own processing facilities. And unless you can do processing, packaging,
marketing,branding,anddistribution,itmaynotpaytobuymorelandand
plantnewtrees.”
I could see that Stewart’s approach to the nut business was a complex
coordinatedmaneuveroveradecadeoftime.Hisoriginallarge-scaleholdings
enabled him to capture the lion’s share of benefits from investments in
research,marketdevelopment,advertising,andpromotion.Theseven-to-ten-
yearlagincompetitiveresponseprovidedboththefinancingandawindowof
opportunity to build large-scale nut-processing facilities. The economies of
scaleinprocessinghavesofarpreventedsmallercompetitorsfromachieving
equivalentcosts.
Itmusthavetakenironnervetowaityearsforthestrategytowork.“You
arestilllookingfivetotenyearsahead?”Iquery.
“It is one of the big benefits of being a private company. When I first
boughttheselandsfrommajoroilcompanies,theywerelookingaheadone
quarteroroneyear.Theywantedtogettheassets‘offtheirbooks’tomake
their financial ratios look better. We can do more with these businesses
becausewedon’tsufferthecrazypressuresthatareputonapubliccompany.”
SomeAdvantagesAreMore“Interesting”ThanOthers
When another person speaks you hear both less and more than they mean.
Lessbecausenoneofuscanexpressthefullextentofourunderstanding,and
more because what another says is constantly mixing and interacting with
your own knowledge and puzzlements. When Stewart Resnick explained
whatmadeabusiness“interesting”tohim,Imadeanunexpectedconnection
toaspectsoftheconceptofcompetitiveadvantagethatIhadbeenpuzzling
overforsometime.Ifeltsomethingclickintoplaceinmymind.Toexplain,I
haveto go backto 2002 whenmy UCLAcolleagueSteven Lippmanand I
createdathoughtexperimentaboutcompetitiveadvantage.
Our thought experiment* concerned an imaginary “silver machine” left
behindbyapassingUFO.Itcouldproduce$10millionperyearinrawsilver
at no cost—it used no inputs of energy, materials, or labor. There were no
taxesandtheconstantinterestratewas10percent.Theoriginalfinderofthe
silvermachinesoldittoanewownerfor$100million.Didthisnewowner,
weasked,haveacompetitiveadvantageinthesilverbusiness?
Thesilvermachineproblembecameanundergroundpuzzleinthestrategy
field. The silver machine was obviously a low-cost producer—zero cost is
aboutaslowasitgoes.Theconundrumwasthatthisadvantagedidnotmake
thenewowneranywealthier.Yes,themachinepaidout$10millionperyear,
butthatwasjustanordinary10percentreturnonwhathadbeenpaidtobuy
it. Its competitive advantage seemed to have evaporated because of the
change in ownership. Yet the machine continued to produce silver at zero
cost.3
Ittooksometime,butIcanunravelthepuzzle.Thesilvermachinedoes
have a competitive advantage in the silver business.4 The conundrum
disappears when you carefully distinguish between competitive advantage
andfinancialgain—manyhaveassumedthattheyarethesamething,butthey
arenot. But itwas StewartResnick who helpedme seeanothereven more
important fact about the silver machine—that its advantage, though real,
wasn’tinteresting.
The silver machine’s advantage gives it value, but the advantage isn’t
interestingbecausethereisnowayforanownertoengineeranincreaseinits
value. The machine cannot be made more efficient. Pure silver cannot be
differentiated. One small producer cannot pump up the global demand for
silver.Youcannomoreincreasethevalueofthesilvermachinethanyoucan,
byyourself,engineeranincreaseinthevalueofaTreasurybond.Therefore,
owningthisadvantageisnomoreinterestingthanowningabond.
For Stewart Resnick, and now for me, a competitive advantage is
interestingwhenonehasinsightsintowaystoincreaseitsvalue.Thatmeans
theremustbethingsyoucando,onyourown,toincreaseitsvalue.
Toseeanexampleofamajorcompetitiveadvantagethatis,presently,not
increasing in value, look at eBay. It should be obvious that eBay has a
considerable competitive advantage in the global person-to-person auction
business. eBay invented this business and remains by far the worldwide
dominantfirminit.Morespecifically,eBay’scompetitiveadvantageliesin
itsunrivaledabilitytooffertheleastexpensive,mosteffectivesolutiontojust
aboutanyonewhowishestobuyorsellapersonalitemonline.Itsbroaduser
base, easy-to-use software, the PayPal payment system, and its methods of
rating sellers all give it a considerable advantage over any competing
platform. Over the years, eBay has been very profitable. During the year
endinginDecember2009,thecompanyhadanoperatingcashflowof$2.9
billion,anafter-taxsalesmarginof26percent,andahealthyafter-taxreturn
onassetsof13percent.Yet,despiteitscompetitiveadvantage,thecompany’s
marketvaluehadbeenstagnantordeclining formorethan sevenyears.By
operating,eBaydefinitelyprovidesaservicewhosecostofprovisioniswell
belowthevalue placedonit bycustomers,and doesthisso efficiently that
others can not horn in on its core business. Nonetheless, it has not been
creatingnewwealthforitsowners.
Like the silver machine, eBay’s value has been static, indicating that its
competitive advantage has been static. However, eBay is a lot more
“interesting” than the silver machine. Although there are no ways (by
definition)toalterthesilvermachine’sadvantage,thereareamyriadofways
tochangeeBay’sservices,itsefficiency,andtheusestowhichitsresources
and skills are put. So, eBay’s advantage is potentially interesting. It will
become truly interesting when someone gains special insights into
unexploited ways to expand the value of eBay’s already considerable
competitiveadvantages.
VALUE-CREATINGCHANGES
Many strategy experts have equated competitive advantage with high
profitability. The example of eBay (and of the imaginary silver machine)
showsthatthisisnotnecessarilyso.Despitealltheemphasison“competitive
advantage” in the world of business strategy, you cannot expect to make
money—to get wealthier—by simply having, owning, buying, or selling a
competitiveadvantage.Thetruthisthattheconnectionbetweencompetitive
advantageandwealthisdynamic.Thatis,wealthincreaseswhencompetitive
advantage increases or when the demand for the resources underlying it
increases.Inparticular,increasingvaluerequiresastrategyforprogressonat
leastoneoffourdifferentfronts:
•deepeningadvantages,
•broadeningtheextentofadvantages,
•creatinghigherdemandforadvantagedproductsorservices,or
•strengtheningtheisolatingmechanismsthatblockeasyreplicationand
imitationbycompetitors.
DeepeningAdvantage
Startbydefiningadvantageintermsofsurplus—thegapbetweenbuyervalue
and cost. Deepening an advantage means widening this gap by either
increasingvaluetobuyers,reducingcosts,orboth.*
Itwouldbefoolishtoattempttosummarizethevastvarietyofmethodsand
approachesthatcanbeusedtomakeimprovementsincostand/orvalue.Itis
moreusefultohighlightthetwomainreasonsthisprocessstalls.
First,managementmaymistakenlybelievethatimprovementisa“natural”
process or that it can be accomplished by pressure or incentives alone. As
Frank Gilbreth pointed out in 1909, bricklayers had been laying bricks for
thousandsofyearswithessentiallynoimprovementintoolsandtechnique.5
By carefully studying the process, Gilbreth was able to more than double
productivity without increasing anyone’s workload. By moving the supply
palletsofbricksandmortartochestheight,hundredsorthousandsofseparate
lifting movements per day by each bricklayer were avoided. By using a
movablescaffold,skilledmasonsdidnothavetowastetimecarryingbricks
up ladders. By making sure that mortar was the right consistency, masons
couldsetandlevelabrickwithasimplepressofthehandinsteadofthetime-
honoredmultipletapswithatrowel.Gilbreth’slesson,stillfreshtoday,isthat
incentivesalonearenotenough.Onemustreexamineeachaspectofproduct
andprocess,casting asidethecomfortableassumption thateveryoneknows
whattheyaredoing.Today,thisapproachtoinformationflowsandbusiness
processes is sometimes called “reengineering” or “business-process
transformation.” Whatever it is called, the underlying principle is that
improvementscomefromreexaminingthedetailsofhowworkisdone,not
justfromcostcontrolsorincentives.
Thesameissues that arisein improving workprocesses also arise inthe
improvementofproducts,exceptthatobservingbuyersismoredifficultthan
examiningone’sownsystems.Companiesthatexcelatproductdevelopment
and improvement carefully study the attitudes, decisions, and feelings of
buyers. They develop a special empathy for customers and anticipate
problemsbeforetheyoccur.
Thesecondreasonfirmsmayfailtoengageinaprocessofimprovement
occurswhenisolatingmechanismssurroundingimportantmethodsareweak.
Companies in such situations sensibly hope to catch a free ride on the
improvements of others. To benefit from investments in improvement, the
improvements must either be protected or embedded in a business that is
sufficientlyspecialthatitsmethodsareoflittleusetorivals.
BroadeningtheExtentofAdvantage
Extendinganexistingcompetitiveadvantagebringsitintonewfieldsandnew
competitions. For example, cell phone banking is a growing phenomenon
outsideoftheUnitedStates,especiallyinthelessdevelopedcountries.eBay
holdssubstantialskillsinpaymentsystemsembeddedinitsPayPalbusiness.
IfeBaycouldbuildonthesetocreateacompetitiveadvantageincellphone
paymentsystems,itwouldbeextendingacompetitiveadvantage.
Extendingacompetitiveadvantagerequireslookingawayfrom products,
buyers,andcompetitorsandlookinginsteadatthespecialskillsandresources
that underlie a competitive advantage. In other words, “Build on your
strengths.”
The idea that some corporate resources can be put to good use in other
productsormarketsispossiblythemostbasicincorporatestrategy.6Itstruth
isundeniableyetitisalsothesourceofgreatmischief.Bemusedbytheidea
thattheircompany’scompetitivestrengthliesinvaporousgeneralitiessuchas
“transportation,”“brandedconsumerproducts,”or“management,”companies
maydiversifyintoproductsandprocessestheyknownothingabout.
Thebasisforproductiveextensionsoftenresideswithincomplexpoolsof
knowledge and know-how. For example, DuPont started as a specialist in
explosives.AfterWorldWarI,itsskillsatchemistryandchemicalproduction
ledDuPonttomanufacturecellulose,syntheticrubber,andpaints.Thework
in synthetics led to new skills in polymer chemistry, which, in turn, led to
Luciteand Teflon in1935. Furtherdevelopments in polymers led to nylon,
Mylar, Dacron, Lycra, and more. Similar patterns of accumulating and
extendingtechnologicalresourcescanbefoundinGeneralElectric,IBM,3M,
andmanypharmaceuticalandelectronicscompanies.
Extensions based on proprietary know-how benefit from the fact that
knowledgeisnot“usedup”whenitisapplied;itmayevenbeenhanced.By
contrast, extensions based on customer beliefs, such as brand names,
relationships, and reputation, may be diluted or damaged by careless
extension.Althoughgreatvaluecansometimesbecreatedbyextendingthese
resources,afailureinthenewarenacanreboundtodamagethecore.
Agoodexampleofthecaremanagementmusttakeinextendingitsbrands
and reputation is that of the Walt Disney Company. It has long enjoyed a
substantialcompetitiveadvantageintheentertainmentindustrybecauseofits
abilityandreputationinfamily-friendlyfare.Toappreciatethemagnitudeof
thisadvantage,notethatnootherfilmcompanyisabletopullviewerstoits
moviesbyitsbrandnamealone.Manykidsgoto(oraretakento)thenewest
Disneyfilmwithoutmuchregardtoitscontent.Bycontrast,noonegoestoa
moviebecauseitisaSonyPicturesStudiosproductorbecauseitwasmade
by Paramount. Those brands have some power in financial circles and in
distributionchannels,butnonewiththeconsumer.
A brand’s value comes from guaranteeing certain characteristics of the
product.Butthosecharacteristicsarenoteasytodefine.What,exactly,isa
“Disney” film? How far can the brand be stretched without losing value?
MarkZoradiispresidentoftheWaltDisneyMotionPicturesGroup(formerly
BuenaVistaMotionPicturesGroup), whichmarketsand distributesmotion
pictures under the Walt Disney, Touchstone, and Miramax imprints. It also
oversees the operations of the Disney and Pixar animation studios. In late
2008, Mark and I were discussing the Disney brand and strategies for
extendingit.Hetoldmethis:
ThemostvaluablethingwehaveistheDisneybrand.Severalyears
back,DickCook[thenchairmanofWaltDisneyStudios]gotusthinking
hardabouthowtobuildonthatstrengthwithoutdilutingit.Somepeople
think a Disney movie has to be suitable for very young children. But
theyforgetthatWaltmade20,000 Leagues Under the Sea,a film that
was probably much too scary for very young kids. We looked at the
wholelistofthemostsuccessfulfilmsinhistoryanddiscoveredthatwe
wouldhavebeenproudtoreleaseasurprisingnumberundertheDisney
name—filmslikeE.T.,Superman,andtheIndianaJonesmovies.
To keepthe faithandstill expandthe brandwecame upwith three
basicguidelines.Nobadlanguage.It’sOKforpeopletogetangryand
redintheface,butnocursing.Nouncomfortablesexualsituations.We
want romance but we will leave making dirty movies to others. No
gratuitousviolence.Weareallinfavorofswashbucklingadventurebut
therewillbenobeheadingsorspurtingblood.Itisthisbroaderviewthat
letus releasePirates of the Caribbean,National Treasure, and Prince
NarniaundertheDisneybrand.
MarkZoradi’sthreeguidelinesareintendedtohelpthecompanyextendthe
Disneybrandintotheincreasinglysuccessfulaction-adventuregenrewithout
damagingthebrand’svalueinitsmoretraditionalsector.
CreatingHigherDemand
Acompetitiveadvantagebecomesmorevaluablewhenthenumberofbuyers
grows and/or when the quantity demanded by each buyer increases.
Technically,itisthescarceresourcesunderlyingtheadvantagethatincrease
in value. Thus, more buyers for small airplanes will increase the value of
Embraer’s (Brazil) brand name and its specialized skills in design and
production.Notethathigherdemandwillincreaselong-termprofitsonlyifa
business already possesses scarce resources that create a stable competitive
advantage.
Becausesomanystrategytheoristshavemistakenlyequatedvalue-creating
strategywith“having”asustainablecompetitiveadvantage,theyhavelargely
ignoredtheprocessofengineeringincreasesindemand.Engineeringhigher
demand for the services of scarce resources is actually the most basic of
businessstratagems.
StewartandLyndaResnick’sPOMWonderfulpomegranatebusinessinan
exampleofactingcreativelytogeneratemoredemand.In1987,theybought
18,000 acres of nut orchards from Prudential Life Insurance. Among the
almond and pistachio trees were 120 acres of pomegranate bushes. “I first
wanted to replant this acreage with nut trees, but we decided to keep the
bushes,” Stewart recalled. “Our company reports split results by crop and,
afterafewyears,Inoticedthatwewereconsistentlymakingmoremoneyper
acrefromthepomegranatesthanfromthenuts.”
Inthe1990s,pomegranateswereaveryminorcropintheUnitedStates,
andAmericanswere largely unfamiliarwiththem.The fruithadits ancient
originsintheMiddleEast,andmanyassociateditwithlife-givingproperties.
In 1998, the Resnicks began to fund research on the properties of
pomegranates. The researchers reported that the juice contained even more
antioxidantsthanredwine.Furtherstudysuggestedthatthejuicemightlower
blood pressure and that its concentration of flavonoids might help prevent
prostatecancer.Since1998,theResnickshavedonatedmorethan$30million
toresearchintothefruit’shealthbenefits.
TheResnicksdevelopedastrategyofdramaticallyincreasingthenational
demand for pomegranates. Like their previous success in nuts, this would
createvalueiftheyownedasubstantialfractionofpomegranateproduction
andifnewcompetitiveproductiondidnotswiftlyappear.Toimplementthis
strategy, the Resnicks began to buy more acreage. By 1998, they had six
thousand acres committed to the future production of pomegranates—a
sixfoldincreaseinU.S.productivecapacity.
The company also began to study ways of packaging and marketing
pomegranatejuice.Thestandardindustryapproachwastodiluteanexpensive
strong-flavored juice with much larger quantities of blander white grape,
apple,and pearjuices.Thatwashow OceanSpray soldits cranberryjuice.
Lynda Resnick suggested a different concept. Their main pomegranate
offering would be 100 percent pure with no fillers. It would deliver 100
percentofthehealthbenefits.Itwouldnotbemarketedasasoftdrinkorkids’
sugar kick. Rather, it would be a new category—a fresh, refrigerated
antioxidantjuice,distributedbesidefreshproduce.Thebrandnamewouldbe
POM with the “O” shaped like a heart. The Resnicks decided to bet on
Lynda’sconcept.
POM’spresidentMattTupperrecentlyrecalledthatthemassiveplantings,
cresting in 2000–2001, created the threat of a “red tide” of unsold
pomegranate juice if the strategy of dramatically increasing demand didn’t
work. “It was daunting,” he said. “We had to go all out. Lynda worked
tirelesslytoshapetheconcept,thepackage,andthemarketingapproach.She
wrote, gave interviews, and introduced POM to every mover and shaker in
herhugenetworkofcontacts.Itworked.Demandsurged.By2004wewere
thedominantproducerinanewhotcategoryofproduct.And,evenbetter,it’s
goodforyou.”
StrengtheningIsolatingMechanisms
Anisolatingmechanisminhibitscompetitorsfromduplicatingyourproductor
theresourcesunderlyingyourcompetitiveadvantage.Ifyoucancreatenew
isolatingmechanisms,orstrengthenexistingones,youcanincreasethevalue
of the business. This increased value will flow from lessened imitative
competitionandaconsequentslowererosionofyourresourcevalues.
The most obvious approach to strengthening isolating mechanisms is
workingonstrongerpatents,brand-nameprotections,andcopyrights.Whena
newproductisdeveloped,itsprotectionmaybestrengthenedbystretchingan
already powerful brand name to cover it. When an isolating mechanism is
based on the collective know-how of groups, it may be strengthened by
reducing turnover. When protections are unclear, legislation or courtroom
verdictsmayclarifyandstrengthencertainpositions.
Anexampleofcollectiveactiontostrengthenpropertyrightsisthehistory
of the U.S. petroleum industry. As soon as oil was first pumped in
Pennsylvaniain1859,theissueofownershipcametothefore.Inthecaseofa
minerallikecoaltherulewasclear—apersonownedthecoalbeneaththeir
land.Butoil,thecourtsdecided,movedandflowedlikeawildbeast—noone
couldreallytellwhereaparticulardropofoilhadcomefrom.Applyingthe
age-old Anglo-Saxon “rule of capture,” oil legally belonged to whoever
pumpeditoutoftheground.
Becauseoilreservoirsextendbeyondpropertyboundaries,mostwellsare
drilledintowhatamountstobeingalargecommonreservoir.Sincetherule-
of-capturesaidthattheoilbelongedtowhoeverpumpedit,eachsuccessful
driller had to pump as fast as possible. If a well was not pumped, others
would empty the reservoir anyway. This created the forests of oil rigs and
fantasticratesofdevelopmentinearlyU.S.oilfieldswhereoverpumpingwas
the rule of the day. For example, soon after the great East Texas field was
discovered in 1930, there were forty-four separate wells pumping on one
squarecityblockinthetownofKilgore.Withineighteenmonths,thepriceof
oilhadfallenfromonedollarto13centsperbarrel,thefield’spressurehad
collapsed, and water was seeping into the reservoir. Many members of the
industrywantedsomewayofstoppingthe“armsrace,”butcourtsthrewout
planstocontrolproductionasillegalpricefixing.Inlate1931,thegovernor
ofTexasdeclaredmartiallawintheEastTexasfieldandusedtheNational
Guardtohaltproduction.
Eventually,overdecades,oilproducers,stategovernments,andthefederal
government struggled to work out the present rules for controlling oil field
productionandthesharingofrevenueamongpropertyowners.Thetaskwas
complicated because not all oil producers had the same interests or
information. In particular, larger holdings had better information about the
ultimatereservesinthefield.7Nevertheless,theobstacleswereovercome.In
this case, it took cooperative action to alter the legal isolating mechanisms
protectingeachdriller’sdiscoveries.
Anotherbroadapproachtostrengtheningisolatingmechanismsistohavea
movingtargetforimitators.Inastaticsetting,rivalswillsoonerorlaterfigure
out how to duplicate much of your proprietary know-how and other
specialized resources. However, if you can continually improve, or simply
alter, your methodsand products,rivals willhave amuchhardertimewith
imitation. Consider, for example, Microsoft’s Windows operating system.
Werethistoremainstableforalongperiodoftime,thereislittledoubtthat
cleverprogrammersaroundtheworldcould,overtime,createafunctionally
equivalentsubstitute.However,bycontinuallychangingtheprogram—even
if the changes are not improvements—Microsoft makes it very costly to
engineeracontinuingseriesoffunctionalequivalents.Windowsisamoving
target.
Along the same lines, continuing streams of innovations in methods and
products are more difficult to imitate when they are, themselves, based on
streamsofproprietaryknowledge.Forexample,acompanythatinnovatesby
using scientific knowledge will have, in general, weaker isolating
mechanismsthanonethatcombinessciencewithinformationfedbackfrom
lead customers or proprietary information gleaned from its own internal
operations.
CHAPTERTHIRTEEN
USINGDYNAMICS
In classical military strategy the defender prefers the high ground. It is
hardertoattackandeasier todefend.Thehigh groundconstitutesanatural
asymmetrythatcanformthebasisofanadvantage.
Much of academic strategy theory concerns more and more intricate
explanationsforwhycertaintypesofeconomichighgroundarevaluable.But
suchdiscussionssidestepanevenmoreimportantquestion:howdoyouattain
such an advantaged position in the first place? The problem is that, as
valuableassuchpositionsare, thecostsofcapturingthem areevenhigher.
Andaneasy-to-capturepositionwillfalljustaseasilytothenextattacker.
Onewayto find freshundefended high ground isby creating ityourself
throughpureinnovation.Dramatictechnicalinventions,suchasGore-Tex,or
business model innovations, such as FedEx’s overnight delivery system,
createnewhighgroundthatmaylastforyearsbeforecompetitorsappearat
theramparts.
Theotherwaytograbthehighground—thewaythatismyfocushere—is
toexploitawaveofchange.Suchwavesofchangearelargelyexogenous—
theyaremostlybeyondthecontrolofanyoneorganization.Noonepersonor
organization creates these changes. They are the net result of a myriad of
shifts and advances in technology, cost, competition, politics, and buyer
perceptions.Importantwavesofchangearelikeanearthquake,creatingnew
highgroundandlevelingwhathadbeenhighground.Suchchangescanupset
the existing structures of competitive positions, erasing old advantages and
enablingnewones.Theycanunleashforcesthatmaystrengthenorradically
weakenexistingleaders.Theycanenablewhollynewstrategies.
Anexogenouswaveofchangeislikethewindinaracingboat’ssails.It
provides raw, sometimes turbulent, power. A leader’s job is to provide the
insight,skill,andinventivenessthatcanharnessthatpowertoapurpose.You
exploit a wave of change by understanding the likely evolution of the
landscapeandthenchannelingresourcesandinnovationtowardpositionsthat
willbecomehighground—becomevaluableanddefensible—asthedynamics
playout.
To begin to see a wave of change it helps to have some perspective.
Business buzz speak constantly reminds us that the rate of change is
increasingandthatweliveinanageofcontinualrevolution.Stability,oneis
told,isanoutmodedconcept,therelicofabygoneera.Noneofthisistrue.
Mostindustries,mostofthetime,arefairlystable.Ofcourse,thereisalways
change, but believing that today’s changes are huge, dwarfing those in the
past,reflectsanignoranceofhistory.
Forexample,comparethechangesduringyourlifetothosethatoccurred
during the fifty years between 1875 and 1925. During those fifty years,
electricityfirstlitthenightandrevolutionizedfactoriesandhomes.In1880,
the trip from Boston to Cambridge and back was a full day’s journey on
horseback.Onlyfiveyearslater,thesametripwasatwenty-minuterideonan
electricstreetcar;withthestreetcarcamecommutingandcommutersuburbs.
Insteadofrelyingonasinglegiantsteamengineorwaterwheeltopowera
factory,producersswitchedtoelectricmotorstobringpowerintoeverynook
andcranny.Thesewingmachineputdecentclothingwithineveryone’sreach.
And electricity powered the telegraph, the telephone, and then the radio,
triggering the first significant acceleration in communications since the
Roman roads. During that fifty-year period, railroads knit the country
together. The automobile came into common use and revolutionized
Americanlife.Theairplanewasinventedandcommercialized.Modernpaved
highwayswerebuiltandagriculturewasmechanized.IBM’sfirstautomatic
tabulating machine was developed in 1906. A huge wave of immigration
changed the face of cities. Modern patterns of advertising, retailing, and
consumer branding were developed—hundreds of famous brands, such as
Kellogg’s,Hershey’s,Kodak,Coca-Cola,GeneralElectric,Ford,andHunt’s,
date from this era. Most of the foundations of what we now see as the
“modernworld”wereputinplace,andgreatstill-standingindustrialempires
wereestablished.Allofthistookplaceinthefiftyyearsbetween1875and
1925.
Now,lookatanother,moremodern,periodoffiftyyears.SinceIwasborn
in1942,televisionhasreshapedAmericanculture,jetairtravelhasopened
theworldtoordinarypeople,thefallingcostsoflong-distancetransporthave
generatedarisingtideofglobaltrade,retailstoresthesizeoffootballfields
now dot the landscape, computers and cell phones are ubiquitous, and the
Internet has made it possible to work, seek out entertainment, and shop
without leaving home. Millions can instantly tweet about their evanescent
likes and dislikes. Yet, all in all, the last fifty years’ changes have had a
smaller impact on everyday life and the conduct of business than did the
momentouschangesthatoccurredfrom1875to1925.Historicalperspective
helpsyoumakejudgmentsaboutimportanceandsignificance.
Afterawaveofchangehaspassed,itiseasytomarkitseffects,butbythen
itistoolatetotakeadvantageofitssurgeortoescapeitsscour.Therefore,
seek to perceive and deal with a wave of change in its early stages of
development.Thechallengeisnotforecastingbutunderstandingthepastand
present.Outofthemyriadshiftsandadjustmentsthatoccureachyear,some
arecluestothepresenceofasubstantialwaveofchangeand,onceassembled
intoapattern,pointtothefundamentalforcesatwork.Theevidenceliesin
plainsight,waitingforyoutoreaditsdeepermeanings.
Whenchangeoccurs,mostpeoplefocusonthemaineffects—thespurtsin
growthofnewtypesofproductsandthefallingdemandforothers.Youmust
digbeneaththissurfacerealitytounderstandtheforcesunderlyingthemain
effect and develop a point of view about the second-order and derivative
changes that have been set into motion. For example, when television
appearedinthe1950sitwasclearthateveryonewouldeventuallyhaveone
andthat“free”TVentertainmentwouldprovidestrongcompetitiontomotion
pictures. A more subtle effect arose because the movie industry could no
longer lure audiences out of their homes with “just another Western.”
Traditional Hollywood studios had been specialized around producing a
steadystreamofB-grademoviesanddidnoteasilyadapt.Bytheearly1960s,
movieattendancewasshrinkingrapidly.WhatrevivedHollywoodfilmwasa
shift to independent production, with studios acting as financiers and
distributors.Independentproducers,freedfromthenepotismandroutinesof
thetraditionalstudio,couldfocusonassemblingahandpickedteamtomakea
filmthatmightbegoodenoughtopullanaudienceoffoftheirfamily-room
sofas.Thus, a second-ordereffectof television wasthe rise ofindependent
filmproduction.
SENSINGTHEWAVE’SSWELL
It is a wet winter day in 1996 and I have driven from my office in
Fontainebleau to Paris in order to meet with executives of Matra
Communications.Severalyearsearlier,the Frenchgovernmenthadsoldoff
its controlling interest in the Matra Group, a large high-tech military,
aerospace, electronics, and telecommunications equipment firm. Canada-
based Northern Telecom had bought a 39 percent stake in Matra
Communications,thecompany’stelecommunicationsequipmentsubsidiary.
Jean-Bernard Lévy, the chairman and CEO of Matra Communications,
welcomes me into his office. At forty he is young for his position by
Americanstandards.ButtheFrenchsystemisdifferent.Anyonewhoisvery
smartandverygoodinmathgetsafreeworld-classeducationatoneofthe
Grand Écoles and is virtually guaranteed a fast track in government or
industry. Lévy has served in government and France Telecom, and was
generalmanagerofMatra’ssatellitebusinessforseveralyears.By2002,he
hadbecomeCEOofVivendi,themediaconglomeratecontrollingUniversal
MusicGroup,Canal+,ActivisionBlizzard,andotherbusinesses,andby2005
hebecamechairmanofVivendi’smanagementboard.
Lévy,hischieffinancialofficer,andIdiscussthechallengesfacingMatra
Communications in the rapidly changing world of telecommunications. He
explains that “the telecommunications business has been, along with
mainframecomputing,anindustryinwhicheconomiesofscale—ataglobal
level—have been determinative. If a company doesn’t have a significant
marketpresence in atleast twolegs of thetriad [Japan,Europe,and North
America],thenitstrugglesalongasanicheplayer,offeringveryspecialized
equipment.” Then, with a wry smile, he adds, “Or it depends upon the
government forcing the local telephone monopoly to buy from the local
supplier.”
“Thatseems,”Isay,“toputMatrainadifficultposition.Matraisnotone
ofthetoptentelecommunicationsequipmentmakersintheworld.”
“No,itisnot,”hesays.“Buttherearebigchangesafoot.Cellulartelephony
willshakeuptheindustry.Europeanderegulationwillchangetherulesofthe
game.AndtheInternetwillblurthelinesbetweencommunications,data,and
entertainment.”
“So,networkandcellularequipmentarethekeyopportunities?”
“Thosearetheimmediatechanges.Morearecoming.”
Changecanmeanopportunity.Yetrecentchangeshavenotbeenespecially
goodforMatra.Iaskapointedquestion.“Iamtryingtounderstandtheforces
that are changing the structure of the industry. For instance, look at the
amazing success of Cisco Systems. It sits right on the interface between
telecommunicationsandcomputing—apositionthateveryonethoughtwould
bethebigbattlegroundbetweenAT&TandIBM.Andyet,insteadofabattle
oftitanswehavethisupstartgrabbingthebusiness.
“As you said, the critical barrier to becoming a major player in
telecommunications equipment and computing has been scale,” I continue.
“Yet, Cisco Systems, started by two university staff members, has broken
rightthroughthescale‘barrier.’Ithasgrabbedtheinternetworkingequipment
market right out from under the nose of giants like IBM, AT&T, Alcatel,
NEC,andSiemens.AndMatra.Howhasthathappened?”
TheCFOarguesthatCiscoofferedstockoptionincentivesthatwereoutof
reachoflarger,moreestablishedfirms.ThatenabledCiscotoattractthetop
technicaltalentintheworld.
Jean-BernardLévyshakeshishead.Hehasadifferentslantontheissue.
“WehavehadMatraengineersworkingoninter-networkingequipment.The
basic principles are well understood. Yet we cannot seem to replicate the
performanceofCisco’smulti-protocolnetworkrouters.”
“Aretherekeypatents?”Iask.
“Therearepatents,buttheyaren’tthecrucialthing,”hereplies.“Theheart
oftheCiscorouterisfirmware—softwareburnedintoread-onlymemoryor
implemented in programmable arrays. Cisco’s product embodies, perhaps,
one hundred thousand lines of code that is very skillfully written. It was
createdbyaverysmallteam—maybetwotofivepeople.Thatchunkofvery
clevercodegivestheproductitsedge.”
Laterthatevening,backinmyoffice,Itranscribedmyinterviewnotesand
reflectedonwhat Ihadbeentold.A router, Iknew, wasreallyjust asmall
computer—it used microprocessors, memory, and input-output ports to
managetheflowofdataoveradigitalnetwork.Itsperformancehadlittleto
dowiththespecificmicroprocessors,memory,andlogicchipsinsideit.After
all,everyoneintheindustryhadaccesstosimilarchips.ThepartoftheCisco
routerthatissohardtoduplicatewasthesoftware.Well…no,itwastheskill
embodiedinthesoftwarethatwassohardtoduplicate.
ThenIsawit.IhadbeentalkingaboutCiscoasifitwereasingleexample
ofskillcounteringscale.ButtheforcesCiscohadharnessedtoitsadvantage
weremuchdeeperthantheskillsofanyonecompany,muchbroaderthanany
oneindustry.
In the computing and telecommunications equipment sectors, economic
successhadtraditionallybeenbasedoncapabilitiesatcoordinatinghordesof
engineersinvast billion-dollardevelopmentprojectsand inmanaginglarge
workforces in the manufacture of complex electronic equipment. That had
beenthebasisofthepowerofIBMandAT&Tandhadbeencentraltothe
engineering-intensivesuccessofJapan.Butnow,in1996,thebasisofsuccess
inmanyareaswasshiftingtosoftware—totheclevernessofchunksofcode
writtenbysmallteams.Itwasashiftfromeconomiesofsizetotheknow-how
and skill of single individuals. It was as if military competition suddenly
shiftedfromlargearmiestosinglecombat.Achillmovedupanddownmy
spine.Therewastheunnervingsenseofhiddensubterraneanforcesatwork,
twistingthelandscape.
Threeyearsearlier,IhadlivedandworkedinTokyoforseveralmonths.
Then, the conviction that Japan would be the economic superpower of the
twenty-firstcenturyhadbeenaliveandwell.Butnowthelocusofinnovation
had shifted to the small-team entrepreneurial culture of Silicon Valley. My
mind’seyesawthiswaveofchangespreadingtoaffectmachinetools,bread
makers,furnaces,toasters,andevenautomobiles.Theforcesatworkwerenot
onlyalteringthefortunesofcompanies,theywereshiftingtheverywealthof
nations.
DISCERNINGTHEFUNDAMENTALS
Thework ofdiscerningwhether thereareimportantchangesafoot involves
gettingintothegrittydetails.Tomakegoodbetsonhowawaveofchange
willplayoutyoumustacquireenoughexpertisetoquestiontheexperts.As
changes begin to occur, the air will be full of comments about what is
happening,butyoumustbeabletodigbeneaththatsurfaceanddiscoverthe
fundamental forces at work. Leaders who stay “above the details” may do
wellinstabletimes,butridingawaveofchangerequiresanintimatefeelfor
itsoriginsanddynamics.
For many years, telecommunications had been one of the most stable
industries.Butin1996,whenJean-BernardLévyandIwerediscussingCisco
Systems, the structure of the computing and communications industry had
suddenly become fluid and turbulent. Of the visible trends, the rise of
personal computing and data networking were on everyone’s radar. The
deregulation of telecommunications and its shift to digital technology had
been long anticipated. The two more mysterious shifts were the rise of
softwareasasourceofcompetitiveadvantageandthedeconstructionofthe
traditionalcomputerindustry.
Itseemsobviousinhindsight.Boththeriseofsoftware’simportanceand
the computer industry’s deconstruction had a common cause: the
microprocessor. Yet these connections were far from obvious in the
beginning. Everyone in high tech could see the microprocessor, but
understandingitsimplicationswasamuchmoredifficultproposition.Letme
sharewithyouapersonalviewofsomeofthestepsalongthatpath.
Software’sAdvantage
Howhadsoftwarebecomesuchasharpsourceofadvantage?Theansweris
that millions of microprocessors, in everything from PCs to thermostats,
breadmachinestocruisemissiles,meantthattheirprogrammingdetermined
theperformanceofthesedevices.
WhenIwasanundergraduatestudyingatUCBerkeleyin1963,twoofthe
mainareasofexcitementwithinelectricalengineeringwereintegratedcircuits
andcomputing.Thefirstintegratedcircuitshadbeendemonstratedin1958,
and devices created for the Minuteman missile project had integrated
hundreds of transistors onto a single chip. With regard to computing, there
was nothing mysterious about making a computer’s central processor—the
circuitpatternshadbeencommonknowledgesincethe1950s.
All of my Berkeley classmates understood that if one could push
integrationfromhundredsoftransistorstothousandsoftransistorsonasingle
chip, it would be possible to have a one-chip computer processor. Silicon
Valleyhistoriansandpatentattorneyslovetoargueoverwho“invented”the
first microprocessor, but the idea of putting all the components of a
processing unit onto one chip was in the air as soon as integrated circuits
appeared.Inanyevent,thefirstmicroprocessorofferedforsalewasIntel’s4-
bit4004in1971,containing2,300transistors.
Atthattime,thechipmarkethadtwosegments.Standardizedchipssuchas
logic gates and memory were produced in high volume but were
commodities.Specializedproprietarychipsorchipsetsprovidedmuchhigher
marginsbutwereonlyproducedtoorderinlowvolumes.Andtherightstoa
complexproprietary chip belongedto the customerwho had orderedit and
sometimesdesignedit.
Significantly,andoftensadly,manycrucialdecisionsdonotappeartobe
decisions at the time. Instead, managers simply apply standard operating
procedures to the situation. Within Intel, the 4004 microprocessor was
classifiedasaspecializedproprietarydesign,sotherightstoitbelongedto
customerBusicom,whichintendedtobuilditintoitslineofcalculators.As
luckwouldhaveit,BusicomcameunderprofitpressureandaskedIntelfora
pricereduction.Intelloweredthepriceinreturnfortherighttosellthechip
to others. Then, amazingly, this pattern was repeated with Intel’s next
microprocessor, the 8-bit 8008. This microprocessor had been created as a
proprietary chip for CTC, the maker of Datapoint computer terminals.
Running out of money, CTC traded the rights to the 8008’s design for the
chipsitneeded.Inthiscase,CTChadactuallydesignedthechip’sinstruction
set—youcanstillseeechoesofthatinstructionsetinIntel’smostadvanced
x86processors.
IttookyearsforIntel’smanagement,andtherestoftheindustry,tofully
appreciatetheimplicationsofageneral-purposechipthatcouldbespecialized
with software. Instead of each customer paying to develop a specialized
proprietarychip, many coulduse thesamegeneral-purpose microprocessor,
creatingproprietarybehaviorwithsoftware.Thus,themicroprocessorcould
beproducedinhighvolume.Insteadofbeingajobshopforothercompanies’
designs,Intelcouldbeaproduct-basedtechnologycompany.Speakingabout
the4004,andmicroprocessorsingeneral,thenchairmanAndyGrovesaid,“I
thinkitgaveIntelitsfuture,andforthefirstfifteenyearswedidn’trealizeit.
IthasbecomeIntel’sdefiningbusiness area.But for…maybethefirstten
years,welookedatitasasideshow.”1
IntelcofounderGordonMoorebecamefamousforhis“law”predictingthe
rateof progressin speedand manufacturingcosts inintegratedcircuits.He
wasless wellknown for hisobservation thatdesign costsfor customchips
were becoming larger than fabrication costs and were escalating at an
unsupportablerate.Hewrote,“Twothingsbrokethecrisisforsemiconductor
component manufacturers … the development of the calculator
[microprocessor] and the advent of semiconductor memory devices.” To
Moore,thebeautyofthesedeviceswasthat,althoughcomplex,theycouldbe
soldinhighvolumes.
