What Makes a Strategy Great?

Many firms develop business strategies. Some are effective, some are less so. Leaving aside the issue of quality of execution, what distinguishes an effective strategy from an ineffective one?

Competitive strategy is about creating a deliberate plan of action that will create a competitive advantage, and compound it over time. Effective strategies are borne out of a deep understanding of the competitive environment in which a firm is operating, including its industry and market structure, its competitors, products and services, threats and opportunities, and internal strengths and weaknesses. Great strategies also have the following four distinguishing characteristics:

  1. The strategy identifies the markets in which it can work. Many strategies fail because there is an insufficient number of customer who find the value being offered under the strategy meaningful.No matter how good the strategy on paper, if it cannot create a sufficient mass of customers, it will ultimately fail.
  2. The strategy is differentiated from competitors’ strategies. Great strategies define distinctive ways to play in the market that cannot be easily copied or replicated by competitors.
  3. The strategy is supported by capabilities. Capabilities are the bundles of processes, skills, competencies, tools and organization that give a strategy its legs. Distinctive capabilities make great strategies.
  4. The strategy considers risk. Every strategy involves risk – strategies are not immune to changes in the economy, competitive landscape, technologies, etc. Great strategies consider the inherent risks, explore “what if” scenarios, and include contingencies in case things change.

Finally, execution is, of course, critical. No matter how great a strategy, if it cannot be successfully executed, it is worthless!

On Differentiation

Differentiation rests on uniquely creating customer value. The economic rationale for differentiating is that the value perceived by the buyer must exceed the costs of differentiation. A differentiation strategy aims to create the widest possible gap between the unique value created for the customer and the cost of providing that uniqueness through the firm’s value chain. Put another way, a firm pursuing a differentiation strategy may have a higher average cost of production curve, but its pricing is also higher as it the unique value being offered can command a price premium.

There are two possible routes to differentiation. A firm may differentiate by performing its existing value chain activities in a unique way, or it may reconfigure its value chain in a way which creates uniqueness.

The first route requires that a firm first identify the drivers of uniqueness and then find ways to execute these in an inimitable way. The second route requires a firm to choose the configuration of value chain activities that create diistinctive value for the customer. In either case, the gap between the customer value created and the cost of differentiation must be as wide as possible.

Practically, differentiation arises out of identifying the set of capabilities that a firm must possess in order to build and deliver customer value. Capabilities are not assets. Rather, a capability is a way to ensure a desired customer outcome. A capability is a combination of processes, skills and competencies, tools, and organization that works together to achieve a desired result. A firm’s set of capabilities must support its overall corporate strategy by defining the things that the firm must excel at to create and keep customers. Differentiation can be achieved by establishing unique capabilities which create superior value outcomes for customers.

Too many firms get into the details of improving their value chains without first taking time to define and formulate their startegy for competing effectively through value creation. The strategy should define the capabilities required, which in turn help define the value chain configuration. Improving your existing value chain outwith the context of strategy and capabilities assumes that your value chain is creating and delivering unique value for customers – an assumption that may not be true.

Competing through a cost advantage is really a form of differentiation, although a special one. A cost advantage competitor achieves the lowest cost structure in their industry and is able to offer pricing which is lower than the competition. While cost advantage can be enabled through economies of scale in some industries, it is more common to achieve it through reconfiguration of capabilities and the value chain.

Differentiation is critical for superior performance. If a firm cannot build unique value for customers, the only thing it can alter is pricing. Put another way, if you are not different, you had better be cheap!

In the Beginning Was Marketing

The biggest single gap in the business system of firms we see today is the lack of a mature marketing process or function. In the absence of a marketing function, or one which is only minimally present, a firm is flying blind – it does not know the marketplace and its needs, either now or in the future.

Despite this glaring gap in their systems, many firms pursue improvement as if this gap did not exist – they focus on improving operational processes, usually to drive costs down, or achieve better performance in some critical-to-customer-satisfaction dimension such as delivery performance or quality. The focus of these firms is on doing what they already do, better.

