Thursday, October 31, 2019

What is Strategy?

"I may be wrong, but at least I am not confused."

Jeff Miller, former CEO of Documentum, repeats this point whenever he has a chance. He strikes a chord. A leader, above all, must point the way. Better to be pointed the wrong way than to be left aimless. After all, clearly going the wrong way, your error will eventually become evident. Aimlessness is probably wrong too, but is harder to correct. If leadership is anything, it is about pointing the way.

But pointing the way is difficult. Organizations face conflicting demands: marketing reports on a new competitor with a dramatically different product; R&D has created a breakthrough technology, but it is behind schedule and needs more funding; legal compliance is at odds with the company's China country head, whose "entrepreneurial" actions are ramping up sales there. Leadership can seem so simple when portrayed as pointing to the top of a hill. In practice, leadership is about deciding amid sharply conflicting priorities. For that you need a strategy.

"Bill says you need a strategy." Obvious. But you would be surprised at how many companies I see that do not have direction. The problem? Let's call it strategy neglect. Meaningful strategy gives direction; you know you suffer from strategy neglect when people in your organization don't know how to resolve conflicting priorities. I'm not talking grand mission statements about changing the world, nor lengthy strategic plans packed with detail. I'm talking about strategy: the logic that explains why we might win.

And to be useful, your strategy’s logic must be specific enough to guide action. This means that a useful strategy includes a working definition of the company's goal, what it does, and how it does it - a logic that a rank-and-file employee can put into action. Maybe I finish my project a day late because our strategy is about completing work to perfection. Or maybe I cut some corners to be on time because we're about time-to-market. Whatever the strategy, it needs to be alive in the day-to-day actions of employees. Otherwise, as in so many companies, we are left confused.

Strategies Emerge

Of course, you not only want your strategy to be logical, but you want your logic to be sound. Logics can be wrong when they are based on assumptions that turn out to be wrong. So it is that often strategies change because we question, and then correct, the underlying assumptions behind our strategy. This kind of strategic change is sometimes called "emergence."

For example, today NetApp is known as a well-established player in the data services space, pulling in revenue in the billions of dollars annually and running complex hybrid cloud services for the world’s largest companies. But when it started in the 1990s, the company’s strategy targeted small firms with simple low-cost file servers. This strategy was based on the assumption that only small firms, which lack IT infrastructure, would value the simplicity of NetApp file servers. That strategy failed, but in the process leadership noticed that large companies loved their file servers – unexpectedly for the dramatic increase in data speed these servers offered. Taking advantage of this discovery, the company pivoted to target large firms – as Tom Mendoza and his team built out a direct sales force and an organization to support it. In this way, we often see winning strategies emerge as, with experience, we revise the assumptions on which they are based.

Since winning strategies need to be based on correct assumptions, all strategies are a work in progress - because the world keeps changing. Moreover, companies are also learning every day about what they are capable of, in much the same way that a person learns about her strengths by trial and error. Remarkably, research tracking companies over time shows that many of the world’s greatest organizations discovered their strategies, winning for reasons they did not understand initially.

Take, for instance, the fintech powerhouse Alipay. Today it has over half a billion users, continues to grow, and is extremely profitable. Yet the service was created originally back in 2004 to help the then-new Taobao C-to-C ecommerce platform compete with eBay. Neither Taobao nor Alipay was initially intended to be money makers. Rather, they were meant to deter eBay from growing as a competitor to Alibaba. Yet by banking the unbanked, and enabling those without other credit options to enter the ecommerce world, Alipay discovered an entirely new and hugely profitable strategy. Today, leadership at Alipay is entirely clear on their strategy - even though the logic of that strategy emerged through experience.

So it is that strategy emerges from experience. Leaders play an important role in this process, because they help their people understand what is happening to the company. As Steve Jobs put it during his commencement address at Stanford in 2005: “You can’t connect the dots looking forward; you can only connect them looking backwards.” Because strategies emerge, one of the primary responsibilities of leadership is to make sense out of why their firm wins. That "sense-making", when formalized and explicitly stated, is strategy.