InadiscussionwithagroupofmanagersatQualcomm,aSanDiegomaker
ofmobilephonechips,IreviewedMoore’spointabouttheescalatingcostsof
designingmoreandmorecomplexspecial-purposechips.Onemanagerwas
puzzledandaskedifitwasn’talsoexpensivetocreatesoftware.Hewenton
to rhetorically ask “Are software engineers less expensive than hardware
engineers?”
Itwasagoodquestion.Noneofushadaninstantanswer.Isharpenedthe
questionwithanexamplefrommyownexperience.Rolls-Roycehadwanted
to create a sophisticated fuel monitoring and control unit to enhance the
efficiency of its jet engines. It could have accomplished this through
proprietaryhardwareembodyingthenecessarylogic,oritcouldhaveuseda
general-purpose microprocessor, expressing its proprietary ideas by writing
software to program it. Whether it chose to use a microprocessor plus
software or proprietary hardware chips, it would have had to do a lot of
engineeringworkforonlyafewthousandinstallations.Whyprefersoftware?
Asisoftenthecase,restatingageneralquestioninspecifictermshelped.
We quickly developed an answer that has since stood up to scrutiny by a
numberofothertechnicalgroups:Goodhardwareandsoftwareengineersare
bothexpensive.Thebigdifferenceliesinthecostofprototyping,upgrading,
and,especially,thecostoffixingamistake.Designalwaysinvolvesacertain
amountoftrialanderror,andhardwaretrialsanderrorsaremuchmorecostly.
Ifahardwaredesigndoesn’tworkcorrectly,itcanmeanmonthsofexpensive
redesign.Ifsoftwaredoesn’twork,asoftwareengineerfixestheproblemby
typing new instructions into a file, recompiling, and trying again in a few
minutesorafewdays.Andsoftwarecanbequicklyfixedandupgradedeven
aftertheproducthasshipped.
Thus, software’s advantage comes from the rapidity of the software
developmentcycle—theprocessofmovingfromconcepttoprototypeandthe
process of finding and correcting errors. If engineers never made mistakes,
thecostsofachievingacomplexdesigninhardwareandsoftwaremightbe
comparable. But given that they do make mistakes, software became the
much-preferredmedium(unlessthecutting-edgespeedofpurehardwarewas
required).
WHYCOMPUTINGDECONSTRUCTED
In1996,soonaftermyconversation withJean-BernardLévyinParis,Intel
chairman Andy Grove published his insightful book Only the Paranoid
Survive. Grove drew on his expertise in both business and technology to
forcefully describe how “inflection points” can disrupt whole industries. In
particular, he described the “inflection” that had transformed the computer
industryfroma“vertical”toa“horizontal”structure.
Intheoldverticalstructure,eachcomputermakermadeitsownprocessors,
memory, hard drives, keyboards, and monitors, and each wrote its own
systems and applications software. The buyer signed up with a maker and
bought everything from that manufacturer. You couldn’t plug an HP disk
driveintoaDECcomputer.Bycontrast,inthenewhorizontalstructure,each
of those activities had become an industry in its own right. Intel made
processors, other firms made memory, others made hard drives, Microsoft
madesystemssoftware,andsoon.Computerswereassembledbymixingand
matchingpartsfromcompetingmanufacturers.
Grove was dead-on in understanding that “not only had the basis of
computing changed, the basis of competition had changed too.”2 Still, as a
strategist, I wanted to know more. Why had the computer industry
deconstructed itself and become horizontal? Andy Grove wrote, “Even in
retrospect, I can’t put my finger on exactly where the inflection point took
placeinthecomputerindustry.Wasitintheearlyeighties,whenPCsstarted
toemerge?Wasitinthesecondhalfofthedecade,whennetworksbasedon
PCtechnologystartedtogrowinnumber?It’shardtosay.”3
I was puzzled over the cause of the computer industry’s deconstruction.
Then, about a year later, the reason snapped into focus. I was interviewing
technicalmanagersataclientfirmandonesaidthathehadformerlybeena
systemsengineeratIBM.Hethenexplainedthathehadlostthatjobbecause
modern computers didn’t need much systems engineering. “Why not?” I
askedwithoutthinking.
“Becausenowtheindividualcomponentsareallsmart,”heanswered.Then
Isawit.
TheoriginofAndyGrove’sinflectionpointwasIntel’sownproduct—the
microprocessor.Themodularizationofthecomputerindustrycameaboutas
eachmajorcomponentwasabletocontainitsownmicroprocessor—eachpart
became“smart.”
Inmanytraditionalcomputers,andearlypersonal computers,theCPU—
theactiveheartofthemachine—didalmosteverythingitself.Itscannedthe
keyboard,lookingforakeystroke.Whenitsensedone,itanalyzedtherow
and column of the keystroke on the keyboard to determine the letter or
number that had been pressed. To read a tape drive, the CPU constantly
controlledthespeedofthetapereelsandthetensionofthetape,stoppingand
startingthedriveasitinterpretedthedatacominginandstoringitinmemory.
Totypewritewitha“daisy-wheel”printer,theCPUcontrolledthespinofthe
wheel and the timing of each separate hammer strike. In some cases,
designers created custom mini-CPUs to manage these peripherals, but the
integration among these devices remained complex and unstandardized and
consumedagreatdealofsystemsengineeringeffort.
Afterthearrivalofcheap microprocessors,allthat changed.The modern
keyboardhasasmallmicroprocessorbuiltintoit.Itknowswhenakeyhas
beenhitandsendsasimplestandardizedmessagetothecomputersaying,in
effect,“TheletterXwaspressed.”Thehard-diskdriveisalsosmartsothat
theCPUdoesn’tneedtoknowhowitworks.Itsimplysendsamessagetothe
harddisksaying“Getsector2032,”andthehard-disksubsystemreturnsthe
data in that sector, all in one slug. In addition, separate microprocessors
control the video screens, memory, graphics processors, tape drives, USB
ports,modems,Ethernetports,gamecontrollers,tape drives,backuppower
supplies, printers, scanners, and mouse controllers that make up modern
computers.
Smartcomponents operating withinade facto standardoperating system
meantthatthejobofsystemsintegrationbecamealmosttriviallysimple.The
skills at systems integration that IBM and DEC had built up over decades
werenolongerneeded.Thatwaswhymyengineer-informanthadlosthisjob.
Withtheglueofproprietary systemsengineering nolongersoimportant,
theindustrydeconstructeditself.Modulesdidnothavetobecustomdesigned
towork with everyother part.Toget a workingsystem, customersdid not
have to buy everything from a single supplier. Specialist firms began to
appear that made and sold only memory. Others made and sold only hard
drives or keyboards or displays. Still others made and sold video cards or
gamecontrollersorotherdevices.
Today, there are many academic researchers who look at the computer
industryandseeanetworkofrelationships,eachoneachannelwherebyone
firm coordinates with another. The idea of a network especially enchants
modern reductionist sociologists who count connections among people,
skippingovertheold-fashionedhard-to-quantifyquestionsaboutcontentand
meaning.However,dwellingonthisnetworkofweakrelationshipsconfuses
thebackgroundwiththeabsentforeground.Whatisactuallysurprisingabout
the modern computer industry is not the network of relationships but the
absenceofthemassivelyintegratedfirmdoingallthesystemsengineering—
allofthecoordination—internally.Thecurrentwebof“relationships”isthe
ghostlyremnantoftheoldIBM’snerve,muscle,andbone.
CISCOSYSTEMSRIDESTHEWAVE
AsImentionedtoJean-BernardLévythatdayin1996,CiscoSystemswasa
recentstart-upthathad“grabbedtheinter-networkingequipmentmarketright
outfromunderthenose”ofindustrygiants.ThestoryofhowCiscoSystems
cameintobeingandhowitcametobeatthegiantsvividlydemonstratesthe
power of using waves of change to advantage. The particular waves Cisco
usedweretheriseofsoftwareasacriticalskill,thegrowthincorporatedata
networking,theshifttoIPnetworks,andtheexplosionofthepublicInternet.
In the early 1980s, Ralph Gorin, the director of Stanford University’s
computerfacilities,wantedaway ofhookingtogetherseparatenetworks of
Apple, Alto, and DEC computers as well as various printers. Each type of
computer network used different kinds of wires, plugs, timing, and, most
important, different proprietary protocols for encoding information. Gorin’s
request was for a way to interconnect these proprietary networks. The
solution,calledthebluebox,wasengineeredbyStanfordstaffmembersAndy
BechtolsheimandWilliamYeager.4
TwootherStanfordstaffmembers,LenBosackandSandyLerner,beganto
refine the blue box, moving the improved designs into their newly formed
company,CiscoSystems.AfteranacrimonioussplitwithStanfordin1987,
Cisco Systems received full legal rights to the software in return for a
payment to Stanford of $167,000 and the promise of discounts on Cisco
products.ItwasthoughtthatCiscowouldsellsomeofitsboxes,nowcalled
routers,tootherresearchuniversities,buttherewasnoexpectationthatCisco
would make much money. There was certainly no expectation that Cisco
wouldbecome,forabriefmomentin2000,themostvaluablecorporationin
theworld.
Soonafter receiving itsfirst injectionofventure capitalin 1988, Cisco’s
management was turned over to professionals. John Morgridge was CEO
from1988to1995,followedbyJohnChambers.BothCEOsskillfullyguided
Ciscototakeadvantageofthepowerfulforcesatworkinitsindustry.During
the1988–93period,Ciscorodethreesimultaneouswaves.Thefirstwavewas
themicroprocessoranditskeyimplication—thecentralityofsoftware.Cisco
outsourcedthemanufactureofitshardware,concentratingonsoftware,sales,
and service. Ralph Gorin remarked that “Cisco cleverly sold software that
pluggedintothewall,hadafan,andgotwarm.”
ThesecondwaveliftingCiscoinitsearlyyearswastheriseofcorporate
networking. Just as at Stanford, corporations were discovering the need to
connect mainframes, personal computers, and printers that used different
networkprotocols.TheCiscorouter’sabilitytohandlemultipleprotocolswas
ingrowingdemand.
The third wave was IP (Internet Protocol) networking. In 1990, most
network protocols had corporate owners and sponsors. IBM had SNA
(Systems Network Architecture), Digital Equipment Corporation had
DECnet, Microsoft had NetBIOS, Apple had AppleTalk, Xerox had
developed the Ethernet, and so on. By contrast, IP was created in the late
1970stohandle trafficon ARPANET, theprecursor to theInternet.IP was
pure logic—it had no wires or connectors, no timing specifications or
hardware. Plus, it was free and was no company’s proprietary product. As
corporationsbegantohookdisparatecomputersintonetworks,corporateIT
departments began to see the value in a protocol that was vendor neutral.
Increasingly, corporations made IP their backbone network protocol and, at
thesametime,CiscobegantomakeIPthecentralhubprotocolonitsrouters.
Critically, none of the industry incumbents jumped to forcefully occupy
thisspace.Eachhaditsownproprietarynetworkprotocolandeachwasloath
tototally abandonit. Andeachwas evenmore loathto produceequipment
thatwouldhelpacompetitor’sequipmentontothenetwork.
Ifthreewaveswerenotenough,Ciscoliterallyexplodedundertheforceof
afourthwavethathitin1993:theriseofInternetusebythegeneralpublic.
Insidecorporations,computeruserssuddenlywantedInternetaccess.Notjust
dial-up access over a modem, but a direct always-on connection to the IP
backbone.Asuniversitiesandcorporationsscrambledtomakethishappen,IP
wonthebattleforinternalnetworkstandards,andCiscorouterscapturedtwo-
thirds of the corporate networking market. At the same time, traffic on the
InternetbackbonewasskyrocketingandCiscowasthere,providingthehigh-
speedrouterstohandletheflowofInternetdataonacontinentalscale.Where
therewerecompetitivebarriers,Ciscomaneuveredaroundthem.In1992–94,
CiscoworkedwithIBMtoaddsupportforIBM’sproprietarySNAprotocol
to its routers and worked with AT&T and others to make sure that its
equipment supported telecommunications industry protocols (for example,
AsynchronousTransferModeandFrameRelay).
Whenfacedwithacorporatesuccessstory,manypeopleask,“Howmuch
ofthesuccesswasskillandhowmuchwasluck?”ThesagaofCiscoSystems
vividly illustrates that the mix of forces is richer than just skill and luck.
Absent the powerful waves of change sweeping through computing and
telecommunications,Ciscowouldhaveremainedasmallnicheplayer.Cisco’s
managers and technologists were very skillful at identifying and exploiting
thesewavesofchange,andwereluckyenoughtomakenofatefulblunders.
KeycompetitorIBMwaspullingitspunchesafterthirteenyearsofantitrust
litigation.TheInternetcamealongatjusttherighttimetoaccelerateCisco’s
upward climb. And various incumbents were held in check by their own
inertia,theirstrategiesofsupportingasingleoraproprietaryprotocol,andby
theveryrapidityofchange.
SOMEGUIDEPOSTS
Itishardtoshowyourskillasasailorwhenthereisnowind.Similarly,itis
in moments of industry transition that skills at strategy are most valuable.
Duringtherelativelystableperiodsbetweenepisodictransitions,itisdifficult
forfollowersto catchtheleader,justasitisdifficultforoneof thetwoor
threeleaderstopullfaraheadoftheothers.Butinmomentsoftransition,the
old pecking order of competitors may be upset and a new order becomes
possible.
Thereisnosimpletheoryorframeworkforanalyzingwavesofchange.In
thewordsofmyUCBerkeleyjunior-yearphysicsprofessor,Nobellaureate
LuisAlvarez,“Thiscourseislabeled‘advanced’becausewedon’tunderstand
itverywell.”Heexplained,“Iftherewereaclearandconsistenttheoryabout
whatisgoingonhere,wewouldcallthiscourse‘elementary’physics.”
Working with industry-wide or economy-wide change is even more
advanced than particle physics—understanding and predicting patterns of
thesedynamicsisdifficultandchancy.Fortunately,aleaderdoesnotneedto
get it totally right—the organization’s strategy merely has to be more right
than those of its rivals. If you can peer into the fog of change and see 10
percentmoreclearlythanotherssee,thenyoumaygainanedge.
Drivingorskiinginthefogisunnervingwithoutanysourceoforientation.
Whenasinglerecognizableobjectisvisibleinthemist,itprovidesasudden
andcomfortingpointofreference—aguidepost.Toaidmyownvisioninto
thefogofchangeIuseanumberofmentalguideposts.Eachguidepostisan
observationorwayofthinkingthatseemstowarrantattention.
The first guidepost demarks an industry transition induced by escalating
fixed costs. The second calls out a transition created by deregulation. The
thirdhighlightspredictablebiasesinforecasting.Afourthmarkstheneedto
properlyassessincumbentresponsetochange.Andthefifthguidepostisthe
conceptofanattractorstate.
Guidepost1—RisingFixedCosts
Thesimplestformoftransitionistriggeredbysubstantialincreases in fixed
costs, especially product development costs. This increase may force the
industrytoconsolidatebecauseonlythelargestcompetitorscancoverthese
fixedcharges.Forexample,inthephotographicfilmindustry,themovement
from black-and-white to color film in the 1960s strengthened the industry
leaders.Oneinsightful analysisofthis waveofchange pointsisthatinthe
previously mature black-and-white photo film industry, there was little
incentive for competitors to invest heavily in R & D because film quality
alreadyexceededtheneedsofmostbuyers.5Buttherewerelargereturnsto
improvementsinqualityandtheeaseofprocessingcolorfilm.Asthecostsof
color-film R & D escalated, many firms were forced out of the market,
includingIlfordintheUnitedKingdomandAnscointheUnitedStates.That
waveofchangeleftbehindaconsolidatedindustryoffewerbutlargerfirms,
dominatedbyKodakandFuji.
AsimilardynamicwasIBM’srisetodominanceincomputinginthelate
1960s, driven by the surging costs of developing computers and operating
systems.Stillanotherwasthetransitionfrompistontomoresophisticatedjet
aircraft engines, cutting the field of players down to three: GE, Pratt &
Whitney,andRolls-Royce.
Guidepost2—Deregulation
Manymajortransitionsaretriggeredbymajorchangesingovernmentpolicy,
especiallyderegulation.Inthe pastthirtyyears,the federalgovernmenthas
dramaticallychangedtherulesitimposesontheaviation,finance,banking,
cable television, trucking, and telecommunications industries. In each case,
thecompetitiveterrainshifteddramatically.
Somegeneralobservationscanbemadeaboutthiskindoftransition.First,
regulatedpricesarealmostalwaysarrangedtosubsidizesomebuyersatthe
expense of others. Regulated airline prices helped rural travelers at the
expenseoftranscontinentaltravelers.Telephonepricingsimilarlysubsidized
ruralandsuburbancustomersattheexpenseofurbanandbusinesscustomers.
Savingsandloandepositorsandmortgagecustomersweresubsidizedatthe
expenseofordinarybankdepositors.Whenpricecompetitiontookhold,these
subsidiesdiminishedfairlyquickly,butthenewlyderegulatedplayerschased
what used to be the more profitable segments long after the differential
vanished. This happened because of the inertia in corporate routines and
mental maps of the terrain, and because of poor cost data. In fact, highly
regulatedcompaniesdonotknowtheirowncosts—theywillhavedeveloped
complexsystemstojustifytheircostsandprices,systemsthathidetheirreal
costsevenfromthemselves.Ittakesyearsforaformerlyregulatedcompany,
oraformermonopolist,towringexcessstaffexpenseandothercostsoutof
its system and to stop its accountants from making arbitrary allocations of
overheadexpensestoactivitiesandproducts.Inthemeantime,thesemental
and accounting biases mean that such companies can be expected to wind
downsomeproductlinesthatareactuallyprofitableandcontinuetoinvestin
someproductsandactivitiesthatoffernorealreturns.
Guidepost3—PredictableBiases
Inseeingwhatishappeningduringachangeitishelpfultounderstandthat
you will be surrounded by predictable biases in forecasting. For instance,
people rarely predict that a business or economic trend will peak and then
decline. If sales of a product are growing rapidly, the forecast will be for
continued growth, with the rate of growth gradually declining to “normal”
levels.Suchapredictionmaybevalidforafrequentlypurchasedproduct,but
itcanbefaroffforadurablegood.Fordurableproducts—suchasflat-screen
televisions, fax machines, and power mowers—there is an initial rapid
expansionofsaleswhentheproductisfirstoffered,butafteraperiodoftime
everyone who is interested has acquired one, and sales can suffer a sharp
drop.Afterthat,salestrackpopulationgrowthandreplacementdemand.
Predictingtheexistenceofsuchpeaksisnotdifficult,althoughthetiming
cannotbepinneddownuntilthegrowthratebeginstoslow.Thelogicofthe
situation is counterintuitive to many people—the faster the uptake of a
durableproduct,thesoonerthemarketwillbesaturated.Manymanagersfind
thesekindsofforecastsuncomfortable,evendisturbing.Asaclientoncetold
me, “Professor, if you can’t get that bump out of the forecast, I can find a
consultantwhowill.”
Anotherbiasisthat,facedwithawaveofchange,thestandardforecastwill
be for a “battle of the titans.” This prediction, that the market leaders will
dukeitoutforsupremacy,undercuttingthemiddle-sizedandsmallerfirms,is
sometimescorrectbuttendstobeappliedtoalmostallsituations.
Forexample,the“convergence”ofcomputingandtelecommunicationshad
beenpredictedformanyyears. Oneofthemost influentialforecasts inthis
regard was NEC chairman Koji Kobayashi’s 1977 vision of “C&C”
(computers and communications). He felt that IBM’s acquisition of a
communicationsswitchmakerandAT&T’sacquisitionofacomputermaker
illustratedthepathforward.Heimaginedtelephonesystemswithcomputing
backup—telephonesthatwouldtranslatespokensentencesfromonelanguage
to another. He predicted that convergence would parallel advances in
integrated circuit technology (large-scale integration, very large-scale
integration, and beyond). With this vision of convergence firmly in mind,
Kobayashi pushed NEC in the direction of greater and greater computing
power.NEC soughttobuildeverfaster andmorecompactsupercomputers.
TheU.S.governmentderegulatedAT&T,inparttoprepareforitsanticipated
battlewithIBM.
The problem NEC, AT&T, IBM, and other major incumbents all
encounteredwasthatconvergencedidn’thappenthewayitwas“supposed”
tohappen.Liketwosumowrestlers,AT&TandIBMadvancedtothecenter
of the ring, preparing to grapple. Then it was as if the floor beneath them
crumbled, dropping both into a pit beneath. The very foundations they had
stood upon were eaten away by waves of change—the microprocessor,
software, the deconstruction of computing, and the Internet. Having a
commonfatewasnotthekindofconvergencethathadbeenenvisioned.
Alongthesamelines,in1998manypunditswerepredictingtheemergence
of global megacarriers that would dominate world communications. Such
companies, foreshadowed by the Concert Communications Services joint
venture between AT&T and British Telecom, would offer global seamless
carriage of data over complex managed intelligent networks. Of course, it
turnedoutthatthereisnomorereasonforonecompanytoownnetworksall
overtheworldthanthereisforUPStoownalltheroadsonwhichitstrucks
travel.
A third common bias is that, in a time of transition, the standard advice
offered by consultants and other analysts will be to adopt the strategies of
those competitors that are currently the largest, the most profitable, or
showingthelargestratesof stockpriceappreciation.Or, moresimply, they
predictthatthefuturewinnerswillbe,orwilllooklike,thecurrentapparent
winners.
• As aviation was deregulated, consultants advised airlines to copy
Delta’sAtlanta-basedhub-and-spokesstrategy.But,unfortunatelyfor
thecopycats,Delta’sprofitshadcomefromsubsidizedpricesonthe
short-haulroutestoruraltownsitservedfromAtlanta—subsidiesthat
weredisappearingwithderegulation.
• While WorldCom’s stock price was flying high, consultants urged
clientstoemulatethecompanyandgetintothegameofputtingfiber-
opticringsaroundcities(twenty-onearoundDenver!).“At10percent
of the volume, WorldCom is already beating AT&T on per unit
networkcosts”onereportclaimed.6Thatadvicehadtobewithdrawn
when sleepy telephone companies awoke and began to cut prices.
WorldComthencrashedandburned.
• In 1999, the Web start-up advice was to create a “portal” such as
Yahoo!orAOL—awebsitethatactedasaguidetotheInternetand
providedaprotected“playground”ofspecializedWebpagesthatusers
wereherdedtoward.Butalthoughthesecompanieswerethestarsof
themoment, theirinitial strategiesofcapturingandchannelingWeb
trafficweresoonmadeobsoleteby thesheer scaleoftheexpanding
Internet.
Guidepost4—IncumbentResponse
This guidepost points to the importance of understanding the structure of
incumbentresponsestoawaveofchange.Ingeneral,weexpectincumbent
firmstoresistatransitionthatthreatenstounderminethecomplexskillsand
valuable positions they have accumulated over time. The patterns of
incumbentinertiaarediscussedindetailinchapter14,“InertiaandEntropy.”
Guidepost5—AttractorStates
InthinkingaboutchangeIhavefounditveryhelpfultousetheconceptofan
attractorstate.Anindustryattractorstatedescribeshowtheindustry“should”
work in the light of technological forces and the structure of demand. By
saying “should,” I mean to emphasize an evolution in the direction of
efficiency—meeting the needs and demands of buyers as efficiently as
possible.Havingaclearpointofviewaboutanindustry’sattractorstatehelps
oneridethewaveofchangewithmoregrace.
Duringthe1995–2000period,whenthetelecommunicationsindustrywas
inturmoil,CiscoSystem’sstrategicvisionof“IPeverywhere”wasactuallya
descriptionofanattractorstate.Inthispossiblefuture,alldatawouldmoveas
IP packets, whether it moved over home Ethernets, wireless networks,
telephone company ATM networks, or submarine cables. In addition, all
information would be coded into IP packets, whether it was voice, text
messaging, pictures, files, or a video conference. Other firms were
envisioning a future in which carriers provided “intelligent” networks and
“value-addedservices,”termsthatactuallymeantthatcarrierswouldprovide
special protocols, hardware, and software to support services such as video
conferencing. By contrast, in the “IP everywhere” attractor state, the
“intelligence”inthenetworkwouldbesuppliedbythedevicespluggedinto
itsendpoints—thenetworkitselfwouldbeastandardizeddatapipeline.
Anattractorstateprovidesasenseofdirectionforthefutureevolutionof
anindustry.Thereisnoguaranteethatthisstatewillcometobe,butitdoes
representagravitylikepull.Thecriticaldistinctionbetweenanattractorstate
and many corporate “visions” is that the attractor state is based on overall
efficiency ratherthana singlecompany’s desireto capturemost ofthepie.
The “IP everywhere” vision was an attractor state because it was more
efficientandeliminatedthemarginsandinefficienciesattachedtoamishmash
ofproprietarystandards.
Two complements to attractor-state analysis are the identification of
accelerants and impediments to movements toward an attractor state. One
type of accelerant is what I call a demonstration effect—the impact of in-
your-faceevidenceonbuyerperceptionsandbehavior.Forexample,theidea
thatsongsandvideosweresimplydatawas,formostpeople,anintellectual
finepointuntilNapster.Then,suddenly,millionsbecamequicklyawarethata
three-minutesongwasa2.5megabytefilethatcouldbecopied,moved,and
evene-mailedatwill.
As an example of an impediment, consider the problems of the electric
power industry. Given the limited carrying capacity of the atmosphere for
burnedcarboncompounds,theobviousattractorstateforthepowerindustry
isnuclearpower. The simplestpath would betoreplace coal- andoil-fired
boilers with modern third- or fourth-generation nuclear boilers. The major
impediment to the U.S. power industry moving in this direction is the
convolutedandhighlyuncertainlicensingprocess—ateachstage,local,state,
and federal authorities are involved as well as the courts. Whereas it takes
France five years to license and build an entire nuclear plant, it would
probably take ten years or more for a U.S. utility to just carry out a boiler
changeover.
Aninterestingattractor-stateanalysiscanbeperformedonthefutureofthe
newspaper industry. The special complexity of newspapers, television,
websites,andmanyothermediaarisesfromtheirindirectrevenuestructure—
theyreceivemuchoftheirincomefromadvertising.
ThechallengeisespeciallyacuteforthebellwetherNewYorkTimes,witha
weekday circulation of about one million copies. The company’s outsized
subscription and newsstand fees garnered $668 million in 2008, more than
enoughtocoverits newsroomandadministrativeexpenses.Theproblemis
thecostofphysicallyprintinganddistributingthenewspaper.Thesecostsare
roughlydoubleortriplethesubscriptionrevenueandhavebeencoveredby
advertisers.Butin2009,advertisingrevenueswentintosteepdecline.
Theforcesatworkaretwofold.First,readershipisslowingbecausetoday’s
readershavefreeaccessto24/7broadcastnews,freeonlineaccesstobasic
headlinestories,andfreeonlineaccesstothousandsofspecializedblogsand
articles that offer commentary and analysis. Just as the big-city midcentury
department store was squeezed between the suburban mall and big-box
discounters,readerscannowskipthegeneral-purposenewspaperinfavorof
bothlowercostandmorefascinatingfare.Second,newspaperadvertisinghas
been declining since the mid-1980s. Today’s advertisers are increasingly
interested in more targeted media, ones that go beyond demographics and
identify a consumer’s specific interests. That is the power of Google—the
ability to use the content of search requests to identify the interests of its
users.General-purposenewspaperswillsufferunderthiswaveofchange.
News media can be differentiated in three basic dimensions: territory
(world, national, regional, local), frequency (hourly, daily, and so on), and
depth (headline, feature story, in-depth expert analysis). I believe that the
attractor state for news contains specialists along each of these dimensions
rather than generalists trying to be all things to all people. With electronic
accesstoinformation,thereissimplynogoodreasontocontinuetobundle
local, national, and world news together and add weather, sports, comics,
puzzles,opinion,andpersonaladvicetothemix.Ibelievethataswemove
towardthisattractorstate,general-purposedailywide-circulationnewspapers
willfadeaway.Localnewsandmorespecializednewsmediawillcontinueto
existandevenflourish.ThestrategicchallengefortheNewYorkTimes and
the Chicago Tribune is not “moving online” or “more advertising,” but
unbundlingtheiractivities.
In this unbundled attractor state, it is very likely that there would be a
continuing market for local news, weather, and sports reported by a daily
newspaper, although it would have to operate with less overhead and less
pretensionthanthecurrentNewYorkTimes.It islikelythattheappropriate
vehicle for in-depth news analysis and investigative journalism would be a
weeklymagazine,ultimatelydeliveredtoadigitalreader(andavailablefree
online after one month). By contrast, top national and world news will be
most appropriately delivered online, especially to mobile platforms. An
interesting complement would be a cable news channel. To reduce costs,
partnershipswithcapital-citynewspapersandindependentjournalistsaround
theworldwillhelp(astrategythatwouldusetheNewYorkTimes’brandasa
bargaining tool). Similar online opportunities will exist for coverage of
business,politics,thearts,andscience.
Inmovingtoanonline model,alargetraditionalnewspaperwill needto
placemuchmoreemphasisonaggregatingcontentfromavarietyofsources
and writers versus depending on staff journalists. Successful online media
present the user with a carefully selected nest of links to articles, stories,
blogs, and commentary. To date, there is no successful online source of
revenue other than advertising. The more that advertising can be targeted
basedonuserdemographicsandrevealedinterests,themoreamediasitecan
chargeforitsplacement.
CHAPTERFOURTEEN
INERTIAANDENTROPY
Evenwithitsenginesonhardreverse,asupertankercantakeonemileto
cometoastop.Thispropertyofmass—resistancetoachangeinmotion—is
inertia.Inbusiness,inertiaisanorganization’sunwillingnessorinabilityto
adapttochangingcircumstances.Evenwithchangeprogramsrunningatfull
throttle,itcantakemanyyearstoalteralargecompany’sbasicfunctioning.
Were organizational inertia the whole story, a well-adapted corporation
would remain healthy and efficient as long as the outside world remained
unchanged.But,anotherforce,entropy, isalso atwork. Inscience, entropy
measures a physical system’s degree of disorder, and the second law of
thermodynamicsstatesthatentropyalwaysincreasesinanisolatedphysical
system. Similarly, weakly managed organizations tend to become less
organizedandfocused.Entropymakesitnecessaryforleaderstoconstantly
work on maintaining an organization’s purpose, form, and methods even if
therearenochangesinstrategyorcompetition.
Inertiaandentropyhaveseveralimportantimplicationsforstrategy:
• Successful strategies often owe a great deal to the inertia and
inefficiency of rivals. For example, Netflix pushed past the now-
bankrupt Blockbuster because the latter could not, or would not,
abandonitsfocusonretailstores.Despitehavingalargeearlyleadin
mobile phone operating systems, Microsoft’s slowness in improving
this software provided a huge opening for competitors, an opening
throughwhichAppleandGooglequicklymoved.Understandingthe
inertia of rivals may be just as vital as understanding your own
strengths.
• An organization’s greatest challenge may not be external threats or
opportunities,butinsteadtheeffectsofentropyandinertia.Insucha
situation, organizational renewal becomes a priority. Transforming a
complexorganizationisanintenselystrategicchallenge.Leadersmust
diagnose the causes and effects of entropy and inertia, create a
sensible guiding policy for effecting change, and design a set of
coherentactionsdesignedtoalterroutines,culture,andthestructure
ofpowerandinfluence.
INERTIA
Organizationalinertiagenerallyfallsintooneofthreecategories:theinertia
of routine, cultural inertia, and inertia by proxy. Each has different
implicationsforthosewhowishtoreduceinertiaorthosewhoseektogainby
attackingaless-responsiverival.
TheInertiaofRoutine
The heartbeat of any sizable business is the rhythmic pulse of standard
proceduresforbuying,processing,andmarketinggoods.Itsmoreconscious
actions are guided by less rhythmic but still well-marked paths. Even the
breathlesschaseafteranimportantnewclient,thesizingofanewfacility,and
theformulationofplansarefamiliarmovesinagamethathasbeenplayed
before. An organization of some size and age rests on layer upon layer of
impacted knowledge and experience, encapsulated in routines—the “way
thingsaredone.”Theseroutinesnotonlylimitactiontothefamiliar,theyalso
filterandshapemanagers’perceptionsofissues.Anorganization’sstandard
routinesandmethodsacttopreserveoldwaysofcategorizingandprocessing
information.
Theinertiacreatedbystandardroutinescanberevealedbysuddenoutside
shocks: a tripling of the price of oil, the invention of the microprocessor,
telecommunicationsderegulation,andsoon.Theshockchangesthebasisof
competition in the industry, creating a significant gap between the old
routinesandtheneedsofthenewregime.
U.S. airline deregulation, inaugurated in 1978, was such a shock. The
routinesforrunningairlinesandconceptsofcompetitionhadbecomesetover
decades of strong regulation. Deregulation acted to suddenly release many
constraintsonaction,butmanyofthemovesmadeinthefirstfewyearswere
guidedbyoldrulesofthumbratherthantherealitiesofthenewsituation.
Two years after airline deregulation, I was asked to help Continental
Airlines with some strategy issues, including the purchase of new aircraft.
ThecompanyhadalargefleetofDC-10s,butsoughthelpinthinkingthrough
its options in spending an estimated $400 million on new equipment. The
CEO,AlFeldman,hadjustjumpedintoContinentalfromtheCEOpositionat
FrontierAirlines,wherehehadbeenastrongsupporterofderegulation.
Inthedecadesofregulation,thegovernmentsetfaresandassignedroutes
toairlines;competitionwasmoreorlesslimitedtoimage,food,andpersonal
service. The standard unit of production in the airline industry is the
available-seat-mile(ASM).Takeaseat,liftittothirty-twothousandfeet,and
moveitonemileandyouhaveproducedoneASM.Airlineoperatingcosts
perASMfallwiththelengthofatripbecausemanytripcostsarefixed.The
costsofservicingtheaircraft,wearandtear,cleaning,food,andevensome
crewcostsdidnotdependmuchontriplength.A367-miletripbetweenLos
AngelesandPhoenixmightcost$0.22perASMwhileamuchlonger2,000-
mile trip to Detroit might cost only $0.09 per ASM. Congress wanted to
promote air travel to small towns, so in the days of regulation the Civil
AeronauticsBoard(CAB)setfaresthatwerebelowcostonshortroutesand
forcedeachairlinetoflythem.Thelossesonshortrouteswerecoveredbythe
profitsonlong-haulroutes,wheretheCABsetpricesabovecost.Ofcourse,
theCABforcedeachairlinetoflyamixofroutes.
Workingwitha smallteam,Idevelopeda viewof thenearfuture ofthe
industry.Myanalysiswasthatderegulatedfareswouldshifttomoreclosely
parallelcosts. Pricesand margins onshort-haul routeswould rise,and they
wouldfallonlong-haulroutes.Theimplicationwasthat,withderegulation,
profits would be made only in two ways: a low-cost operating structure or
clevernessingrabbingshort-haulroutesthatdidnothaveenoughvolumeto
support vigorous competition. At that time, the dominant feeling in the
industrywasthatlow-coststrategieswouldpullinlotsofconsumers,butthat
thebusinesstravelerwouldremainrelativelyinsensitivetoprice.Mythinking
was different. Of course business travelers wanted frequent, convenient,
comfortabletravel,butmostbusinessflyersdidn’tpayfortheirtravel—their
employersdid. Andemployers mightbe moreinterestedintravelcost than
comfort.Businesstravelerslikedcomfort, butwouldtheir companiespaya
premiumfor it? We thought thatfalling long-haulpriceswould makethem
less willing to do so. I forecast that even as load factors rose, prices and
marginswouldfall.
Thispointofviewdirectlycontradictedthedominantwisdominthenewly
deregulated industry. Long haul had always been profitable. Just a few
monthsbefore,DickFerris,UnitedAirlines’feistyCEO,hadgivenatalkto
WallStreetanalysts,sayinghisstrategywastoeliminateshortfeederroutes
and“concentrateonthelong-haulrouteswherethebucksare.”Hecommitted
United to spending $3 billion to build a new long-haul fleet, centered in
Chicago.BraniffInternationalhadalsoreactedtothenewerabyaddingnew
long-haulroutes.IhopedthatouranalysiswouldshowhowContinentalcould
besmarter.
Myideaswerenotwellreceivedbytheexecutivecommittee.Thebottom
line,announcedfromthetop,was“You’vegotitallwrong.Wehavealready
runaplanningmodelandweknowcoast-to-coastfareshavetorise,notfall.
Thequestioniswhichnewequipmentweshouldbebuying:Boeing,Airbus,
orMcDonnellDouglas.”
At moments like this, one is never sure what to think. Perhaps I was
missing something. What was this “planning model” that was forecasting
higher prices on the long hauls? It took a week for me to chase down the
modelanditsforecast.Sureenough,thereitwasinblackandwhite:current
long-haulfareswereoutofequilibriumandwereforecasttorise.
Continental’s“planningmodel”wasacomputerprogramcalledtheBoeing
Fleet Planner. The program was provided by Boeing to help airlines make
equipment acquisition decisions. Given a route structure and equipment
profile, it worked out operating costs and spat out predicted financial
statements. Continental used McDonnell Douglas equipment, but the Fleet
Plannerprogramknewtheoperatingcharacteristicsofallmajoraircraft.
I sat down next to the finance-office specialist who explained how it
worked.Toruntheprogramonehadtotellitwhichrouteswouldbeflown,
project a market share on each, and specify the equipment. The program
combinedthisinformationwithoperatingcostdataandcomputedthecostper
ASMoneachroute.Estimatingthat55percentofseatswouldbefilled(the
loadfactor),itthenadded ina12 percentreturnoncapitalandprojecteda
fare.Thatwasthefarethat“hadtorise,notfall.”
Incredulous, I said, “This is the predicted fare? But it’s just cost plus a
markup!”
“Wehaveusedthistoolforalongtime,”thespecialistcoollyreplied.“It
hasbeenprettyreliable.”
I was astonished. “What happens to these numbers—where do they go
fromhere?”Iasked.
“They go to the CAB, along with a bunch of other stuff, as part of fare
planning,”hesaid.
Continental’ssystemforprojectingairfaresfortheneweraofcompetition
was the same one it had used all during the regulation era to suggest and
justifyfaresinnegotiationswiththeCAB.Thisprojectionhadnothingtodo
with competition, supply, demand, capacity, or market forces. It took costs
andaddedamarkup.It“predicted”whattheCABwoulddoinsettingfares.
TheBoeingPlannerwasafinetool,butitwasn’tafarepredictorunlessyou
hadaregulatorguaranteeingthatyouwouldmakea12percentreturnflying
half-fullairplanes.
Despitederegulation,theCEO’sanimatedspeechesonhowthecompany
had a new, competitive spirit, and an aggressive posture assumed by the
senior management group, the company’s planning, pricing, and marketing
routines were unchanged from the era of regulation. The new competitive
spiritwaspureaggressiveness,unalloyedbycraft.