Yet, doing things better is only half the story. If those things are not the right things, then making them better is only a partial answer at best.

In the absence of a marketing function, it is hard for a firm to know what the right things are. What is the unique value that is needed by the marketplace, both now and in the future, and what are the capabilities and processes that are needed to supply this differentiated value? These are the key questions that only a mature marketing function can answer. Marketing is a business development process, not an operational one, and as such is the key process in the business which creates customers.

Differentiation is a strategic concept, not a tactical one. Differentiation implies that a firm will do things that are uniquely different from other competitors. Only marketing can supply the answers to what the sources of a firm’s uniqueness will be.

To differentiate effectively, a firm must innovate. This is implied in the definition of “differentiation” – if something is uniquely different, then it has not been done before, by any competitor. Innovation drives differentiation. Firms that have no capacity or capability to innovate are not likely to successfully differentiate themselves.

Marketing is the necessary precursor to innovation. It is marketing that guides innovation and ensures its accuracy, whether it be innovation of products and services, or innovation of capabilities and processes. A firm which lacks a mature marketing function is incapable of innovating accurately.

Closing the gap of a missing or immature marketing process is not just a question of adding resources. It is a question of risk mitigation. Supplying missing resources is only one way to close a system gap. Every firm that has a missing or immature marketing process must address how they will mitigate to their business by not having this key function effectively present.

A Simple Improvement Cycle: Standardize, Control and Improve

Improving business processes first requires that they be standardized. Many firms omit this critical step and move directly to improving their processes without first establishing any standardized baseline from which to drive improvement. Standardizing is essential for two reasons: first, unless you improve from a known standard, you cannot know if any change is an improvement; and secondly, if there is no known standard, the process is likely chaotic and not amenable to improvement.

In our process improvement work with client firms, we advocate and teach a simple three-step cycle consisting of Standardize-Control-Improve. Let’s look at the steps of this cycle.

Standardizing involves defining the process as it is executed, right now. That means defining the process inputs and outputs, the resources used, the work methods and procedures employed (including tasks and times), and the measurements of process performance. The process does not need to be executed perfectly – after all, that’s why you are improving it – but it does need to be standardized.

Once a process is standardized, it should be assessed for the state of Control which it exhibits. The Control phase means several things. Firstly, it means determining the stability and predictability of the process. This can be done by measuring with appropriate techniques the amount of variation inherent in the process and determining how much of that variation is special cause variation. Special cause variation is variation for which there is an assignable cause and is distinct from the variation which represents the normal “noise” of the process. In the Control phase, we look to identify the special cause variation and use root cause analysis to identify its causes. Once the causes are known, countermeasures against the causes can be developed to improve the process.

Secondly, Control means determining if improvements introduced into a process have in fact reduced or eliminated the problems they were designed to address. After improvements have been introduced within a process, the process should be re-standardized and then reassessed to see if it remains in a state of Control.

Improvement is that phase where process improvements are designed and implemented to attack the causes of a lack of Control. The Control and Improvement phases represent experiments where hypothesize about the causes of process problems and develop solutions for implementation and testing. If the hypothesis is disproven (i.e., the implemented solutions do not address the postulated cause), we must go back and re-analyze the cause of the problem.

Many firms are using Six Sigma which advocates a five step process for improvement known as Define-Measure-Analyze-Improve-Contol (DMAIC). In our practical work, we find the three-step cycle of Standardize-Control-Improve to be much easier to learn for most firms, and certainly much easier to apply. The key thing to remember, though, is that the whole cycle starts with Standardize.

Expansionary Austerity: A Myth for Both Countries and Firms

Just a follow-up to my last post. Firms that engage in wanton cost cutting are falling into the same trap as the advocates of the notion that cutting spending in a macro economy will fuel growth.

In a macro economy such as Canada’s, where government spending accounts for about 20% of nominal GDP, cutting government spending signficantly can only have one result: contraction of the economy due to less expenditure and its subsequent shifting of the demand curve.

