Strategy isn't hard: don't overcomplicate it

Episode #85 Strategy isn't hard: don't overcomplicate it

Hey there, and welcome to Episode #85 of the No Bullshit Leadership podcast. This week’s episode, “Strategy isn’t hard: don’t overcomplicate it”. The word strategy is much misused and misunderstood. A lot of people use the word without really understanding what it means. Have you ever had that well-meaning boss give you the feedback, “You need to be more strategic”? Well, even if that were true, it’s not particularly useful unless they explain what that means. Today, I want to take a step back and ask the question, “What is strategy?”, and give you some practical tips for how to think about it, if you ever find yourself in the position where you need to. I’ll start with my definition and take on strategy. I’ll then move on to talk about the three generic strategic choices that every organisation needs to make. We’ll look at some common tools and frameworks that can help you to want to take strategic analysis, and I’ll finish with a few tips on how to use strategy in a practical way to make better decisions. So let’s get into it.

Before we start, I just want to make it really clear that you’re not going to learn how to develop strategy in this 20 minute podcast episode. A strategy is something that takes years to develop. Having said that, there are some incredibly useful theory pieces around, which I’ll touch upon at different points. But developing strategic capability takes a mindset and level of thinking that only develops over time as you learn, apply and make mistakes. Having said that, this episode should give you a really good idea of where to start if you want to further your journey on strategy, but I’ll be skipping over the concepts in the same way that you would skip a pebble on the surface of a pond.

What is strategy? I’m a little different to some when it comes to defining strategy and I particularly like one of Peter Drucker’s quotes where he said, “Strategy is a set of principles around which to improvise.”

Now I believe that strategy is simply about making the highest order choices for your organisation about where and how it will compete. The keywords here are “choices” and “compete”, and we’ve got to remember that strategy doesn’t happen in a vacuum. It has to be conceived in the context of and in reference to an industry, a market, and a set of competitors, both existing and potential future competitors. It’s then about setting the highest-order objectives and targets that put a beacon on the hill to guide the lower order decisions that need to be made at the various levels in your organisation. Strategy is necessarily long-term in its nature. So for most the minimum horizon for strategic planning is around five years, but in many cultures it’s much, much longer. For example, in Japan, it’s not at all unusual for a company to have a 50 year or even sometimes a hundred year strategy.

Clearly this requires high-order thinking that doesn’t facilitate low-level detailed planning, although that has to feed into the execution plan at some point. I just prefer to separate strategy formulation and strategy execution because it avoids any confusion between making strategic choices and the low-level planning tasks because they’re two very different disciplines. The strategies brought to life through tactical and operational plans, both of which seek to narrow the time window to something more achievable. And this lends itself more to the detailed planning process. Remember though that the choices you make at the strategic level have a much bigger impact than those that you make at the operational and tactical level. That’s why getting it right is so much more important. But also, having the latitude to shift in a fast changing environment is also critical. Strategic choices imply high levels of ambiguity and the need to make many assumptions. So one of the mistakes we can make is to ascribe an overly high level of certainty or accuracy to things that are based on very loose assumptions just because they’ve turned up in a strategic plan.

Standing back and looking at this from the highest level, there are only three big strategic choices, and I could even narrow that down to two, I think, but they come from Michael E. Porter, the luminary academic who’s the father of modern strategy. His book entitled, “Competitive Strategy”, released about 40 years ago, is still as relevant today as it was then. The three strategic choices that he outlines are, differentiation, cost leadership, and focus – which is a hybrid strategy – and they aren’t difficult to understand. In differentiation, you have a better product or service than anyone else in the market. Not only that, but you can clearly articulate how and why it’s different, which is a function of marketing. And most importantly, you can capture additional value because of the difference or uniqueness in your product or service. Now that value can come in the form of either greater market share, or higher profit margins, but differentiation implies that what you’re selling is not a commodity.

Now, we do have some cases where clever marketing can be used to overcome this. So since when do you care what type of silicon is used inside your smartphone, for example, yet Intel ran a super clever marketing campaign in the eighties and nineties to differentiate the computers that used their chips. It was the “Intel Inside” campaign that some of you may be well familiar with.

The second generic strategy is cost leadership. In cost leadership, your product is not materially different to everyone else’s, but you’ve worked out how to provide it to the customer at a lower cost. Now this necessarily implies that you will have scale, efficiency and continuous improvement. You need to have some advantage in processes, supply chain, or perhaps you own a privileged asset in order to achieve this. In the electricity sector, for an example, an electron generated is identical regardless of where it comes from – wind, solar, coal, gas, it doesn’t matter. And it’s the most fungible commodity of all. However, CS Energy had a cost advantage through a privileged asset that it owned called the Kogan Creek power station. The low cost nature of the mine and the power station meant that it could produce a megawatt hour of electricity at a lower cost than anyone else in the market, making more money when prices were lower.