Ittookanothermonthtouncoverthedead,yetcontrolling,handofanother
regulation-eraruleofthumb.Bysettingfarestoallowtheairlinesa“fair”12
percentreturnoncapital,wherecapitalwasequityplusdebt,theCABhad,in
effect,guaranteedthatanairline’sdebtinterestwouldalwaysbepaid.Alla
firmhadtodowasnotdeviatetoomuchfromtheoverallnorm.Bankshada
similar rule about airline debt being a good credit risk. This had a big
influence on the attitude toward new equipment. When the airlines moved
from props to jets, and when they again moved from narrow to wide-body
aircraft, billions of dollars were spent on new aircraft, adding tremendous
chunks of new capacity. In a normal industry, a surge of new equipment
placedinservicebyallcompetitorswouldhaveforcedacrashinpricesand
majorlosses.And,inanormalindustry,competitorscannotalladdcapacityat
thesametimeunlessthereisaremarkablesurgeindemand.Butintheairline
business,theCABlentahand,proppingupprices—andevenincreasingthem
—intheseperiodsofovercapacity.Reequipmentbytheregulatedairlineshad
notbeenastrategicproblem.Asimplerulesufficed:reequipwheneveryone
elsedoes.
Deregulationmeantthattheoldrulesofthumbwereobsolete.Goforthe
long-haulroutes,fareswillcovertotalcosts,andreequipwheneveryoneelse
doeswere not going to work in the future. From 1979 to 1983, the majors
keptenactingtheoldrules.In1981,United,American,andEasterntogether
lost $240 million, while all of the shorter-haul carriers (Delta, Frontier,
USAir,andsoon)madeaprofit.Overthenexttwodecades,onlySouthwest
wouldbeconsistentlyprofitable.In1984and’85,faresonlong-haulroutes
fell27percent.Onshort-haullow-volumeroutes,faresrose40percent,more
than covering costs. Our team’s analysis was essentially right. Not rocket
science,butcountertothelong-standingrulesofthumb.
Beingrightdoesn’talwayshelpthedecisionmaker.InContinental’scase,a
nasty strike dragged management’s attention away from market dynamics.
Theplantobuynewaircraftwasscuttledwhenfaresdidnotriseandlosses
mounted. Then, sensing the firm’s plight, entrepreneur Frank Lorenzo of
Texas Air initiated a hostile takeover of the company. Top management
couldn’t believe that tiny Texas Air could take over a major airline—it
wouldn’tbeuntilthelate1980sthatU.S.corporatemanagementsgotusedto
this idea. Frustrated, angry, and suffering a secret deep depression,
ContinentalCEOAlFeldmanshothimselfathisdeskinAugust1981.
In 1982, Frank Lorenzo merged Continental and Texas Air in a reverse
takeover. A year later the new company was bankrupt, in part a tactic to
separate the equipment from the old union contracts. A new Continental
Airlines emerged from bankruptcy in 1986 and soon consolidated with
Frontier,PeopleExpress,andNewYorkAir.FrankLorenzosoldhisinterest
in1990.
Inertiaduetoobsoleteorinappropriateroutinescanbefixed.Thebarriersare
theperceptionsoftopmanagement.Ifseniorleadersbecomeconvincedthat
newroutinesareessential,changecanbequick.Thestandardinstrumentsare
hiring managers from firms using better methods, acquiring a firm with
superior methods, using consultants, or simply redesigning the firm’s
routines.Inanyofthesecases,itwillprobablybenecessarytoreplacepeople
whohaveinvestedmanyyearsdevelopingandusingtheobsoletemethodsas
wellastoreorganizebusinessunitsaroundnewpatternsofinformationflow.
TheInertiaofCulture
In1984,Ihadaclose-uplookatoneoftheepicentersofcorporatecultural
inertiainthatera—AT&T.*AsthecorporateinventorofUnix,whichtoday
underliestheopen-sourceLinuxandApple’sMacOSXoperatingsystems,
AT&Tshouldhavebeenamajorplayer,especiallywithregardtocomputer
communications. Retained as a strategy consultant, I worked with the
companyonnewproductsandstrategiesincomputingandcommunications.
ThestrategicplansIhelped formulateatAT&Tincluded developingand
bondingkeysoftwarepackageswiththeAT&Tbrandname.1Inaddition,we
planned on making these packages and add-on modules available for sale
electronically, over telephone lines, with AT&T “communicating
computers.”*Finally,wewereinterestedindevelopingasimplerversionof
AT&T’s Unix for the PC platform, one that would begin to support a
graphicaluserinterface.
AsIdevelopedworkingrelationshipsatAT&T,somehigh-levelmanagers
let me in on what they saw as an embarrassing secret. AT&T wasn’t
competentatproductdevelopment.Yes,thecompanywastheproudownerof
Bell Labs; the inventor of the transistor, the C programming language, and
Unix;andwasamarvelousplacethatprobeddeeplyintothefundamentalsof
nature. But there was no competence within AT&T at making working
consumer products. One story that was told concerned cellular phones.
Starting in 1947, Bell Labs developed the basic ideas underlying mobile
telephony.However,thefirstmarkettest,in1977,hadtobeundertakenusing
Motorola’sequipment.
Anotherstoryconcernedvideotex.In1983,AT&Thadajointventurewith
theKnightRiddernewspaperchaintotestavideotexsystem(Viewtron).The
system would provide news, weather, airline schedules, sports scores, and
communityinformationastextonahomeTVscreen.ButBellLabshadnot
beenabletodeliversoftwarecapableofhandlingeventhelightdemandsof
thetestmarket.Thesoftwaretorunthesystemwasinsteaddevelopedbya
smallcompany(Infomart)workingundersubcontracttoKnightRidder.
Mypersonallessoninthisregardcamewithrespecttothe“communicating
computer,” aPC tiedby amodem tonetwork services.(This wasadecade
beforetheInternetcameintowidespreadpublicuse.)Iwantedtodemonstrate
to senior management the potential for selling software via computer. The
metaphorwasanelevator:firstfloorgames,secondfloorutilities,thirdfloor
calculations,andsoon.WetalkedwithAT&TBellLabsaboutasimplePC-
based program to demonstrate this interface. They quoted three million
dollarsandtwoyears.IsuggestedasimplerapproachandwastoldbyaBell
Labsrepresentative“nottointerferewithourdesignprerogatives.”Frustrated,
Iwrotethestraightforwardcodeforthedemonstrationmyselfinthreeweeks.
The problem at AT&T was not the competence of individuals but the
culture—theworknormsandmindsets.BellLabsdidfundamentalresearch,
not product development. The reaction to a request for demonstration code
wasasifBoeingengineershadbeenaskedtodesigntoyairplanes.Justasina
large university, the breakthroughs of a tiny number of very talented
individuals had been used to justify a contemplative life for thousands of
others.ThroughthemanydecadesduringwhichAT&Thadbeenaregulated
monopoly, this culture grew and flourished. Now, with deregulation,
competition, and the soaring opportunities in mass-market computing and
data communications, this way of doing things was a huge impediment to
action.Tomakemattersevenworse,themassiveinertiaofthesystemwasnot
being countered. With no real understanding of technology, most senior
managersatAT&Tdidnotcomprehendorappreciatetheproblem.Andthose
few who did had almost no chance of changing the character of Bell
Laboratories,acrownjewelofAmericanR&D,adevelopmentcenterthat
producedNobellaureates.
ThestrategyworkIdidatAT&Tin1984–85wasawaste.Thehard-won
lesson was that a good product-market strategy is useless if important
competencies,assumedpresent,areabsentandtheirdevelopmentisblocked
by long-established culture. The seemingly clever objectives I helped craft
wereinfeasible.It wouldbeat least adecade before AT&Tslimmed down
and gained enough engineering agility to support work on competitive
strategy.
Western Electric and most of AT&T Bell Laboratories were spun off as
LucentTechnologiesin1996.WallStreetlovedthenewcompanyanddrove
itspricefromeightdollarstoeightydollarspersharebeforealackofprofits
becameevidentanditspricecollapsedtobelowonedollarin2002.French
telecommunications equipment maker Alcatel merged with Lucent in 2006.
Sincethemerger,Alcatel-Lucent’svaluehasdeclinedby70percent,largely
duetolossesinLucent’soperations.
We use the word “culture” to mark the elements of social behavior and
meaning that are stable and strongly resist change. As a blunt and vivid
example, Khmer Rouge leader Pol Pot killed one-fifth of the Cambodian
population,executedalmosteveryintellectual,burnedalmostallbooks,and
outlawed religion, banks, currency, and private property, but still did not
muchalterCambodianculture.Theculturesoforganizationsaremorelightly
heldthanthose of nationality, religion,or ethnicity. Still, itisdangerous to
thinkthatorganizationalculturecanbechangedquicklyoreasily.
The first step in breaking organizational culture inertia is simplification.
Thishelpstoeliminatethecomplexroutines,processes,andhiddenbargains
among units that mask waste and inefficiency. Strip out excess layers of
administration and halt nonessential operations—sell them off, close them
down,spinthemoff,oroutsourcetheservices.Coordinatingcommitteesand
amyriadofcomplexinitiativesneedtobedisbanded.Thesimplerstructure
willbegintoilluminateobsoleteunits,inefficiency,andsimplebadbehavior
thatwashiddenfromsightbycomplexoverlaysofadministrationandself-
interest.
Afterthefirstroundofsimplification,itmaybenecessarytofragmentthe
operatingunits.Thiswillbethecasewhenunitsdonotneedtoworkinclose
coordination—whentheyarebasicallyseparable.Suchfragmentationbreaks
politicalcoalitions,cutsthecomfortofcross-subsidies,andexposesalarger
number of smaller units to leadership’s scrutiny of their operations and
performance.Afterthisroundoffragmentation,andmoresimplification,itis
necessary to perform a triage. Some units will be closed, some will be
repaired,andsomewillformthenucleiofanewstructure.Thetriagemustbe
basedon both performanceand culture—you cannotaffordto have ahigh-
performingunitwithaterriblecultureinfecttheothers.The“repair”thirdof
the triaged units must then be put through individual transformation and
renewalmaneuvers.
Changing a unit’s culture means changing its members’ work norms and
work-relatedvalues.Thesenormsareestablished,held,andenforceddailyby
smallsocialgroupsthattaketheircuefromthegroup’shigh-statusmember—
thealpha.Ingeneral,tochangethegroup’snorms,thealphamembermustbe
replaced by someone who expresses different norms and values. All this is
speededalongifachallenginggoalisset.Thepurposeofthechallengeisnot
performance per se, but building new work habits and routines within the
unit.
Oncethebulkofoperatingunitsareworkingwell,itmaythenbetimeto
install a new overlay of coordinating mechanisms, reversing some of the
fragmentationthatwasusedtobreakinertia.
InertiabyProxy
Alackofresponseisnotalwaysanindicationofstickyroutinesorafrozen
culture.Abusinessmaychooseto not respond to change or attack because
respondingwould undermine still-valuablestreams ofprofit. Those streams
of profit persist because of their customers’ inertia—a form of inertia by
proxy.
As an example, in 1980 the prime interest rate hit 20 percent. With the
then-newfreedomtocreatemoneymarketcustomeraccounts,howdidbanks
respond?Smallerandnewerbanksseekingretailgrowthwerehappytooffer
this new type of high-interest deposit account. But many older banks with
long-established customers did not. If their customers had been perfectly
agile, quickly searching for and switching to the highest-interest accounts,
theywouldhavehadtoofferhigher-interestaccountsordisappear.Buttheir
customerswerenotthisagile.
IwasaconsultanttothePhiladelphiaSavingsFundSociety(PSFS)atthe
timeandaskedaboutitsratestructureondeposits.Avicepresidenttriedto
findthebrochuredescribingthehigher-interestmoneymarketaccountsand
thengaveup.Hesaid,“Ouraveragedepositorisaretiredpersonandnotthat
sophisticated.Thosedepositorfundsmakeupthelastgiantpoolof5percent
money left on the planet!” What he meant was that he could loan out his
depositors’moneyandearn12percentormore,whilepayingonly5percent
tothedepositors.Sure,somedepositorswoulddepart,butmostwouldnotand
the profits on their inertia were enormous. The important implication for
competitors was that, at that moment, a rival could poach customers away
fromPSFSwithouttriggeringacompetitiveresponse.
In an example from telecommunications, the regional Bell operating
companiesvariedinthenumberofbusinesscustomerstheyserved.Withthe
advent of the Internet, which were the first to offer digital subscriber line
services? The telephone companies’ primary data offering to business had
beenT1lines,pricedataboutfourthousanddollarspermonthandoffering
1.5mbps.In1998,DSLspeedswereaboutone-thirdofT1speeds,butDSL
priceswereone-thirtieth.Thatis,acustomercouldreplicatea T1linewith
three DSLs for one-tenth the cost. Rather than cannibalize their very
profitableT1business,telephonecompaniesservingNewYork,Chicago,and
San Francisco just punted—they didn’t offer DSL. These telephone
companieslostabout10percentoftheircorporatedatabusinesseachyearto
thenew-wavecarriers(WorldCom,IntermediaCommunications,anddozens
ofdigitalcompetitivelocalexchangecarriers,orCLECs),buttheveryhigh
profitsintheT1businessmorethanmadeupforthedecline.*
Again,theapparentinertiaofthetelephonecompanieswasactuallyinertia
byproxy,inducedbecausetheircustomersweresoslowtoswitchsuppliers,
evenin thefaceof dramaticprice differences. Thisinertia byproxy fooled
hundredsofcompaniesandinvestors.Thefantasticrateofexpansionofthe
“new network” carriers was taken as evidence of competitive superiority,
unleashingafrenzyofinvestmentandstockappreciation.Whenthetelephone
companies finally began to respond in 2000, the bubble popped. Once real
competitionbegan,itwasarout.NotasingleCLECsurvived.
Inertia by proxy disappears when the organization decides that adapting to
changed circumstances is more important than hanging on to old profit
streams.Thiscanhappenquitesuddenly,asitdidintelecommunicationsafter
1999. Attackers who have taken business away from an apparently sleepy
firmmay findthemselves suddenlywithoutanyprofits.Thiseffectmay be
magnified because the customers who switched away from the inert
incumbentare,byself-selection,themostsensitivetoabetteroffer.
Ontheotherhand,iftheattackerhasbeensuccessfulinbuildingbondsof
costandloyaltywithnewlyacquiredcustomers,thentheincumbent’sreturn
toacompetitiveposturemayfailtogainbackitslostbuyers.
ENTROPY
Itisnothardtoseeentropyatwork.Withthepassageoftime,greatworksof
art blur and crumble, the original intent fading unless skillful restorers do
theirwork.Drivedownasuburbanstreetanditiseasytospottheuntended
home.Weedsgrowinthegarden,paintpeelsfromadoor.Similarly,onecan
sense a business firm that has not been carefully managed. Its product line
grows less focused; prices are set low to please the sales department, and
shippingschedulesaretoolong,pleasingonlythefactory.Profitsaretaken
homeas bonusestoexecutives whoseonly accomplishmentisoutdoing the
executive next door in internal competition over the bounty of luck and
history.
Entropyisagreat boontomanagementandstrategyconsultants.Despite
allthehigh-levelconceptsconsultantsadvertise,thebreadandbutterofevery
consultant’sbusinessisundoingentropy—cleaningupthedebrisandweeds
thatgrowineveryorganizationalgarden.
Denton’s
In 1997, I was retained by Carl and Mariah Denton to look at the overall
performanceandvalueoftheirfamilycompany.Thecompany,Denton’sInc.,
operated a chain of garden and landscape supply outlets in four states.
Denton’s dated back to the 1930s, when a number of separate retailers
combined as a way of surviving the Great Depression. Originally serving
fairlyruralcommunities,ithad,overtheyears,expandedintoexurbanareas
as well. The twenty-eight retail outlets operated under three separate brand
names but were all actually quite similar. Each outlet had a retail store
building that sold garden supplies and tools and a large outdoor space that
soldplants,trees,soils,andlandscapingmaterials.Denton’sownedtwentyof
itslocationsoutrightandleasedtheremainingeight.
CarlandMariahDentonwereavidgardeners,andtheirhomecouldhave
beenanadvertisementforthecompany’sproductsandservices.Theairwas
heavywiththescentofflowers,andanartificialstreamburbleddownledges
ofstoneandrock.Underalargeshadyoaktreewetalkedaboutthecompany
andtheirdesireto“getitinshape”tohandovertotheirchildren.Theygave
meaCD-ROMcontainingfiveyearsoffinancialresultsforeachstoreandthe
companyasawhole.
Digging into the financial statements I began to untangle layers of
complexity.Themainsourceofconfusionwasthetreatmentofcapital.The
company’sreturn-on-capitalmeasureforeachretailoutletmixedapplesand
oranges.Onelocation purchased in1950 had cost$5,000per acre andone
boughtin1989hadcost$95,000anacre.Thecomputedreturn-on-investment
figures for these locations made the older one look like a huge winner
comparedwiththenewerone.2Thiswayofmeasuringbusinessperformance
confoundedretailingwithrealestateinvestmentgains.
To puteach locationona comparablebasis, I deviseda newmeasureof
operating profit I called gain to operating (GTO) that adjusted for these
differences and for various allocations.3 Denton’s best store had a GTO of
$1.05 million and its worst had a GTO of negative $0.97 million. That is,
closingthatstorewouldyield$0.97millionmoreperyearthancontinuingto
operate it. Denton’s whole chain showed a GTO of $0.32 million, a very
differentpicturefromthe$8millioninnetincometheaccountsshowed.
The chart I prepared for Carl and Mariah Denton is reproduced on the
followingpage.TobuildthischartIrankedoutletsinorderoftheirgainsto
operating,withoutlet1havingthehighestand28havingthelowest.Thebars
show,foreachrank,thecumulativegaintooperatingalloftheoutletsatthat
rankorbetter.Thus,thefirstbarontheleftrepresentsthebestoutletinthe
chain—itsGTOwas$1.05millionperyear.ThenextbarrepresentstheGTO
ofoutlet1plusthat ofoutlet 2, a total cumulative GTO of $1.05 + 0.63 =
$1.68million.Thethirdbestoutletearned$0.5million,sothethirdbarshows
thecumulativeGTOofoutlets1,2,and3(1.05+0.68+0.5=$2.18million).
Outlets 4 through 14 added another $2.5 million to the cumulative total,
bringingitupto$4.68million.But,beginningwithoutlet15,negativeGTOs
begintodragdownthecumulativetotal.Infact,thenegativeGTOsofoutlets
15through28summedtonegative$4.4million,almosttotallycancelingout
thecontributionsofthepositiveGTOstores.Asyoucansee,thenumberone
outlet’sGTOwashigherthanthatofthewholechainoftwenty-eight!
DENTON’SADJUSTEDCUMULATIVEGAINTOOPERATING
(MILLIONSOF$)
OutletsRankedinOrderofDecreasingGaintoOperating
I call this a humpchart. Whenever you can assign profit or gain to
individualproducts,outlets,areas,segments,oranyotherportionofthetotal,
you can build a hump chart. I built my first hump chart in an analysis of
WesternElectric’spre-deregulationproductmix.Sincethen,Ihaveseenand
helpedbuildhumpchartsforplanningmilitarybaseclosings,Sonyproducts,
telephonecompanycustomers,andavarietyofothersituations.Ifthereare
no cross-subsidies, the bars will rise smoothly to a maximum. But if some
operations,someproducts,orsomelocationsaresubsidizedbyothers,there
willbeatrue“hump”onthechart—thebarswillrisetoamaximumandthen
begin to sag downward as the loss operations pull down the profits of the
whole.
Iftheoperationsareseparable,thenadistincthump,sustainedovertime,
indicates a lack of management. It is a way to see entropy at work. At
Denton’s,thecross-subsidieswereobscuredbythemeasurementsystemand
institutionalizedovertime.Forexample,inadditiontothedistortionscaused
by poor measures of space and land costs, Denton’s measured the monthly
andannualperformanceofeachlocationbyits“businessoperationsprofit,”a
figure that omitted employee incentive and bonus payments. Because
incentive payments were set each year by corporate management, the logic
wasthattheyshouldnotbechargeddirectlytoeachlocation.Butovermany
years incentive and bonus payments had become close to entitlements and
werepaidonthebasisoftotalcorporateprofit,creatingasubsidyfromthe
moreprofitablelocationstothelessprofitable.
CarlandMariahwereshockedbythehumpchart.“Youcan’tbesuggesting
thatwedrophalfofthelocations,”Mariahsaid.
“No,”Ireplied.“Butitmightmakeagreatdealofsensetoclosethevery
worst performing locations. If you do that, and fix the other eight weak
locations,youwilldoubletotalearnings.”
Improving the performance of the weaker locations took two years. The
methods were straightforward data-driven management and transfer of best
practices. The key at Denton’s was to figure out why some locations
performed better than others. Sales per square foot was a major driver of
performance and it turned out to be strongly affected by location, the
closeness of a competing Home Depot, the nursery layout, and the
landscaping presentation. Better performing outlets, we discovered, had
movedbeyondtheold-stylegridlayoutandlookedmorelikegardens.Plants
were not simply labeled but described in detail along with planting
suggestionsandideasaboutpairingswithotherplants.Plantswerepresented
in attractive collections, promoting impulse buying. Landscaping supplies
were not simply piled up but shown off in set-piece presentations, again
helpingcustomerstovisualizehowtousethesematerialsattheirownhomes.
Sellingactivitiesin thestore, garden,andlandscaping areaswereseparated
because the knowledge bases of the sales personnel differed greatly across
theseactivities.
At the end of two years, Denton’s gain to operating had risen from
$100,000 to more than $5 million and its accounting profit had doubled.
Aboutone-halfoftheincreasecamefromdroppingfiveweakoutletsandthe
other half from a best-practices program. None of this improvement came
from a deep entrepreneurial insight or from innovation. It was all just
management—justundoingtheaccumulatedclutterandwastefromyearsof
entropyatwork.
Planningandplantingagardenisalwaysmoreinterestingandstimulating
than weeding it, but without constant weeding and maintenance the pattern
that defines a garden—the imposition of a special order on nature—fades
awayanddisappears.
GeneralMotors
Oneoftheclearestexamplesofentropyinbusinesswasthegradualdecayof
theorderimposedontheearlyGeneralMotorsbyAlfredSloan.Inthisdecay,
onecanseethevalueofcompetentmanagementbyitsabsence.Indeed,you
cannotfullyunderstandthevalueofthedailyworkofmanagersunlessone
acceptsthegeneraltendencyofunmanagedhumanstructurestobecomeless
ordered,lessfocused,andmoreblurredaroundtheedges.4
In1921,HenryFordheld62percentoftheU.S.automobilemarket,having
builtagiantenterprisearoundtheModelT.Ford’ssuccesscamemainlyfrom
the Model T’s low price, achieved by world-class industrial engineering of
eachaspectofautomobilemanufacturing.
GeneralMotorswassmallerthanFordandhadbeenassembledthrougha
number of acquisitions. In April 1921, the company’s president, Pierre du
Pont,asked Alfred Sloan(then vice presidentof operations) toundertake a
study of “product policy” for the company. At that moment, the company
produced ten lines of vehicles that together held about 12 percent of the
automobile market. As can be seen in the following diagram, GM’s
Chevrolet, Oakland, Oldsmobile, Sheridan, Scripps-Booth, and Buick
divisionsallofferedautomobilesinthe$1,800–$2,200range.Noneproduced
acarthatcompetedwithFord’s$495ModelT.Plus,theChevrolet,Oakland,
andOldsmobiledivisionswerebadlyinthered.
Two months later, Sloan presented his product policy to the executive
committee.Sloaninsistedthat“GeneralMotors’carlineshouldbeintegral,
thateachcarinthelineshouldproperlybeconceivedinitsrelationshiptothe
lineas awhole.”More specifically, hewanted “qualitycompetition against
carsbelowa given pricetag, and pricecompetitionagainst carsabovethat
pricetag.”5Sloan’splannotonlycutthepricesofthecarsintheline,itgave
each brand a unique range of prices to work within. This new policy
dramatically reduced the amount of intracompany competition and product
clutter.UnderSloan’sconcept,therewasnofuzzinessorconfusionaboutthe
differencebetweenaChevrolet,aBuick,andaCadillac.Lookatthediagram
onthenextpagetoseethelogicandorderSloan’sdesignimposed.
TheexecutivecommitteeadoptedSloan’splan,soldSheridanMotors,and
dissolvedScripps-Booth. Sloanbecamepresident in1923. Oakland became
Pontiac five years later. By 1931, General Motors had become the largest
automakerandoneoftheleadingcorporationsintheworld.Throughoutthe
1940sand’50s,Sloan’sconceptbecameapartofAmericanculture.Walking
throughasuburbanneighborhood,youcouldtellwholivedineachhouseby
thecarparkedoutinfront:ordinarypeopledroveChevrolets,theforemana
Pontiac,themanageraBuick,andtheCEOaCadillac.
Sloan’sproductpolicyisanexampleofdesign,oforderimposedonchaos.
Makingsuchapolicyworktakesmorethanaplanonapieceofpaper.Each
quarter,eachyear,eachdecade,corporateleadershipmustworktomaintain
the coherence of the design. Without constant attention, the design decays.
Without active maintenance, the lines demarking products become blurred,
andcoherenceislost.
Ifthecompanyisfullydecentralized,thisblurringofboundariesisbound
to happen and the original design, based on brands defined around price
ranges, becomes buried under a clutter of new products. For example,
executivesrunningtheChevroletdivisionknewthattheycouldincreasethe
Chevroletdivision’ssalesandprofitbyofferingsomehigher-pricedmodels.
ThismovemighttakesomebusinessawayfromChrysler;itwouldalsotake
businessawayfromPontiacandOldsmobile.Conversely,executivesrunning
thePontiacdivisionsawthattheycouldincreasetheirdivision’srevenuesif
theyofferedsomelower-pricedmodels,sotheypushedinthatdirection.Like
a parent who must resist fourteen-year-olds’ pushing for beer at the party,
corporatemanagement’sjobis toresisttheseimprecationsandpreservethe
design.Ifthedesignbecomesobsolete,management’sjobistocreateanew
wayofcoordinatingeffortssothatthecompetitiveenergyisdirectedoutward
insteadofinward.
Bythe1980s, Sloan’sdesignhadfadedaway—avivid illustrationofthe
power of entropy. General Motors not only had blurred its brands and
divisions, it engaged in badge engineering, offering essentially the same
vehicleunderseveralmodelandbrandnames.
More recent administrations worked to reduce the amount of overlap. In
2001,theOldsmobiledivisionwascloseddown,astarkrecognitionthatits
models had lost any distinction in either style or price. Lawsuits from
displacedOldsmobiledealersmadethisaveryexpensiveproposition.
The 2008 product lineup at General Motors is shown on the next page,
along with competitor Toyota’s product lineup. Because GM’s product mix
was much more complex in 2008 than it had been in 1921, the display is
restrictedtosedansandcoupes,omittingSUVs,vans,hybridenginevehicles,
and all trucks. Although Oldsmobile no longer existed in 2008, I have
projectedthepricerangesofitsmodelsbyadjustingitsmodelyear2000cars
forGM’soverallpriceinflationovertheinterveningeightyears.
Ascanbeseen,modelswereclusteredaroundthemass-market$20,000–
$30,000range. Infact,at aprice pointof $25,500,General Motorsoffered
nine vehicles (two Chevrolets, one Saturn, four Pontiacs, and two Buicks).
Toyota,bycontrast,offeredtwocarsatthatprice.
The loss of coherence in General Motors’ product line dramatically
increased the amount of internal competition among its brands. Business
leaderstendtoseecompetitionasacleansingwind,blowingawaywasteand
abuse.Buttheworldisnotthatsimple.Ifyouinvestinadvertisingorproduct
developmenttotakebusinessawayfromacompetitor,thatmayincreasethe
corporatepie.Butifyouinvesttotakebusinessawayfromasisterbrandor
division, that may make the whole corporate pie smaller. Not only are the
investments in advertising and development partially wasted, but you have
probablypusheddownthepricesofbothbrands.
InJune2009,GeneralMotorsdeclaredbankruptcyandwasbailedoutby
theObamaadministration,makingthe U.S.Treasurythe majorityownerof
thecompany.Undertheprotectionofbankruptcy,thecompanydroppedthe
Saturn,Pontiac,andHummerbrands.
Reversing the effects of entropy at Denton’s took work, but the problem
wasnotcompoundedbysubstantialinertia.Oncetheissuesbecameevident,
both leaders and most managers were willing to remedy the situation. By
contrast, the problems affecting General Motors in 2008 were created by
decadesofentropycombinedwithinertiaduetoembeddedobsoleteroutines,
frozenculture,andchain-linksystems.Bankruptcymaynotbeenoughtofix
thisdifficultsituation.Iexpecttoseethecompanyfragmentfurtherandsell
offvaluablebrandnamesoverthenextdecade.
TOYOTAANDGENERALMOTORSMODELSIN2008
Each black bar is a model, and brands are collected within
dottedrectangles.ThischartleavesoutSUVs,hybridvehicles,vans,
and all trucks. General Motors’ Oldsmobile division was closed in
2001. The “virtual” products shown for Oldsmobile are the model
year 2000 products price-inflated to 2008. The high-priced
componentoftheChevroletdivisionistheCorvette.
CHAPTERFIFTEEN
PUTTINGITTOGETHER
Nvidia,adesignerof3-Dgraphicschips,hadaveryrapidrise,shootingin
afewshortyearspastapparentlystrongerfirms,includingIntel,todominate
the high-performance 3-D graphics chip market. In 2007, Forbes named
Nvidiathe“CompanyoftheYear,”explainingthat“SinceHuang[CEOand
founder]tookthecompanypublicin1999,Nvidia’sshareshaverisen21-fold,
edgingouteventhemightyAppleoverthesametimeperiod.”1
Nvidia jumped from nowhere to dominance almost purely with good
strategy.FollowthestoryofNvidiaandyouwillclearlyseethekernelofa
good strategy at work: diagnosis, guiding policy, and coherent action. You
will also glimpse almost every building block of good strategy: intelligent
anticipation,aguidingpolicythatreducedcomplexity,thepowerofdesign,
focus,usingadvantage,ridingadynamicwaveofchange,andtheimportant
roleplayedbytheinertiaanddisarrayofrivals.
Therearechunksofcommentaryandanalysissprinkledthroughthisstory.Theyaresetin
smallertypeandlookjustlikethischunkoftext.Thesecommentariesshinealightonsomeofthe
strategicconsiderationsrevealedbythestory,issuesthatmaynotbeapparentonafirstreading.
3-DGRAPHICS,UTAH,ANDSGI
Nvidia’s domain of 3-D graphics has nothing to do with wearing special
glassesorwithimagesthatjumpoffthepageoroutofthemoviescreen.The
“3-D” in 3-D graphics describes the process used to create an image
appearingonacomputermonitor.Ifyouarelookingatastillimage,itmay
notbeobviousthatiswascreatedwith3-Dgraphicstechnology—itisjusta
still image generated by dots of color. However, once you gain real-time
controloverthepositionoftheimaginarycamera,thedifferenceisdramatic.
Usingamouseorjoysticktocontroltheimaginarycamera,youcanexplorea
3-Dscene,viewingitfromdifferentpositions,movingyourviewpointaround
objects to view them from behind or above, and moving into rooms and
spaces at will. This is possible because the computer “knows” the three-
dimensionalstructureofthewholescene.
Manyofthefundamentalcomponentsofmodern3-Dgraphicstechnology
were developed at the University of Utah as part of a stream of research
initiated by Professors Ivan Sutherland and David Evans in the late 1960s.
Whileothercomputerscienceprogramswereteachinghightheory,theUtah
programwasfocusedonthepracticalchallengeofrendering3-Dimagesand
building flight simulators. The program produced an astounding number of
computer graphics superstars, including John Warnock, founder of Adobe
Systems; Nolan Bushnell, founder of Atari; Edwin Catmull, cofounder of
Pixar;andJimClark,founderofbothSiliconGraphicsandNetscape.
JimClarkwasatStanfordwhenheformedSiliconGraphicsInc.(SGI)in
1982. From its inception, SGI aimed to make the fastest high-resolution
graphicsworkstationsontheplanet.SGI’sinfluenceonthegraphicsindustry
wasimmense.Itnotonlyprovidedthehighestperforminggraphicshardware,
italsodevelopedaspecialgraphicslanguage(GL)thatbecamethestandard
for many in the industry. Together, SGI’s hardware and GL framed the
problem of 3-D graphics in a way that became the dominant logic in 3-D
graphics.Calledthegraphicspipeline, thisapproachrested on breakingthe
images in the scene into triangles, processing each triangle separately, and
puttingthembacktogetheragaintoformthefinalimage.Onefamoususeof
this technology was rendering the velociraptors in Jurassic Park. In 1992,
SGI finally realized the whole graphics pipeline in hardware—a system of
banks of processors tied to a “triangle bus.” Called the Reality Engine, the
machinestoodfourfeethighandwaspricedatover$100,000.
GAMERS
Bytheearly1990sitwasevidentthatchipswouldeventuallygetfastenough
todogood3-DgraphicsonaPC.Butwouldpeopleusethiscapability?And,
iftheydid,whatwouldtheyuseitfor?Expertsopinedthat,perhaps,people
wouldtakevirtualtripsto far-offcitiesvia 3-Dgraphics,orthatrealestate
agents would use 3-D graphics to give prospective buyers virtual walk-
throughsofhomes.But,asitturnedout,themarketwasdrivenbyadifferent
application.Thesuddenriseofviolent3-DactiongamesforthePCpulled3-
Dchipsontothemarket.
Once,visitingafriend’shome,Inoticedhisteenageson,Paul,playinga
game called Myst on a personal computer. Paul’s monitor showed a still
pictureofascene.PaulclickedontheimageofabridgeandtheCD-ROM
drivegroundforafewsecondsbeforetheimagechangedtoaviewfromthe
bridge. Music played, but nothing moved and each new scene took several
seconds to render. It was the summer of 1994 and Myst was then a very
populargameonpersonalcomputers.
Two weeks later, I visited again, and this time Paul was playing a game
called Doom. The image on the screen showed a monster dropping into a
room on a descending platform. The monster was firing red blobs at Paul,
whichstreakedacrosstheroom.Paulwasusingthemouseandkeyboardto
bobandweaveawayfromtheredblobs.Therewasnodelay.Witheachflick
ofhiswrist,theimageshiftedashescrambledaroundthisthree-dimensional
space. He ran through a door and down a corridor. The monster followed.
Paulduckedintoanalcove,poppingoutintothecorridortoletoffapistol
shotandthenbackintothealcovetoavoidreturnfire.Herepeatedthismove
threetimesandkilledthemonster.Thevisualeffectswerefastandtheoverall
effectwasawhite-knuckleadrenalinerush.
Paul’sfatherwasacomputerscientistattheprestigiousÉcoledesMinesde
Paris in Fontainebleau. Commenting on Doom, he said, “It is really
remarkable.Iwouldnothaveguessedonecouldrender3-Dgraphicsthatfast
onapersonalcomputer.Thereare programsthatdo3-D renderingonPCs,
buttheytakeminutesorevenhourstocreateascene,notmilliseconds.”
Doom was the brainchild of John Carmack and John Romero, who had
formedidSoftwarein1991.Theirhitcreations,especiallyDoomandQuake,
redefinedactiongames,introducedclevernewtechnologiesfordisplaying3-
D scenes on PCs, and moved the center of gravity of computer gaming
innovation from the console industry to the PC platform. In addition, id
Software was one of the first companies to adeptly exploit the then-new
Internet.ItdistributedDoom,togetherwithninelevelsofplay,withoutcost,
online. Once addicted to the game, a player could purchase the registered
versionandplayadditionallevels.Withfreedistributionovertheburgeoning
Internet,Doomwasanovernightsensation.
In1996,idSoftwareaddedonline competitiveplaytoits newlyreleased
gameQuake.Aplayer’sPC,runningQuakelocally,couldbeconnectedvia
theInternettootherplayerssothegroupcouldshareagame.Eachplayerwas
abletomoveandtoseethemovementsoftheothers’charactersinrealtime—
andtoattackthem.AfterQuake,mostPCactiongamesincludedonlineplay
asafeature.
Internetcompetitivegamingmadethequalityof3-Dgraphicsahigh-stakes
affair for the players. If you were a corporate executive reading research
reports on the graphics industry, or studying statistics on chip sales, you
would not appreciate this growing need. On the other hand, if you played
Quake online, you quickly discovered that having a poor graphics system
meantthatyourviewofthesituationwasunclearandoutofdate—“lagged”
in the jargon of the players—and you died over and over again. There is
nothinglikelife-or-deathstakestogenerate ademandforan edge,andthis
online struggle among teenage boys created a sharply focused demand for
high-performance3-Dgraphicschips.
Thefirstcompanytotapintothisdemand,andtherebycashinonPC-based
3-Dgraphics,was1994start-up3dfxInteractive.Formedbythreeengineers,
all alumni of Silicon Graphics, the company’s first add-on graphics board,
branded Voodoo, was tied to its own Glide proprietary graphics language.
Glidewasacut-downversionofSiliconGraphics’GLlanguage,simplifiedso
itcouldrunon3dfx’sdedicatedchipswithouthelpfromthecentralprocessor.
ThefirstgamewrittentouseGlidewasTombRaider,andtheVoodooboard’s
real-time 3-D images of Lara Croft were the hit of the 1996 Electronic
EntertainmentExpo.
When a product gives a buyer an advantage in competition with others, there will be an
especially rapid uptake of the product. When, for example, the first spreadsheet, VisiCalc,
appeared in 1979, it provided an edge to MBA students, financial analysts, and other
professionals who used it. VisiCalc was rapidly adopted and helped push personal computers
fromtheirhobbynicheintothemainstream.Similarly,interactiveonline3-Dgamingcreateda
demandfortheedgeprovidedbybetterandfaster3-Dgraphics.
3dfx’s idea of setting a de facto standard came right off the pages of Geoffrey Moore’s
influential 1991 book, Crossing the Chasm: Marketing and Selling Technology Products to
MainstreamCustomers.This book popularized academics’ concepts of “network externalities”
and “standards lock-in” and was the bible for people who wanted to be, or to spot, the next
Microsoft.Ifenoughgameauthorsbegantouse3dfx’sGlidelanguage,itwouldbecomethede
factostandardin3-Dgamingand3dfxwouldbecomethe“architecturalstandardsetter.”
STRATEGYATNVIDIA
Nvidia was formed in 1993, by Jen-Hsun (pronounced Jen-Sun) Huang,
CurtisPriem,andChrisMalachowsky.Huanghadbeenanengineer-manager
atLSILogic.PriemandMalachowskyhadbeenchieftechnologyofficerand
vicepresidentforhardwareengineering,respectively,atSunMicrosystems.
Atthattimetheindustrywasalivewithtalkaboutthecomingmultimedia
revolution.However,atthatmomentexistingaudiocardsworkedwithsome
softwareandnotothers.Therewasnostandardwaytocompressordisplay
video.CD-ROMdriveswerenotfullystandardizedandtherewasnostandard
atallfor3-Dgraphics.Microsoft’sWindows95andthewideuseofInternet
browserswereseveralyearsinthefuture.
Nvidia executive vice president of sales Jeff Fisher recalled that “the
originaldreamwastobetheSoundBlasterofmultimedia.”Thecompany’s
firstproduct,theNV1,introducedin1995,wasintendedtoestablishanew
multimedia standard. But its considerable audio capabilities were no better
thanthefast-movingcompetition’s,anditsquirky3-Dgraphicsapproachdid
notcatchon.TheNV1wasacommercialflop.