In a micro economy, such as that of a firm, the same logic applies. Cut costs too deeply and business performance becomes seriously impaired. This comes about because, in the fixation to temporarily boost profit levels, the organization cannot the make the investments it needs to sustain and grow revenues, which are its lifeblood. In addition, indiscriminate cost-cutting reduces or eliminates vital resources which are essential for serving customers. This depresses customer satisfaction and retention, leading to a loss of market share and sales volume.

Expansionary austerity – the notion that you can grow by reducing spending and costs – is a myth. There is no evidence for its success and it violates principles that any student of macro 101 would know. Wash, rinse and repeat if you are thinking of trying it in your firm.

The Economics of Improvement: Creating and Keeping Customers

I wrote earlier this month in Quality Digest about the economics of Lean-based improvement – the fact that Lean lower’s a firm’s average cost of production, thereby allowing it to reduce its cost structure and drive greater profitability.

What I also mentioned in that article was that for firms operating in imperfect competition, there is a profit maximization point where marginal revenue equals marginal cost. Firms should strive to maximize their profits by producing an output quantity where this occurs.

Firms that are price takers in the marketplace – those that have little or no market power to set or influence prices – must accept the market price as given and choose an ouptut quantity which maximizes profitability. In contrast, firms that are price setters – those can set and influence market prices – can choose the market price they wish to charge and then set output quantities where marginal revenues equal marginal costs.

Too much improvement effort is focused on cost reduction. This requires a firm to have a mindset focused on gaining efficiencies in production by eliminating non-value adding activity. The problem with a cost-reduction only approach is that it always has a threshold beyond which it not possible to go further before a firm seriously impairs its viability as a going concern. In addition, many firms talk a good talk, but refuse to make difficult decisions when it becomes apparent that their single largest cost is usually labour and that improvement initiatives have resulted in an over-supply of labour within the firm which cannot be reassigned or absorbed in other ways.

Of course, cost reduction is important but so, too, is revenue generation. Improving revenues requires a different mindset. It requires a firm to ask itself how it is going to create and keep customers. For many firms this is more difficult question to answer than going down the cost reduction route. However, if that question cannot be answered, the firm is likely to die a slow death, no matter how successful cost reduction initiatives are.

What is needed is a balanced approach. In my estimation it is better to focus first on understanding deeply what value must be provided to create and keep customers, and then to set about designing and improving the business system to create and deliver that value. Then, at the same time, focus on reducing or eliminating the costs that are not directly related to providing that value. A value-first approach makes so much more sense than mindlessly cutting costs and forces a firm to think about how it will sustain itself by creating and keeping customers.

The System Includes the Customer

As a follow on to my last blog post about defining and stabilizing processes, I always find it interesting that firms oftentimes do not include the customer when defining their business systems. Customers are the lens through which processes should be viewed. If you do not adopt a customer-centric perspective when defining processes, then it becomes that much harder to rationalize why business processes should be improved.

There are many methods available for defining and visualizing processes – value stream maps, process maps, and the like. The approach that myself and colleague Angelo Lyall prefer, though, is to help a firm build a simple model of what we call its Customer Oriented Processes (or COPS for short). A customer oriented process is a process which faces out towards, and interacts with, an external customer. This external customer may be the person who buys the firm’s final products and services, but it may also include other customers, real or potential, of a firm: persons who require marketing and sales information or support; persons who require designs, quotes or estimates; persons who require product support and warranty service; suppliers with whom the firms receives input materials; transportation and logistics firms who deliver the product; etc.

Viewed this way, an organization might find that it can define a set of key business processes that interact with, and serve, external customers. The connections and interactions between these processes can then be defined and a detailed process model built up where each COP is exploded out into its constituent elements, including customer requirements, inputs and outputs, resources, work methods and procedures, etc. Managing and improving these core business processes then becomes the objective of process management within the organization.

The benefit of this approach is that it is a customer-first way to look at an organization’s business system. Customer value for each COP can be defined and then each COP can be managed and improved in a way that maximizes value creation and delivery to the customer. It also recognizes that a firm has not just one customer, but many. This enhances an organization’s ability to create and deliver value to all types of customers, not just those who buy final products and services.