The third type of generic strategy is what we call the focus strategy. This is where you take either your differentiated product or service or your lowest cost product or service and you attack a specific market niche. So for example, I may have a software application that I want to differentiate, and then I choose to focus specifically on say, small accounting firms of three to thirty people. In my view, the focus strategy lends itself much more to a differentiation strategy than a low cost strategy because you’re implicitly limiting your opportunity for cost efficiencies that might come through say economies of scale.

I do want to mention a close colleague and friend of mine, Andrew MacDonald, who has very much shaped my thinking on competitive strategy over the years. He took my somewhat academic views and really brought to life the competitive, real-world nature of how to design and execute an effective competitive strategy – particularly looking at the strengths and weaknesses of a company relative to its competitors. And I don’t think this discussion on generic strategies would be complete without tipping my hat to one of Andrew’s key insights: that the best strategy one could possibly have is to own or control a monopoly asset, and then price it in a way that recognises its market scarcity. So in other words, you can charge like a wounded bull because you’re the only game in town. Now these are mainly large scale infrastructure assets, think airports, electricity, distribution networks, water and gas pipeline assets, toll bridges and so forth. And even though these types of industries are normally heavily regulated, it’s still great work if you can get it, right?

Let’s look at a couple of simple tools and frameworks to help you understand strategic analysis. In Andrew MacDonald’s inimitable style, he says there are two key questions you need to ask in strategy. The first question, “Is the market worth winning in?”, and the second question, “If it is, can we win?” This takes into account both the assessment of whether or not the industry and market is sufficiently attractive, and also whether your organisation is in a position to compete with others in that industry or market. Answering these questions requires two fundamental steps. The first is industry analysis, so let’s go back to Michael Porter. Porter devised the “Five forces model of industry attractiveness”. This enables us to assess the attractiveness of any industry or market we might consider entering, or that we might be playing in already. Without getting too heavily into it, here’s the general thrust of the model.

There are five competitive forces that determine whether an industry can be profitable for a business in a sustainable sense. These five forces are, the power of the buyer or the customer, the power of the supplier, the threat of new entrance, the threat of substitutes and competitive rivalry. Let’s have a brief look at each of these. The power of the buyer or the customer. How limited is the market that you’re selling into? Do you have lots of buyers spread across geographical regions, different industries, or do you have just a handful of key customers? See the risk to revenue is much higher with fewer buyers as loss of one or two contracts can drastically affect your cashflow. Good example of this is the supermarket industry in Australia where the two big players, Coles and Woolworths have such a stranglehold on national retail distribution that they manage to hold suppliers of both products and services down to very skinny margins.

When you’re dealing with these two behemoths, with you’re selling organic hand wash or running the freight trucking company that delivers it, their power ensures that you can never take super profits. The second force is the power of the supplier. Now this is the same deal as the power of the buyer, but on the other end of the equation. For example, in commercial airline manufacturing, US owned Boeing and European owned Airbus have huge power over the airline industry, ensuring for the most part that the super profits aren’t shared by the customers that buy their planes. So in the same value chain, aircraft manufacturers can do very, very well, while airlines are an incredibly tough business to run.

The third force is the threat of new entrance. How easy is it for new players to enter and of course to exit the market. For example, in the consulting industry, anyone over the age of 18 can set up shop easily at almost no cost. But even though the barriers to entry are super low, I’m assuming that threat doesn’t bother McKinsey and company too much. In contrast to this, industries with high capital requirements such as telecommunications infrastructure have high barriers to entry and this favours the incumbents.

The fourth power is the threat of substitutes. What can be used instead of your product? And there’s a classic strategy insight from Clay Christensen in his, “Jobs to be done theory of innovation”. If you want to increase the sale of thick shakes at McDonald’s for example, making it a better thick shake than a Burger King thick shake is not going to cut it, because you aren’t just competing with other thick shakes. You’re actually competing against substitutes for the same job and that job is filling you up and keep you entertained on your commute to work. So this set of competing products includes bagels, bananas, and muesli bars and so forth.

The last of the five forces is competitive rivalry. Now try operating in a monopoly. Competitive rivalry is non-existent and this is bad for the customer, but it’s good for the asset owner. But limited markets where duopolies or oligopolies exist need to be overseen by regulator as they lend themselves to market failure, there’s just not enough competition there. More firms mean more competition for profits. So think of retail clothing and accessories and the impact of online retailers in the last many years. Alternatively, look at the super profits where competitive rivalry is low and the companies have what we call privileged assets. Going through that process is critical to understand what type of industry you’re in, and how likely it is that you can make profits over and above a desired return on invested capital.

So after you’ve had a look at industry attractiveness using that model – and that’s the first question, is the market worth winning in – we come to question two, can we win? So that second step is all about thinking about whether you can compete in this attractive market, assuming that you’ve chosen one. It’s really useful to ask a series of questions here. What makes me uniquely different from my competitors? And regardless of whether or not you’ve chosen a low cost, a differentiation or a focus strategy, this is still something that you have to be able to answer clearly. What unique resources do I have that enable me to compete? Do I have any unique physical assets, any financial assets that are better than my competitors? Do I have any organisational assets like better processes or better culture? What is it and what are the grounds on which I’m better able to compete in my market?