Facedwiththefailureofthecompany’sfirstproductandthesuddenriseof
3dfx,Jen-HsunHuangreformulatedthecompany’sstrategy.Keyinputscame
from a temporary technical advisory board made up of both insiders and
expertoutsiders.2
Thenewstrategywasasharpchangeindirection.Insteadofmultimedia,
the company would focus on 3-D graphics for desktop PCs. Instead of its
initialproprietaryapproachtographics,thecompanywouldembracetheSGI-
based triangle method. About the only thing that stayed unchanged was
Nvidia’scommitmenttobeinga“fabless”chipcompany,focusingondesign
andoutsourcingfabrication.
Progressinthesemiconductorindustrywasbasedonreducingthesizeofa
transistor.Smallertransistors meantmoretransistors per chip.Plus, smaller
transistors were faster and consumed less power. The whole semiconductor
industrycoordinatedaroundachievingahigherlevelofintegration,basedon
smaller transistors, about every eighteen months. This rate of progress was
calledMoore’slaw.Noonecouldjumpmuchaheadofthispacebecauseall
thetechnologies,fromphotolithographytoopticaldesigntometaldeposition
to testing, had to advance in lockstep. The industry called this pattern of
collectiveadvancethe“roadmap.”
Nvidia’stopmanagementanditstechnologyboardsketchedoutadifferent
road map, one that would push 3-D graphics performance at a much faster
rate than Moore’s law predicted. There were two factors crucial to making
thishappen.First,theyanticipatedalargejumpinperformancefromputting
more and more of the graphics pipeline onto a single chip. Second, most
manufacturers,suchasIntel,didn’tkeepcrammingthemaximumnumberof
transistorspossibleontoachip—theytookadvantageofincreasesindensity
tomakemorechipsperwafer,therebycuttingthecostofachip.Nvidia,by
contrast, planned to use that extra density to add more parallel processors,
boostingperformance—aconsequenceofusingtheUtah-SGI“trianglebus”
idea.
On the demand side, management judged that the market would buy
virtuallyallthegraphicsprocessingpowerthatcouldbeprovided.Therewas
nosharpcallforwordprocessorsorspreadsheetsthatranonehundredtimes
faster, but there was a very sharp demand for faster and more realistic
graphics. Chief scientist David Kirk put it this way: “There is a virtually
limitless demand for computational power in 3-D graphics. Given the
architectureofthePC,thereisonlysomuchyoucandowithamorepowerful
CPU.Butitiseasytouseuponetera-flopofgraphicscomputingpower.The
GPU[graphicsprocessingunit]isgoingtobethecenteroftechnologyand
valueaddedinconsumercomputing.”
With regard to a graphics language, Nvidia’s management judged that it
wouldbe self-defeating towork with 3dfx’s Glide. Therefore,they bet that
Microsoft’s new but unproven DirectX would become a workable high-
performancegraphicsstandard.Theymadethisassessmentaftermeetingwith
theDirectXteamandfindingthemtobegraphicsenthusiastswhowantedto
pushthefrontierasfastaspossible.
Finally, CEO Jen-Hsun Huang believed that Nvidia could construct an
advantage by breaking out of the industry’s eighteen-month cycle. He
reasonedthatsinceitlookedpossibletoadvancegraphicspowerthreetimes
fasterthanCPUpower,Nvidiacoulddeliverasubstantialupgradeingraphics
powereverysixmonthsinsteadofeveryeighteenmonths.
Thisisthepointwhereabadstrategistwouldhavewrappedtheconceptof
afaster development cyclein slogans aboutspeed, power,andgrowth, and
thensoughttocashinbytakingthecompanypublic.Instead,theNvidiateam
designed a set of cohesive policies and actions to turn their guiding policy
intoreality.
Thefirststepinexecutingtheguidingpolicywastheestablishmentofthree
separatedevelopmentteams.Eachwouldworktoaneighteen-monthstart-to-
market cycle. With overlapping schedules, the three teams would deliver a
newproducteverysixmonths.
Atwo-monthdelayinasix-monthcyclewasmuchmoreseriousthanthe
same delay in an eighteen-month cycle. Accordingly, the second set of
policiesweremeanttosubstantiallyreducethedelaysanduncertaintyinthe
developmentprocess.
Aserioussourceofpossibledelayswasadesignerror.Afterdesigninga
chip,thecompanypassedthedesigntoafabricator.Afteraboutonemonth,
engineersreceivedbackthefirstsamplesofactualchips.Ifbugswerefound
inthesechips,thedesignwouldhavetobechanged,newmaskswouldhave
tobecreated,andanew fabricationruninitiated.Toaddressthissource of
possible delays, Nvidia invested heavily in simulation and emulation
techniquesandorganizeditschipdesignprocessaroundthesemethods.
SuchtoolsweretheforteoffounderChrisMalachowsky,andhepushedthe
useofthesetoolsfortheformalverificationofachip’slogic.Still,evenifthe
logicaldesignwascorrect,problemsmightariseinthephysicalfunctioning
ofthechip—issuesrelatedtotimelagsintheflowofelectronsandtosignal
degradation. To protect against these kinds of problems, the company also
investedinthemoredifficulttaskofsimulatingtheelectricalcharacteristics
ofthechip.
Another area of delay and concern was the creation of software drivers.
Traditionally,driverswerewrittenbytheboardmakers,whocouldstartdriver
development only after receiving working chips from the chip maker. In
additionto the problemof delay, the new3-D graphics methodsdemanded
much more sophisticated drivers. Plus, board makers had mixed incentives
aboutcommunicatingdriverproblemsbacktothechipmaker.Forexample,if
Nvidiaweresellingchipstotwoboardmakers,eachwouldtendtokeepits
learningand bug fixestoitself, soasnot tobenefitthe otherboardmaker.
Finally,thecurrentpracticegenerateddifferentdriversforidenticalchipson
differentboards,greatlycomplicatingthetasksofkeepingdriverscurrentand
ofhelpingusersupdateolderdrivers.
To address these problems, Nvidia took control of the creation and
managementofdriversforitschips,developingaunifieddriverarchitecture
(UDA). All Nvidia chips would use the same driver software, easily
downloadedovertheInternet.Thedriversoftwarewouldadaptitselftoeach
chipbyqueryingthechipabouttheactionsitsupported,andthenthedriver
wouldtailoritscommandstothatchip.Thisapproachwouldgreatlysimplify
thingsforusersbecausetheywouldnothavetobeconcernedwithmatching
driverstochips.Italsomeantthatdriverconstructionanddistributionwould
beproprietarytoNvidiaandtakenoutofthehandsoftheboardmakers.
To speed up driver development, the company made a significant
investmentinemulationfacilities.3Thesewerecomplexhardware“mockups”
of new chips that allowed driver development to begin four to six months
beforethefirsttruechipsappeared.
Thebenefitofafastercycleisthattheproductwillbebestinclassmoreoften.Comparedto
acompetitorworkingonaneighteen-monthcycle,Nvidia’ssix-monthcyclewouldmeanthatits
chipwouldbethebetterproductabout83percent of the time. Plus, thereis the constant buzz
surroundingnewproductintroductions,asubstituteforexpensiveadvertising.Asafurtherplus,
the faster company’s engineers will get more experience and, perhaps, learn more about the
tricksofturningthetechnologyintoproduct.
Implementing the new strategy, Nvidia invested its remaining cash in
emulationequipmentandinengineeringanewchip.ReleasedinAugust1997
as the RIVA 128, it received high marks from reviewers for its speed and
resolution,butmanyjudgedthatrival 3dfx’s Voodoohadsmootherimages.
Thechipwasamoderatesuccess,keepingthecompanyaliveandproviding
fundstopayformoredevelopment.
Withthenextnewchip,theRIVATNT,releasedin1998,Nvidiabeganto
hit its stride. Appearing in coordination with Microsoft’s new DirectX 6, it
wasthefirstchiptousethenewunifieddriverarchitecture.TheTNTandits
“spring refresh,” the TNT2, matched or surpassed the competition on most
measures.Seven monthsafterthe TNT2,Nvidia releasedthe GeForce256,
movingthe3-Dgraphicsindustryintonewterritory.GeForce256hadnearly
twenty-three million transistors, twice the complexity of Intel’s Pentium II
CPU.Itsfloatingpointcalculationcapacitywas50gigaflops,theequivalent
of the Cray T3D supercomputer. Chief scientist David Kirk told me: “At
Nvidia,ourtechnicalpathhasbeentocrawlupthegraphicspipeline.Ateach
stage we put more operations onto specialized silicon, where performance
improvedbyafactoroftencomparedtotheCPU.…WithGeForcewegotall
ofSiliconGraphics’pipelinestepsonone$100chip,runningfasterthanthe
RealityEngine,whichhadcost$100,000dollarsin1992.”
AsNvidiagainedleadershipinperformance,itbegantofocusevenmore
intensely on the problems of the delays, driver problems, and extra costs
created by its board makers. First, management tried to negotiate a new
arrangementwithDiamondMultimediabutwererebuffedbecauseDiamond
didnotwanttoseeadecreaseinitsmargins.
A senior team then traveled to Dell and made a presentation. They
described the obstacles created by current industry practices, showed the
economicbenefitsoftheunifieddriverarchitecture,andpointedoutthelower
pricescontractboardmanufacturerscoulddeliver.Dellreactedpositivelyand
agreed to offer boards with Nvidia chips, manufactured by Celestica Hong
Kong Ltd. In the months and years to come, Nvidia increasingly relied on
contractelectronicsmanufacturersforboardproductionanddistribution.The
contractmanufacturerswerefreetobrandtheboardastheychose;mostchose
toemphasizetheNvidianame.
Over the next five years, Nvidia continued its pattern of rapid releases,
pushing the envelope in 3-D graphics capabilities. During the 1997–2001
period, Nvidia obtained extraordinary gains from integrating the graphics
pipelineontoa singlechip, achievinga157percentaverageannual gain in
performance.* From 2002 to 2007, it achieved an annual performance gain
averaging 62 percent per year, about as much as was possible, given the
general movement of semiconductor technology. Intel CPUs, for example,
increasedtheirprocessingpower(millionsofoperationspersecond)atabout
thesamerateperyearduringthatperiod.Thedifferenceisthattheeffectsof
Intel’sperformanceincreaseshavebeensubstantiallydulledbyhardwareand
softwarebottlenecksitcannotcontrol.Ontheotherhand,asNvidia’sleaders
envisioned, the performance of graphics chips is experienced directly and
immediatelybyusers.Enthusiastscontinuedtowaitanxiouslyforeachnew
improvement.
Achangeintechnologywilloftensetinmotionachangeinindustrystructure.Inthiscase,
therelationshipbetweenthechipmakerandtheboardmakeraltered.Interestingly,fewforesaw
the importance of this shift. A standard approach to such a problem in established industries
would be to have certain board makers work directly with Nvidia’s emulators early in the
development cycle. This, however, would increase a board maker’s bargaining power and the
leakageofproprietaryknowledgetorivals.
WithregardtoDiamondMultimedia,Nvidiamanagementbelievedthattheshiftfrom2-Dto
3-DgraphicshadeliminatedmostofDiamond’straditionalvalueadded.Yetcompaniesdonot
slidequietlyintothedarkness.DiamondshouldhavemadethedealwithNvidia,butitelectedto
trytomaintainitshighmargins(about25percent).
Standard industry analysis would classify powerful buyers such as Dell as a negative for
Nvidia.ButwithoutpowerfulPCmakerssuchasDellandHP,Diamondmighthavemaintained
itsholdonretailchannels.ItwasthepoweroftheseconcentratedbuyersthatallowedNvidiato
skate around Diamond’s established brand. Note that, in general, if you have a “me-too”
product,youpreferfragmentedretailbuyers.Ontheotherhand,ifyouhaveabetterproduct,a
powerfulbuyersuchasDellcanhelpitseethelightofday.
THECOMPETITION
ForNvidia’sstrategyin3-Dgraphicstowork,otherfirmswouldhavetofall
bythewayside,notbeingabletokeepup.Toalargeextent,thatisexactly
what happened. Whenever a company succeeds greatly there is a
complementary story of impeded competitive response. Sometimes the
impedimentistheinnovator’spatentorsimilarprotection,butmoreoftenitis
anunwillingnessorinabilitytoreplicatetheinnovator’spolicies.Nvidiabet
thatitcouldrapidlychargeupthegraphicspipeline,butitalsobetthatkey
rivalswouldnotbeabletoreplicateitsfast-releasecycle.
Rival 3dfx followed spurious advice from Wall Street and the marketing
instincts of a new CEO, setting out after the mass market. Instead of
capitalizing on its leadership with enthusiasts, it allocated engineers away
fromthecuttingedgetoworkonlower-techboards,rampedupadvertisingin
imitation of the “Intel Inside” campaign, and bought board maker STB
Systems. Spreading its resources too thin, it attempted to compensate by
stretching the goals for its next high-performance chip beyond the
competencies of its development process. In the last months of 2000, 3dfx
closed its doors, selling its patents, brands, and inventory to Nvidia, where
many of its talented engineers wound up working. A surface reading of
history makes it look like 3dfx did itself in with too many changes of
direction.The deeper realitywasthat Nvidia’s carefullycrafted fast-release
cycleinduced3dfx’slesscoordinatedresponses.AsHannibaldidtoRomeat
Cannae,Nvidiaenticeditsrivalintooverreaching.
Rival Intel was unable to compete in the high-performance 3-D graphics
market. One of the world’s great companies, a technological powerhouse,
Intelwas,nevertheless,notinfinitelyflexible.Accordingtoindustryanalyst
Jon Peddie, “Intel developed the i740 with the same processes and same
approachthatitusedtodevelopitsCPUs.Thisdidn’tworkintheextremely
competitive 3-D graphics industry. Intel’s development cycle was 18–24
months,not6–12months.Itdidn’tadapttothisquickdevelopmentcycle.It
wasn’tabouttoredesignitswholedevelopmentandfabricationprocessjust
forasidelinebusiness.”4
Intel did, however, succeed in dominating the standard 2-D graphics
businessbyincorporatingitsofferingsinitsmotherboardchipsets.In2007,
Intel announced a second plan to enter the high-performance 3-D graphics
businessbutthencanceledtheprojectinDecember2009.
AtrivalSiliconGraphics,founderJimClarkleftthecompanyin1994.The
newCEO,Ed McCracken,aimedthefirmatsellinglargeworkstationsand
serverstocorporateAmerica,instructinghislieutenantsto“thinkoutofthe
box and figure out how to grow 50 percent.”5 They attempted to engineer
growththroughtheacquisitionofaraftofworkstationfirms.
ThechallengeforSGIanditsacquiredfirmswasthatWindows-Intel-based
workstations were gaining in power and surpassing those based on their
proprietaryprocessorsandoperatingsystems.Thestrategyofagglomeration
didnothingtomeetthatchallenge.SiliconGraphics,thefountofsomanyof
theideasandpersonnelthatsparked3-Dgraphics,neverenteredPC-based3-
Dgraphics. Oncehavinga marketcapitalizationof morethan $7billion,it
declaredbankruptcyin2006.
McCracken’s“growby50percent”isclassicbadstrategy.Itisthekindofnonsensethat
passesforstrategyintoomanycompanies.First,hewassettingagoal,notdesigningawayto
dealwithhiscompany’schallenge.Second,growthistheoutcomeofasuccessfulstrategy,and
attempts to engineer growth are exercises in magical thinking. In this case, the growth SGI
engineeredwasaccomplishedbyrollingupanumberofotherfirmswhoseworkstationstrategies
hadalsorunoutofsteam.
Nvidia’s one serious competitor was, and remains, ATI Technologies. At
first,ATIseemedtobeleftinthedustbyNvidia’ssix-monthreleasecycle.
Then,in2000, itboughtArtX, acompanyformed bystillanother cadreof
ex–SiliconGraphicsengineers.Thenewbloodmadeanimmediatedifference.
ATI moved to a six-month release cycle and began to introduce chips that
matched Nvidia’s in performance. In 2006, CPU maker Advanced Micro
Devices(AMD),Intel’sarchrival,orchestratedamergerwithATI.
PassingonArtXwasastrategicblunderbyNvidia.Thenetworkofhumancapitalinthis
industry was sparse and well understood. Had there been many pockets of talent like ArtX,
acquiring it would make no sense. But even though Nvidia did not need the extra expertise,
acquiringitwoulddenythesescarcecompetenciestoacompetitor.
WHATNEXT?
Nvidia’schosenfieldisoneofthefastestmovingandmostcompetitiveonthe
planet.Itssuccessfulstrategyof1998–2008doesnotensureenduringsuccess.
In particular, by 2009 the waves of change Nvidia had exploited in its rise
werewaning.TheSGIpipelinewasfullyrealized.Mostgamersarenolonger
waiting breathlessly for the next graphics chip. DirectX had become so
complexthatfewgamecompaniescanmasterallofitsfeatures.
Strategically, Nvidia is presently engaged in a two-pronged pincer
movement.Oneinitiativehasbeenopeningupaccesstothecomputingpower
ofitsgraphicschips.Eachgraphicsprocessorcontainshundredsofseparate
floating-pointprocessors.Itsnewhardwaresupportingthisconceptiscalled
Telsa and delivers desktop supercomputing. In November 2010, Chinese
researchers announced the world’s fastest supercomputer—powered by
Nvidia’sTeslagraphicschips.
ThesecondarmofthepincerisTegra—acompletesystemonachip.This
tactic is called “disruption from below” and aims to upset the Intel-AMD-
Windowshegemonybybuildingonamuchsimpler,moreefficientplatform.
The chip is aimed at the makers of smart phones, netbooks, and game
consoles. In a demonstration, Nvidia showed a lightweight Tegra-based
devicecapableofplayinga high-definitionmovie fortenhourson asingle
batterycharge.
Thispincermovementofferstwowaystosucceedandmakestrouble for
competitors.Butthereare manydifficultiesonbothpaths,and botharefar
fromsurethings.
PARTIII
THINKINGLIKEASTRATEGIST
In creating strategy, it is often important to take on the viewpoints of
others,seeinghowthesituationlookstoarivalortoacustomer.Advicetodo
thisisbothoftengivenandtaken.Yetthisadviceskipsoverwhatispossibly
themostusefulshiftinviewpoint:thinkingaboutyourownthinking.
Ourintentionsdonotfullycontrolourthoughts.Webecomeacutelyaware
of this when we are unable to suppress undesired ruminations about risk,
disease,anddeath.*Agreatdealofhumanthoughtisnotintentional—itjust
happens.Oneconsequenceisthatleadersoftengenerateideasandstrategies
withoutpayingattentiontotheirinternalprocessofcreationandtesting.
This section of the book presents a number of ways of thinking about
thinkingthatcanhelpyoucreatebetterstrategies.Chapter16,“TheScience
of Strategy,” explores the analogy between a strategy and a scientific
hypothesis.Eachisaninductiveleapthatmustbesubjectedtobothlogical
andempiricaltestsbeforeitsvaliditycanbeascertained.Chapter17,“Using
Your Head,” presents some specific techniques that can be helpful in
expandingthescope ofyourthinking aboutstrategyandinsubjectingyour
ideastodeepercriticism.Chapter18, “KeepingYour Head,” is designedto
sharpenyoursensitivitytotheneedtoformanindependentjudgmentabout
important issues. It tells the stories of the Global Crossing debacle and the
financial crisis of 2008 to illustrate the ways in which many leaders and
analystsabandonedtheirjudgmenttotheexcitementsofthecrowd.
CHAPTERSIXTEEN
THESCIENCEOFSTRATEGY
Goodstrategyisbuiltonfunctionalknowledgeaboutwhatworks,what
doesn’t,andwhy.Generallyavailablefunctionalknowledgeisessential,but
because it is available to all, it can rarely be decisive. The most precious
functionalknowledgeisproprietary,availableonlytoyourorganization.
An organization creates pools of proprietary functional knowledge by
activelyexploringitschosenarenainaprocesscalledscientificempiricism.
Good strategy rests on a hard-won base of such knowledge, and any new
strategy presents the opportunity to generate it. A new strategy is, in the
languageofscience,a hypothesis,anditsimplementationisanexperiment.
Asresultsappear,goodleaderslearnmoreaboutwhatdoesanddoesn’twork
andadjusttheirstrategiesaccordingly.
STRATEGYISAHYPOTHESIS
Standinginthehangar-sizedHughesElectronicsfabricationfacility,Imarvel
atthehugecommunicationssatellite.Itgleamsandsparkleslikeajewel,each
part fashioned with exquisite precision. A modern cathedral, the eighteen-
thousand-pound device embodies the highest skills and knowledge of my
civilization.In it,the technologiesof orbitalmechanics, solar power, three-
axis orientation, and sophisticated computation, as well as the reception,
amplification,andbeamingofelectromagneticwavesoverentirecontinents,
arewoventogetherintoaworkingharmonythatwilllastdecadesunattended
instationaryorbit,22,500milesaboveEarth’ssurface.
IamworkingwithHughesElectronicstohelpmanagersdevelopstrategies
fortheirbusinesses:communicationssatellites,spysatellites,missilesystems,
and various other aerospace activities. My clients are engineers who have
risen to management positions by ability at performing, organizing, and
directingtechnicalwork.
I had started by having them look at various examples of competitive
strategy.Amonthlaterwedidashortstudyofthecommunicationssatellite
business.Todaywearediggingintotheproblemofcreatingstrategiesforthe
variousbusinessunits.Aswetrytomakeprogress,thereisagrowingsense
of frustration. Partway into the session, Barry, an experienced engineering
manager,speaksforseveralothers,saying:“Thisstrategystuffisnonsense.
Givemeabreak!Thereisnocleartheory.Look,whatweneedisawayof
knowingwhatwillhappenifwedoA,versuswhatwillhappenifwedoB.
Thenwe canwork outwhatwillbethe beststrategy.We areactually very
good at planning here. You can’t build a major aerospace system without
meticulousplanning.Butthisstrategystuffseemsvacuous.”
Barry’s attack hits home. I had once been an engineer, and I know an
engineerdoesn’tdesignabridgethatmightholditsload.Anengineerstarts
withcomplexityandcraftscertainty.Iknewwhatitwasliketobecareful,to
balanceliterallythousandsofconsiderationsinmakingasystemwork.Iknew
how maddening it was to move from that world to business, where an
executivecanchooseanactionbasedongutfeeland,evenayearlater,no
onewillknowwhetheritwasagoodchoice.
I search my mind for a response. Struggling for an answer, I make a
connectionbetweenbusinessstrategyandtheprocessofscience:
Where does scientific knowledge come from? You know the process. A good scientist
pushestotheedgeofknowledgeandthenreachesbeyond,formingaconjecture—ahypothesis—
abouthowthingsworkinthatunknownterritory.Ifthescientistavoidstheedge,workingwith
whatisalreadywell knownandestablished,lifewillbecomfortable, butthere willbeneither
famenorhonor.
Inthe sameway,a goodbusinessstrategy dealswiththe edgebetween theknownand the
unknown.Again,itiscompetitionwithothersthatpushesustoedgesofknowledge.Onlythere
arefoundtheopportunitiestokeepaheadofrivals.Thereisnoavoidingit.Thatuneasysenseof
ambiguityyoufeelisreal.Itisthescentofopportunity.
In science, you first test a new conjecture against known laws and experience. Is the new
hypothesis contradicted by basic principles or by the results of past experiments? If the
hypothesissurvivesthattest,thescientisthastodeviseareal-worldtest—anexperiment—tosee
howwellthehypothesisstandsup.
Similarly,wetestanewstrategicinsightagainstwell-establishedprinciplesandagainstour
accumulatedknowledgeaboutthebusiness.Ifitpassesthosehurdles,wearefacedwithtryingit
outandseeingwhathappens.
Giventhatweareworkingontheedge,askingforastrategythatisguaranteedtoworkislike
asking a scientist for a hypothesis that is guaranteed to be true—it is a dumb request. The
problem of coming up with a good strategy has the same logical structure as the problem of
coming up with a good scientific hypothesis. The key differences are that most scientific
knowledge is broadly shared, whereas you are working with accumulated wisdom about your
businessandyourindustrythatisunlikeanyoneelse’s.
Agoodstrategyis,intheend,ahypothesisaboutwhatwillwork.Notawildtheory,butan
educatedjudgment.Andthereisn’tanyonemoreeducatedaboutyourbusinessesthanthegroup
inthisroom.
Thisconceptbreakstheimpasse.Aftersomediscussion,thegroupbegins
toworkwiththenotionthatastrategyisahypothesis—aneducatedguess—
about what will work. After a while, Barry starts to articulate his own
judgments,saying“Ithinkinmybusinesswecan…”
Whenengineersuseanicecleandeductivesystemtosolveaproblem,they
callitwindingthecrank.Bythistheymeanthatitmaybehardwork,butthat
the nature and quality of the output depends on the machine (the chosen
system of deduction), not on the skill of the crank winder. Later, looking
back, I realize the group had expected strategy to be an exercise in crank
winding.TheyhadexpectedthatIwouldgivethema“logicalmachine”that
theycould usetodeduce businessplans—a systemforgenerating forecasts
andactions.
ENLIGHTENMENTANDSCIENCE
Ifnewinsightsorideasarenotneeded,deductionissufficient.Therecanbe
times when results are fine, when no new opportunities seem to have
developedandnonewriskshaveappeared.Then,thelogicalanswertothe
strategyquestionissimply“Keepitup,domoreofthesame.”Butinaworld
of change and flux, “more of the same” is rarely the right answer. In a
changing world, a good strategy must have an entrepreneurial component.
That is, it must embody some ideas or insights into new combinations of
resourcesfordealingwithnewrisksandopportunities.
The problem with treating strategy as a crank-winding exercise is that
systemsofdeductionandcomputationdonotproducenewinterestingideas,
no matter how hard one winds the crank. Even in pure mathematics, the
ultimatedeductivesystem,statingandprovinganinterestingnewtheoremis
aprofoundlycreativeact.
Treatingstrategylikeaproblemindeductionassumesthatanythingworth
knowing is already known—that only computation is required. Like
computation, deduction applies a fixed set of logical rules to a fixed set of
known facts. For example, given Newton’s law of gravity, one can deduce
(calculate)theperiodofMars’sorbitaroundthesun.Orgiventhecostsand
capacitiesoftankers,pipelines,andrefineries,onecanoptimizetheflowof
oilandrefinedproductwithinanintegratedoilcompany.Ifeverythingworth
knowingisalreadyknown,theproblemofactionreducestocrankwinding.
The presumption that all important knowledge is already known, or
availablethroughconsultationwithauthorities,deadensinnovation.Itisthis
presumption that stifles change in traditional societies and blocks
improvement in organizations and societies that come to believe that their
wayisthebestway.Togenerateastrategy,onemustputasidethecomfort
and security of pure deduction and launch into the murkier waters of
induction,analogy,judgment,andinsight.
Todaywe findit hardtocomprehendthatreason slumberedinthe Western
world for more than a thousand years. After the fall of Rome, inquiry was
blocked by the omnipresent assumption that all important knowledge had
already been revealed. Intellectual energy was channeled toward faith, art,
battle,andself-discipline.Then,intheseventeenthcentury,somethingtruly
remarkablehappened:WesternEuropecamealivewithargumentanddebate.
Men searched for first principles in science, politics, and philosophy,
purposefully pushing aside the authority of power, faith, and custom. The
periodhasbecomeknownastheEnlightenment(1630–1789).Theleadersof
the Enlightenment—Descartes, Hobbes, Hume, Jefferson, Leibniz, Locke,
Newton,Paine,Smith,andVoltaire,tonameafew—werethefirsttosurpass
thehighpointofrationalinquiryachievedtwothousandyearsearlier,inthe
eraofPlatoandAristotle.
TheintellectualtriggerfortheEnlightenmentwasGalileoGalilei’sheresy
trial.BorninPisa,Italy,GalileoheldapositioninmathematicsinVenice.In
1609, word of a spyglass invented by the Dutch reached him. He thought
throughtheopticsofsuchadeviceandgroundlensestobuildhisown,better
thananythingtheDutchhad.Lookingatthenightsky,hemadeastounding
discoveries within a matter of weeks—he was the first to see and report
mountainsonthemoon,theindividualstarsoftheMilkyWay,thephasesof
Venus,andthefourlargestmoonsofJupiter.
At that time two distinct theories of celestial motion competed for
acceptance: The Ptolemaic (sometimes called Aristotelian) held that Earth
wasthe stillcenter andthattheheavensrevolvedaboutit. Bycontrast, the
Copernicanviewheldthatthesunwasthecenter,thestarsimmobile,andthat
Earth and the other planets revolved about the sun. Most practicing
astronomers were Copernicans because the system gave more accurate
predictions. Although the heliocentric model contradicted a number of
biblicalpassages,thechurchinRomehadtreatedtheastronomers’useofthe
theoryasasetofproceduresforcalculationratherthanasaworldview.
WiththespreadingfameofGalileo’sdiscoveries,Europeandinnerchatter
turnedtoastronomyandtotheCopernicantheory.ToGalileo,thephasesand
motion of Venus showed that it orbited the sun, not Earth, and his careful
measurementsoftheperiodsofJupiter’smoonssuggestedthatEarthdidas
well. In 1616, Galileo wrote “Letter to the Grand Duchess Christina,”
attacking the Ptolemaic system. The cardinals of the Inquisition ruled that
Galileo’spositionwas forbiddenbuttook noaction.In 1630,Galileoagain
wroteonthesubject.ThistimetheInquisitionsentencedhimtoarrestforthe
restofhislife.HewasorderednottobelieveintheCopernicansystemorto
writeaboutit.
The story of Galileo sped through Europe. Galileo’s name became a
rallyingcryforthoseseekingtobreakthemanaclesonthoughtimposedby
churchandstate.Hediedunderhousearrestin1642.Atthatmoment,John
Locke,thetoweringphilosopheroftheEnlightenment,wastenand,notquite
oneyearlater,IsaacNewtonwasborn.*Newtonwouldinvent calculusand
showthattheplanets’orbitsaboutthesunobeyedanaturallawmoreprecise
andlessforgivingthanthecommandsofanycardinal,pope,orking.Locke
wouldextendtheconceptofsuchnaturallawstosocietyandproclaim,“The
naturallibertyofmanistobefreefromanysuperiorpoweronearth,andnot
tobeunderthewillorlegislativeauthorityofman,buttohaveonlythelawof
Nature for his rule.”1 It was Locke’s natural liberty that, a century later,
Thomas Jefferson penned into American history when he wrote “We hold
these truths to be self-evident, that all men are created equal, that they are
endowedbytheirCreatorwithcertainunalienablerights,thatamongtheseare
life,libertyandthepursuitofhappiness.”
Ifthoughtisfreedfromthebondsofhumanauthority,howdopeopleknow
whattobelieve?TheEnlightenment’sanswerwasscientificempiricism—we
believe our senses and the data our instruments report to our senses. A
scientist tests a belief by experiment or by the analysis of real-world data.
With false beliefs thrown aside, we shall be left with the truth. This is the
centerpieceofscientificthinking—theideaofrefutation.Unlessanideacan
possiblybeprovedfalsebyobservablefact,itisnotscientific.Otherkindsof
knowledge,suchasself-knowledgeandspiritualinsight,arenotruledout,but
suchknowingsarenotscientific.
Inscience,anewideaortheoryiscalledahypothesis,afancywordfora
testableexplanationforsomethingthathappens.(Ofcourse,betterscientists
have better hypotheses.) The new theory cannot have been deduced from
existingknowledge,elseitwouldn’tbenew!Itarisesasaninsightorcreative
judgment.Theheartofthescientificmethodisthattheworthofahypothesis
is determined by empirical data drawn from the physical world, not by the
author’spopularity,caste,orwealth.Thatistheradicalrevolutionwroughtby
theEnlightenment.
Astrategyis,likeascientifichypothesis,aneducatedpredictionofhowthe
worldworks.Theultimateworthofastrategyisdeterminedbyitssuccess,
notitsacceptabilitytoacouncilofphilosophersoraboardofeditors.Good
strategyworkisnecessarilyempiricalandpragmatic.Especiallyinbusiness,
whatevergrandnotionsapersonmayhaveabouttheproductsorservicesthe
world might need, or about human behavior, or about how organizations
shouldbemanaged,whatdoesnotactually“work”cannotlongsurvive.
In science one seeks explanations for broad classes of events and
phenomena;inbusinessoneseekstounderstandandpredictamoreparticular
situation. But the lack of universality does not make business unscientific.
Science is a method, not an outcome, and the basic method of good
businesspeopleisintenseattentiontodataandtowhatworks.
ANOMALIES
Ananomalyisafactthatdoesn’tfitreceivedwisdom.Toacertainkindof
mind,ananomalyisanannoyingblemishontheperfectskinofexplanation.
Buttoothers,ananomalymarksanopportunitytolearnsomething,perhaps
something very valuable. In science, anomalies are the frontier, where the
actionis.
When I was a graduate student living on a tight budget, an enlarged
photograph of M31, the Great Nebula in Andromeda, served as my living
roomdecoration.Thisfamiliarimageshowsaflattishdisklikespiral,tiltedup
ontherightbyabout30degrees,withabrightbulbouscentralcore.M31isa
galaxy—a collection of stars, gas, and dust slowly rotating in space. The
typical galaxy contains billions of stars, and the visible universe contains
about125milliongalaxies.
From a great distance, our own Milky Way galaxy would probably look
somethinglikeM31.IntheMilkyWay,oursun,Sol,liesaboutone-thirdof
the way out from the center, in what is called the Orion Arm. Sol and her
planetsorbitthecoreofthegalaxyonceevery240millionyears,travelingat
aspeedof137milespersecond.Starsfartheroutfromthecentertakelonger
thanSol tocompletearevolution;thosecloserto thecenter completetheir
orbitsaboutthecoremorequickly.
Sincemy daysin graduateschool, amajor anomalyhas beendiscovered
with regard to galaxies like ours and M31. Because most of the mass of a
galaxy lies in its dense bright core, the theory of gravity predicts that stars
fartheroutfromthecoreshouldnotonlytakelongertoorbitthecore,they
shouldalsotravelmoreslowlythroughspaceintheirlongerorbitsaroundthe
core. More precisely, a star’s speed in its swing about the core should be
proportionaltotheinversesquarerootofitsdistancefromthecenter.Astar
one-halfasfaroutfromthecoreasSolshouldspeedthroughspaceatfour
timesSol’sspeed.Butmeasurementsofmanygalaxiesbegantoappearinthe
early1980sshowingthatalmostallofthestarsinthespiralorbitataboutthe
same speed, regardless of their distance from the core! Galactic “rotation
curves”wereflat.Thisistrulyahugeanomaly.Somethingverybasicabout
ourworldviewseemswrong.
Thispuzzleofgalacticrotationdrivesagreatdealofmodernresearchin
astronomy.Twohypothesesarepresentlyunderinvestigation.Thefavoriteis
thatthe glowing starmatter wephotograph is onlyabout 10percentof the
physicaluniverse—therestis“darkmatter”—notsimplyunlightedmatter,but
aspecialkindofmatterthatdoesn’tinteractwithlight.Byimagininggalaxies
asembeddedinaninvisibleblobofdarkmatter,theanomalyisresolvedby
thegravityofthishiddendarkmass.But,ofcourse,thisleavesopenagreat
manyotherquestionsaboutthehypothesized darkmatter.Theothertheory,
lesspopular,isthatreceivedtheoriesofgravity—Newton’sandEinstein’s—
are wrong. Thus, the simple facts of galactic structure lead in amazing
directions—eithermostoftheuniverseisinvisibledarkmatter,orgravitation
theoryisincorrect.
Ananomalylikethisappearsthroughcomparison.MerelylookingatM31
does not suggest puzzles other than the overall mystery of creation. But as
Sherlock Holmes said to Watson, “You see, but you do not observe.” The
anomaliesarenotinnaturebutinthemindoftheacuteobserver,revealedby
acomparisonbetweenthefactsandrefinedexpectations.
ESPRESSOANOMALY
In 1983, Howard Schultz noticed an anomaly and from that insight a
fascinatingnewbusinesswaseventuallyborn.Atthattime,Schultzwasthe
marketing and retail operations manager for a tiny chain of Seattle stores
sellingdark-roastedcoffeebeans.OnavisittoItaly,Schultzdiscoveredthe
Italian espresso experience. He recalled his first visit to an espresso bar in
Milan:
Atallthinmangreetedmecheerfully,“Buongiorno!”ashepresseddown onametalbar
andahugehissofsteamescaped.Hehandedatinyporcelaindemitasseofespressotooneofthe
three people who were standing elbow to elbow at the counter. Next came a handcrafted
cappuccino,toppedwithaheadofperfectwhitefoam.Thebaristamovedsogracefullythatit
lookedasthoughheweregrindingcoffeebeans,pullingshotsofespresso,andsteamingmilkat
thesametime,allwhileconversingmerrilywithhiscustomers.Itwasgreattheater.…
It was on that day I discovered the ritual and romance of coffee bars in Italy. I saw how
populartheywere,andhowvibrant.Eachonehaditsownuniquecharacter,buttherewasone
commonthread: the camaraderie between the customers, who knew each other well, and the
barista,whowasperformingwithflair.Atthattime,therewere200,000coffeebarsinItaly,and
1,500aloneinthecityofMilan,acitythesizeofPhiladelphia.2
Witharetailer’seye,Schultzalsonoticedtherapidcustomerturnoveratthe
espressobarsandtherelativelyhighpricesbeingpaidforcoffee.
ForSchultz,theexperienceinMilanwasananomaly.InSeattle,themarket
fordark-roastedarabicabeanswasaniche,populatedbyasmallbutgrowing
group of especially discerning buyers. But the vast majority of people in
Seattle,andinAmerica—eventhewell-to-do—drankcheap,blandcoffee.In
Milan,expensivehigh-qualitycoffeewasnotanicheproductbutthemass-
marketproduct.Andtherewasafurtheranomaly:intheUnitedStates,fast
food meant cheap food and plastic surroundings. In Milan he saw “fast
coffee” that was expensive and served in a lively social atmosphere, so
different from that of an American Main Street diner or coffee shop.
Americans, especially those in the Northwest, were at least as wealthy as
Italians.Whyshouldtheydrink“bad”coffeeandnotenjoythepleasuresof
anespressolatteinasocialsetting?
Schultz formed a strategic hypothesis—the Italian espresso experience
couldbere-createdinAmericaandthepublicwouldembraceit.Hereturned
toSeattleandexplainedhisideatothetwoownersofthecompanyheworked
for—the Starbucks Coffee Company. They listened and gave him a small
spacetotrytobrewupespressodrinks,buttheydidnotsharehisbeliefinthe
project.TheythoughtthatStarbucks’strengthsandpurposewereinbuying,
roasting,andretailingfinearabicacoffees,notinrunninganespressobar.In
addition, they thought that espresso coffee restaurants were nothing new,
beinganichebusinessfrequentedbybohemians,beatniks,hippies,andGen
Xnocturnals,dependingontheera.
COFFEEDIVERGENCE
WhenHowardSchultzpitchedhisproposaltotheownersofStarbucks,the
coffeeshopwashardlyanewidea.Arabsbegantobrewcoffeesixhundred
years ago, and the first European coffee shop opened its doors in Oxford,
England, in 1652 when Isaac Newton was ten years old. The cause of the
EnlightenmentmayhavebeentheCopernicanrevolution andtheProtestant
Reformation,butcoffeewasitsdailyfuel.