Creating and Capturing Value

I've talked about winning, but business leaders often succeed at their strategy only to end up losing money. The problem is that a business can produce a valuable product or service, only to find that some other business gets to keep that value. For instance, one of the most hard-working entrepreneurs I know runs a vending machine company here in Silicon Valley, devoting endless hours to keeping the machines stocked and well functioning. But every time his revenues increase, his host clients increase his rents - the fees he pays to have his machines on good properties. So although he creates a great deal of value, this entrepreneur keeps very little of it. Winning in business requires that we both create and capture value.

Effective strategies constantly grapple with the need to both create and capture value. For example, the video entertainment industry has recently seen tremendous changes, with viewership moving from traditional television broadcasters to online and streaming services. How do we understand the various strategies emerging in this context? Why is Netflix, a streaming service, spending so much on original content creation? Why is Disney, the storied king of content creation, now moving aggressively into direct-to-consumer streaming?

The answer, in both cases, comes down to creating and capturing value. Video production studios create value when they produce content that people really want to watch, like the comedy series Seinfeld produced by Warner Brothers. Video distribution services, such as Netflix, also create value when they enable consumers to conveniently view such content. Taken together, the content producers and distribution services create and deliver entertainment - the "value" that the consumers are willing to pay for.

But who gets to keep that value? Consumers pay Netflix billions of dollars in revenue every year, but Netflix, in turn, pays billions of dollars in license fees to the studios that create much of the content that they distribute. Netflix does get to capture some of the value, but the studios that produce content also capture a great deal of that value.

The struggle to both create and capture value has led these companies to change their strategies. If Netflix can produce original content, it will reduce the amount of value it pays out to the studios; that is, it will capture more value. If Disney can stream its content directly to consumers, it will reduce the amount of value it leaves with distribution services like Netflix; it will capture more value. Companies in this industry today are following a strategic logic that includes both the production and distribution of content, in the hope that they can create and capture the most value possible.

But there is a catch: Value is created only if the costs of doing so are less than the amount consumers are willing to pay. Netflix is paying a great deal to create original content. Some pundits speculate that they may not recoup their investment. Similarly, Disney is paying a great deal to create a direct-to-consumer streaming service. Each of these companies is following a strategic logic - one built on the assumption that it can create value greater than the costs involved. Whether this assumption turns out to be correct, only time will tell. No matter how this particular example works out in the end, the lesson is clear: A winning strategy lays out the logic of how a company will both create and capture value.

What About Planning?

If strategies emerge, then what about planning? After all, If you say “strategy” to most people, they will think of the annual “strategic planning” (budget-and-goal) process at their place of work. Even though strategies emerge from experience, we must of course plan because we must create budgets and goals to guide action over the year to come. But that budget-and-goal process, in and of itself, is not strategy, since such planning can and often does take place without any guiding logic.

The best example of planning without logic is historical: The Soviet Union. Business school professors miss the Soviet Union. The nemesis of old used to provide us with a stream of cautionary tales.

Take nails, for instance. Socialist economist Alec Nove wrote of this example: In an effort to increase the production of nails, the Soviet planning authorities created production incentives based on numbers of nails produced. In response, the Soviets enjoyed the following year a plentiful supply of many many very small nails. 

To correct the problem, the authorities cleverly switched to incentives based on weight, and the producers responded by manufacturing very large nails. The travesty was parodied in this cartoon from the satirical magazine Krokodil. Ah yes, better to use the market. But the real lesson of the Soviet experiment is about planning: Unless it is guided by a strategic logic, planning doesn't work.

Corporations must and do plan, of course. Their leaders often call these plans "strategic" to give them gravitas. But typically strategic plans are just budgets and goals. Budgets and goals are important, but they are not "strategy" if by strategy we mean the logic that drives action.

For planning to be strategic, it needs to be guided by a clear logic that links the actions of people throughout the organization to the success of the firm. In this way, planning is a way to go from sense-making - "connecting the dots" - to giving direction. Planning guided by strategy builds on what we have learned about our organization's successes and failures, turning those lessons into guidance for future action.