And once you’ve worked that out, how do you articulate and sell the differences that you have in the market? Now remember, if we’re using a differentiation strategy and we think we have a benefit to offer the customer, always remember this: if we can’t articulate it and if we can’t price it, then it doesn’t exist. So what do you have that your competitors don’t? And forget things like, we have the best people. You don’t. You have the same level of average employee as your competitors. When you go through this exercise, just remember you will tend to overestimate your unique competitive advantages and you’ll tend to underestimate your competitors. Be brutal, and look at the data, and don’t believe your own bullshit. When devising strategy, it would serve us to remember two really important things. The first is that even though strategy is about trying to create competitive advantages, we also need to realise that competitive advantages are fleeting.

Most firms that outperform their peers reverted to the mean within two to seven years. Why? Because if they’re highly profitable, they become targets for their competitors, who become more creative in order to attack. And it might just be the case that incumbency leads organisations to become a little more complacent. The second thing to bear in mind is that different competitive advantages have different lifespans. For example, if you can get an advantage in pricing by applying discounts to your products, your competitors can catch up to you within about 60 days. If on the other hand, you can manage to get an advantage in people, culture and organisational processes, it can take your competitors over seven years to bridge that gap. Not all advantages are equal.

All of this is fun and interesting, but let’s finish off by looking at how you can use strategy to help you better with your business judgement and your decision making. I’ve turned these six tips into a free downloadable you can pick up from our website, it’s www.yourceomentor.com/episode85. Number one, first things first, focus on the money. Are the strategic choices you’re making, adding to the profitability of the company? Are you buying businesses to keep market share or grow even though that business might be unprofitable? Are you focusing on going after the most profitable customers and letting the less profitable customers be served by your competitors?

Number two, it’s important that you know why your customers buy from you or why they don’t. As Peter Drucker once said, customers rarely buy what companies think they’re selling. In other words, the reasons for buying are often very different from what we might think. Showing that analysis of our competitive advantage can quite often be misguided. This can get a little complex, but should be at the forefront of our thinking.

Number three a core realisation is that strategy doesn’t happen in a vacuum. It’s a live playing field with economies, markets, customers, regulators and competitors all moving all of the time, so you need to treat it as such. Too many companies only deal with strategy in the annual board strategic planning session forgetting about it for the rest of the year. No wonder we see so many companies blindsided by their competitors with very simple strategic moves.

Number four, understand your positioning against your competitors. Not just your obvious competitors either. Many years ago, Southwest airlines in the US disrupted the industry, not just by competing against other airlines, but by running low cost services to less popular destinations, when their competitors were all working on a hub and spoke model of efficiency. They captured huge market share from ground transportation – so think Greyhound buses. It’s not just those competing on traditional dimensions, but also those thinking about substituting what you do for other products and services. Once again, link this back to what your customers value.

Number five strategies should be constructed at a sufficiently high level that you can make decisions and manoeuvre effectively as the environment shifts, without changing the base level of the strategy itself. If you’ve devised a five year strategy and then you find yourself having to change it every six months, there’s something fundamentally wrong with that. Execution of a strategy is a different thing, of course. Tactical planning, which addresses the two to three year time horizon enables much more tangible objectives. So for example, mergers and acquisitions during that time. Operational planning can give a really solid plan for the current period, whether it’s a year, a quarter or so forth.

Number six, get as much data as you can lay your hands on to support your decisions. As Edwin R. Fisher once said, “In God we trust, all others must provide data.” Historical data is often useful and so is the modelling scenario planning and good judgement to cast forward to what might happen. Not everyone can afford an intensive high quality market intelligence unit in their organisation – I had the benefit of one of those when I was at Aurizon. But in smaller businesses you should be able to access secondary research data. This is the research that’s not carried out specifically for you or your context, but it’s often generic research commissioned by government or maybe an independent think tank on a selected market or region. To finish off strategy isn’t hard, but it is about asking good, simple questions that enabled you to make choices in how you deploy your organisation’s resources.

The objective of strategic planning is not to come up with a 55 slide PowerPoint deck that you can mesmerise stakeholders with, it’s to go through the thought and discovery process that ultimately enables you to win in your market. As president Eisenhower said once, “Plans are useless, but planning is indispensable.”

Alright, so that brings us to the end of Episode #85 thanks so much for joining us and remember at Your CEO Mentor, our purpose is to improve the quality of leaders globally. So please take a few minutes to rate and review the podcast, as this enables us to reach even more leaders. I look forward to next week’s episode, “The silver lining on the pandemic cloud”. Until then, I know you’ll take every opportunity you can to be a No Bullsh!t Leader.