In England, coffeehouses developed a unique culture, far different from
thatoftaverns.Incoffeehouses,apennywouldbuyatablefortheday,with
entrancepermittedtoanyonewithgoodclothes.Insteadofinebriatedrevelry,
ormoroseself-reflection,coffeehousesstimulatedenergetictalkanddebate.
Books and newspapers were available there, and many people used
coffeehousesastheirpostaladdresses.NewtonfrequentedtheGrecian(where
he was seen to dissect a dolphin); John Dryden held forth at Will’s. Much
later,AdamSmithfinishedTheWealthofNationsattheBritishCoffeeHouse
(Cockspur Street) that was a London hangout for Scottish thinkers. Joseph
Addison,AlexanderPope,andJonathanSwiftheldforthatButtons.
In England, tea eventually replaced coffee as the daytime beverage of
choice. London coffeehouses gradually disappeared, morphing into private
clubs, restaurants, and businesses. Edward Lloyd’s coffeehouse became
LloydsofLondonandJonathan’scoffeehousein“ChangeAlley”becamethe
LondonStockExchange,whererunnersarestillcalled“waiters.”
IntheUnitedStates,historytookadifferentcourse.TheBostonTeaParty,
theRevolution,andtheWarof1812interruptedtradeintea,revivinginterest
incoffee.Americansfoundincoffeeaninexpensiveteasubstitutethatcould
bedrunk inquantity.By1820, thetransition wascomplete, andthe United
Statesbecamethelargestmarketforcoffeeintheworld.
Intheearlytwentiethcentury,analternativetotheoriginalEthiopiancoffee
tree(arabica)wasfoundintheCongo—therobustacoffeeplant.Therobusta
plant grew faster, was more disease resistant, was easier to harvest, and
containedmorecaffeine.Italsohadaharsher,lessmellowtaste.Butmixing
robustawitharabicatookoffmuchoftheharshedge,especiallyifyouadded
sugarandcream.Thenewinexpensivebeanwasthekeytosuperchargingthe
growingAmericancoffeehabit.Instantcoffeewasthefinalstepinthepath
that took American coffee-drinking practices a great distance from their
Europeanorigins.
WhileAmericansweredevelopingrobustaandinstantcoffee,ItalianLuigi
Bezzera invented the espresso machine (1901). This device made a cup of
coffeebypassinghotsteamthroughachargeofground-roastedcoffeebeans.
The reaction of the steam and the coffee produced a rich, almost syrupy,
beverage. The theory was that the quick brewing time prevented the
extractionofbittercoffeeoils andreducedtheamountof caffeine. Asmall
porcelain cup of Italian espresso has a brown foamy crema on its surface,
which fades within a minute. The crema layer traps aromatics and volatile
flavors. The drink could not be easily prepared at home as it needed high-
pressuresteamandexpensiveequipmentandwasquitelaborintensive.Italian
espressobarsbecamepopularplacesforaquickpick-me-upandurbansocial
interaction.
TESTINGTHEHYPOTHESIS
AdeepproblemSchultzfacedwasthathisvisionrequiredaradicalchangein
consumer tastes and habits. What he observed in Milan was not just a
differentbusinessmodelbuttheresultofseveralhundredyearsofdivergent
social history. In the United States, coffee had emerged as a bland tea
substitute to be drunk both at meals and at breaks throughout the day. In
southernEurope,coffeewasanalcoholsubstitute,takeninsmallstrongdoses
atlively“bars.”Whetherheknewitornot,Schultzwantedtodomorethan
justopenacoffeeshop;hewantedtochangeAmericantastesandhabits.
Schultz’ssecondproblemwasthatthereseemednothingnewaboutcoffee,
espresso, coffee bars, or espresso shops. Millions of other Americans had
traveledtoItalyandexperiencedItalianespressobars.Knowledgeaboutthese
businesses was hardly privileged. To expect to make money from a new
business,theentrepreneurshouldknowsomethingthatothersdonot,orhave
controlofascarceandvaluableresource.Thedelicacyinthesituationwas
that Schultz’s proprietary information was only a glimmer in his mind, a
mood, a feeling. Others, exposed to exactly the same information and
experiences,did not have thisinsight or feeling.The privacy ofhisinsight
was both blessing and curse. Were it easily shared with others, Schultz
himselfwouldhavebeenirrelevant.Butbecauseitcouldnotbefullyshared,
itwasdifficulttoconvinceotherstobacktheproject.LuckilyforSchultz,his
hypothesis could be tested without a vast investment. Opening a single
espresso bar would cost several hundred thousand dollars, but not the
hundredsofmillionsorbillionsthatsomeventuresrequire.
Aftersometime,SchultzleftStarbuckstostarthisownshop(IlGiornale).
ThenewshopwasadirectcopyofanItalianespressobar.Init,he“didn’t
want anything to dilute the integrity of the espresso and the Italian coffee
experience.”3Theseven-hundred-square-footspacehadItaliandecorandno
chairs—it was a stand-up bar just like the bars in Milan. Shots of espresso
wereservedinsmallporcelaincups.Operamusicplayedinthebackground,
thewaitersworeformalshirtsandbowties,andthemenuwaspepperedwith
Italian.
HadSchultzstucktothisinitialconcept,IlGiornalewouldhaveremaineda
singlesmallespressobar.But,likeagoodscientistwhocarefullystudiesthe
resultsofexperiments,Schultzandhisteamwerealerttocustomerresponse.
IlGiornale,oncestarted,becamealivingexperiment.
One of the most important resources a business can have is valuable
privilegedinformation—thatis,knowingsomethingthatothersdonot.There
isnothingarcaneorillicitaboutsuchinformation—itisgeneratedeveryday
in every operating business. All alert businesspeople can know more about
their own customers, their own products, and their own production
technology than anyone else in the world. Thus, once Schultz initiated
businessoperations,hebegantoaccumulateprivilegedinformation.
Asknowledgeaccumulated,healteredpolicies.HetooktheItalianoffthe
menu,theneliminatedtheoperamusic.Heknewthebaristaswerecentral,but
he did away with their vests and bow ties. He departed from the Milanese
model and put in chairs for the sit-down trade. Over more time, Schultz
discovered that Americans wanted takeout coffee so he introduced paper
cups.Americanswantednonfatmilkintheirlattes,so,afteragreatdealof
soulsearching,heallowednonfatmilk.Inthetechnicaljargonofinternational
business,hegradually“localized”theItalianespressobartoAmericantastes.
In1987,hiscompanyboughtoutStarbucks’retailoperationsandadopted
theStarbucks name. Thenew firm combinedthe old Starbucksbusiness of
selling dark-roasted arabica coffee beans with the new one of operating
espressobars.By1990,thecompanywasprofitable.In1992,itwentpublic
with125storesandtwothousandemployees.
By2001,StarbuckshadbecomeanAmericanicon,with4,700worldwide
outletsand$2.6billioninrevenue.Thebulkofitsrevenuescamefromselling
coffee drinks—the company called them handcrafted beverages. The rest
camefromthesaleofcoffeebeans,someotherfooditemsinitscoffeebars,
andlicensingagreementswithfood-service firms.Onlya fewyears before,
“coffee”hadbeenseventy-fivecentsandcameinaplasticfoamcup.Nowthe
urbanlandscape is pepperedwith Starbucks outlets,and the sightof young
professionals sipping pint-sized three-dollar takeout lattes has become
commonplace.
HowardSchultzenvisionedanItalianespressobarinSeattle.Hetestedthis
hypothesisandfounditwanting.Butthetestproducedadditionalinformation,
sohemodifiedhishypothesisandretested.Afterhundredsofiterations,the
original hypothesis has long since vanished, replaced by a myriad of new
hypotheses, each covering some aspect of the growing, evolving business.
This process of learning—hypothesis, data, anomaly, new hypothesis, data,
and so on—is called scientific induction and is a critical element of every
successfulbusiness.
CAPTURINGPROPRIETARYINFORMATION
OneelementofStarbucks’successwasthatmanypeoplewerewillingtopay
premiumpricesforits“handcrafted”beveragesservedinurbanoasissettings.
Butyoushouldalwaysconsiderthecompetition.Whatkeptthecompetition
atbay forso manyyears? Inthe springof2001,seekingananswerto this
question,ItraveledtoParisandtalkedtoJoeSantos.Joewasthenastrategy
instructoratINSEAD,theinternationalschoolofmanagementinFrance.But
before he joined the academy, Joe Santos had been the CEO of Segafredo
Zanetti,amajorItaliancoffeecompanyandanimportantEuropeansupplier
ofespressoroaststorestaurantsandespressobars.
“Joe,”Iasked,“espressocoffeewasyourspecialtyandthespecialtyofa
number of big European companies. Why did Starbucks pick up this
opportunityratherthanoneofthebigespressoroasters?Surelyyousawwhat
washappeningbythelate1980s?”
In response, Joe explained that it was difficult to react because the
EuropeanindustryhaddifficultyunderstandingStarbucks:
WewereawareofStarbucks,butyoumustunderstandtheissueofscale.Segafredosupplies
over fifty thousand different cafés and restaurants each week. That is a huge volume, and
Starbuckswasquitesmall.AndthelargeAmericanroasters,Kraft,SaraLee,andP&G,wereall
focusedonthemassmarket.*
Itwasalsodifficult,fromaEuropeanperspective,tounderstandexactlywhatStarbuckswas.
In Europe, coffee roasters are distinct from restaurants. Although Starbucks was known as a
coffeecompany,itwasreallyaretailer.McDonald’sisaretailer,butitisneverconfusedwitha
“beef”company!YetStarbuckswascalleda“coffeecompany,”andAmericansseemedtothink
thatitscoffeewasspecial.
Europeans see Starbucks as “American coffee.” Americans think Starbucks is an Italian
espresso bar. But at an Italian espresso bar, everyone drinks standing up at the bar; almost
everyonetakesasmallcupofpureespressoinatinyporcelaincup.Café-latteisforbreakfast
only,orforchildren.Thereisnotakeout;therearenotables.Thecoffeeisnotarestaurantbrand
butissuppliedby oneof themajorcoffeecompanies,like Segafredo.Finally,Italianespresso
barsaresmallfamilybusinesses,notpartsofagiantchain.
Bycontrast,atStarbuckspeopledrinkcoffeeattablesortakeitout.Theydrinkfrompaper
cupsandthereisaverylong,complexmenuofdrinksEuropeanshaveneverheardoforwanted.
ThecoffeeisallStarbucks’ownbrandandthestoreiscompanyowned.Andalmostallofthe
drinksaremilkbased.Infact,viewedfromEurope,Starbucksismoreofamilkcompanythana
coffeecompanyandmostofitsdrinksaresimplycoffee-flavoredmilk.
Andthen,Starbucksmarriedtogethernotonlycoffeeandrestaurants,butalsotheAmerican
penchantforchainsandpublicfinancing.ItexpandedmuchfasterthanEuropeancompanies.By
the time we began to understand Starbucks, it was well established. But you should also
understandthatStarbucksisstillasmallplayerintheoverallworldcoffeebusiness.
JoeSantos’scommentsimplythatincumbentshaddifficultyunderstanding
Starbucksbecauseitwasvertically integrated—becauseitroasted, branded,
andserveditsowncoffeeinitsowncompanyrestaurants.Starbucksdidnot
verticallyintegratetopurposefullyconfusethecompetition.Itdidsoinorder
tobeabletomutuallyadjustmultipleelementsofitsbusinessandtocapture
theinformationgeneratedbyeachelementofitsbusinessoperations.
Integrationisnotalwaysagoodidea.Whenacompanycanbuyperfectly
goodproductsandservicesfromoutsidesuppliers,itisusuallywastefultogo
through the expense and trouble of mastering a new set of business
operations.However,whenthecoreofabusinessstrategyrequiresthemutual
adjustment of multiple elements, and especially when there is important
learning to be captured about interactions across business elements, then it
maybevitaltoownandcontroltheseelementsofthebusinessmix.
CHAPTERSEVENTEEN
USINGYOURHEAD
I am twenty-five and nervous. Each doctoral student at the Harvard
BusinessSchoolisexpectedtowritecasesbasedonfieldinterviews.So,in
thesummerof1967,IaminLosAngeles,assignedtowriteastrategycase.
Sittingacrossfromaseniormanager’sdesk,Iholdayellowlegalpadanda
ballpointpen,butIhavenoideahowtoproceed.Noonehascoachedmeon
interviewingseniorexecutivesaboutstrategy.
FredFletcher,thegeneralmanagerofFansteelInc.’sAdvancedStructures
division, shows no sign that he has noticed my youth or inexperience. He
simply asks me how we should begin. I have to say something, so I say,
“Let’sstartwithwhatyouaretryingtoaccomplishhere.Whatisthepurpose
oftheAdvancedStructuresdivision?”
Fletchertellsmethatthedivisionischargedwithintegratingtheactivities
of six recently acquired firms, each a specialist in making things out of a
high-techmaterial(forexample,titanium,columbium,tungsten,fiber-epoxy
composites,andspecialtyceramics).Theideaistobringmoreofascience
base to these essentially craft-based enterprises and act like a general
contractorwithrespecttoaerospaceprimecontractors.
Iamsurprisedthatthesehigh-techbusinessesaresmallentrepreneurialjob
shops.FletcherexplainsthattheyhavegrownupintheLosAngelesareain
support of the aerospace industry. Universities don’t teach about real
fabricationissues, and neitherdo tradeschools.The large establishedfirms
haveskillsindesignbutlittleknowledgeaboutactuallyformingobjectsout
ofexoticmaterials.Basically,eachofthesebusinessesisrunbysomeonewho
has a special knack with a particular material, like making high-precision
castingsout of tungsten,or bodyarmorout ofceramics, or claddinga fuel
tankincolumbium.
Iaskabouthisexperiencesintryingtocombinetheseskillsor tojointly
sellthesecapabilities.Iaskaboutthecompetition.Iaskabouthisdivision’s
competitive strengths and its weaknesses. I ask him to describe the most
difficultmanagementissueshefaces.
Allinall,Iaskaboutsixorsevenquestionsandfillfifteenpagesofyellow
legalpadwithnotes.Thewholeinterviewlastsaboutthreehours.Whenitis
done,Fletcherstandsandshakesmyhand.“Ididn’tknowwhattoexpect,”he
says.“ButthatwasthemostusefulconversationI’vehadallyear.”
Forweeksafter,Iheldthatbafflingcommentupandexaminedit,turningit
over in my mind like an odd-shaped stone. There had been no real
conversation.AllIhaddonewasasktheobviousquestionsaboutstrategyand
write down his answers. How could that have been the most valuable
conversation of the year? Perhaps, I thought, Fletcher was glad to have
someone to talk to who wasn’t his boss, his subordinate, or a customer—
someonewhohadasimpleagendaandwhowashappyjusttolisten.
MAKEALIST
ItwasfifteenyearsbeforeIgenuinelyunderstoodFletcher’scomment.The
occasion was a lunch in Pittsburgh, in Republic Steel’s executive dining
room.Duringthemorning,Ihadmadeapresentationtotheboardofdirectors
ofRepublicSteel’sinsurancebusiness,ajointventurewithUK-basedHogg
Robinson.Atlunch,ourconversationturnedtotheglorydaysofPittsburgh
andtoAndrew Carnegie, theman who wasoncethe richest American,the
creatorofU.S.Steel.“Sinceyouareaconsultant,”myhostremarked,“you
willappreciatethisstory:”
Itwas1890,andtherewasacocktailpartyhereinPittsburgh.Allthemoversandshakers
werethere,includingCarnegie.Heheldcourtinacorneroftheroom,smokingacigar.Hewas
introducedtoFrederickTaylor,themanwhowasbecomingfamousasanexpertonorganizing
work.
“Young man,” said Carnegie, squinting dubiously at the consultant, “if you can tell me
something about management that is worth hearing, I will send you a check for ten thousand
dollars.”
Now,tenthousanddollarswasagreatdealofmoneyin1890.Conversationstoppedasthe
peoplenearbyturnedtohearwhatTaylorwouldsay.
“Mr. Carnegie,”Taylor said, “I would advise you to make alist of the ten most important
thingsyoucando.Andthen,startdoingnumberone.”
And,thestorygoes,aweeklaterTaylorreceivedacheckfortenthousanddollars.
Myimmediatereactiontothestorywaspuzzlement.Wasthisajoke?Why
would Carnegie pay ten thousand dollars for this advice? Making a list is
baby-steps management. Pick up any book on self-help, on organizing
yourself,oronthenutsandboltsofrunninganofficeororganization,andit
willprofferthisadvice:“Makealist.”Howcouldthatbeofanyrealusetoan
experienced businessperson? It was just too simple. Yes, we all make
shopping lists, but did Andrew Carnegie, a titan of industry, really benefit
frommakingalistofthetenmostimportantthingstodo?
Laterthatnight,Isawthattherewasadeepertruthinthestory.Carnegie’s
benefitwasnotfromthelistitself.Itcamefromactuallyconstructingthelist.
Theideathatpeoplehavegoalsandautomaticallychaseafterthemlikesome
kindofhomingmissileisplainwrong.Thehumanmindisfinite,itscognitive
resources limited. Attention, like a flashlight beam, illuminates one subject
onlytodarkenanother.Whenweattendtoonesetofissues,welosesightof
another.Peoplecanforgettocallsomeone.Youmayforgettobuymilkonthe
way home because you have attended to driving instead of shopping. And,
moreimportant,peoplecanforgettheirlargerpurposes,distractedbythepull
ofimmediateevents.Abusyprofessional,caughtupincareerbuilding,may
payscant attention tomarriage and children,regaining asenseof priorities
onlyafterdamagehasbeendone.ACEO,lockedincompetitionwithanother
bidder for a company, can lose track of the broader reasons for the
acquisition.
Given Frederick Taylor’s assignment, some people might have listed the
billstheyhadtopayorthepeopletheyneededtosee.Onecanonlyguessat
Carnegie’s list, but the ten-thousand-dollar payment suggests that it wasn’t
justalistoferrands.
Taken seriously, Taylor’s injunction was not simply to make a list of
important issues. It was not simply to make a list of things to do. And it
wasn’ttomakealistofwhatmightbeimportant.Taylor’sassignmentwasto
think through the intersection between what was important and what was
actionable.CarnegiepaidbecauseTaylor’slist-makingexerciseforcedhimto
reflectuponhismorefundamentalpurposesand,inturn,todevisewaysof
advancingthem.
Fletcher’scomment,madefifteenyearsbefore,suddenlymademoresense.
When I asked about his division’s purpose, its competitive strengths and
weaknesses,andthemanagementissueshefaced,hehadtoreflectandbring
theseissuestotheforefront.Theinterviewremindedhimabouthisbroader
situation and the things he had to do to move forward. He was essentially
remindedofhis“list”andvariousprioritiesduringourconversation.
Makingalistisabasictoolforovercomingourowncognitivelimitations.
The list itself counters forgetfulness. The act of making a list forces us to
reflectontherelativeurgencyandimportanceofissues.Andmakingalistof
“thingstodo,now”ratherthan“thingstoworryabout”forcesustoresolve
concernsintoactions.
Today,weareofferedabewilderingvarietyoftoolsandconceptstoaidin
analysisandtheconstructionofstrategies.Eachofthesetoolsenvisionsthe
challengeslightlydifferently.Forsomeitisrecognizingadvantage;forothers
it is understanding industry structure. For some it is identifying important
trends; for others it is erecting barriers to imitation. Yet, there is a more
fundamental challenge common to all contexts. That is the challenge of
working around one’s own cognitive limitations and biases—one’s own
myopia.Ourownmyopiaistheobstaclecommontoallstrategicsituations.
Beingstrategicisbeinglessmyopic—lessshortsighted—thanothers.You
mustperceiveandtakeintoaccountwhatothersdonot,betheycolleaguesor
rivals.Beinglessmyopicisnotthesameaspretendingyoucanseethefuture.
You must work with the facts on the ground, not the vague outlines of the
distant future. Whether it is insight into industry structures and trends,
anticipating the actions and reactions of competitors, insight into your own
competenciesandresources,orstretchingyourownthinkingtocovermoreof
thebasesand resistyourown biases,being“strategic”largelymeansbeing
lessmyopicthanyourundeliberativeself.
TIVO
Ateighta.m.thegroupofseventeenmanagerssettlesintotheroom.Itisa
rainyfalldayin2005,theseconddayofathree-dayprogram.Iamworking
withthegroupeachmorningonstrategy.Themostseniorexecutiveissitting
inthecenterofthefrontrow,agoodsign.Whentheseniorpersonsitsinthe
back, and to the side, I have learned that it generally signals an early exit
ratherthanengagement.
Today, we are studying TiVo, a much more complicated situation than
yesterday’s case. I start the session by joking that I saw some late-night
partyingandamworriedthatnoonehaspreparedthematerials.Iask,“Did
everyonedotheassignment?”
Theyallnodaffirmativelyorsay,“Yes.”
The assignment was to write one paragraph describing a recommended
strategyforTiVo.Theresponsesarenowstackedneatlyonthepodiuminthe
frontoftheroom.Ipointtothestackandsay,“Well,thenyoumusthaveall
seenthequickandeasysolutiontoTiVo’sproblems!”
They laugh because they all appreciate that the situation facing TiVo is
thorny. There are issues of technology, competition, intellectual property,
manufacturing efficiency, standards, bargaining with cable and satellite TV
providers,privacy,andtheroleoftelevisioninmarketing.
I have glanced briefly at their recommendations, having planned to
comparethesepre-discussioncommitmentstotheirpost-discussionviews,a
way of measuring the contribution of the discussion. But looking at these
short one-paragraph recommendations, I was struck anew by the variety of
judgment within even a homogeneous group like this one. Yesterday, this
group had proven to be unusually open and frank, less self-protective than
most.Idecidedtoworkwiththemonthinkingandjudgment.
“BeforewegetintoTiVo’ssituation,”Isay,“Iwanttobackupastepand
askyouaquestionthatwasnotontheassignmentfortoday.Iwanttoaskyou
howyouarrivedatyourrecommendations.Howdidyoucomeupwithyour
responsetothisassignment?”
Itisn’tthequestiontheyhavebeenexpecting,andthereisalongmoment
ofquiet.Peopleshiftintheirseatsandlookatoneanother.Iglancepointedly
atthemostseniorexecutive.Hespeaksup,sayingthathehad“readthecase
andmadesomemarginalnotes.”
“Whileyouwerereadingthecase,”Iask,“whatdidyouthinkabout?”
“Hewasthinkingaboutgettingabeer!”acolleaguejokes.
Wealllaugh.“BesidestheneedforaSamAdams,”Ipress,“whatdidyou
thinkabout?”
“Well, it’s actuallyhard toremember. IguessI wasmainly thinkingthat
this is a great product, a real innovation, yet the company is losing money
becauseofthecostofmanufacturingtheboxes.”
“Fine.Youbegantofocusonmanufacturing.”
“Yes,Ithinktheyneedtostopsubsidizingthemanufactureoftheseunits.I
think—”
“Good,”Isay.“Let’snotgetintothespecificsofyourrecommendationjust
yet.Iwanttostaywithhowyouarrivedatthatinsight.”
Helooksdownathiscopyofthecase.Ithassomenotesintheright-side
margins. I want to see if we can actually talk about where his ideas came
from. I called his advice an “insight” to suggest that he need not make up
somegrandiosestoryabouthisanalyticalprowess.
“It’s really just experience, or at least, my experience. I saw these large
losses.Andtheyseemtobeduetomanufacturing.…Well,no.Tobehonest,
thefirstthingIthoughtofwasthatmostcustomersarepayingforagianthard
diskthattheydon’tneed.Ifyouonlywanttotime-shifttwoprograms,you
don’tneedtostoreawholeseason.So,Ithought,whynotusesmallerdisks
andmakeonlythemoreintensiveuserspayforhardwareupgrades?”
“So,yourinitialideawas…anintuition…aboutanaction.Unbundlethe
diskcapacity,maybepricediscriminate?”
“Yeah.That’sit.”
“Fantastic.Veryinteresting.Didyougodownanyotheravenues?”
“No.…Hey,youonlywantedoneparagraph!”
Iampleasedwithhiscontribution.Honestandinteresting.Ofcourse,just
because I had asked for only one recommendation didn’t mean he was
constrainedtoconsideronlyoneapproach.ButIdon’twanttopointthatout
justyet.
I turn to another member of the group who has a hand halfway up. She
says,“Ijustthoughtaboutthesituationandcameupwitharecommendation.
ItjustsortofemergedasIwasthinkingabouttheproblem.Irealizedthatif
other firms come to dominate the cable TV segment, while TiVo holds the
satelliteTVsegment,itwilllosethebattleforscale.”
“Wheredidthatideacomefrom?”Iask.
“Well,Idon’treallyremember.”
“That’s how good ideas come to us,” I say. “There are lots of sausage-
makingtoolsbeinghawkedforstrategywork,butgoodideasdon’tcomeout
of mechanical tools. Conceptual tools may help us get oriented, but, in the
end,goodideasbasicallyjustpopintoourheads.It’scalled‘insight.’”
Shelikesthisfeedbackbuttriestolookmodest.
“Didanyotherapproachestotheproblempopintoyourhead,orjustthat
one?”Iask.
“Well,Idon’trememberany.…Itwasjustthatone.”
“Great—it is important to be honest with ourselves about this.” I had
startedwiththemostseniorpeopletogivethemorejuniorassociatesachance
tobehonest.
Anotherparticipantwantstocontribute.Hesays,“ReadingtheTiVocase,I
hadtheimmediatesensethatthecompanyistryingtoohardtogetintobed
withtheTVindustry.Butitisnotanaturalalliance.TiVohelpsmoveshows
aroundintime,helpsskipcommercials,andcutsintoloyaltytochannels.It
provides a consumer benefit, not a TV broadcaster or network benefit. Its
problemisthatitisanoutsider—notillegallikeNapster,butsimilarlyloved
bytheconsumerandhatedbytheindustry.”
Onceagain,Ihavetoremindthemthatwearetryingtogetathowthese
pointsofviewdeveloped.“Whatledyoutothatview?”Iask.
“Idon’tknow,”hesays.“Iwasthinking,Iguess,aboutFCCcommissioner
Michael Powell’s comment that TiVo is ‘God’s machine.’ So many people
loveityetitishavingsomuchcommercialtrouble.”
Hisone-paragraphrecommendationrepeatsthisdescriptionoftheproblem
but has little in the way of any recommendations. That lack is a different
issue,andIdeferittolater.
AsIgoaroundtheroom,onlyonepersonreportshavinggivenanything
morethanthebriefestconsiderationtomorethanonecourseofaction.Most
ofthemhadfirstidentifiedaproblemarea—manufacturing,cablecompanies,
softwarerivalry,andsoon—andthencreatedarecommendationaimedatthat
area. No one using this two-step approach had gone back and considered
rethinking the initial identification of a key problem area. Nor had any of
theminvestigatedmorethanoneresponsetothatproblem.
Iperchonthestoolinfrontoftheclassandtrytotalkaboutwhatwehave
justlearned:
When you prepared for this class, each of you read the same
material. But some focused on one issue and others on another. Some
focused on manufacturing, some on software, some on cable TV
provider relationships, and so on. When it came to recommending a
courseofaction,almosteveryonechosethefirstonetheythoughtof.
Thisispredictable.Mostpeople,mostofthetime,solveproblemsby
grabbingthefirstsolutionthatpopsintotheirheads—thefirstinsight.In
alargenumberofsituationsthisisreasonable.Itistheefficientwayto
getthroughlife.Wesimplydon’thavethetime,energy,ormentalspace
todoafullandcompleteanalysisofeveryissueweface.
Mycommentsmakepeopleuncomfortable.Aparticipantpushesupahand
up and says: “According toBlink, a first judgment may be best.1 Gladwell
saysthatpeoplemakecomplexjudgmentswithoutknowinghowtheydoit.
Tryingtoanalyzeeverythingmayleadtopoorerdecisions.”
Itisagoodpoint.MalcolmGladwell’sBlinkisagreatread,afascinating
book. He argues that we all have the ability to process certain kinds of
complexinformationquicklyandcomeupwithajudgmentandyetnotknow
howwegotthere.Weallknowthisistrue,especiallywithregardtomaking
decisionsaboutotherpeopleandsocialsettings,andaboutmatchingpatterns
—seeingthatone thinghascharacteristicsthatremindusof another.These
are lightning-quick computations. Gladwell makes the case that we should
trustthesejudgmentsmadeintheblinkofaneye,especiallywhentheyare
madebypeoplewithgoodexperience.
Our instincts can often produce amazingly good judgments. But our
instincts also tell us, incorrectly, that our instincts are always right. You
shouldrecognizewhichsituationsrequiredeeperreflection.Arecompetitors
or nature leading us into a trap? Can we can set a trap for less-wary
adversaries?
IexplainthatBlinkjudgmentsmayworkforpeoplesituationsandcertain
kindsofpatternmatching.Unfortunately,thereisalsoagooddealofresearch
revealing that most people are poor at making many kinds of judgments,
whether done in a blink or in a month. Of special concern are judgments
about the likelihoods of events, about one’s own competence relative to
others’,andaboutcause-and-effectrelationships.Inestimatingthelikelihood
of an event, even experienced professionals exhibit predictable biases. For
example,peopletendtoplacemoreweightonvividexamplesthanonbroad
statisticalevidence.2MyMBAstudentswilleachpredictthattheywillgeta
gradeputtingtheminthetophalfoftheclass,evenafterthisinformationis
fedbacktothem.3Inreasoningaboutnaturaldata,peopletendtoseepatterns
wherethereisonlyrandomness,tendtoseecausesratherthanassociations,
andtendtoignoreinformationthatconflictswithamaintainedtheory.
TurningbacktotheparticipantwhobroughtupBlink,Iask,“Wouldyou
wantthepresidentoftheUnitedStatestomakeadecisiontogotowarinthe
blink of an eye? Do you think it is appropriate for a CEO to decide on a
mergerwithoutcarefullythinkingthroughthecostsandbenefits?”Theseare
rhetoricalquestions,andhenodsthatheacceptsthatsomeissuesseemtobe
tooimportantandtoocomplextoconcedetoinstantintuition.
“So,” I continue, “in strategy work this quick closure can get us into
trouble. Almost by definition, strategy is about very difficult yet very
important issues. Because they are important situations, they may deserve
more than a quick closure around our first hunch. You know that. And
becauseyouknowthat,wehaveapuzzle.Whywouldexperiencedexecutives,
likeyourselves,gowithquickclosureinastrategysituation?”
Afterafewmoments,aparticipantsays,“Therewasn’tenoughtime.”
“Alwaysaproblem,”Iagree.ButIkeepscanningtheroom.
“It’sajudgmentcall,”anotherblurtsout.“Thereisno‘answer’tothiskind
ofthing;thereisonlysomeone’sjudgmentaboutwhatmakesthemostsense.
Therearetoomanymovingparts.…”
Itisanacuteobservation.Weareallawareofthebasicformalapproachto
makingadecision.Listthealternatives,figureoutthecostorvalueassociated
witheach,andchoosethebest.ButinasituationsuchasTiVo’s,youcannot
perform this kind of clean “decision” analysis. It is too complex, too ill-
structured.Thus,themostexperiencedexecutivesareactuallythequickestto
sense that a real strategic situation is impervious to so-called decision
analysis.Theyknowthatdealingwithastrategysituationis,intheend,all
aboutmakinggoodjudgments.So,theymakeajudgmentcall.
“That’sright,”Isay.“Itisajudgment.Intheend,whatwerecommendwill
be a best judgment, based on what we know. Still, why not revisit that
judgmentandgeneratealternativeviews?And,whynotthenevaluatethemin
lightofoneanother?Whytheoverlyquickclosureonthefirst?”
Idon’tprobeforananswertothisquestion.Istandupandstartpacingin
thefrontoftheroom.ItellthemthatIhaveobservedandthoughtaboutthis
formanyyearsandthatIhaveaviewaboutwhathappenstous:
Facing a complex situation like this makes most people
uncomfortable.Themoreseriouslyyoutakeit,themoreyouwillseeit
asarealanddifficultchallengethatrequiresacoherentresponse.And
thatrealizationwill,inturn,makeyouevenmoreuncomfortable.Itisso
ill-structured.Therearetoomanyvariables,somanyfactors,toomany
unknowns, no clear list of potential actions and no way to make clear
links between actions and outcomes. You are not even sure what the
problemis.Likeaswimmerdroppedintoverychoppywaters,itishard
to get your bearings. Under pressure to develop a way out of the
difficulty, that first idea is a welcome relief. Thank goodness, here is
somethingtohangonto!Itfeelsmuchbettertogetoriented.
Theproblemisthattheremightbebetterideasoutthere,justbeyond
theedgeofourvision.Butweacceptearlyclosurebecauselettinggoof
ajudgmentispainfulanddisconcerting.Tosearchforanewinsight,one
wouldhaveto put asidethe comfort ofbeingoriented and onceagain
castaroundinchoppywatersforanewsourceofstability.Thereisthe
fearofcomingupempty-handed.Plus,itisunnatural,evenpainful,to
questionourownideas.
Thus,whenwedocomeupwithanidea,wetendtospendmostofour
effort justifying it rather than questioning it. That seems to be human
nature, even in experienced executives. To put it simply, our minds
dodgethe painfulworkof questioningand lettinggoof ourfirstearly
judgments,andwearenotconsciousofthedodge.
Willingthemtounderstand,Isay,“But,youdonothavetobeacaptiveto
thatunconsciousdodge.Youcanchoosehowyouwillapproachaproblem;
youcanguideyourownthinkingaboutit.”Iwantthemtoseethatthisisthe
heart of the matter. This personal skill is more important than any one so-
calledstrategyconcept,tool,matrix,oranalyticalframework.Itistheability
to think about your own thinking, to make judgments about your own
judgments.
SOMETECHNIQUES
Tocreatestrategyinanyarenarequiresagreatdealofknowledgeaboutthe
specifics. There is no substitute for on-the-ground experience. This
experience accumulates in the form of associations between situations and
“what works” or “what can happen” in those situations. Just as doctors
prescribed aspirin for headache and fever without knowing how it worked,
just as the ancient Romans dealt in life insurance without any theory of
probability, so you must normally work with patterns and analogies. Of
course,insomecases,ourknowledgeisevenstronger,andwehavetheories
aboutthecausalstructureofthesituation—aboutwhatcauseswhat.
Instrategywork,knowledgeisnecessarybutnotsufficient.Therearemany
peoplewithdeepknowledgeorexperiencewhoarepooratstrategy.Toguide
yourownthinkinginstrategywork,youmustcultivatethreeessentialskills
orhabits.First,youmusthaveavarietyoftoolsforfightingyourownmyopia
andforguidingyourownattention.Second,youmustdeveloptheabilityto
questionyourownjudgment.Ifyourreasoningcannotwithstandavigorous
attack, your strategy cannot be expected to stand in the face of real
competition. Third, you must cultivate the habit of making and recording
judgmentssothatyoucanimprove.
What follows are a few techniques that I have found useful in jogging
minds loose from their ruts, for helping to check that strategies have some
coherence, and for improving your ability to make judgments as well as
critiquethem.Thereare,ofcourse,otherwaystoguideyourownthinking.
AsIdescribethesetechniques,youwillrecognizesomethatyouhaveusedor
comeacross.Ratherthanletthoserecognitionsglimmerandfade,itmightbe
usefultomakealist.
TheKernel
Thekernelisalistremindingusthatagoodstrategyhas,ataminimum,three
essentialcomponents:a diagnosis of the situation, the choice of an overall
guidingpolicy,andthedesignofcoherentaction.Theconceptofthekernel
defines the logic of a strategy—the bare-bones minimum. For a strategy to
haveanybite,itmustchartadirectionbasedonadiagnosisofthesituation.
Absentadiagnosis,onecannotjudgeone’sownchoiceofanoverallguiding
policy, much less someone else’s choice. A strategy must also translate the
overalldirectiveintocoordinatedactionfocusedonkeypointsofleveragein
the situation. (The concept of the kernel and its elements is explored in
greaterdepthinchapter5.)
When one has an initial insight into what to do about a challenging
situation, it never occurs in the form of a full-blown strategy. Rather, the
lightningofinsightstrikesinoneofthethreeelementsofthekernel.Itmay
beaninsightintoaction,asinthecaseoftheparticipantwhowantedtoput
smaller disk drives in TiVo machines. It may be an insight into a general
directive,asitwasfortheparticipantwhowantedtoshiftfocustothecable
TVsegment.Orinsightmayarriveintheformofadiagnosis,asinthecase
of the participant who saw TiVo as the consumer’s friend but also as a
Napster-likethorninthesideoftheindustry.
Thereisnothingwrongwithalocalizedinsight.Wehavenorealcontrol
overtheprocessofinsightandshouldbegladwhenitworksatall.Whatthe
kernel does, however, is remind us that a strategy is more than a localized
insight. It is an internally consistent argument that leads from facts on the
ground to diagnosis, thence to an overall directive, thence to action. The
kernel reminds us to expand the scope of our thinking to include all three
elements.
Therearethosewhoprefertobegintheirapproachtostrategywithaction.
Myowninsights,however,normallydon’tstartwithaction.Itendtousea
problem-firststructure.Iambetteratstartingwithaframeordiagnosisofthe
situationandthenworkingthroughtheguidingpolicyandactionelementsof
thekernel.Atthestartofmostconsultingengagements,theclientwantsan
appraisal of a particular course of action or wants advice on what to do. I
almost always back up and try to create a better diagnosis of the situation
beforegettingintorecommendations.
Problem-Solution
Manyattemptsatstrategylackagooddiagnosis.Hence,itisusefultohave
mental tools for working backward from a guiding policy to the realm of
diagnosis and fact. There is nothing deep about this process other than
realizingthatitcanandshouldbedone.
Peoplenormallythinkofstrategyintermsofaction—astrategyiswhatan
organization does. But strategy also embodies an approach to overcoming
somedifficulty.Identifyingthedifficultiesandobstacleswillgiveyouamuch
clearerpicture ofthe patternof existingandpossiblestrategies.Even more
important,youwillgainaccesstohowchangesinsomefactorsmayradically
alterthemixofefficaciousstrategies.Togainthischangeinperspective,shift
your attention from what is being done to why it is being done, from the
directionschosentotheproblemsthatthesechoicesaddress.
Applying the problem-solution methodology to TiVo’s situation means
identifyingtheobstaclesitisattemptingtoovercome.Asimpleengineering
viewwouldbethatittriestoletconsumerstime-shifttelevisionviewingand,
perhaps,skipcommercials.Otherwaysofaddressingthisproblem—solutions
thatcompetewiththeTiVosolution—areVCRs,video-on-demandservices,
andDVDrentalandsales,especiallyofentirecommercial-freeseasonsofTV
shows.
A slightly different perspective is gained by defining the problem as the
content-aggregator’scontroloftheset-topbox.CompaniessuchasComcast,
Time Warner, DirecTV, and EchoStar bundle set-top boxes with their
televisionservices.Theseboxesprovide,ataminimum,accesstotheregular
andpremiumchannelsandanyvideo-on-demandorotherinteractiveservices
offered. They may also include, usually for a higher price, digital video
recorder(DVR)featuresofvariouslevelsofsophistication.ForaTiVoboxto
bean economicalsolution forthe averageconsumer,it mustaccess regular
andpremiumchannelsaswellasdownloadschedulinginformationoverthe
cableorsatellitelink.4Itcandothisonlyunderacontractualagreementwith
the cable or satellite company. These companies’ ability to bundle set-box
rentalswithservicecontracts,andthecablecompanies’monopolypositions,
allowthemtoextractmostofTiVo’spossibleprofits.
Monopolies that use bundling to restrict competition are an old story in
antitrust,asillustratedbythecasesofIBM,theregionaltelephonecompanies,
and Microsoft. As long as monopoly cable companies can bundle, it will
always be extremely difficult for outside companies to add value to the
television experience. This perspective suggests that TiVo spend less on
marketingandmoreonalegalattackontheindustry’sstructure.Insuchan
attack,itwouldhavemanyimportant,andlarger,allies.
Create-Destroy
Overcoming quick closure is simple in principle: you look for additional
insightsandstrategies.But,mostofthetime,whenaskedtogeneratemore
alternatives,peoplesimplyaddoneortwoshallowalternativestotheirinitial
insight.Consciouslyorunconsciously,theyseemtoresistdevelopingseveral
robuststrategies.Instead, mostpeopletaketheirinitialinsightand tweakit
slightly,addingastraw-manalternative,orincludingoptions suchas“walk
away,” or “more study,” that are generic to any situation rather than being
responsivetothespecialcircumstancesathand.
A new alternative should flow from a reconsideration of the facts of the
situation,anditshouldalsoaddresstheweaknessesofanyalreadydeveloped
alternatives.Thecreationofnewhigher-qualityalternativesrequiresthatone
tryhardto“destroy”anyexistingalternatives,exposingtheirfaultlinesand
internalcontradictions.Icallthisdisciplinecreate-destroy.
Tryingtodestroy yourownideas isnoteasy orpleasant.It takesmental
toughnesstopickapartone’sowninsights.Inmyowncase,Irelyonoutside
help—IinvokeavirtualpanelofexpertsthatIcarryaroundinmymind.This
panelofexpertsisacollectionofpeoplewhosejudgmentsIvalue.Iusean
internal mental dialogue with them to both critique my own ideas and
stimulatenewones.Itrytodothisbeforeputtingmyideasbeforeothers.
Thepanelofexpertstrickworksbecauseweareadeptatrecognizingand
comprehendingwell-integratedhumanpersonalities.Thinkingthroughhowa
particularwell-rememberedexpertmightrespondtoaproblemcanbearicher
sourceofcriticismandadvicethanabstracttheoriesorframeworks.
Myownpersonalvirtual panelofexpertscontainsrespectedexecutivesI
have known and worked with, people who educated and trained me,
colleagues I have worked with over the years, and certain people whose
pointsofviewemergeclearlyfromtheirownwrittenworkorfrombiography.
WhenIfaceaproblem,orhavegeneratedafirsthunch,Iturntothispanel
andask,“Whatiswrongwiththisapproachtothesituation?Whatwouldyou
dointhiscase?”
ProfessorBruceScott,whochairedmydissertationcommitteelongagoin
1971,sitsonmypanelofexperts.Inmyimagination,Icanseehim,leaning
backinhischairandaskingmetoexplainwhyanyoneshouldlistentome
andtotellhimwhattheactionimplicationis…andtherehadbetterbeone.
AlsopresentisProfessorAlfredD.ChandlerJr.,whopassedawayin2007
butwholivesoninmypanel.Unimpressedbystrategiesofquickprofitand
narrow focus, Chandler speaks in terms of broad historical trends and the
powerofscaleandscopetobuildenduringenterprises.
Foradviceontechnologystrategy,asinthecaseofTiVo,Imightturnto
panel of experts members David Teece and Steve Jobs. David Teece is a
longtimefriendandcolleagueandamasterinstrategy,economics,thelaw,
andbusiness.IhaveneverspokentohimaboutTiVo,butinmyimagination
hiseyescrinkleandhesays,“Theydon’thavealockonDVRtechnology,so
there will be other companies offering similar software and hardware. The
cableandsatellitecompaniesareinmuchstrongerpositions,controllingkey
complementaryassets.Theyprobablyshouldbelicensingthesoftwarerather
than trying to build equipment. They are trying to make money on
advertising,butiftherewererealmoneythere,thecableandsatelliteplayers
wouldtakeitawayfromthem.”
SteveJobs,cofounderofApple,founderofNeXT,andCEOofPixaruntil
it was acquired by the Walt Disney Company, is the world’s best-known
SiliconValleyentrepreneur.SinceguidingthedevelopmentoftheMacintosh
computer,Jobs’sbasicoperatingprincipleshavebecomethestuffoflegend:
(1)imagineaproductthatis“insanelygreat,”(2)assembleasmallteamof
the very best engineers and designers in the world, (3) make the product
visuallystunningandeasytouse,pouringinnovationintotheuserinterface,
(4) tell the world how cool and trendy the product is with innovative
advertising.
SteveJobsisgreatatcriticism.Arrogantandsmart,hecutstotheheartof
anissuewithnowastedeffort.In1997,weusedAppleasthe“livingcase”in
the UCLA Anderson MBA strategy course. I and several other faculty
members met with Jobs to discuss Apple’s future prospects. “I know
Stanford,”hesaid,“butIamnotallthatfamiliarwithUCLAAnderson.”
My colleague and department chair, Jack McDonough, responded by
offering the school’s party line: “We like to think that we are the
entrepreneurialschool.”
“That’sinteresting,”saidJobs.“Which SiliconValleyentrepreneurshave
comeoutofyourprogramthatIwouldrecognize?”
Jackgrimaced,thenansweredtruthfully,“Therearen’tany.”
“Well, then, you’ve failed,” Jobs said with finality. That day, he became
partofmymentalpanelofexperts.
What would Jobs think of TiVo? What you get from a person is not a
conceptualframeworkortheory,butaviewpointintegratedintoapersonality.
Jobs,Ithink,woulddisliketheTiVobusiness—thecompanydoesnotcontrol
enoughofthevariablestodeliveratruly“cool”experience.Evenifyouput
theworld’sbestdesignteamatworkonmakingabetterTiVo,muchofthe
functionalitywould depend onhow the machineinteracts withthecable or
satelliteprovider.IfyoucouldverticallyintegratewithDirecTVorComcast,
then,perhaps,youcouldreallydeliversomethinginteresting.Notjustmovies,
butmusicondemand.NotjustaTVbox,butanintegratedwirelessInternet
deliverysystem.JustashedidwiththeiPodandiPhone,Jobswouldwantto
integratethe machine,the userexperience,andthedeliveryofproductinto
somethingfairlyseamless.
Listening to Teece’s and Jobs’s imaginary counsel, I am reminded that
goodstrategiesareusually“cornersolutions.”Thatis,theyemphasizefocus
overcompromise.Theyfocusononeaspectofthesituation,nottryingtobe
all things to all people. As Jobs might argue, TiVo could be a much more
interesting proposition were it merged with a major platform, providing
somethingmoreintegratedthancurrentDVRofferings.AndasTeecemight
observe,theyarealreadytryingtodotoomanyconflictingthings,thingsthat
putthemincompetitionwiththeirplatformcustomers.
Learningfromotherscanbemorethansimplylisteningtothem,watching
them,orreadingwhattheywrite.Whenyoubuildyourownpanelofexperts
yougoonestepfarther,tryingtoshapeyourunderstandingoftheirteachings
intoavirtualpersonality.Whenitworks,itdoessobecausewehumanshave
built-insoftwareforunderstandingotherhumans,softwarethatismoreexpert
atrecognizingandrecallingpersonalitiesthanatalmostanythingelse.
PRACTICINGJUDGMENT
Asailorhastojudgethewindandaskiracermustjudgethetextureofthe
snow.Inbusinessandpolitics,andinmanyaspectsofmilitarystrategy,most
of the important judgments are about people, especially anticipating their
actionsandreactions.Judgmentbeginswithknowingyourself,yourabilities
and biases. Then it extends to knowing other individuals. Much more
complexisjudgmentaboutsmallgroupsandhowtheywillreactinresponse
toinformationor challenges—thedomainof many managers,trial lawyers,
andplatoonleaders.Finally,thereisjudgmentaboutlargegroupsofpeople
and markets—the domain of marketing and advertising experts, corporate
management,andpoliticalleadership.
Goodjudgmentishardtodefineandharderstilltoacquire.Certainlysome
partofgoodjudgmentseemstobeinnate,connectedwithhavingabalanced
character and an understanding of other people. Still, I am convinced that
judgmentcanbeimprovedwithpractice.Forthatpracticetobeeffective,you
shouldfirstcommityourjudgmentstowriting.
Onewaytoseetheneedforpre-commitmentistoimagineanMBAstudent
whohasstudiedandpreparedabusinesscaseforclass.Readingandthinking
aboutthecase,manydifferentissueshavecrossed hermind.Shewill have
triedtothinkofanumberofwaystohandlethecasesituation,andtherewill
be some she prefers to others. Then, in a one-hour case discussion, it is
probablethateveryissuesheidentifiedwillhavebeenmentionedandevery
actionshe considered willalsohave been putforward.As these issuesand
actionsareexaminedandevaluated,shethinks,“Ithoughtofthat.”Whenthe
classfinallynarrowsdownthedefensibleinterpretationsofthesituationand
therangeofusefulaction,shewillprobablythink,“Yes,Ihadconsideredall
that.”
Whatthisstudenthasmissedistheopportunitytopre-committoaposition
and thereby subsequently evaluate her own judgment. To commit to a
judgmentistochooseaninterpretationofwhichissuesarecriticalandwhich
arenotandthentochooseanimpliedaction.Bycommittingtoajudgment—
especially a diagnosis—you increase the probability that you will disagree
withsomeoftheassessments ofothers,andtherebyincrease thechanceof
learningsomething.
Thesameprincipleappliestoanymeetingyouattend.Whatissuesdoyou
expect to arise in the meeting? Who will take which position? Privately
commityourselfinadvancetosomejudgmentsabouttheseissues,andyou
willhavedailyopportunitiestolearn,improve,andrecalibrateyourjudgment.
CHAPTEREIGHTEEN
KEEPINGYOURHEAD
Ifyoucankeepyourheadwhenallaboutyou
Arelosingtheirs…
—“IF,”RUDYARDKIPLING
Goodstrategygrowsoutofanindependentandcarefulassessmentofthe
situation, harnessing individual insight to carefully crafted purpose. Bad
strategyfollowsthecrowd,substitutingpopularslogansforinsights.
Beingindependentwithout beingeccentricand doubting withoutbeing a
curmudgeonaresomeofthemostdifficultthingsapersoncando.Iwillnot
pretendthatIhavetheformulaforachievingthissubtlebalance,butIwilltell
youtwostoriesthatmayhelp.Theyshouldalertyoutobeingsweptalongin
thestrongcurrentofthecrowd.ThefirststoryisaboutGlobalCrossingand
thecardinallessonisaboutassessingthefundamentals.Thestockmarketwas
wrong about Global Crossing, and it did not take inside information to see
this.Thesecondstoryisaboutthefinancialcrisisof2008andthestrongroles
playedbysocialherdingandabiascalledtheinsideview.
GLOBALCROSSING
After a decade of attempts, the first successful Atlantic cable was laid in
1866,thankstotheentrepreneurialzealofCyrusFieldoftheUnitedStates
and,inBritain,CharlesBrightandtheBrettbrothers.Theeventwasgreeted
with huge parades and joyous celebrations on both sides of the Atlantic.
Beforethen,messagesbetweentheoldandnewworldswerecarriedbysail
andsteam,atwo-to-three-weekpassageatsea.Warscouldbewonorlostand
kingdomsfallintwoweeks.WithCyrusField’scable,suddenly,throughthe
miracleofelectricity,thepressofatelegraphkeyinEnglandmadea“click”
in America. The Atlantic community was suddenly knit together by a slim
copperwire.
Ninetyyearslater,in1956,thefirsttransatlantictelephonecablewaslaid.
Atacostof$250million,itprovidedthirtyvoicecircuitsbetweentheUnited
States and the United Kingdom. During the next forty years, over a dozen
new and increasingly sophisticated telephone cables were laid across the
Atlantic.Eachnewcableprojectwascarriedoutbyaconsortiumofnational
telephonecompanies.Atthecompletionofeachproject,thecable’scapacity
was split among consortium members. Neither the cables nor the national
telephone companies competed with one another. All prices were fixed by
eitherregulatorsorinternationalagreements,andtherewerenoalternativesto
thenationaloperatorsforhandlinginternationaltraffic.
In 1997, two former AT&T managers (William Carter and Wallace
Dawson)wereseekingfundingforaprivatelyownedcableprojecttheycalled
AtlanticCrossing.Tothisventuretheybroughttheirpersonalexpertiseanda
turnkeycontractwithAT&Ttodotheworkofbuildingandmaintainingthe
cable.CarterandDawsonhadtalkedtoGECapitalaboutfunding,butsmall
LosAngeles–basedPacificCapitalGroupworkedfaster.GaryWinnickand
histhreepartnersatPacificCapitalputtogetheradeal:$75millioninequity
and$660millionindebtwouldfinanceconstructionandinitialoperations.A
newcorporation,GlobalCrossing,wasformedtocarryouttheproject,with
Winnickasitschairman.
Atlantic Crossing-1 (AC-1) was an 8,886-mile loop of optical fibers
connectingtheUnitedStatestotheUnitedKingdomandGermany.Thenew
cablemorethandoubledthetotalcapacityundertheAtlantic.Thetelephone
industry measured capacity in STM-1, one STM-1 being a data rate high
enoughtocarrytheinformationcontainedin2,016voicecircuits.AC-1had
an initial capacity of 256 STM-1, and it was expected that advancing
technology would soon double that to 512 STM-1: about 80 gigabits per
secondorabout1millionvoicecircuits.
Thecostofasubmarinecabledependedmoreonitslengthandtheocean’s
depththanonitsdatacapacity.ThetotalcostoftheAC-1was$750million,
about $1.5 million per STM-1. It took fifteen months to complete, and
operationsbeganinthesummerof1998.
GlobalCrossingofferedthe256STM-1sforsaleatacut-ratepriceof$8
millioneach.*Thiswas considerablylessthan the$18to $20millionprice
charged by the most recent telephone company consortium project. By the
endof1998,35percentoftheAC-1’scapacityhadbeensoldforanaggregate
amount of $950 million, more than paying back the $750 million cost of
construction.Aftersixmonthsofoperations,GlobalCrossingofferedstockto
the public, and the resulting price valued the firm at an astounding $19
billion. Six months later it was valued at $38 billion, more than the Ford
MotorCompany.
Much of the enthusiasm for Global Crossing arose from the burgeoning
trafficontheInternet.Underseacablesweredigital,carryingvoicetrafficby
convertingittodataandcarryingdatatrafficdirectly.Internettrafficwassaid
tobedoublingeachyear,andforecasterssawnoendinsight.GeorgeGilder,
ahigh-techguru,wrotethisinGlobalCrossing’s1998annualreport:
With growth in the number of international Internet users rapidly
outpacing U.S. growth, undersea traffic will grow several times faster
thanterrestrialtraffic.Takemywordforit.Overthenextfiveyears,the
submarineportionsoftheInternetwillprovetobeanagonizingchoke
point.ThusGlobalCrossinghasatrulycosmicpositionasthesupplier
ofthemissingelementthatcompletestheglobalsystem.
Looking to the future, Global Crossing planned a second Atlantic cable
(AC-2), projected to again cost $750 million but this time delivering 2,048
STM-1 of capacity, a unit cost of only one-fourth that of the AC-1. This
staggering reduction in unit cost derived from the advances in optical
multiplexing technology—more colors of light per fiber and more base
capacity per fiber. These technologies were not proprietary to Global
Crossing,beingavailabletoanycablebuilder.Infact,anewconsortiumof
nationaloperatorswasplanningacablewithacapacityof4,096STM-1,and
theprivate360atlanticprojectplannedacablethatwouldaddanother4,096
STM-1overfouryears.Indeed,engineersexpectedthatbysimplychanging
theelectronicsateachendofthepresentAC-1,thecable’scapacitycouldbe
againalmostdoubledto1,000STM-1.Furthermore,engineersforecastedthat
by2001,awhollynewfour-fibercable(liketheAC-1)wouldhaveacapacity
of20,480STM-1.
I became interested in Global Crossing in 1998, as I examined the overall
surge in telecommunications industry investment. I wondered how new
players like Global Crossing and others could be valued so highly by the
stockmarket.Seekinginsight,IvisitedDavidCleevely,themanagingdirector
ofAnalysys,inCambridge,England.Cleevelywasawell-regardedobserver
ofthenewtelecommunicationseconomics.
“Thekeythingtounderstand,”Cleevelytoldme,“isthehugeadvantageof
thefatpipe.”By“fatpipe,”hemeantveryhigh-capacityfiberopticchannels.
He moved to the small whiteboard in his office and drew two circles, one
smallandonelarge.Cleevelywrote“300M£”beneatheach,andcontinued.
“Thecostoflayingfiberismainlythecostofright-of-wayanddigging.Orof
layingitundertheocean.Recentadvancesletusinstallenormouscapacityat
nomorecostthanbuildinganarrowpipe.Theeconomiesofscaleofthefat
pipearedecisive.Thefatpipewins.”
Economiesofscalehavealwaysplayedacentralroleinstrategythinking.
Thelogicseemssimple—thefatpipesofthenew-wavetelecombuildersand
operators gave them much lower average unit costs. As my taxi struggled
back to London in the afternoon traffic, I thought about fat pipes, scale
economies,andtelephonecalls.Whatwasthe“cost”ofmovingonetelephone
call,oronemegabyteofdata,undertheAtlanticOcean?
Theconceptofcostistricky.Peopletalkasifproductshavecosts,butthat
is shorthand easily leading to confusion. Choices, not products, have costs.
Thecostofchoosingtomakeonemoreunitofaproductissometimescalled
marginal,orvariable, cost.The cost(perunit)ofchoosing toproduceata
fixedrateforayeariscalledaveragecost.Thecostperunitofchoosingto
buildaplantandproduceatafixedrateiscalledlong-runaveragecost.The
cost of filling a rush or special order has no particular name, but it clearly
exists.Therereallyisnosuchthingasthesinglecorrect“cost”ofaproduct.It
alldependsonthedecision—onwhatisbeingcomparedtowhat.
Thecostof“deciding”tocarryonemoretelephonecallwasonlythatof
theelectricalpowerrequired—essentiallyzero.Thecostofdecidingtocarry
onemorecalleverydayforayearwasstillveryclosetozero.Thecostof
decidingtoturnonthecableandcarrythousandsofcallseverydayforayear
begantoincludemaintenanceandoverheadexpenses,butnotthecapitalcost
oftheequipment.Ibegantorealizethatthe“cost”ofmovingdataoverallof
thesecableswasessentiallyzero,whethertheywerefatornarrow.And,with
the advent of competition in a formerly monopolized industry, there was
nothingkeepingpricesfromfallingtocost.
Theintroductorytopictaughtinanymoderncourseonbusinessstrategyis
the connection between industry structure and profit. This topic is usually
called the “Five Forces,” following Michael Porter’s pioneering analysis of
industry structure, published in 1980. A quick summary is that a terrible
industry looks like this: the product is an undifferentiated commodity;
everyonehasthesamecostsandaccesstothesametechnology;andbuyers
are price sensitive, knowledgeable, and willing to switch suppliers at a
moment’snoticetogetabetterdeal.
Inearly 1999 Iasked a classof UCLAMBA students toanalyze Global
Crossing’sentryintothetransatlanticcablebusiness.Stepbystepthestudents
lookedateachaspectoftheindustry:
•OneSTM-1onatransatlanticcableisasclosetoaperfectcommodity
asthehumanmindhasbeenabletocreate.Notgood.
•Oneoperator’scapacityisessentiallyindistinguishablefromanother’s.
Notgood.
• Global Crossing has introduced competition into the business, and
three other private companies have announced plans to enter. Not
good.
•Thetechnologyisnotproprietary.Notgood.
• Technology is making it ever cheaper to add huge chunks of new
capacity:overcapacityisanearcertainty.Notgood.
• The capital costs of transatlantic cables are very literally “sunk.” If
pricesdon’tcovercapitalcosts,oldcableswillneverthelesscontinue
tooperate.Notgoodatall.
Onestrugglestoimagineaworseindustrystructure.
“ButtheInternetisdoublinginsizeeveryyear,”astudentsaid.
“True,” I said. “But capacity is growing even faster, and the cost of
capacity is falling even faster than that. Look, given your analysis, the
endgameisclear.Therewillbeovercapacity,priceswillfalltocost,whichis
closetozero,andnoonewillmakeaprofit.”
“That is not what the stock market is saying,” another student said
dismissively.Playingwhatpassedforatrumpcardin1999,hesaid,“Idon’t
carewhatthisindustryanalysissays,themarketissayingthatthisisoneof
thebiggestprofitopportunitiesofalltime.”
It has always been understood that stock prices reflect expectations about
future profits. But the doctrine that stock prices are trustworthy, accurate
estimatorsoffutureprofitsaroseinthe1970sandwasinfullbloomby1999.
Hereisanexampleofhowthatlogicshapedanalysis.In1998,aLehman
Brothers report estimated that total capacity of 1998 U.S. terrestrial fiber
systems was seventy times the 1998 working capacity, which was, in turn,
quite a bit larger than current demand. In a normal industry, the holders of
excesscapacitycompetewithoneanother,tryingtoearnalittlerevenue,and
this drives down prices. Was there a glut of installed capacity in the fiber-
opticindustry?TheLehmananalystwrote:
Inordertobegintofillthepotentialcapacity,bandwidthneedsper
user,numberofusers,andusage/monthhavetoincrease.Ifeveryphone
lineinthecountrywereupgradedtoaT1[1.5megabitspersecond],then
networkcapacitywouldhavetoincreasejust24times(atconstantusage
levels). Therefore, in order arrive at 70 times increases even higher
speedsandgreaterusageisrequired[sic].1
At this point a good analyst should conclude that there seems to be too
much capacity. But the stock market was saying otherwise. So the next
paragraphintheLehmanreportoffersanalmostpsychoticbreakinreasoning,
expressingasublimefaithinthevoiceofthestockmarket:
Webelievethatelectroniccommercewillgrowexponentiallyhelping
todrivedemandforhigherbandwidthforInternetanddataservices.PC
industry pundits see the day when every person has electronic agents
constantlyinthenetworkpullingdowndatatothePCthatiscustomized
to the individual user. In addition, there is potential for connecting
virtually every appliance with a chip to the Internet to increase the
usefulnessofthe appliance andcommunicate informationtousers and
manufacturers.
Atalate1999conferenceIdiscussedthisissueoverlunchwithagroupof
strategy consultants. They brushed aside the immediate problem of price
competition.“ThenewplayerslikeQwestandGlobalCrossinghaveyearsto
gainmarketshareagainstthehigh-pricedold-linenationaloperators,”opined
a Boston Consulting Group consultant. In easy conversation, all referred to
the enormous stock market performance of Qwest, WorldCom, Global
Crossing, and other new-wave telecommunications players. Their huge
valuations were taken as strong proof of sound, even brilliant, business
strategies.
At that time many consultants’ presentations were simply comparisons
betweenthestockperformancesofcompaniesfollowingoneapproachversus
another.Whybothertodothehardworkofevaluatingthelogicofabusiness
strategy if the all-knowing stock market does a better job? If WorldCom’s
stockappreciatedfasterthanSprint’sandMCI’s,thenrollingupfiberloops
mustbebetterthanbeingabroad-linenetworkoperator.Likethevoiceofa
deity,the“market”hadspoken.
In the spring of 2001, I began to write a case on Global Crossing.2 I was
particularlyfascinatedwiththesituationfacingGaryWinnick.Hehadmadea
hugeprofitontheAC-1,butthatventurehadthestructureofaonetimereal
estatedeal.Hehadconstructedthe“building”for$750millionandsoldthe
“condos”formorethan$2billion,and,amazingly,woundupwithacompany
valued at $30 billion. Why were his sophisticated telecom customers, I
wondered,sowillingtooverpay?WhypayGlobalCrossing$8millionforan
STM-1whenthecostofcreatinganewSTM-1waslessthan$1.5million?
Didinvestorsreallythinkhecouldkeepdoingitagainandagain?Whatdo
youdo,Iwondered,whenyourstockseemsoutrageouslyovervalued?
FinishingtheGlobal Crossingcasebecamearaceagainsttime. Myfinal
scheduled interview with Winnick was canceled because the company
declared bankruptcy on that day in December 2001. Today, years after the
telecommunications meltdown, newspapers and business magazines have
reducedthateratoalistofrogueCEOs,withWinnickinthemiddleofthe
list.Butthatanalysisisjustasfoolishasweretheextravagantexpectationsof
1999.WhathappenedtoGlobalCrossingwasamicrocosmofwhathappened
tothewholesetofnew-agetelecomcarriers:trillionsofdollarsinexpected
revenuesnevermaterialized.
The telecom companies built too much fiber capacity. How much is too
much? The combined plans in place for the Atlantic in 2001 amounted to
16,384STM-1s.Thatwouldbeenoughcapacitytoallowthirty-fivemillion
people,halfinEuropeandhalfinAmerica,tobroadcastcontinuousreal-time
videocoverageoftheirlivestooneanother,twenty-fourhoursadayseven
daysaweek.
Critically,ascapacitysurgedonthetransatlanticroute,asecondarymarket
soon developed. Stuck with mountains of unused capacity, the original
customers,mostlynationaloperators,triedtomakealittlemoneybyoffering
their unused capacity for resale or on short-term leases. Fierce price
competitionquicklybecame thenorm. Inlate1999, theprice ofanSTM-1
collapsed from $6.5 million to $2 million. By early 2002, one could buy a
transatlantic STM-1 for $325,000, only 4 percent of Global Crossing’s
originalaskingprice!
What happened to the fantastically high and growing revenues expected
fromtheInternet?Twothingswentwrong.First,contrarytoGeorgeGilder’s
forecast, Internet traffic over undersea cables grew much more slowly than
did terrestial traffic. Most Internet traffic was local, not international.
Furthermore, the need for rapid response times pressed many high-usage
websitesto duplicate theirserverscity by city, obviatingthe need for huge
intercontinentalbandwidth.
Second, despite its rate of growth, Internet traffic did not earn high
revenue.Thetelecomindustrywasusedtocharginghighpricesforhandling
“corporatedata”andfailedtothinkthroughtheobvious:Therapidgrowthof
Internet traffic was largely a result of its near-zero price. It was exploding
because of individual Web browsing, pornography, and music (now video)
piracy. The absurd idea that major corporations would be the driver of
growth, or that consumers would pay high fees to companies who moved
Internet traffic, met a messy death. Costs and prices fell even faster than
trafficgrew.3
Thecollapseofpricescouldhavebeenforeseenbyanyonedoingasimple
Five Forces analysis. Why was this analysis ignored? Because the stock
market promised something better. Consultants, investors, analysts, and
strategistswerebeguiledbythemarketvaluesofthenewnetworkoperators.
“Yes, their products look like perfect commodities,” one told me, “but
something new is happening. The market is giving them a vote of
confidence.”Thus,judgmentfled.
For centuries, mathematicians believed that within any axiomatic system—
suchasgeometry,arithmetic,oralgebra—everystatementwaseithertrueor
false.In1931,ViennesemathematicianKurtGödelprovedthatthisintuition
was wrong. He showed that sufficiently complex logical systems are
“incomplete.”Thatis,theycontainstatementsandpropositionsthatcannotbe
judgedtrueorfalsewithinthelogicofthesystem.Tojudgetheirtruthone
mostlookbeyondthesystemtooutsideknowledge.4
Ibelievethisideaapplies,metaphorically,tohumansystems.Specifically,
whenexecutivesandexpertsinvestandmanagesolelybasedonrecentstock
marketsignals,theflowofinformationfromcorporateinvestmentdecisions
to traders to stock prices and then back to corporate decisions becomes a
closedcircle.The“axiom”ofmarketaccuracyanchorsthecircle’scenter.In
the fiber-optic business, this closure was sealed because analysts measured
“growth” by looking at increases in installed capacity. Within that closed
system, a question such as “Are transatlantic cables an overcapacity
commoditybusiness?”becamewhatKurtGödelwouldcallanun-decidable
proposition. To answer this question one would have to look outside the
closedsystemandmakeanindependentestimateofthesituation.
Similar closed circles occur when political leaders create public policy
based on opinion polls. “Is it wise to have large government agencies
committed to making a rapidly growing number of high-leverage mortgage
loans?”Thequestionisun-decidablewithinthelogicofpopularopinionand
election campaigns. Only by looking carefully at the past and at the
experiencesofothernationscanthequestionbeanswered.
Another closed circle occurs when schools design curricula based on
studentratings,andstudentsapplytoschoolsbasedonpastratings.Inmodern
business schools, for example, the question “Should graduate students be
required to read a book?” has become un-decidable. To break the circular
logiconemustlookatknowledgeandprinciplesthataremoredeeplyrooted
thancurrentpopularopinion.
SOCIALHERDINGANDTHEINSIDEVIEW
Thefinancial andeconomic crisisof 2008 wasthe burstingof animmense
credit bubble, the largest in history. In a credit bubble, lending standards
become less and less stringent. Easy credit, in turn, helps drive up prices
withinaclassofassets,usuallyrealestateorequities.Thesenewlyrisenasset
valuesthenformthecollateralforfurtherborrowing.Therecentcreditbubble
hadalargerealestatecomponentbutextendedtoawidevarietyofdeals—
leveragedbuyouts,majormergers,industryroll-ups,certainhedgefunds,and
soon.
There can be asset bubbles without easy credit. In the late 1990s, rising
pricesofdot-comsdrewinmoreandmorebuyersfortheirstocks,pushingup
pricesevenfaster.Butwithlittleleverage,the2000crashindot-comprices
hadonlyaminorimpactonthelargereconomy.Itistoo-easycredit,showing
up as overleveraged borrowers, that transmits shocks from company to
company, from person to person, from sector to sector, and from nation to
nation, turning what would otherwise be individual losses into a collective
calamity.5
WhenBear Stearnscollapsed in2008,its reportedleverage was32 to1.
That is, it had $1 of equity for each $32 of debt. (Bear Stearns’s typical
leveragewasactuallymorelike50to1,butthecompanyfollowedapolicyof
reducingitsleverageattheendofeachmonthforreportingpurposes.)Some
of its hedge funds were leveraged 85 to 1. Lehman Brothers was about as
leveraged as Bear Stearns. Citigroup, Merrill Lynch, and the rest of Wall
Streetwerenotfarbehind.
Thefirsthomeownerstowalkawayfromtheirmortgagesinlate2006had
takenout90percentfirstmortgagesaswellassecond“piggyback”loansto
coverthe10percentdownpayments.Whatismore,theyhadtakenouthome-
equityloanstopayfornewfurnitureandotherconsumptiongoods.By2007,
overleveraged positions had become epidemic on Wall Street and among a
goodchunkofhomeowners.
Asinothercreditbubblesinothertimesandotherplaces,thingsseemfine
aslongasthevalueofassetsputupascollateralcontinuetheirbubblyrisein
value. On the way up, as asset values inflate, deal makers, companies,
homeowners,andbanksallfeelthatborrowingsare“secured”byassetvalues
—stocks,homes,and companies.Theyfeel thatthereisgroundundertheir
feet.
In the Road Runner cartoons there is the moment when Wile E. Coyote
mistakenlyrunsoffthetopofacliffbutcontinuestohangintheair,hisfeet
churning.Notuntilhelooksdownandseesthatthereisnothingunderhisfeet
doeshebegintofall.Increditbubbles,thatmomentcomeswhenassetprices
firstbegintodecline.It takesonlyagentledeflation oftheassetbubble to
triggerthecollapse.Asassetpricesbegintodriftdownward,investorswho
have recently bought inflated assets using high leverage suddenly realize
thereisnogroundundertheirfeet.Themorenimblerushtosellbeforetheir
equityiswipedout.Andthosesales,inturn,drivedownpricesfaster.This
new downward lurch in prices panics still more overleveraged owners and
they,too,rushtosell.Thisprocessiscalled“unwinding”or“deleveraging.”
As large numbers of people try to unwind at the same time, the selling
pressure makes asset prices fall even more sharply. Bankers, suddenly
regaining their sanity, also start deleveraging, which reduces the amount of
credit available in the economy. The slowing economy causes even more
defaultsanddistressedsalesofassets.Thisfeedbackfromdebttoassetsales,
tofallingassetprices,backtomoredefaultsandyetmoreassetsales,iscalled
“debt deflation.” It was first explained by Irving Fisher in the midst of the
Great Depression. Easy credit quickens the boom, and its consequences
acceleratethebust.
Lookatthe followingchartand youcansee therisingtide ofhousehold
debtrelativetoincome.Here,householddebtincludesmortgages,automobile
loans,andconsumercredit.In1984,theaveragehouseholdowed60percent
ofitsannualafter-taxincomeindebt.By2007,thathadgrownto130percent
ofafter-taxincome.
Although standard media coverage during most of the 1980s and 1990s
focusedongovernmentdebt,itisstrikingthat,relativetotheeconomyasa
whole,itwasnotthegovernmentthatwasgoingonaborrowingspree.Itwas
the debt held by households and financial institutions that exploded.
Household debt began its upward surge in 1984. By 1988, household debt
exceeded all government debt and it continued to grow rapidly until the
recessionof2008.
Onecan heap blameon foolish citizensand venal mortgagebrokers, but
thiscrisis was aproduct ofthedecisions madein Washingtonand on Wall
Street.Washingtonissupposedtooverseetheoverallstabilityandhealthof
theeconomyandespeciallythefinancialsector.WallStreetissupposedtobe
expertatpricingandpackagingrisk.Inthiscase,bothfailedmiserably.How
didthishappen?Whatweretheythinking?
RATIOOFHOUSEHOLDDEBTTODISPOSABLEINCOME
This disaster—like the Johnstown Flood, the burning of the Hindenburg,
the aftermath of Katrina* in New Orleans, the BP gulf oil spill, and many
otherman-madedisasters—wastheresultoffiveintertwinederrorsinhuman
judgmentandbehavior.
1. There was engineering overreach, where designers built systems
whosefailuremodesandfailureconsequencesexceededtheirability
tocomprehendor analyze. Thenew financial instrumentscreated in
the decade leading up to the 2008 crisis had failure modes no one
understoodorpredicted.
2.TherewaswhatIcallthesmooth-sailingfallacy,wherepeopleassume
thatalackofrecenttremorsandstormsmeansthatthereisnorisk.
Thisfallacywasinstitutionalizedbythefinancialindustry’sdoctrine
of measuring risk by analyzing past vibrations in prices. A system
withacriticaldesignflaw—suchastheHindenburg,theNewOrleans
levees,orthebuildingofamountainofsecuritiesonthepremisethat
homepricesneverdecline—doesnotnecessarilydisplaytheflawuntil
itcollapses.Thecollapseisvirtuallycertain,butitisnotsignaledbya
historyofshakinessorvibration.Importantly,thecollapseisnotdue
to totally unforseeable or almost impossible events—things the
financial community tends to call “black swans”6 or “tail-risks.”
Giventhedesignflawsinthesystem,acollapsewasinevitable.
3. There are many organizations and individuals working under risk-
seekingincentives.Wheneveryouprofitgreatlyifthingsgowelland
otherpeopletakethelosswhenthingsgopoorly,youbecomearisk
seeker. The core of the malincentives have been the federal
government’s willingness to bail out large entities with unpayable
debts—New York City in 1975, Continental Illinois in 1984, and
especially Long-Term Capital Management in 1998. Such bailouts
encouragefutureexcessrisktaking.Inaddition,thefinancialservices
industry floats in a sea of top-executive compensation arrangements
and middle-man fee structures that are all upside and no downside.
And since these movers and shakers are not just passive actors, the
incentives work to actually increase the amount of riskiness in the
economy.
4.Thereissocialherding.Whenwedon’tknowaboutsomething,itmay
be sensible to look at the behavior of others, assuming that at least
some of them know things that we do not. But if everyone else is
doingthesame,thenthisprocessofmutualcalibrationcanresultinall
themembersofagroupundertakinguninformedactionsorbelieving
thatthe“otherguy”ispayingattentiontofundamentals.
5.Finally,thereistheinsideview,alabelgivenbyNobellaureateDaniel
KahnemanandcoauthorDanLovallotothetendencytoignorerelated
pertinentdata—tobelievethat“thiscaseisdifferent.”7
The fourth and fifth problems—social herding and the inside view—
deservespecialattention,especiallywithregardtothe2008financialcrisis.
Animportantvirtueofagoodleaderisputtingthesituationinperspectiveand
havingcool-mindedjudgment.Bothvirtueshelpmitigatethebiasinherentin
socialherdingandtheinsideview.
Theinsideviewdescribesthefactthatpeopletendtoseethemselves,their
group, their project, their company, or their nation as special and different.
Thus, for example, many people are aware of today’s outside-view statistic
thattalkingon acellphone whiledrivingincreasesyouraccidentriskbya
factor of five—about the same as being drunk. But the inside view of the
situationis“Iamagooddriver;thosestatisticsdon’tapplytome.”Similarly,
weknowthatalthoughmostnewrestaurantsfail,eachentrepreneurthinkshis
orhernewrestaurantisdifferent.
Inthe2008financialandeconomiccrisis,suchinside-viewpremiseswere
widely held and expressed, rising above mere assertion and becoming
doctrines—principles that, though unprovable, serve as the basis for
argument, policy, and action. In particular, the belief that the economic
histories of other nations and other times had little relevance to modern
America played a key role. Secondly, there was the belief that the Federal
Reserve’sexpertiseatmanaginginterestrateshadeliminatedtheriskofmajor
economicswings—thattimeshadchanged.Therewasabeliefinthepowerof
America’s “deep and liquid” financial markets to withstand and absorb
shocks.AndtherewasabeliefintheefficacyofWallStreet’snewtoolsfor
managing, pricing, and parceling risk. All of these doctrines blocked the
simplerealizationthatwhathadhappenedtoothers,andwhathadhappened
hereanumberoftimesbefore,washappeningagain.Realestatepriceswere
soaringandtoomucheasycreditwasbeingextendedonallfronts.
The outside view of the situation was hardly complex. The international
evidence is clear—sharp economic problems following credit booms,
especially credit booms connected with real estate booms, are frequent and
very damaging. In fact, during the past fifty years there have been twenty-
eightseverehouse-priceboom-bustcyclesandtwenty-eightcreditcrunchesin
twenty-one advanced Organization for Economic Co-operation and
Development(OECD)economies.8AsRichardHerringandSusanWachterof
theWhartonSchoolattheUniversityofPennsylvaniaobserved,“Realestate
cycles may occur without banking crises. And banking crises may occur
without real estate cycles. But the two phenomena are correlated in a
remarkablenumberofinstancesrangingover awidevarietyofinstitutional
arrangements,inbothadvancednationsandemergingeconomies.”9
LookingbackinU.S.history,onefindsthatthedangerousmixtureofeasy
creditandrealestateboomshasrepeatedlyappearedbecauseofthecountry’s
deepestpoliticalandculturalroots.Foralmosttwocenturies,theU.S.federal
governmenthaspursuedabroadagendaofsettlingopenlands,promotingthe
ownership of small farms, and now pushing the individual ownership of
homes.Itis aprogramthatunites populistswiththosewho seeanationof
freeholdersasabulwarkagainstthetyranniesofoligarchyandcollectivism.It
unites Democrats and Republicans, rich and poor, Wall Street and Main
Street.
Theordinaryworking peopleandimmigrantswhoaretheobjectsof this
programrarelyhavethewealthtobuypropertyoutright,oftenlackingeven
thefundsforadownpayment.Therefore,therehavebeenconstantpolitical
and financial “innovations” in methods for extending credit to settlers,
farmers, and prospective homeowners. When times turn bad, these loans
defaultand,foratime,thewholeeconomyisdamaged.
America’sfirstdepression,in1819,wasadirectresultofthegovernment
sellinglargetractsofpubliclandoneasycredit.Thesesaleswereespecially
concentrated in Tennessee, Mississippi, and Alabama. Attracted by high
prices for crops, especially cotton, settlers borrowed heavily from highly
leveragedstatebankstopurchaselandandsupplies.Theconsequentmassive
increase in production, coupled with the gradual recovery of European
agriculturefromthedevastationoftheNapoleonicwars,triggeredacollapse
inpricesin1819.In1818,cottonwas31centsapound;in1819itwashalf
that,andby1831ithadfallento8centsapound.Landpricesfollowedsuit
andmassivedefaultsensued.ThecrisiswasexacerbatedbytheSecondBank
of the United States’ policy of calling in loans and demanding payment in
specie.*Thecrisisspreadtothecitiesand,inPhiladelphia,realestateprices
fellby75percent.Thousandslanguishedindebtorsprisons.
Eighteen years later, the Panic of 1837 was rooted in the federal
government’s sale of thirty million acres of public land—a chunk of real
estate constituting a large part of what is now the Midwest. Financing for
theselandsalescamefromthenewlegionsofstateandlocalbanksandwas
mostlyintheformof privatebanknotes.StatessuchasIndianaandIllinois
began to anticipate future tax revenue from this new land and borrowed
against this hoped-for revenue to finance development projects, especially
canals. When confidence in all of these banknotes faltered, the ensuing
collapsetookdownalmostone-halfofthebanksinthenation,devastatedland
values,andstartedasix-yeardepression.
After the end of the Civil War, the United States began constructing
railroadsonatranscontinentalscale.WantingtosettleanddeveloptheWest,
thefederalgovernmentgaveawayvasttractsoflandtocompaniesthatwere
to build railroads connecting the two coasts. The Northern Pacific, for
example,receivedlandgrantsequalinareatoNewEngland,spreadalonga
route from Chicago to the Pacific Ocean. These railroad companies issued
bonds that were sold at a discount by networks of brokers, dealers, and
salespeoplealloverNorthAmericaandEurope.
Thebusinessconceptwasincrediblybold—theNorthernPacificwouldsell
large parcels of their land-grant empires to American settlers and poor
immigrants.ThiswouldpopulatetheWest,andthenewsettlers’demandfor
commercialrailtransportwould,intheend,makethesemassiveinvestments
pay off. By 1870, over $1 billion in U.S. railroad bonds had been sold in
Europe.NorthernPacificagentsscourednorthernEurope,seekingimmigrants
accustomed to harsh winters—the ancestors of Garrison Keillor’s Lake
Wobegonresidents.Aspeoplesettledtheselands,morecreditwasextended
tofinancetheirpurchasesofland,theirseedandcattle,andtheconstruction
oftheirhomesandtowns.
Whenthisgiantcreditbubbleburst,itwasdevastating.InSeptember1873,
the New York Stock Exchange closed for ten days and a chain reaction of
bank failures and corporate collapses followed. About eighteen thousand
businesses failed, including one-quarter of the United States’ railroads.
Unemployment reached 14 percent and the U.S. labor movement began in
earnest.
Twenty years later, the Panic of 1893 was triggered by the failure of
railroad bonds and by farm bankruptcies. Newly leveraged farms failed in
large numbers as crop prices collapsed. The dive in prices was not a
fluctuation, but the inevitable outcome of rising farm productivity and the
soaring amount of western land coming under cultivation. Unemployment
climbed to over 12 percent, and the national economy did not recover for
sevenyears.
Inthesameera,aphenomenallandboomandbustoccurredduringthelate
nineteenth century in Melbourne, Australia. Beginning in 1880, the
government borrowed to invest in railways, the harbor, water systems, and
urban transport. Although there was no shortage of land, and although
Melbournewas,by1886,oneofthegeographicallylargestcitiesintheworld,
a speculative boom pushed prices to levels far beyond those in London or
NewYork. MichaelCannon’swonderful bookThe Land Boomers says this
(page18):
The land mania of the 1880s took two main forms. The first was
based on a plethora of building societies, whose optimistic officials
believedthateveryfamilyinthecolonycouldsimultaneouslybuildtheir
own house, keep up the payments through good times and bad, and
supportanarmyofinvestorswhowerebeingpaidhighratesofinterest
for the use of their money. The second form of mania was the deeply
heldbeliefthatitwasimpossibletolosemoneybyinvestinginland,a
beliefthatpersiststothepresentday.
Thebust, in1891,was devastating.Melbournelandbecamealmost fully
illiquid,therebeingnocashbuyersatanyprice.Stockpricescollapsed—the
sharepriceofthecity’sTramwaycompanyfallingby90percent.10Banksand
businessesfailedinlargenumbers,andtheeconomyfellintoadepression.A
strident union movement began, and Melbourne’s growth and confidence
werestoppedintheirtracksforatleastageneration.
In America, the nineteenth-century credit crises grew out of initiatives
aimed at settling western lands and at the concomitant extension of the
railroads.Duringmostofthetwentiethcentury,thefocusswitchedtohome
ownership. In housing, a myriad of government policies, tax breaks,
regulations, oversight organizations, and other instruments have, over
generations, promoted an ever-increasing rate of home ownership. The
originalJeffersonianidealwasanationofcitizenfarmers,eachowningthe
meansofhisorherownsupport.Today,thisvisionhasmorphedintooneofa
nationofhomeowners,eachworking100daysayeartopaytheirtaxesand
another125daysayeartopaytheirmortgages.
TheopeningsalvointhehomeownershipcampaignswasfiredbyHerbert
Hoover’s 1922 “OwnYour Own Home”program. The battlewas joinedin
earnest when Franklin D. Roosevelt created the Federal Housing
Administration and Fannie Mae. It accelerated when Harry Truman pushed
through the GI Bill. The modern emphasis on home ownership among
minorities was begun by Bill Clinton. In 1995 he promised to push home
ownershipfrom65percentto67.5percentoffamiliesby2000,anincreaseof
several million. His National Home-ownership Strategy aimed to “cut
transactioncosts…reducedown-paymentrequirements…[and]increasethe
availabilityof alternativefinancingproducts inhousing markets throughout
the country.”11 Under the leadership of Housing and Urban Development
secretaryHenryCisneros,thegovernmentreducedthestandardsrequiredfor
a mortgage to qualify for federal insurance. Instead of five years of stable
income, three were now enough. Instead of face-to-face interviews with
borrowers, now paperwork was enough. Instead of physical branch offices,
lenders now only needed a telephone. When George W. Bush came into
office,hesteppedontheacceleratorevenharder,unveilingaplantoincrease
thenumberofblackandHispanichomeownersby5.5million.
Despitethelargeamountofhistoricalandinternationalevidencethateasy-
credit real estate booms have sad and costly endings, policy makers,
economists, and financial industry leaders defended the status quo with a
variety of inside-view arguments and doctrines. For instance, even as the
mortgage crisis began to unfold in late 2007, Treasury secretary Henry
PaulsoncontinuedtoextolAmerica’s“deepandliquid”financialmarketsand
preachtheadvantagesofoursystemtoChina:
The U.S. economy also faces challenges from our housing market
andinourcapitalmarketsasriskisbeingreassessedandrepriced.Aswe
work through this period, deep and liquid U.S. capital markets are
playingavitalroleinmaintainingstability,justastheyhaveinproviding
thefinancingwhichallowed69percentofU.S.familiestoownhomes.
Similarly, China needs to further open its financial sector, to develop
capital markets that can provide access to the capital it needs for
continuedinclusiveeconomicgrowth.12
Paulson’s confidence was strengthened by social herding among Wall
Street barons, academic economists, and political leaders. In praising
America’s“deepandliquid”financialmarkets,theherdconvenientlyskipped
over the giant bag of flammable gas keeping those markets buzzing—easy
credit, overleveraging, a vast expanse of unpriceable derivative securities,
long-term assets financed with overnight borrowing from trigger-happy
counterparties,andhugetopmanagementbonusesfortakingonhiddenrisks.
Inparallelwiththistrustin“deepandliquid”financialmarketswasabelief
inthecompetenceoftheFederalReserve.Indeed,manyexpertsshruggedoff
the mounting leverage because they believed that the Federal Reserve’s
monetary policies had reduced the overall risk in the economy. Here, for
example,isBenBernanke,currentlythechairoftheboardofgovernorsofthe
U.S.FederalReserve,speakingin2004totheEasternEconomicAssociation:
Oneofthemoststrikingfeaturesoftheeconomiclandscapeoverthe
pasttwentyyearsorsohasbeenasubstantialdeclineinmacroeconomic
volatility.… The variability of quarterly growth in real output (as
measuredbyitsstandarddeviation)hasdeclinedbyhalfsincethemid-
1980s,whilethevariabilityofquarterlyinflationhasdeclinedbyabout
two-thirds. Several writers on the topic have dubbed this remarkable
decline in the variability of both output and inflation the “Great
Moderation.”13
As he spoke in 2004, the Federal Reserve’s short-term target rate was a
verylow2.25percent,mortgagelendingwassoaring,andhomepriceswere
accelerating into the blue. Why weren’t alarm bells ringing? Because the
government doesn’t include home prices in its inflation index—the index
includes only the rental rate of homes. And as owners expect larger future
capitalgains,rentalratesdon’tinflate.Inaddition,afloodofimportedlow-
pricedclothing,electronics,furniture,andothergoods,especiallyfromChina,
waskeepingU.S.consumerpriceslow.Andtherapidlygrowingnumberof
poor immigrants from Mexico and Central America helped cap working
peoples’wagesoutsideofthepublicsector.So,tothoseattheFed,itwasa
wonderfulnewworldwheretheycouldconstantly“juice”theeconomywith
low interest rates without producing any upward jolts in consumer goods
pricesorwages.
In addition to believing that the Fed had things under control, policy
makersandfinancialleadersplacedagreatdealoftrustinthevalueofthe
recent explosion in mathematical financial engineering and the creation of
derivative securities (securities based on other securities). Although there
weresomevoicescautioningthatthesenewfinancialvehicleswerenewand
untested,thedominantpositionwasthattheeconomywasgrowingandthe
financeindustrywasprospering,hencethesenewfinancialinnovationsmust
be doing something beneficial. Here is Alan Greenspan, then chair of the
FederalReserveBoard,speakingin2005:
Conceptualadvancesinpricingoptionsandothercomplexfinancial
products … have significantly lowered the costs of, and expanded the
opportunitiesfor,hedgingrisksthatwerenotreadilydeflectedinearlier
decades.…Aftertheburstingofthestockmarketbubblein2000,unlike
previous periods following large financial shocks, no major financial
institutiondefaulted,andtheeconomyheldupfarbetterthanmanyhad
anticipated.14
Singingoutofthesamehymnal,TimothyGeithner,thenpresidentofthe
FederalBankofNewYorkandtodaysecretaryoftheTreasury,saidthisin
2006:
[W]earenowinthemidstofanotherwaveofinnovationinfinance.
Thechanges nowunderway aremost dramaticin therapid growthin
instruments for risk transfer and risk management, the increased role
played by nonbank financial institutions in capital markets around the
world,andthemuchgreaterintegrationofnationalfinancialsystems.
These developments provide substantial benefits to the financial
system.Financialinstitutionsareabletomeasureandmanageriskmuch
more effectively. Risks are spread more widely, across a more diverse
groupoffinancialintermediaries,withinandacrosscountries.15
The Old Testament instructs “Pride goes before destruction, a haughty
spiritbeforeafall.”16Inretrospect,wecanhearthehubrisinBernanke’sand
Greenspan’s and Geithner’s statements. The benefits of the U.S. financial
system’sinnovativenewtoolswereclaimedwithoutsufficientevidence.Just
becausetherewerealotofcleverswapsandnewsecurities,andjustbecause
theyhadnotyetcrashedandburned,didnotmeantheycouldnotorwould
not.Ittakeslong-termreal-worldstresstestinginawidevarietyofconditions
—throughupanddownrealestatemarkets,up anddowneconomiccycles,
low and high interest rates, low and high inflation, and other conditions—
together with various combinations of all of these, to warrant the kind of
confidencethesefinancialluminariesexuded.
SocialherdingpressesustothinkthateverythingisOK(ornotOK)because
everyoneelseissayingso.Theinsideviewpressesustoignorethelessonsof
othertimesandotherplaces,believingthatourcompany,ournation,ournew
venture, or our era is different. It is important to push back against these
biases.Youcandothisbypayingattentiontoreal-worlddatathatrefutesthe
echo-chamberchantingofthecrowd—andbylearningthelessonstaughtby
historyandbyotherpeopleinotherplaces.
NOTES
INTRODUCTION:OVERWHELMING
OBSTACLES
1. I use the term “inspirational leadership” to demark the aspect of
leadership concerned with motivation and linking people to shared
values.Iusethemoregeneral“leadership”toincludeanyandallof
thefunctionsofleaders,includingplanning,strategy,andsoon.
CHAPTER1:GOODSTRATEGYIS
UNEXPECTED
1.BruceW.Nelan,“Strategy:Saddam’sDeadlyTrap,”Time, February
11, 1991. Available at
www.time.com/time/magazine/article/0,9171,972312,00.html.
2. “As the History of Warfare Makes Clear, Potential for Catastrophe
Remains,”LosAngelesTimes,February23,1991,20.
3. During Desert Storm, the United States destroyed bunkers of Iraqi
chemical weapons at Tallil. By 1998, UNSCOM had eliminated or
overseen the destruction of more than eighty thousand chemical
munitionsandtonsofbulkchemicalagents.
4.Agreatdealofcontroversyeruptedoverwhetherthewarwasended
too early in that two Republican Guard divisions escaped to Basra.
ThisdebategenerallyignoredthefactthatIraqhadmaintainedmore
than twenty army divisions (770,000 soldiers) in Iraq, safely
positionedfarfromthetheaterofoperations.
5.ThecurrentequivalentpublicationisFM3-0.Itcanbefoundonlineat
http://www.globalsecurity.org/.
CHAPTER2:DISCOVERINGPOWER
1.PankajGhemawat,“Wal-MartStores’DiscountOperations,”Harvard
BusinessSchoolcasestudy9-387-018,1986.
2.AndrewMarshallandJamesG.Roche,“StrategyforCompetingwith
theSovietsintheMilitarySectoroftheContinuingPolitical-Military
Competition,” typed manuscript, 1976. Now declassified, this
documentcanbeviewedatwww.goodstrategybadstrategy.com/.
CHAPTER3:BADSTRATEGY
1.AlsopresentwereDavidM.Abshire,CEOoftheCenterfortheStudy
of the Presidency, former U.S. ambassador to NATO, and special
counsel to President Reagan; Lieutenant General David W. Barno,
former commander, Combined Forces Command in Afghanistan;
AndrewKrepinevich,presidentoftheCSBA,authorofTheArmyand
Vietnam,ananalysisofU.S.strategyinVietnam,andformermember
of the National Defense Panel and the Joint Forces Command’s
Transformation Advisory Board; Andrew Marshall, director of the
DepartmentofDefense’sOfficeofNetAssessment;CaptainJanvan
Tol, CSBA senior fellow and former special assistant to the vice
presidentandcommanderoftheUSSEssex;andBarryWatts,CSBA
senior fellow, former air force officer, director of Northrop
Grumman’s Analysis Center, and head of the DOD’s Office of
ProgramAnalysisandEvaluation.
2.MicheleA.FlournoyandShawnW.Brimley,“StrategicPlanningfor
U.S. National Security: A Project Solarium for the 21st Century,”
Princeton Project on National Security, 2005, 1,
http://www.princeton.edu/~ppns/papers/interagencyQNSR.pdf.
3.BarryD.Watts,“WhyStrategy?TheCaseforTakingItSeriouslyand
Doing It Well,” Center for Strategic and Budgetary Assessments,
2007. Barry Watts is a senior fellow at the CSBA. See also the
updatedversion,“RegainingStrategicCompetence,”CSBA,2009,by
Andrew F. Krepinevich and Barry D. Watts, available at
http://www.csbaonline.org/.
4. The White House, “The National Security Strategy of the United
StatesofAmerica,”2002and2006;andtheDepartmentofDefense,
“The National Defense Strategy of the United States of America,”
2005. These documents were printed by the White House and
deliveredtoCongress,butnotofficiallypublishedbythegovernment.
They are available at georgew bush-
whitehouse.archives.gov/nsc/nss/2002 and georgewbush-
whitehouse.archives.gov/nsc/nss/2006.
5. Lutz Schubert, Keith Jeffrey, and Burkhard Neidecker-Lutz, “The
FutureofCloudComputing,”European CommissiononInformation
Society and Media, 2010. Available at
cordis.europa.eu/fp7/ict/ssai/docs/cloud-report-final.pdf.
6.CiaraRyan,“StrategiesoftheMoversandShakers,”ArthurAndersen,
Risk Consulting, August 15, 2000. Available at
www.goodstrategybadstrategy.com/.
7. “Bridging the Gap,” Defense Advanced Research Projects Agency,
February 2007. Available at
www.darpa.mil/Docs/DARPA2007StrategicPlanfinalMarch14.pdf.
8.LAUSD’sofficialfigureis$11,000perstudent.This,however,omits
spending on transportation, capital improvements, construction, and
interestonschoolbonddebt.
CHAPTER4:WHYSOMUCHBADSTRATEGY?
1.NicolasdeCondorcet,aFrenchphilosopherandmathematician,was
thefirsttomathematicallyanalyzedemocraticvotingrules.Hediedin
prisonfollowingtheFrenchRevolution.
2.KennethArrow,SocialChoiceandIndividualValues(NewYork:John
WileyandSons,1951).
3. NSC 162/2, “Basic National Security Policy,” October 30, 1953.
Availableatwww.fas.org/irp/offdocs/nsc-hst/nsc-162-2.pdf.
4.ThisconversationisreportedinAndrewS.Grove,OnlytheParanoid
Survive: How to Exploit the Crisis Points That Challenge Every
CompanyandCareer(NewYork:Doubleday,1996),89.
5. Max Weber, “The Sociology of Charismatic Authority,” in Max
Weber:EssaysinSociology,eds.andtrans.H.GerthandC.W.Mills
(London:RoutledgeandKeganPaul,1948).
6.DowChemicalCompany,2009AnnualReporttoShareholders,24.
7. Strategic Planning Council, “Strategic Plan,” California State
University,Sacramento,2007,2.
8. “CIA Vision, Mission & Values,” last reviewed April 12, 2007,
https://www.cia.gov/about-cia/cia-vision-mission-values.
9.PrenticeMulford,Thoughts Are Things (London: G. Bell and Sons,
Ltd.,1908),96.ReprintedbyKessingerPublishing(Whitefish,MT),
1996.Emphasisadded.
10. Wallace D. Wattles, The Science of Getting Rich (Radford, VA:
Wilder Publications, 2007), 14. Originally published in 1910, this
workisnowinthepublicdomain.
11.ErnestHolmes,CreativeMindandSuccess(NewYork:G.Putnam’s,
1997),17.FirstpublishedbyR.M.McBride,1919.
12.PeterM. Senge,The Fifth Discipline: The Art and Practice of the
LearningOrganization(NewYork:Doubleday,1990),207.
13.StevenWozniak,cofounderofAppleComputer,attributedmuchof
hiscompany’srisetoVisiCalc:“VisiCalcandthefloppydisksent
thiscompanyintothenumberoneposition.…AfterVisiCalc,itwas
perceivedthat90percentofallAppleIIssoldweregoingtosmall
businesses.… Originally we were a home hobby computer. Now,
suddenly, small businesses were buying Apple IIs.” Quoted in
GreggWilliamsandRobMoore,“TheAppleStory,”Byte,January
1985,173–74.
14.Ford’snewspaper,theDearbornIndependent,publishedalongseries
of articles critical of Jewish influence in American life. These
articlesweregatheredintoabooktitledTheInternationalJew:The
World’sForemostProblem.Inhisautobiography,Fordexplainshis
critique of Jews as defending against an “Orientalism which has
insidiouslyaffectedeverychannelofexpression.”SeeHenryFord,
My Life and Work (Garden City, NY: Doubleday, 1922), 251–52.
SeealsoAnneJardin,TheFirstHenryFord:AStudyinPersonality
andBusinessLeadership(Cambridge,MA:MITPress,1970).
15. Mark Lipton, Guiding Growth: How Vision Keeps Companies on
Course(Boston:HarvardBusinessSchoolPress,2003),81.
16. Peter Senge, C. Otto Scharmer, Joseph Jaworski, and Betty Sue
Flowers, Presence: Exploring Profound Change in People,
Organizations,andSociety(NewYork:Doubleday,2005),134–35.
CHAPTER5:THEKERNELOFGOOD
STRATEGY
1.“CastlesintheSand,”DeutscheBank,GlobalMarketsResearch,July
30,2008,3.
2. “Starbucks Corporation: Slower Growth De-levers Margins, but
Greater EPS Visibility Ahead,” Oppenheimer Equity Research, July
31,2008,4.Availableatwww.goodstrategybadstrategy.com.
3. William G. Ouchi and Lydia G. Segal, Making Schools Work: A
Revolutionary Plan to Get Your Children the Education They Need
(NewYork:SimonandSchuster,2003).
4. X [George Kennan], “The Sources of Soviet Conduct,” Foreign
Affairs,July1947,566–82.
5.“TheVisionandValuesofWellsFargo,”WellsFargo,2007.Available
atwww.goodstrategybadstrategy.com.
6.Privateconversation,1995.
CHAPTER6:USINGLEVERAGE
1.TheancientGreekshadaccuratelymeasuredthediameteroftheearth.
They also measured the distance to the moon, but got that wrong
because their method was extremely sensitive to errors in the
measurementoftheanglebetweenthesunandthehalf-litmoon.
2.DonaldWright,etal.On Point II: Transition to the New Campaign
(FortLeavenworth,KS:CombatStudiesInstitutePress,2008),568.
3. Bob Woodward, State of Denial(New York: Simon and Schuster,
2006),122.
4. These predictions were described in Pierre Wack, “Scenarios:
Uncharted Waters Ahead,” Harvard Business Review, September–
October1985,73–89.
5. It is difficult to observe this effect in data because few firms are
foolishenough toadvertisebelow thethreshold.Foravery cunning
research design that observes a threshold effect in advertising, see
Jean-Pierre Dubé, Günter Hitsch, and Puneet Manchanda, “An
Empirical Model of Advertising Dynamics,”Quantitative Marketing
andEconomics3,no.2(2005):107–44.
CHAPTER7:PROXIMATEOBJECTIVES
1. Wernher von Braun to the Vice President of the United States, 20
April 1961, NASA Historical Reference Collection, NASA
Headquarters,Washington,DC.
2.ThefirstbetterphotographofthesurfacewastakenbyRanger7 in
1964, snapped at an altitude of about one thousand feet before it
smashedintothesurface.Thephotodidlittletosettlethehard-soft-
sharpdebate,anditshowedonlyobjectsthatwerelargerthanabout
threefeet.
3.“TentativeModelfortheLunarEnvironment,”JPLDocument61-263,
1961.
4.OranW.Nicks,FarTravelers:TheExploringMachines(Washington,
DC: Scientific and Technical Information Branch, National
AeronauticsandSpaceAdministration,1985),3.
5. Herbert Goldhamer, “The Soviet Union in a Period of Strategic
Parity,”RANDR-889-PR,November1971,7,quotedbyWatts,“Why
Strategy?”5.
6.Theobviousdrawbacktothisprocessofelaborationisthatthepeople
in the offices on the fiftieth floor may have unrealistic ideas about
whatcanactuallybedoneontheground.Thefirstbestcureforthisis
for some people on the fiftieth floor to have had ground-level
experience.Thesecondbestsolutionislotsofcommunicationupand
downthetowerasthestrategyisputtogether.Thethirdbestsolution
is to change the objective once there is very strong evidence that it
can’tbeachieved.That,however,rarelyhappenswithoutaturnoverin
leadership.Someofthereasonisego,butalotofitiscommonsense.
Noteveryonelikesoragreeswitheverystrategicpath,andthereare
alwaysthosewithintheorganizationwhowouldpreferorbenefitfrom
a change in direction. If you have a policy of changing direction
whenever you hit a snag, such people will be happy to create the
necessarysnags.
CHAPTER8:CHAIN-LINKSYSTEMS
1.Thelogicofqualitymatchingisnotobviousatfirstglance,butitisby
such deductions that scholars earn their keep. See Michael Kremer,
“TheO-RingTheoryofEconomicDevelopment,”QuarterlyJournal
ofEconomics,108,1993:551–575.
CHAPTER9:USINGDESIGN
1.TheRomanRepublicelectedmembersofthesenateandtwocounsels,
who were joint executives and magistrates of the government, each
able to veto the other. In times of war, at least one counsel was
normallyageneralandledthearmy.Intimesofextremeemergency,
the senate asked the counsels to appoint a dictator, who ruled with
absoluteauthorityforasix-monthterm.
2.Whathappenednextisequallyfascinating.Hannibalsentambassadors
totalkwithRome,expectingapeacetreatythatwouldacknowledge
his territorial gains. Rome refused to talk. Any nascent peace
movement was stopped in its tracks when the senate outlawed the
word“peace.”Everymalecitizenwasmobilized,andRomereturned
toapolicyofharassingHannibalbutavoidingmajorbattlesinItaly.
After some time, a skilled Roman commander, Publius Cornelius
Scipio,wasgivenafreehandtoconquerSpainandhedid,denying
Hannibalakeysourceofsuppliesandmanpower.Scipiothentookhis
armies across the Mediterranean, attacked Carthage itself, and
conqueredit.HannibalneverlostabattleinItaly,butCarthagelostthe
war. After defeating Carthage, Rome went on to subdue Macedon,
Syracuse,andtheSeleucidEmpire.
3. Theodore Ayrault Dodge, Hannibal: A History of the Art of War
AmongtheCarthaginiansandRomansDowntotheBattleofPydna,
168 B.C., with a Detailed Account of the Second Punic War (New
York:DaCapoPress,1995),633.Firstpublishedin1891.
4.AlexanderofMacedonhadachievedstunningvictoriesusingtactics,
formations,andweaponsdevelopedbyhisfather,Philip.Hisvictory
over Darius at Gaugamela a century earlier was strategically as
brilliantasCannae,aswellasbeingbolder,butwaslessorchestrated
andreliedlessonmultiplecoordinatedactions.
5.Thetechnicalwordforthesegainstovariouscombinationsofpartsor
resourcesis“complementarities.”
6.Technically,thebettermetrictoworkwithissurplus—thedifference
betweenwhatthebuyeriswillingtopayforthecar andthecostto
produce and deliver it. Willingness to pay is higher for wealthier
buyers and higher for those who especially value the product’s
differentiatingcharacteristics.
7.StevePostrelmakesthissamepointwithregardtoknowledge.Todo
designwork,he argues, teamsneedbothspecializedknowledge and
knowledgeofhowthespecialtiesfittogether.But,heargues,youcan
achievethesameperformancebyhavingmoreofoneandlessofthe
other. See his article, “Islands of Shared Knowledge: Specialization
and Mutual Understanding in Problem-Solving Teams,”
Organizational Science 13, no. 3 (May–June 2002): 303–20. At a
morebasiclevel,theideaoffactorsbeingpartialsubstitutesarosein
classicaleconomics.DavidRicardoarguedthatonecouldincreasethe
amountofcropsgrownbyapplyingmorelabortoexistinglandorby
having the existing number of farmers work more land. See David
Ricardo,“On theprinciples ofpolitical economyand taxation,” The
Works and Correspondence of David Ricardo, 3rd ed., ed. P. Sraffa
(Cambridge:CambridgeUniversityPress,1821).Reprintedin1951.
CHAPTER10:FOCUS
1. James S. Garrison, “Crown Cork and Seal Company, Inc.,” rev.
StephenBradleyandSheilaM.Cavanaugh,HarvardBusinessSchool
casestudy378-024,1987.
2.Thisstatement wasinan earlierversionof thecase.I providedthis
andotherinformationinasupplementIhandedout.
CHAPTER11:GROWTH
1.MeenaPanchapakasen,“IndecentExpansion,”FinancialWorld, July
6,1993.
2.MarkTranandMarkMilner,“AmericansPlantoWrapUpWorldin
Pounds3.3BnDeal,”Guardian,May24,1995.
3.MichaelPorter,CompetitiveStrategy(NewYork:FreePress,1980).
4.ForthischartIhavemeasuredreturnoncapitalastheratioofafter-tax
EBIT (sometimes called NOPAT) to lagged invested capital plus
goodwill. Thus, the numerator is the profit that would have been
earned were debt replaced by equity, and the denominator is assets
lessnondebtcurrentliabilities.
5. “An In-House M&A Team Reshapes a Company,” Global Finance,
March1997.
CHAPTER12:USINGADVANTAGE
1.“ToraBoraRevisited:HowWeFailedtoGetBinLadenandWhyIt
Matters Today,” Report to Members of the Committee on Foreign
Relations, United States Senate, November 30, 2009. According to
thisanalysis,U.S.CommanderGeneralTommyFranksdidnotusethe
fullforcesavailablebecausehe“fearedalienatingAfghanallies.”
2. The phrase comes from biology where it describes any barrier to
interbreeding. See Richard Rumelt, “Towards a Strategic Theory of
the Firm,” in Competitive Strategic Management, ed. R. Lamb
(Englewood Cliffs, NJ: Prentice-Hall, 1984), 556–70. Reprinted in
Resources, Firms, and Strategies:A Reader in the Resource-Based
Perspective, ed. N. J. Foss (New York: Oxford University Press,
1998).
3.Anequivalentargumentwasthatthe“advantage”didn’tmakethenew
owneranybetteroffbecausehecould,atanytime(inourimaginary
setting), sell the machine for $100 million, invest the proceeds, and
earn$10millionininterest.
4.Themachine’sopportunitycost,properlydefined, iszerobecauseit
has no value in use outside the silver industry. Return on invested
capital is only “above average” when key resources have not been
recentlymarkedtomarket.
5. Frank B. Gilbreth, Bricklaying System (New York: Myron C. Clark
Publishing, 1909). Gilbreth, along with Frederick Taylor, are
consideredthefathersofscientificmanagement.
6.Theideaissogeneralandwidespreadthatitresistspreciseattribution.
In 1951, Edith Penrose introduced economists to the idea that firms
grewandexpanded becauseofunderutilizedskillsand resources.In
my 1972 dissertation I called the knowledge underlying linkages
amongbusinessescoreskills.Eighteenyearslater,writingwithmuch
greaterpersuasivenessandusingbetterexamples,GaryHamelandC.
K. Prahalad catapulted their phrase “core competence” right out of
specialistcirclesandintocommonusage.
7. Steven N. Wiggins and Gary D. Libecap, “Oil Field Unitization:
Contractual Failure in the Presence of Imperfect Information,”
AmericanEconomicReview,75,1985:368–85.
CHAPTER13:USINGDYNAMICS
1.QuotedinMichaelKanellos,“Intel’sAccidentalRevolution,”CNET
News.com,November14,2001.
2.Grove,OnlytheParanoidSurvive,45.
3.Ibid.,44–45.
4.BechtolsheimdesignedthehardwareandYeakerwrotethesoftware.
WhileatStanford,BechtolsheimalsodidhisinitialdesignfortheSun
1 workstation, before he left to cofound Sun Microsystems. Yeager
joinedhimthere.
5.JohnSutton,TechnologyandMarketStructure(Cambridge,MA:MIT
Press,1999),ch.5.
6.BostonConsultingGroup,“TheTransitiontoaNewEnvironmentHas
Begun,”1997.Atthattime,AT&T’snetworkwasmorethantentimes
larger than WorldCom’s and was mostly older technology. The
difference in average cost per unit had nothing to do with AT&T’s
abilitytobuildmoderncapacitysimilartoWorldCom’s.
CHAPTER14:INERTIAANDENTROPY
1. “Strategic Plan for the Consumer Computer Market,” AT&T
Consumer Products, Strategic Planning and Consumer Information
ProductsSection,July1983.Companyconfidential.
2. The very popular economic valued added (EVA) measure,
trademarkedbyStern,Stewart&Co.,hasthesameproblemsinceitis
alsobasedon“investedcapital”measuredathistoricalcost.
3.“Gaintooperating”wasdefinedascurrentcashoperatingprofit(after
taxes)lesstheannualizedcashflowthatcouldbeobtainedbyclosing
the outlet, selling off the inventory, and leasing (or subleasing) the
propertyatmarketrates.Incomputingcurrentcashprofit,Ieliminated
the various interest and mortgage interest expenses the company
charged against each outlet. In addition, I stopped the allocation of
“overhead” that was actually the owners’ salaries and benefits and
allocated the remaining corporate expenses based on cost of goods
sold instead of square feet. I also added incentive payments to the
wagebillforeachlocation.
4. The formal term for this is “corruption”—the decay of an original
form.But this wordhas lost itsoriginal meaning andnow connotes
moralperversion.
5.AlfredSloan,MyYearswithGeneralMotors(NewYork:Doubleday,
1990),67.
CHAPTER15:PUTTINGITTOGETHER
1. “Vidia” is an amalgam of “video” and “via,” from Latin words
meaning“to see” and“the way”or“the road.”The letter“N”is an
abbreviationoftheLatinnatus,meaning“tocomeintoexistence.”
2.EdCatmull(Pixar),JohnCarmack(idSoftware),DougKay(Mondo
Media, Web graphics), and Pat Hanrahan (Stanford Computer
GraphicsLab).DavidKirk(CrystalDynamics)washiredtobechief
scientist.
3.Whereassimulationwasaccomplishedbysoftwareprogramsrunning
on general-purpose computers, emulation was done by configuring
specialchipstobehavelikethetargetchip.Slowerthantheactualchip
wouldbe,emulationwasmuchfasterthansimulation.
4. Jon Peddie Research is a technically oriented marketing and
managementconsultingfirmspecializingingraphicsandmultimedia.
5.QuotedbyWayTing,formervicepresidentatSGI,inRobertHof,Ira
Sager, and Linda Himelstein, “The Sad Saga of Silicon Graphics,”
BusinessWeek,August4,1997.
CHAPTER16:THESCIENCEOFSTRATEGY
1.JohnLocke,SecondTreatiseonGovernment,1690,ch.4,availableat
http://www.constitution.org/.
2.HowardSchultzandDoriJonesYang,PourYourHeartintoIt:How
StarbucksBuiltaCompanyOneCupataTime(NewYork:Hyperion,
1997),50–51.
3.Ibid.,87.
CHAPTER17:USINGYOURHEAD
1.MalcolmGladwell,Blink: The Power of Thinking Without Thinking
(NewYork:Little,Brown,2005).
2. This is called base-rate neglect. It may be explained by the
representativeness heuristic. See Daniel Kahneman and Amos
Tversky, “On the Psychology of Prediction,” Psychological Review
80,no.4(July1973):237–51.
3. This is probably an example of the inside-view bias applied to
competitivesettings.SeeDanielKahnemanandDanLovallo,“Timid
ChoicesandBoldForecasts:ACognitivePerspectiveonRiskTaking,
Management Science 39, no. 1 (January 1993): 17–31, as well as
ColinCamererandDanLovallo,“OverconfidenceandExcessEntry:
An Experimental Approach, American Economic Review 89, no. 1
(March1999):306–18.
4.Astand-aloneTiVoboxduplicatesfunctionsalreadyprovidedinthe
bundledset-topboxandmustdownloadschedulinginformationover
thetelephonelineoranInternetconnectionratherthandirectlyover
thecableTVlink.Theseaddedcostsandcomplicationskeepitfrom
beingamass-marketsolution.
CHAPTER18:KEEPINGYOURHEAD
1. Garrahan, Bath, and Stricker, “Emerging Network Companies:
ExploitingIndustryParadigmShifts,”LehmanBrothers,October27,
1998.
2. R. P. Rumelt, “Global Crossing (A) and (B),” Anderson School at
UCLAcasestudy,2002,www.goodstrategybadstrategy.com.
3. For a detailed and nuanced exploration of the fiber optic capacity
bubble, see Andrew Odlyzko, “Bubbles, Gullibility, and Other
Challenges for Economics, Psychology, Sociology, and Information
Sciences,” University of Minnesota School of Mathematics, 2010,
http://www.dtc.unm.edu/~odlyzko.
4.SeeTorkelFranzén,Gödel’sTheorem:AnIncompleteGuidetoItsUse
and Abuse (Wellesley, MA: A K Peters, Ltd., 2005). Gödel showed
thatlogicalsystemsatleastascomplexasarithmeticwereincomplete.
5. For one analysis, see Nobuhiro Kiyotaki and John Moore, “Credit
Cycles,”JournalofPoliticalEconomy105,no.2(April1997):211–
48.Theysay,“Thedynamicinteractionbetweencreditlimitsandasset
prices turns out to be a powerful transmission mechanism by which
theeffectsofshockspersist,amplify,andspillovertoothersectors.”
6. This term was popularized by Nassim Taleb in his book The Black
Swan:TheImpactoftheHighlyImprobable(RandomHouse,2007).
However,asTalebarguedonhisblog,thefinancialcrisiswasnota
“blackswan,”becauseitwasnot“highlyimprobable.”
7. Daniel Kahneman and Dan Lovallo, “Timid Choices and Bold
Forecasts:ACognitivePerspectiveonRiskTaking,”inFundamental
Issues in Strategy: A Research Agenda, eds. Richard Rumelt, Dan
Schendel, and David Teece (Harvard Business School Press, 1994),
71–96.
8.TheOECD,a descendantoftheMarshallPlan, containsthirty-three
advanced countries. Its purpose is to foster economic progress and
trade.
9. Richard J. Herring and Susan Wachter, “Real Estate Booms and
Banking Busts: An International Perspective,” Wharton Financial
InstitutionsCenterworkingpaper99-27,1999.
10. “Australia Frightened; the Results of an Abnormal Land Boom,”
NewYorkTimes,August15,1892.
11.U.S.DepartmentofHousingandUrbanDevelopment,UrbanPolicy
Brief,no.2,August1995.
12.HenryM.PaulsonJr.,“OpenStatementattheMeetingoftheU.S.-
China Strategic Economic Dialogue,” U.S. Department of the
Treasurypressreleasehp727,December12,2007.
13. Ben Bernanke, “The Great Moderation,” remarks to the Eastern
EconomicAssociation,February20,2004.
14. Alan Greenspan, “Economic Flexibility,” remarks to the National
ACKNOWLEDGMENTS
I owe debts to everyone who taught me and worked with me over the
years. They are, literally, too numerous to mention and I will limit most
specificacknowledgmentstothosewhoreadandcommentedonportionsof
thismanuscript.
DanVivoli,seniorvicepresidentatNvidia,helpedmeopendoorsatthat
company. He read my chapter on Nvidia at least twice, providing helpful
feedback each time. Stewart Resnick (chairman of Roll International) was
generouswithhistimeandinsights.
AllenWebb, withMcKinsey&Company, reada numberof thechapters
and offered many useful insights, as did Lang Davison, when he was with
McKinsey. Sid Barteau, formerly vice president of sales at American Can
Company,helpedmeunderstandthemorerecentdynamicsinthecanindustry
andprovidedfeedbackonmytreatmentofCrownCork&Seal.Francescode
Leo, presently executive chairman of Green Comm Challenge, has been a
patientsoundingboard.AndyMarshall,thedirectorofnetassessmentatthe
DOD,readandcommentedonseveralofthesechapters.BarryWatts,senior
fellow at the Center for Strategic and Budgetary Assessments, has been a
carefulreaderofmyworkandofferedwonderfullyinsightfulfeedback.
DanLovallo,attheUniversityofSydney,readseveralofmychaptersand
offeredlongeveningsofdiscussiononthesetopics.Iamdeeplyappreciative
of his enthusiasm and interest in this project. Charles O’Reilly, at Stanford
University, helped me sort out my opinions about leadership and vision.
AmongmycolleaguesatUCLA,SteveLippman,JohndeFigueiredo,Steve
Postrel, Craig Fox, and John Mamer all read various chapters and made
wonderfullyhelpfulcomments.
IwanttothanktheKuninfamilyfortheendowedchairIhold—theHarry
and Elsa Kunin Chair in Business & Society. The earnings on their
endowmentfreemefromtheritualofbeggingforresearchsupportandletme
follow my interests. I also want to acknowledge the support of UCLA
Anderson’sdean,JudyOlian,whoencouragedmyworkonthisbook.
My literary agent, Michael Carlisle (InkWell Management), skillfully
cajoledmeintoperformingthesurgeryonmymanuscriptthatwasnecessary
to make it salable. My editor, John Mahaney, patiently directed the further
operationsneededtomakeitreadable.Mythankstobothofthem.
Icouldnothavewrittenthisbookwithouttheloveandsupportofmywife,
Kate.Aformerteacherandresearcherinstrategy,Katereadandrereadthese
chapters,alwayswith patienceandalwaysofferingpointedcriticismswhile
markingpassagessheespeciallylikedwithsmallhappyfaces.
RichardRumelt
UCLAAnderson
INDEX
Accenture,40
action:
coherent,77,87–94
coordinated,129–30
movingto,88
Addison,Joseph,251
AdvancedMicroDevices(AMD),236
advantage,9,160–77
competitive,29,85,163–64
andcreatingdemand,173–75
deepening,170–71
extending,171–73
“interesting,”164–69
andisolatingmechanisms,175–77
andsilvermachineproblem,167–68
value-creatingchanges,169
wrestlingthegorilla,160–61
advertising,thresholdeffectin,103
Afghanistan,161–62
Agnellifamly,157
airlines:
Continental,204–8
deregulationof,197,204–5,206–8
Alcatel-Lucent,208n,210
AlexanderofMacedon,304n4
alQaeda,161–62
Alvarez,Luis,193
Amazon,163n
ambiguity,resolving,108–11
ambition,5
Amelio,Gil,11
AmericanAirlines,207
AmericanCanCompany,143
AndersenConsulting,13,40
Andropov,Yuri,102
anomalies,247–49
Ansco,194
anticipation,85,98–100,128–29
AOL(AmericaOnline),197
AppleInc.,11–15,163,191,208
andcompetition,11,14,203
successof,74
Archimedes,97
Aristoteliantheory,245–46
Aristotle,245
Army,U.S.:
envelopmentmaneuverby,18–19
fieldmanualof,3–4
ARPANET,191
Arrow,Kenneth,61
ArthurAndersen,38,40
ArtX,235,236
assetbubbles,286
AT&T,192,197
andcompetition,270
andderegulation,196
inertiaofculturein,208–10
andtransatlanticcable,277
ATITechnologies,235–36
Atlanticcable,277–81
AtlanticCrossing,277
attraction,lawof,72
attractorstates,198–201
AvayaInc.,208n
Avery,William,151–56
badstrategy,32–57
andavoidinghardwork,58
badobjectives,32,51–57
commonnessof,58
detectionof,7
failuretofacethechallenge,32,41–44
fluff,32,37–40
hallmarksof,32
inabilitytochoose,59–64
mistakinggoalsforstrategy,32,45–51
natureof,4–5,7–8,36–37
andNewThought,58,71–76
originofconcept,33–37
template-style,58,64–70
bar-codescanners,25
Bass,Bernard,65
battleofthetitans,196
BearStearns,286
Bechtolsheim,Andy,191
BellLaboratories,208n,209–10
Bennis,Warren,65
BerlinAirlift,82
BerlinWall,fallof,29
Bernanke,Ben,296,297
Bezzera,Luigi,252
biases,predictable,195–97
binLaden,Osama,71,162
blackswans,289
Blockbuster,202
bluebox(router),191
BMW,130
BoeingFleetPlanner,205–6
BoozAllenHamilton,41
Bosack,Len,191
BPGulfoilspill,288
brand-nameprotections,175
BraniffInternationalairlines,205
Braun,Wernervon,107–8
Brettbrothers,277
Brewer,David,54–55
Bright,Charles,277
BritishAirways,2
BritishTelecom,197
Brown,Harold,29
Brown,Richard,157
Buffett,Warren,163
bundling,270
Bush,GeorgeH.W.,15,20,82
Bush,GeorgeW.,3–4,33–34,100,295
Bushnell,Nolan,224
business-processtransformation,170
Buwalda,Phyllis,109–11
Byrne,Rhonda,73–74
Cable&Wireless,157
CaliforniaStateUniversityatSacramento,69
Calle,Craig,151,155
Cambodia,KhmerRougein,211
Cannae,125–30
Cannon,Michael,TheLandBoomers,293–94
Canon,137
Carmack,John,226
Carnegie,Andrew,258–59
Carter,William,277
Catmull,Edwin,224
CelesticaHongKongLtd.,232
centralizeddirection,92–93
chain-linksystems,116–23
excellence,122–23
gettingstuck,117–18
gettingunstuck,119–21
Challenger,O-rings,116
challenges:
failuretoface,32,41–44
ill-structured,81
overcoming,2,4
Chambers,John,191
Chandler,AlfredD.Jr.,272
change:
adjustmentsfor,66
maineffectsof,180–81
asobjective,120
andperspective,179
reengineering,170
resistanceto,64
intechnology,233
value-creating,169
wavesof,seewavesofchange
charisma,64–66,67,106
ChenBrothers,52–53
Cheney,Dick,20
Children’sCrusade,66–67
choice,86–87
anddecisiontheory,129
inabilitytomake,59–64
strategyas,62,64
Chopra,Deepak,73
ChristianScience,72,73
Churchill,Winston,48,64
CIA(CentralIntelligenceAgency),69–70,100
CiscoSystems,182–83,184,190–93,198
Cisneros,Henry,294
Citigroup,286
CivilAeronauticsBoard(CAB),204,206,207
Clark,Jim,224–25,235
Cleevely,David,279
Clinton,Bill,294
cloudcomputing,37
clusters,119
Coca-Cola,180
coherence,77,85,87–94,268
lossof,1
ofpoliciesandactions,9
Comcast,273
Compaq,137
competition,blocking,236,270
competitiveadvantage,29,85,163–64
complexity,reducing,85
computerindustry,verticaldisintegrationof,83
concentration,102–5
Condorcet’sparadox,60–61
Connelly,JohnF.,142,151,154,155
Conrad,Pete,110
containment,81–82
ContinentalAirlines,204–8
ContinentalCanCompany,143
ContinentalIllinoisbailout,289
Conway,John,153
Cook,Dick,172
coordination,92,94,115
CoorsBrewingCo.,146
Copernicantheory,245–46,251
copyrights,175
corecompetence,306n6
CornellUniversity,68–69
corruption,307n4
costs:
average,280
buyer’s,170n
fixed,194
long-runaveragecost,280
marginal(variable),280
Coyote,WileE.,287
create-destroy,271–73
creditbubbles,286,293
CrownCork&Seal,142–50,151–56
CSBA(CenterforStrategicandBudgetaryAssessments),33
culture:
inertiaof,208–12
useofterm,211
DaimlerAG,138
darkmatter,248–49
DARPA(DefenseAdvancedResearchProjectsAgency),43–44
DavidandGoliath,21–22
Dawson,Wallace,277
debtdeflation,287
DEC(DigitalEquipmentCorporation),59–62,63,189,191
decisions,formaltheoryof,129
DefenseDepartment,U.S.,28–31,68
deleveraging,287
Dell,12,137,232,233
DeltaAirlines,197,207
demand,creating,173–75
democracy,groupirrationalityin,61
demonstrationeffect,199
Denton,CarlandMariah,214–15,217
Denton’sInc.,214–18,222
depressions:
(1819),292
financialcrisis(2008),290
Panicof1837,292
Panicof1893,293–94
deregulation:
airlines,197,204–5,206–8
telecommunications,194–95,196,204
Descartes,Rene,245
DesertStorm,15–20
design,124
anticipation,128–29
thearcofenterprise,134–38
andcompetition,137
ofcoordinatedaction,129–30
costsof,186,187
andentropy,220–21
natureof,134
orderoutofchaos,138–41,220
partsofawhole,130–34
premeditation,128
trade-offsin,132,133–34
trialanderrorin,187
determination,5
diagnosis,77,79–84,268
DiamondMultimedia,233
DirecTV,273
DisneyCompany,172–73
Dodge,Theodore,127
Doom(PCgame),225–26
Doriot,GeorgesF.,88
DowChemicals,67–68
Drucker,Peter,65
Dryden,John,251
DuPont,171–72
duPont,Pierre,218
dynamics,178–201
andhighground,178–81seealsowavesofchange
EasternAirlines,207
eBay,168–69
economiesofscale,279
Eddy,MaryBaker,72
Einstein,Albert,249
Eisenhower,DwightD.,62,64,65
Embraer(Brazil),173
Emerson,RalphWaldo,71,75
energycrisis,99–100,108
engineeringoverreach,289
England,BattleofTrafalgar,1
Enlightenment,245–47,251
Enron,38–40,67–68
enterprise,arcof,134–38
EnterpriseRent-A-Car,137
entropy,214–22
Denton’s,214–18
GM,218–22
scientificdefinitionof,202
EuropeanBusinessGroup,88–90
Evans,David,224
excellence,122–23
experience,267–68
experts,virtualpanelof,271–73
Facebook,163n
Fahd,kingofSaudiArabia,20
failuretofacethechallenge,32,41–44
Falkenhayn,Erichvon,48
FansteelInc.,257–58
FederalReserveSystem,295–97
FedEx,137
Feldman,Al,204,208
Ferris,Dick,205
fiberopticchannels,279,283
Field,Cyrus,277
Fisher,Irving,287
Fisher,Jeff,228
FiveForcesframework,153,280,284
Fletcher,Fred,257–58,260
Flowers,BettySue,75
fluff,32,37–40
focus,142–50,155
Ford,Henry,74–75,218
FordMotorCompany,91,180
ModelTFord,218
forecasting,biasesin,195–97
fragmentation,211
FranklinMint,164
FrontierAirlines,207,208
Fujifilm,194
Fuld,Richard,3
gaintooperating(GTO),215–16
galacticrotation,248–49
GalileoGalilei,245–46
games,and3-Dgraphics,225–27,236
Gandhi,Mahatma,64,67
Gates,Bill,12,98,138
Geithner,TimothyF.,297
GeneralElectric(GE),180,194
GeneralMotors(GM):
bankruptcydeclaredby,222
chain-linkedissuesin,117–18,123
entropyin,218–22
modelsandprices,219,220,221,222
Gerstner,Lou,83,84
Getty,J.Paul,104
GettyFoundation,104–5
GettyTrust,104–5
Gilbreth,Frank,170
Gilder,George,284
Gladwell,Malcolm,Blink,264–65
Glide(language),227,229
GlobalCrossing,276,277–84
goals:
mistakingforstrategy,32,45–51
objectivesvs.,52
setting,6–7
Gödel,Kurt,285
Goldhamer,Herbert,111
goodstrategy:
andcompetition,11
coreof,2
kernelof,seekernel
natureof,6,9,11
overcomingchallengesin,2,4
simplicityof,1–2,12,85
Google,100,137,200,203
Gorbachev,Mikhail,102
Gore-Tex,160
Gorin,Ralph,190–91
Graham,Bob,16
graphicspipeline,224–25,229,232,236
gravity,theoriesof,249
Greenspan,Alan,296–97
groupirrationality,61
Grove,Andy,63,186
OnlytheParanoidSurvive,188–89
growth,151–59
byacquisition,156
healthy,159
reasonsfor,156
andstrategy,235
valuecreatedin,155–56
guidingpolicy,77,84–87,268
GulfWar(1991),15–20
Haig,Douglas,48
Hannibal,125–29,234
HayAssociates,41
heliocentricuniverse,245–46
Herring,RichardJ.,291
Hershey’s,180
highground,178–81
Hindenburgdisaster,288,289
Hobbes,Thomas,245
HoggRobinson,258
Holmes,Ernest,CreativeMindandSuccess,73
Hoover,Herbert,294
householddebt,286–88,291–92,294–95
HP(Hewlett-Packard),12,62,137,233
Huang,Jen-Hsun,223,227,228,229
HughesElectronics,241–44
Hume,David,245
humpchart,216–17
Hunt’sproducts,180
Hussein,Saddam,15,17,36,99
hypothesis:
inscience,247
strategyas,241–44,247
IBM,83–84,179
andantitrustlitigation,192,196,270
andchange,188–89,190,191,192,194
andcompetition,137,138
idSoftware,226
IKEA,122–23
Iklé,FredC.,33
Ilford,194
inertia:
businessdefinitionof,202
andcompetition,202–3,204
ofculture,208–12
byproxy,212–14
revelationsof,204
ofroutine,203–8
inflationindex,296
information:
privileged,253
proprietary,254–56
innovation,5,178
Inquisition,246
INSEAD,88
insideview,276,290–91,298
insight,263,264
game-changing,10
localized,269
instinct,265
Intel:
choicesin,63
andcompetition,137,188,229,232,234–35
firstmicroprocessorfrom,185–86,189
“IntelInside”campaign,234
andWindows,11,14,83,235,236
IntermediaCommunications,213
InternationalHarvester,41–43
Internet:
PCgameson,226
riseof,192,196,197,278,281,282,284
InternetProtocol(IP)networking,191–92,198–99
Iran,andIraq,15,17
Iraq:
invasionofKuwait,15–17
andIran,15,17
U.S.invasionof,3–4,98–99
andweaponsofmassdestruction,34
isolatingmechanisms,175–77
Jaworski,Joseph,75
Jefferson,Thomas,245,246,294
Jobs,Steve:
andApple,12–15
onauthor’sexpertpanel,272,273
andnextbigthing,14–15
Joffre,Joseph,48
Johnson,LyndonB.,107
JohnstownFlood,288
judgment,268,274–75
JurassicPark(movie),225
Kahneman,Daniel,290
Katrina,Hurricane,288,289
Kellogg’s,180
Kennan,George,82–83
Kennedy,JohnF.,106–8
Kenworthtrucks,138–39
kernel,77–79,268–69
coherentactionin,77,87–94,268
diagnosisin,77,79–84,268
elementsof,7,77
guidingpolicyin,77,84–87,268
Khalid,Prince(SaudiArabia),20
KhmerRouge,211
King,MartinLutherJr.,64,106
Kipling,Rudyard,276
Kirk,David,232
Kmart,25,27,137
KnightRidder,209
knowledge,268
alreadyknown,244–45
Kobayashi,Koji,196
KodakCorporation,180,194
KoreanWar,82
Kovacevich,Richard,84
Kreider,Torsten,151
Kuwait:
Iraqiinvasionof,15–17
weaponsin,36
lawofattraction,72
leadership:
charismatic,64–66,67,106
inspirational,5–6
responsibilityof,2
andstrategy,66
transformational,56,65
useofterm,299n1
LehmanBrothers,2–3,286
Leibniz,GottfriedWilhelm,245
Lerner,Sandy,191
leverage,85,97–105
andanticipation,98–100
andconcentration,102–5
andpivotpoints,101–2
Lévy,Jean-Bernard,181–83,184,188,190
limitingfactors,117
Lippman,Steven,167
Lipton,Mark,GuidingGrowth,75
lists,making,53,258–61
Lloyd,Edward,251
LloydsofLondon,251
Locke,John,245,246
Logan,Chad,45–47,49–50,71
LondonStockExchange,251
Long-TermCapitalManagement,289
Lorenzo,Frank,207–8
LosAngelesUnifiedSchoolDistrict(LAUSD),53,54–57
Lovallo,Dan,290
Lynch,Peter,142
M31galaxy,248–49
Madison,James,97
Malachowsky,Chris,227,230
Mamer,John,79
MaoTse-tung,92
Marshall,Andy,28–31
Marshall,GeorgeC.,65
MatraCommunications,181–84
McCardell,Archie,41,43
McCormick,Cyrus,41
McCracken,Ed,235
McDonald’s,80
McDonnellDouglas,206
McDonough,Jack,272–73
MerrillLynch,286
microprocessors:
first,185–86,189,204
andsmartcomputers,189
andsoftware,191
andwavesofchange,196
Microsoft:
andApple,12
andcompetition,137,138,188,203,270
DirectX,229,232,236
andGoogle,100
andJusticeDepartment,12
Windows,11,14,83,176,235,236
mission,67
Mogadishu,99
momentum,103
monopolies,270
Moore,Geoffrey,CrossingtheChasm,227
Moore,Gordon,63,186
Moore’slaw,186,228–29
Morgridge,John,191
mortgages,286–88,289,294–96
Moses,64,66
Mulford,Prentice,ThoughtsAreThings,72,74
Murata,Noritoshi,101
Myst(PCgame),225
NAFTA,141
Nanus,Bert,65
NapoléonBonaparte,1
Napster,199,263
NASA,JetPropulsionLaboratory(JPL),108–11,131–34
Nasser,Jacques,91
NationalCanCompany,143
nationalsecurity,33–36,64
NATO,33,35,82
naturallaws,246
Navistar,138
NECCorporation,70,196
Nelson,Horatio,Viscount,1
Nestlé,113
Netflix,202
network,26–27,190
networkeffect,163n
networking:
corporate,191
IP,191–92
proprietaryprotocolsin,192
NewAgeideas,74
Newland,Ted,99
newspaperindustry,199–201
NewThought,58,71–76
Newton,Isaac,245,246,249,251
NewYorkAir,208
NewYorkCitybailout,289
NewYorkTimes,199–201
NeXT,13,15
Nicks,OranW.,110
NorthernPacific,292–93
NorthernTelecom,181
nuclearpower,199
Nucor,138
Nvidia,223–24
andcompetition,137,234–36
formationof,227
strategyat,227–33
Teslagraphicschips,236
whatnext?,236–37
objectives:
badstrategy,32,51–57
blue-sky,54,56
changeitselfas,120
dog’sdinner,53
feasible,112
goalsvs.,52
hierarchiesof,113–15
long-term,53
proximate,92,106–15
OceanSpray,174
oil:
energycrisis,99–100,108
priceof,204
andpropertyrights,175–76
Olsen,Ken,61–62
OPEC,99
opinionpolls,closedcirclesof,285
Organization for Economic Co-operation and Development (OECD),
291
Ouchi,Bill,MakingSchoolsWork,81
Paccar,138–41
PacificCapitalGroup,277
Paine,Thomas,245
Palmer,Robert,62
patents,175
Paulson,HenryM.Jr.,295
Peale,NormanVincent,73
Peddie,Jon,234
Penrose,Edith,306n6
PeopleExpress,208
Perot,H.Ross,48
personalmastery,75
perspective,179
Peterbilttrucks,138–39
Petraeus,David,Army/MarineCorpsCounterinsurgencyFieldManual,
3–4
PhiladelphiaSavingsFundSociety(PSFS),212
pivotpoints,101–2
Pixar,172
PJ(pilot),114–15
planning,50–51
Plato,245
PolPot,211
POMWonderful,165,166,173–75
Pope,Alexander,251
Porter,Michael,153,163,280
positivethinking,58,73–74,75,76
Powell,Michael,264
power:
discoveryof,22
andleverage,97–105
sourcesof,95–96
Pratt&Whitney,194
Priem,Curtis,227
PrincetonProjectonNationalSecurity,33–34
problem-solution,269–70
profit:
gaintooperating(GTO),215–16
humpchart,216–17
streamsof,212
profitability,169
ProjectSolarium,62
propertyrights,175–76
ProtestantReformation,71,251
proximateobjectives,92,106–15
creatingoptions,111–13
hierarchiesof,113–15
resolvingambiguity,108–11
proxy,inertiaby,212–14
Ptolemaictheory,245–46
Quake(PCgame),226
Qualcomm,186–87
qualitymatching,117,120
Qwest,282
Randolph,Edmund,97
Rao,SrikumarS.,75–76
Reagan,Ronald,30,102
reason,andEnlightenment,245–47
Reed,John,TenDaysThatShooktheWorld,30
reengineering,170
Reformation,71,251
refutation,247
ReligiousSciencemovement,73
RepublicSteel,258
Resnick,Lynda,164–65,173–75
Resnick,Stewart,164–68,173–74
Ricardo,David,305n7
risk-seekingincentives,289
RIVATNTchip,231,232
roadmap,useofterm,228
Roche,James,29–31
RollInternationalCorporation,164–67
Rolls-Royce,187,194
RomanRepublic,304n1
Romero,John,226
Rommel,Erwin,127
Roosevelt,FranklinD.,93,294
Rossignolo,Gianmario,157,159
routine,inertiaof,203–8
Rowntree,113
Rutherford,Alan,151
salienceeffect,103
Santos,Joe,254–55,256
SaudiArabia,36
Saul,kingofIsrael,21
Scharmer,C.Otto,75
Schlesinger,JamesR.,33
Schultz,Howard,249–54
Schwarzkopf,Norman,16–20
science,241–56
anomaliesin,248
andEnlightenment,245–47
hypothesisin,247
asmethod,247
refutationin,247
scientificempiricism,241,246–47
scientificinduction,254
Scipio,PubliusCornelius,304n2
Scott,Bruce,272
SEATO,82
SegafredoZanetti,255
semiconductors,228
Senge,Peter:
TheFifthDiscipline,74,75
Presence,75
September11attacks,33–34,161
Seven&iHoldings,101
7-Eleven,101
Shaw,GeorgeBernard,106
ShellInternational,99
SiliconGraphicsInc.(SGI),224–25
andcompetition,235
andgraphicspipeline,232,236
andtrianglebus,228,229
simplification,211
skiinginthefog,193
Sloan,Alfred,218–20
Smith,Adam,245,251
smooth-sailingfallacy,289
socialherding,289–90,298
software:
advantageof,184–87
developmentcycleof,187
Sony,216
SouthwestAirlines,207
SovietUnion,collapseof,29–31
specie,292
Sputnik(1957),106
S.S.KresgeCorporation,25
Stalin,Joseph,92
Starbucks:
anomalyand,249–50
capturingproprietaryinformation,254–56
andcompetition,254–55
anddivergence,251–52
formationof,250
ill-structuredchallengeof,80–81
testingthehypothesis,252–54
verticalintegration,256
stockmarket,asclosedcircle,285
stockprices,andexpectations,281–82,284
StrategicDefenseInitiative,30
strategicobjectives,bad,32,51–57
strategicresources,135–37
strategy:
basicideaof,9
aschoice,62,64
coherenceof,9
cornersolution,273
create-destroy,271–73
entrepreneurialcomponentof,244
andgrowth,235
ashypothesis,241–44,247
andjudgment,274–75
andleadership,66
mistakinggoalsfor,32,45–51
misuseofterm,5–7
natureof,6–7,66
problem-solution,269–70
scienceof,241–56
template-style,58,64–70
thinkingabout,239–40
seealsobadstrategy;goodstrategy
strategyretreat,2
supply-chainmanagement,28
surplus,304n6
Surveyormoonlanding,108–11
sustainability,163
Sutherland,Ivan,224
Swift,Jonathan,251
tail-risks,289
Taliban,161–62
Taylor,Frederick,259,260
Teece,David,272,273
Tegrasystem,236–37
TelecomItalia,13,156–59
telecommunications:
Atlanticcable,277–81
CiscoSystems,182–83,190–93,198
convergenceofcomputingand,196
deregulationof,194–95,196,204
economicsof,279–80
fatpipes,279
GlobalCrossing,276,277–84
inertiabyproxyin,213–14
inflectionpointsin,188–90
andInternet,191–92,198–99
Italia,13,156–59
Matra,181–84
Teleflora,164–65
TexasAir,207–8
Thatcher,Margaret,157
thermodynamics,secondlawof,202
thought:
aboutthinking,239–40
anomaliesof,247–49
hypothesis,241–44,247
techniques,267–73
3dfxInteractive,226–27,228,229,234
3-Dgraphics:
competitionin,234–36
andgamers,225–27,236
graphicspipeline,224–25,229,232,236
andtrianglebus,228,229
thresholdeffect,103
Tinelli,Marco,119–21,123
TiVo,261–67,269,270,273
TombRaider(PCgame),227
tools,268
Toyota,98–100,221,222
Trafalgar,Battleof,1
transcendentalism,71
transcontinentalrailroads,292–93,294
transformation,170
trianglebus,228,229
Truman,HarryS.,64,65,82,294
Tupper,Matt,175
20/20plan,45–47,49
underperformance,55
UnitedAirlines,205,207
UnitedNations,35
UniversityofUtah,224,229
Unix,208–9
unwinding,287
USAir,207
U.S.Steel,258
value-creatingchanges,169
values,67–68
verticalintegration,256
VietnamWar,3,82,99
VisiCalc,227
vision,65,67,74
Voltaire,245
Volvo,138
Voodoo(graphicsboard),227,231
Voyagermission,131,133
Wachter,Susan,291
Wack,Pierre,99–100
Wal-Mart,23–28
andcompetition,24–25,26,27,137
conventionalwisdombrokenby,23,26–27
integratedlogisticsin,25
networkof,26–27
Walton,Sam,23,28,31
Warnock,John,224
WaronDrugs,108
Wattles,Wallace,TheScienceofGettingRich,72–73,74
wavesofchange:
attractorstatesin,198–201
andderegulation,194–95
discerningthefundamentalsof,184–87
inearlystages,180
exogenous,178–80
forecastingbiasesin,195–97
guidepostsfor,193
incumbentresponsesto,198
maineffectsof,180–81
risingfixedcosts,194
swellof,181–84
intelecommunications,188–93
Weber,Max,65
Web2.0business,4
Welch,Jack,47,71
WellsFargo,84
WesternElectric,208n,210,216
WholeFoods,52
Williams,Harry,104–5
windingthecrank,243–44
Winfrey,Oprah,74
Winnick,Gary,277,283
Woodward,Bob,99
WorldCom,197,213,282,283
WorldWarI,Passchendaele,47–49
WorldWarII,centralizeddirectionin,93
Wozniak,Steve,74
wrestlingthegorilla,160–61
Xerox,135–37,191
Yahoo!,137,197
Yeager,William,191
Zoradi,Mark,172–73
*A“networkeffect”increasesthevalueofaproductasthenumberof
buyersorusersgetslarger.Itislikeaneconomyofscale,butinstead
ofreducingtheproducer’scost,itincreasesthebuyer’swillingnessto
pay. We see very strong network effects in businesses like Amazon
andFacebook.
*Atthatmoment,AT&Thadbeensplitofffromitshistorictelephone
system businesses. It consisted of Bell Labs research units, Western
Electric manufacturing divisions, the consumer products businesses,
computingproducts,networksystemsandservices,andlong-distance
telephoneservices.Today,theAT&Tlabelappliestoaverydifferent
company–a combination of long-distance services, national wireless
services, and many of the original local telephone companies. Bell
Labs and Western Electric are today owned by Alcatel-Lucent.
Business communications and network services have been spun off,
becomingAvayaInc.
* Understanding this balance should allow you to predict that the first
telephonecompanytoofferDSLservicestobusinesseswouldbeU.S.
West,theformerMountainBell,headquarteredinDenver.U.S.West
hadthefewestnumberofT1linesonleaseandservedfast-growing
corporateandresidentialmarkets.Itwasaninnovatorincreatingand
offeringDSLservicestobusinesses.
ABOUTTHEAUTHOR
RICHARDP.RUMELTisoneoftheworld’smostinfluentialthinkers
onstrategyandmanagement.TheEconomistprofiledhimasoneoftwenty-
fivelivingpersonswhohavehadthemostinfluenceonmanagementconcepts
and corporate practice. The McKinsey Quarterly described him as being
“strategy’sstrategist”andas“agiantinthefieldofstrategy.”Throughouthis
career he has defined the cutting edge of strategy, initiating the systematic
economicstudyofstrategy,developingtheideathatcompaniesthatfocuson
core skills perform best, and that superior performance is not a matter of
beingintherightindustrybutcomesfromafirm’sindividualexcellence.He
isone ofthefounders ofthe resource-basedviewof strategy, aperspective
thatbreakswiththemarket-powertradition,explainingperformanceinterms
of unique specialized resources. He received his doctoral degree from
HarvardBusinessSchool,holdstheHarryandElsaKuninChairattheUCLA
AndersonSchoolofManagement,andisaconsultanttosmallfirmssuchas
theSamuelGoldwynCompanyandgiantssuchasShellInternational,aswell
astoorganizationsintheeducationalandnot-for-profitworlds.
Running head: LITERATURE REVIEW
Literature Review
Name
Institution
LITERATURE REVIEW 2
Literature Review
Literature review is an essential element in the writing process and often aims at
surveying the literature in the selected study, synthesize information, and analyze the gathered
information. Literature review often presents the topic of study being written and demonstrates
an in-depth grasp of the study. This paper presents a detailed literature review on specific topics
including how individual and group decisions tend to either help or hinder business decision
making, the new directions in strategy development and business decision making and the
various ways that my academic discipline impact the process of business strategy.
How do individual and group decision processes aid or impede business decision making?
Different researches provide different conclusions on group and individual decision
processes. Tindale & Winget (2019), view individual decision as decision made by one
individual, mainly the leader in a given organization while group decision is a decision that is
unanimously concluded by several individuals in an organization. This is not necessarily the case
in almost all business corporations since both individual and group decisions often have different
impacts on the business. As Mukherjee, et al., (2016), point out in their article, there are a
number of complex psychological aspects that play into an organization’s decision-making
process that result in either the selection of individual or group decision process. The authors
reviewed several articles on both individual and group decision making and afterward came up
with several ways in which these decision-making processes impede business decision making.
In Individual decision making, an individual often comes up with prompt decisions.
According to De Maio (2016), while different individuals often dominate a given group in an
organization setting, it could be time-consuming to make decisions using this model. As a result
LITERATURE REVIEW 3
of saving time, individual decision making aids in business decision as it eradicates the
assembling of group members. Also, it aids in business decision making such that individuals
take full responsibility for their decisions and are accountable for the choices made, thus
enhancing business decision process. However, individual decision making, on certain occasions,
tends to impede business decision. When making individual decisions, the individual only
employs their personal views and intuitions, which could impede the decision-making process
(Mukherjee et al., 2016). According to this conclusion made by the authors, this hinders making
effective and more practical decisions since the individual does not consider the interests of other
members in the organization in making the decision.
Several researchers argue for the use of group decision process to in business decision
making. This decision making process involves a participatory process whereby many
individuals who primarily act collectively analyze situations and problems within the
organization, evaluate alternatives and choose the best options to devise the best solution
(Tindale & Winget, 2019). This process is essential to an organization when making a decision
since it encourages several methods in its processes such as brainstorming ideas or relevant
actions, nominal group technique and dialectal inquiry which focuses on a complete
consideration of all alternatives.
This process also aids business decision making by taking full advantage of the expertise
and diverse strengths in the members. Tindale & Winget (2019), support this argument in their
conclusion that tapping the exceptional qualities of all the members allows the group to generate
countless alternatives that are generally more quality compared to individual decisions.
Furthermore, group decision process aids business decision making by utilizing the collective
understanding of a selection decision. This creates ownership of the decision, which contributes
LITERATURE REVIEW 4
commitment to the decision. Despite these crucial ways that group decisions aid decision
making, certain aspects impedes this approach. In most organizations, groups take too much time
to arrive at decisions compared to individuals. According to Mukherjee et al., (2016), this
concern makes it quite challenging to utilize them in occasions where decisions are required
relatively fast. Another way that group decision impedes decision making is by group
polarization. The predisposition of a group to converge on more extreme solutions and in most
cases often results in the risky shift phenomenon.
What are the newest directions in the process of strategy development and execution?
The new directions in the process of strategy development and execution are a crucial
topic in management currently. In recent years, most business enterprises utilized a highly
structured methodology to strategy development and execution (Thompson, Strickland &
Gamble, 2015). This approach involved utilizing annual processes of instituting plans to be used
in the coming year. However, in the current complex and very competitive business
environment, it is quite challenging to plan effectively for every possible eventuality. Developing
a strategy also need to be a dynamic and flexible process that must reflect strategic thought in the
business as well as the general environment that it operates.
The newest directions in the process of strategy development, according to contemporary
researches, ought to identify strategic options by choosing the most promising options while
deciding the allocation of resources in the organization in order to archive the desired objectives.
Thompson, Strickland & Gamble (2015), argue that the key resolve for strategy development is
to identify and establish the organization’s long-term as well as short-term opportunities by
adopting the newest directions. The first direction in this process includes clarifying the vision of
the organization. This involves defining short and long-term goals. According to Thompson,
LITERATURE REVIEW 5
Strickland & Gamble (2015), the set objectives should be realistic, detailed, and fit the core
values of the organization.
Secondly, adequate data should be gathered and analyzed. This analysis allows the
management to understand all the needs of the organization as a suitable entity. According to
new directions, it is essential to examine any possible internal and external concerns that could
influence the goals of the organization. Other directions involve formulating strategies and
evaluating and control of the strategy. On formulating a strategy, Thompson, Strickland &
Gamble (2015), propose that the business should determine the existing resources that could help
it reach the set objectives. In this stage, all the issues that the business is facing must be
prioritized.
Sull, Homkes, & Sull (2015), in their article “Why strategy execution unravels—and
what to do about it” holds a different opinion on strategy execution and further provides
significant insights to new approaches and directions. The authors propose that strategy
execution should be conducted in relation to the newest step by step directions. The new
direction in the execution strategy includes visualizing the strategy before executing it. This
could be achieved by utilizing the available frameworks such as the Success Map, Activity Map,
or the Strategy Map by Norton and Kaplan. Another direction in executing a strategy is reporting
progress. According to Sull, Homkes, & Sull (2015), the strategy under this stage ought to be
reviewed continually with emphasis on determining whether the strategy is providing the
expected results.
Managers should also identify strategy projects. This new direction implores business
managers to organize and capture all projects during the execution process. In this case,
researchers argue that organizations should have a clear understanding of the range of projects.
LITERATURE REVIEW 6
Another direction in execution is reward performance. Upon explaining and aligning the strategy
to the personnel, senior managers ought to institute incentives that aim to drive behaviors that are
relatively consistent with the strategy.
How can my academic discipline, as a function within the organization, impact the process
of business strategy development and execution?
Since strategic management as my academic discipline involves laying out business
goals, the advancement of strategic vision, and creating and implementing strategies in an
organization, it plays a key role in impacting the process of business strategy development and
execution. Strategic management can impact strategy development and execution processes
through necessitating a robust commitment to the processes, which exemplify the ability of an
organization to set long-and short-term goals. Mordern (2016), supports this argument in his
conclusion that strategic management positively impacts business strategy development and
execution by determining the crucial actions and decisions required to meet the set strategic
goals. This enables organizations to identify relevant processes quite easily and allocate
resources in order to archive the set goals; thus strengthening and supporting the core
competencies of the organization.
My discipline also impacts strategy development and execution processes by helping the
organization to determine strategy. This allows the organization to develop strategic goals and
make logical choices in order to keep pace with the alternating contemporary business
environment. Through strategic management, the organization not only enhances its market
share, but it also gains a competitive advantage. This discipline also impacts the process of
business strategy development and execution by assisting the organization to become proactive.
According to research conducted by Mordern (2016), results concluded that a proactive firm is
LITERATURE REVIEW 7
able to analyze competitor’s actions and implement steps that enhance competition. As a result,
strategic management proves to be the basis for all essential decisions for strategy development
and execution process.
LITERATURE REVIEW 8
References
De Maio, C., Fenza, G., Loia, V., Orciuoli, F., & Herrera-Viedma, E. (2016). A framework for
context-aware heterogeneous group decision making in business processes. Knowledge-
Based Systems, 102, 39-50.
Morden, T. (2016). Principles of strategic management. Routledge.
Mukherjee, N., Dicks, L. V., Shackelford, G. E., Vira, B., & Sutherland, W. J. (2016).
Comparing groups versus individuals in decision making: a systematic review
protocol. Environmental Evidence, 5(1), 19.
Sull, D., Homkes, R., & Sull, C. (2015). Why strategy execution unravels—and what to do about
it. Harvard Business Review, 93(3), 57-66.
Thompson, A., Strickland, A. J., & Gamble, J. (2015). Crafting and executing strategy: Concepts
and readings. McGraw-Hill Education.
Tindale, R. S., & Winget, J. R. (2019). Group decision-making. In Oxford Research
Encyclopedia of Psychology.
Outline
Literature Review
Literature review is an essential element in the writing process and often aims at
surveying the literature in the selected study, synthesize information, and analyze the
gathered information.
How do individual and group decision processes aid or impede business decision making?
Different researches provide different conclusions on group and individual decision
processes. Tindale & Winget (2019), view individual decision as decision made by one
individual, mainly the leader in a given organization while group decision is a decision
that is unanimously concluded by several individuals in an organization. This is not
necessarily the case in almost all business corporations since both individual and group
decisions often have different impacts on the business.
What are the newest directions in the process of strategy development and execution?
The new directions in the process of strategy development and execution are a crucial
topic in management currently. In recent years, most business enterprises utilized a
highly structured methodology to strategy development and execution.
The newest directions in the process of strategy development, according to contemporary
researches, ought to identify strategic options by choosing the most promising options
while deciding the allocation of resources in the organization in order to archive the
desired objectives.
Secondly, adequate data should be gathered and analyzed. This analysis allows the
management to understand all the needs of the organization as a suitable entity.
According to new directions, it is essential to examine any possible internal and external
concerns that could influence the goals of the organization.
Sull, Homkes, & Sull (2015), in their article “Why strategy execution unravels—and
what to do about it” holds a different opinion on strategy execution and further provides
significant insights to new approaches and directions.
Managers should also identify strategy projects. This new direction implores business
managers to organize and capture all projects during the execution process.
How can my academic discipline, as a function within the organization, impact the process
of business strategy development and execution?
Since strategic management as my academic discipline involves laying out business
goals, the advancement of strategic vision, and creating and implementing strategies in an
organization, it plays a key role in impacting the process of business strategy
development and execution.
